**UNITED STATESSECURITIES AND EXCHANGE COMMISSIONWashington, D.C. 20549**

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FORM 10-K

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

 

**Forthe fiscal year ended December 31, 2003**

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

 

**Forthe transition period from               to               **

**Commissionfile number 0-21421**

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

 

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

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

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

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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 Noo

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 $2.40 per share on June 30, 2003, onthe Nasdaq SmallCap Market System was approximately $6,834,266 as of such date.Shares of Common Stock held by each executive officer and director and by eachperson who owns 10% or more of the outstanding Common Stock have been excludedin that such persons may be deemed to be affiliates. This determination ofaffiliate status may not be conclusive for other purposes.

Asof March 25, 2004, the registrant had outstanding 6,203,028 shares ofCommon Stock.

**DOCUMENTS INCORPORATED BYREFERENCE**

Portionsof the Company’s Proxy Statement for the 2004 Annual Meeting of Stockholdersare incorporated herein by reference into Part III.

 

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**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. Actualevents or results could differ materially from those currently anticipated dueto a number of factors, including those set forth herein and in VCampus’ otherSEC filings, and including, in particular: continuing losses and negativeoperating 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**

**Item1. BUSINESS**

VCampus Corporation is a provider of outsourced e-learningservices. We manage and host Internet-based learning environments forcorporations, government agencies, institutions of higher education, andassociations. Our services cover a broad range of e-learning programs, fromenrollment and payment to course development and delivery, as well as trackingof students’ progress and reporting of results. VCampus was incorporated inVirginia in July 1984 and reincorporated in Delaware in March 1985.

We have incurred significant losses since ourinception in 1984, including net losses attributable to common stockholders of$6.6 million, $7.1 million and $6.2 million for the years ended December 31,2001, 2002 and 2003. As of December 31, 2003, we had an accumulateddeficit of $90.4 million. We expect losses from operations to continue untilour online revenue stream matures.

Our goal is to be the leading service provider ofintegrated e-learning services by helping customers improve their performanceand achieve their goals. Through our proprietary software we provide customerswith comprehensive services on an outsourced, or hosted, basis. We believe thatour outsourced hosting approach to web-based e-learning services providessignificant business advantages to our customers. Our primary target marketsare the government, corporate training and higher education distance learningmarkets. As a result of the significant reduction in revenues and marketcapitalizations of many companies in the telecommunications market over thepast few years (i.e., the Dow Jones U.S. Telecommunications Market Index lost64% of its value between February 2000 and December 2002), weexperienced high customer turnover due to heavy exposure to telecommunicationscustomers who either went out of business or eliminated or serious curtailedtheir e-learning spending. In 2002 and 2003, our online tuition revenues werebalanced fairly equally among the government, corporate training and highereducation distance learning segments.

Our primary marketing goals are to identify andattract organizations that offer large potential relationships with VCampus. Weare targeting industries and organizations that require mandatory training,reach a large potential audience and can be well served by our e-learningservices. Primary market segments targeted by us include the federalgovernment, the healthcare, insurance, financial services/banking,pharmaceuticals and manufacturing industries, and institutes of highereducation offering extensive adult distance learning.

We currently offer approximately 5,400 online courses.To date we have delivered more than 2.8 million courses to more than835,000 desktops/users.

We believe ourmarket strengths to be:

·       arapid, non-time-consuming implementation, achieved in a matter of days;

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·       minimalupfront investment required for the service;

·       ready-to-golibrary of approximately 5,400 online courses;

·       consistentdelivery of high-quality courseware;

·       provensystem performance and scalability;

·       deliveryof content from virtually any source; 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:

***Diverse customerlist.******  ***We have adiverse set of customers, including relationships with VCampus that haveextended for as many as six years. Our customer base is noteworthy forrepresenting a wide range of sectors, including corporations, governmentagencies, institutes of higher education, professional associations and retail-orientedtraining sites.

***Diversifiedbusiness base.******  ***We servecustomers from a wide variety of market sectors—including corporations,associations, government agencies, and institutes of higher education. As such,we are able to provide our customers with a unique ability to participate incommunities of learning. The VCampus platform enables our customers to sharecontent, thereby creating cross-sale opportunities from customer to customer.Several of our customers successfully sell their content to other VCampuscustomers simply by offering their content on the advanced VCampus platform.

***Open technology.******  ***Ourtechnology affords customers a number of advantages in terms of its ability torapidly and cost-effectively implement a comprehensive and secure e-learningand training environment. Our content-neutral, open architecture platformallows for access to a wide range of aggregated content and the ability toquickly add new functionality, leverage new technology and to support a vastnumber of users. Our web services capabilities enable customers to easilyintegrate our technology with other existing systems (including enterpriseresource planning systems and human resource information systems).

***Expansive libraryof content aggregated from leading sources.******  ***Ourexisting content library, marketed as ContentMattersTM, includes approximately 4,500publicly-available online courses from more than 40 publishers, includingSkillSoft, Infosource, American Media, Vital Learning and Crisp Learning(Course Technology). We also have agreements to distribute some courseware thathas been developed by our customers, such as the New York Institute of Finance,to other VCampus customers. Our wholly-owned library oftelecommunications and desktop publishing courses are marketed under theTeletutor and VCampus brand names.

***Extensiveexperience.******  ***We havedelivered over 2.8 million courses over the past eight years to more than835,000 desktops/users. We have operated in the e-learning space for more thaneight years. We maintain solid, long-term relationships with establishedcustomers and benefit from a highly experienced and knowledgeable managementteam.

***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.

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***Comprehensive Services.******  ***Weoffer a completely hosted system, accessible by virtually any web browser. Ourofferings include a leading edge Learning Management System, Course ManagementSystem, Course Construction SetTM and Courseware Delivery Engine. The technologyand service have been proven and tested through successful implementations forscores of customers, where thousands of students have experienced VCampus-basede-Learning for up to seven years. We have introduced technology  that provides additional features for ourcustomers.

**CompanyStrategy**

Our goal is to be theleading service provider of integrated e-learning services by helping customersimprove their performance and achieve their goals. Our strategies to achievethis objective include continuing to: focus on high-revenue opportunities,develop strategic relationships, develop strategic content, provide superiorcustomer service, and develop new and upgrade existing technologies. Ourstrategy also includes increasing revenue from each customer by converting moreof each customer’s proprietary content to online distribution through theVCampus platform. We also intend to grow the cross-selling of contentbetween various customers. The intended result is increased penetration andenhanced customer loyalty.

*Focus on High-RevenueOpportunities*

We are focused on finding and developing newopportunities for significant revenue based on three factors. We seek salesopportunities in which: 1. training is for a *largeaudience* (e.g., employee base of government institution or corporationor students of distance education school); 2. training is *required* (e.g., mandatory for employees,required certification, academic degree); *and*3. training is *paid for by a third party*,not by the student (e.g., paid directly by employer or through tuitionassistance programs).

We believe that one of thehighest-growth segments of the e-learning market is the service of onlinedistance education programs for institutions of higher education. We recentlyintroduced new proprietary technology designed to significantly improve ourability to compete in this target market. Additionally, we are working todevelop significant new customer relationships with institutions of highereducation offering significant distance learning programs online.

*Develop StrategicRelationships*

Based on success with pastand current relationships with several customers, we target organizations thatprovide the opportunity for mutual benefit from a multi-facetedrelationship through our Select Partner program. Typically, target SelectPartners provide classroom-based training to a wide audience but have notyet incorporated online training into their training model. We enable theseorganizations to add online learning quickly, efficiently and inexpensively.Collaboration opportunities include online delivery of content the customerconverts, conversion and online delivery of courses by VCampus and developmentof courses for online delivery, which would be owned, at least partially, byus. We have signed several Select Partner agreements in the past year and planto pursue additional Select Partners meeting the criteria for our program.

*Develop StrategicContent*

We invest in thedevelopment of courses deemed strategic in nature to attract customers withstrong revenue prospects. Typically, these courses are developed incollaboration with a recognized subject matter expert. Content considered forco-development must lend itself a large, reachable audience and offer theaudience a powerful reason to attend the course (e.g., compliance with laws,certification, Continuing Professional Education credits (CPEs) or ContinuingEducation Units (CEUs)). Examples of strategically-developed courses atVCampus include Information Security and several HIPAA (Health 

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InsurancePortability and Accountability Act) courses. Courses so developed may be owned,at least partially, by us.

*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, the team is responsible forcontinuous review of the customer’s content needs, introduction of existing andnew VCampus services, recommendation of suitable additional content,identification of the potential need for custom courseware development,pedagogy and instructional design and the recommendation of platformconfigurations for customer-specific business processes.

*Develop and UpgradeProprietary Technology*

We intend to maintain our position as a leader inonline courseware 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,enabling us to serve a wide range of end users without requiring a largeinvestment on their part. Additionally, our system is a completely outsourced system;no investment in software or hardware is required of customers or students(other than access to the 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, critical to thesuccess of today’s online learning programs, based on a recent IDC survey. ThisCMS release marks the implementation of a new Java-based enterprisearchitecture designed for highly reliable, hosted e-Learning. CMS 5.0 alsoincludes a newly-designed course authoring tool.

Early in 2004,VCampus announced availability of a new Learning Management System (LMS). ThisLMS, which we license from a third-party provider, provides our customers withthe ability to support and manage online, live and blended learning.Capabilities include advanced LMS features, live chat, skills assessment andmultilingual capabilities. The LMS provides learners with convenient access tocourse-specific data, supporting information, and communications functions—inone convenient location on the desktop. The system also includes a personalcalendar, reminder notes and other tools that make learning more efficient. Thesystem is fully customizable and allows VCampus clients to obtain their ownlook, feel and features on a hosted basis. The new LMS integrates with humanresource, enterprise resource planning and customer relationship management andother enterprise systems.

During 2002, we announcedthe Launch of VNexusTM, a next generation platform making us the firste-learning company to launch a fully SOAP-compliant Learning Managementplatform with superior web services capabilities. By standardizing on the SOAPprotocol, VNexus employs XML, a recognized universal standard, to communicatewith an organization’s information technology infrastructure. XML providesinherent flexibility because it can operate across any operating system orplatform, thereby reducing possible barriers to integration. Recognizing thatsome organizations have not standardized on XML, we also offer othercommunication formats with VNexus.

**Products and Services**

We offer a wide range of products and services, themajority of which center around a virtual campus or “vcampus.” The vcampusmimics the functions of a university campus on the Internet—handling student 

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admissions, registrations,course delivery, grading and tracking. Customers are able to choose from ourextensive off-the-shelf library, convert existing courses to an online format,and use courses provided by another vendor, all for use within their vcampus.

Our technology allows customers to use a variety ofcontent on an open, internet-based architecture, on an outsourced hostingbasis. The system displays each customer’s graphical “look and feel.” Webelieve this open architecture makes our hosted technology more flexible thanthat of many of our competitors.

Our vcampus is a centrally-hosted e-Learningdelivery and tracking system accessible by virtually any Internet-readyPC. Students generally enroll in our courses online through a vcampus, but havethe option to enroll in person, by telephone or through the mail. Customersalso have the ability to register students in bulk. Once registered, studentscan access the courseware online, typically through a PC connected to theInternet or through a corporate intranet or extranet. When a student hascompleted the course, he or she will receive credit or certification, ifappropriate. Our technology is a proven system, having served approximately2.8 million courses since introduction.

The vcampus environment is customizable and designedfor ease of administration and access to students, instructors and trainingadministrators. In addition, by using any combination of courses from ourcourseware library and the customer’s own internal training libraries,customers can offer a variety of distance learning options.

The vcampus supports a wide variety of tools andutilities supplied by third parties, such as Netscape Navigator/Communicator,Microsoft Internet Explorer, Macromedia Shockwave and Flash, Real NetworksStreaming, and other browser-based plug-ins. In addition, we havedeveloped the following proprietary software tools that facilitate thefunctionality of the vcampus:

*The Course Management System (CMS) 5.0**—*a newly-designed system for creating, managing andserving e-learning courses on a high volume, highreliability basis. Utilizing a java-based enterprise architecture, the CMS 5.0includes an integrated authoring tool, gradebook, communications tool,assessment tool and discussion tool. All of these elements are designed to worktogether seamlessly. VCampus launched its first live customer on the system in December 2003.We anticipate more new and existing customers will begin using this platformover the coming months.

*Learning Management System**—*Early in 2004,VCampus announced availability of a new Learning Management System (LMS). Weanticipate our first customer will go live on this system in April 2004.This LMS, which we license from a third-party provider, provides our customerswith the ability to support and manage online, live and blended learning.Capabilities include advanced LMS features, live chat, skills assessment andmultilingual capabilities. Learners have convenient access to course-specificdata, supporting information, and communications functions—in one convenientlocation on the desktop. The system also includes a personal calendar, remindernotes and other tools that make learning more efficient. The system is fullycustomizable and allows VCampus clients to obtain their own look, feel andfeatures on a hosted basis. The new LMS integrates with HR, ERP, CRM &other enterprise systems.

*The Courseware Delivery Engine*isa proven system for presenting the total e-learning experience. This productwas designed and built to serve as an integrated, Web-based coursewareconstruction and delivery tool. First delivered in August 1997, we haveused the product to build and deliver our courseware library of more than 5,400online courses as of December 31, 2003. The VCampus Courseware DeliveryEngine provides a simple, easy-to-use environment for instructors and studentscapable of assessing, tracking and testing students as they complete a course.

*The Course Construction Set*isdesigned to be simple to use yet rich in possibilities and performance. Thecourseware developer has access to a complete suite of Web-based toolsnecessary to construct and deliver highly interactive, online courses. The “PointPage”functionality of the product provides a 

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choice of methods for displaying content. The “ActivityStudio” enables non-programmers to construct and include multimedia-rich(animation, sound and student interactivity) activities by answering a fewsimple questions. Courseware developers can also take advantage of the testingsystem, which includes many advanced features such as question randomizationand pooling. Additionally, courseware developers can choose to link selectedtest questions and PointPages to learning objectives, which allows acourseware developer to group content and assess a student’s progress based onperformance.

*The Curriculum Group Manager*allowstraining managers to create an enterprise-wide individualized training programby facilitating the grouping of students with similar education needs andabilities to appropriate groups of courses within a VCampus. The result is aspecific student “Training Plan” designed to guide students to courses thatmatch the student’s ability. Additionally, the Training Plan can evaluate astudent’s performance in each course against standards established for testscores and attendance.

*Batch/Mass Enrollment Tools*facilitatethe enrollment of large groups into the vcampus and/or courses. Organizationswith a large population of students can use this tool to import demographicdata from legacy enterprise resource planning or human resources systems, thusstreamlining the implementation process.

To provide a complete learning experience forcustomers, we also provide threaded discussions (*VDiscussion*), live virtual meetings (*VMeeting*), online surveys (*VSurvey*), platform administrator training,Course Construction Set training, e-Learning consulting on strategy and overallprograms, custom courseware development and integration with other systemsthrough VNexus.

**Existing Courseware Library**

We currently offerapproximately 5,400 courses real-time on our e-learning system. Our 4,500publicly-available courses are marketed under the name ContentMattersTM.Our courseware strategy involves the provision of the following threecomponents: (1) strategically-developed courses from VCampus; (2) COTS,or commercial off-the-shelf, courses from a variety of leading third-partycourse vendors; and (3) custom courseware development for the proprietarytraining needs of our customers.

*Strategically Developed Courses*

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. Content considered forco-development must target a large, reachable audience and offer the audiencesome compelling reason to attend the course (e.g., compliance with laws,certification, CPEs or CEUs). Examples of strategically-developed coursesinclude Information Security and several HIPAA courses. Courses so developedmay be owned, at least partially, by us.

*COTS Library*

From our COTS library, wecurrently offer approximately 4,500 online courses real-time on our e- earningsystem. The current library was built from a combination of acquisitions, ourown development efforts and relationships with leading content providers suchas SkillSoft, Infosource, Vital Learning, Crisp Publications Inc. (CourseTechnology), Aztec Software and American Media Inc. Although we do notprovide accreditation or certification itself, a number of our current coursesprovide either accreditation or certification through our content providers.

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*Custom Library*

Ourexisting custom courseware library includes more than 900 online courses builtby our corporate, higher education and government customers for their ownproprietary use. We believe these courses provide more long-term revenuepotential than commercial off-the-shelf courses, which are beginning to becomecommoditized and might continue to become so over time. We believe the growthof this custom library is evidence of customer satisfaction with our authoringand delivery products.

**Customers**

Our primary target marketsare the government, corporate training and higher education distance learningmarkets. In 2002 and 2003, our online tuition revenues were balanced fairlyequally among the government, corporate training and higher education distancelearning segments. In 2003, three customers, Park University, the U.S.Department of Veterans Affairs and a large insurance company accounted forapproximately 36%, 18% and 15% of our revenues, respectively. We currentlyanticipate 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, inFebruary 2004, Park University notified us that it intends to negotiatewith another vendor to provide e-learning services as of May 2004.Accordingly, we do not expect to continue to derive revenues from ParkUniversity, our largest customer in 2002 and 2003, beyond that point. See “Risksand Uncertainties” beginning on page 9.

**Salesand Marketing**

Our primary marketing goals are to identify andattract organizations that offer large potential relationships with us. We aretargeting industries and organizations that require mandatory training, reach alarge potential audience and are well served by our e-Learning services.Primary markets include the federal government, the healthcare, insurance,financial services/banking, pharmaceuticals and manufacturing industries, andinstitutes of higher education offering extensive adult distance learning.

In addition to directsales efforts, we market our products and services through a variety of means,including the Web, public relations, trade shows, direct mail, tradepublications, customers, resellers and strategic partners. We believe thatforming strategic marketing alliances with parties who will sell, promote andmarket our 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. Thereare no substantial barriers to entry in the online education and trainingmarket. Competition in the developing market for online training and educationis based upon various factors, including quality, breadth and depth of content,pricing, quality, flexibility, reliability of delivery system, marketing andthird party relationships.

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 or in an e-mail-based format. They, andmany other education providers, use some of our methods, including e-mail,bulletin boards, threaded discussion and electronic conferencing, as well asother delivery methods such as satellite communications and audio andvideotapes.

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 

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courses; the ability toproduce customized courses quickly and effectively; and value-addedfeatures that allow flexibility and scalability, thereby maintaining thelearner as the number one proponent. Additionally, successful e-learningservices must be affordable, convenient and easy to use and administer.

Although there is a broad range of approaches to thee-learning marketplace, most can be generally categorized as follows, thoughseveral companies are active in more than one segment:

*ASP Hosted Services:**  *Provideconsolidated access to learning and training from multiple sources byaggregating, hosting and distributing content.

Examples: VCampus, GeoLearning, Saba, SumTotal Systemsand KnowledgePlanet.

*Technology, Software, Learning Management System(LMS):**  *Provide specific software tools andinfrastructure to companies that typically implement technology andapplications behind a corporate firewall. These are usually sold under aone-time, non-annuity license/maintenance model.

Examples: Saba, SumTotal, WBT Systems, Pathlore andPlateau Systems.

*Content:**  *Createthe e-learning courses used to train corporate employees. Content typicallyfalls into one of the three generic categories: information technology, softskills and customized content. Leading content providers often provide supportservices in conjunction with their content.

Examples: SkillSoft, DigitalThink, Element K,ExecuTrain, Learning Tree International and New Horizons.

*Professional Services and Consulting:**  *Provideconsulting, implementation and support services, contract content developmentand distribution.

Examples: Intellinex, DigitalThink and BearingPoint.

Most of our competitors have significantly greaterfinancial, technical and marketing resources than we do. We will requireadditional financing to compete effectively in this evolving market. Inaddition, any of these competitors may be able to respond more quickly than usto new or emerging technologies and to devote greater resources to thedevelopment, promotion and sale of their services. A number of our currentcustomers and partners have also established relationships with some of ourcompetitors, and future customers and partners may establish similarrelationships. In addition, our partners could use information obtained from usto gain an additional competitive advantage over us. Our competitors may haveor may develop products and services that are superior to those of VCampus orthat achieve greater market acceptance than our products and services.

**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. The Company owns registered trademarks in theUnited States for: CoursewareConstruction Set, Pointpage, Content Matters, V (& design),www.VCampus.com, and VCampus. The company has filed intent-to-useapplications for the following:VCampus Your e-Learning Partner, VCampus (& design), Pointpage, GoverlearnVCampus (& design), and Govlearn.

**Employees**

As of March 1, 2004,we had 42 employees, consisting of 13 full-time employees in general businessoperations, 11 full-time employees in sales and marketing, 12 full-timeemployees in product development, 

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and sixfull-time employees in general and administration. None of our employees isrepresented by a union and there have been no work stoppages. We believe thatour employee relations are good.

**Risks and Uncertainties**

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

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.

***We have incurredlosses and anticipate future losses, which could have an adverse impact on yourinvestment.******  ***We have incurred significant lossessince our inception in 1984, including net losses attributable to commonstockholders of $6.6 million, $7.1 million and $6.2 million for theyears ended December 31, 2001, 2002 and 2003. As of December 31,2003, we had an accumulated deficit of $90.4 million, stockholders’ equityof $2.0 million and a working capital deficit of $1.2 million. Weexpect losses from operations to continue until our online revenue streammatures. For these and other reasons, we cannot assure you that we will everoperate profitably, which could have an adverse impact on your investment.

***If we do not havethe resources to meet our business objective, we might not survive or besuccessful.******  ***Our key objective is to be the leadingservice provider of integrated e-learning solutions. Pursuing this objectivemay significantly strain our administrative, operational and financialresources. 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 raise additional capital, as and whenneeded, could prevent us from executing our business strategy and could preventus from maintaining compliance with Nasdaq listing standards.***   If we are not able to generate sufficient cash forongoing operations, we will need to raise additional funds through public orprivate sale of our equity or debt securities or from other sources for thefollowing purposes:

·                    tobuild our core online business;

·                    tofund our operating expenses; and

·                    tomaintain compliance with Nasdaq listing requirements.

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 sufficientfunds could also prevent us from taking advantage of important opportunities orbeing able to respond to competitive conditions. Any of these results couldhave a material adverse effect on our business, financial condition and resultsof operations.

Our need to raise additional funds could also directlyand adversely affect your investment in our common stock in another way. When acompany raises funds by issuing shares of stock, particularly at a discount tothe market price, the percentage ownership of the existing stockholders of thatcompany is reduced, or diluted. If we raise funds in the future by issuingadditional shares of stock (as we have in the past), you may experiencesignificant dilution in the value of your shares. Additionally, certain typesof equity securities that we have issued in the past and may issue in thefuture do have and could have rights, preferences or privileges senior to yourrights as a holder of our common stock.

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***If we fail tomaintain compliance with our Nasdaq SmallCap Market listing, the value andliquidity of your 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 SmallCap Market. If we continue toexperience losses from our operations or if we are unable to raise additionalfunds as needed, we may not be able to maintain compliance with the minimum$2.5 million stockholders’ equity requirement for continued listing on theNasdaq SmallCap Market. At December 31, 2003, our stockholders’ equity was$2.0 million, although it is $5.0 million on a pro forma basis as of December 31,2003 after giving effect to the $5.3 million private placement completed in March 2004..

The Nasdaq SmallCap Market and the NasdaqOver-the-Counter Bulletin Board are significantly less active markets than theNasdaq National Market. You could find it more difficult to dispose of yourshares of our common stock than if our common stock were listed on the NasdaqNational 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, your ability to resell your shares, and theprice at which you could sell your shares, of our common stock could beadversely affected. At December 31, 2003, VCampus had total stockholdersequity of $2.0 million, which did not meet the minimum Nasdaq SmallCapMarket listing requirement of $2.5 million.

If our common stock were delisted from the NasdaqSmallCap Market, it could be more difficult for us to retain existing andobtain new customers. The ability to continue to form new strategicrelationships may be negatively impacted. As a result, delisting could resultin a negative impact on our customer base and revenue, and, consequently, anegative impact on stockholder value.

***The large number ofour shares eligible for future sale could have an adverse impact on the marketprice of our common stock.******  ***A large numberof shares of common stock already outstanding, along with shares issuable uponexercise of options or warrants or conversion convertible notes, is eligiblefor resale, which may adversely affect the market price of our common stock. Asof March 1, 2004, we had 5,190,528 shares of common stock outstanding,another 64,285 shares were issuable upon conversion of convertible notes andanother 2,891,398 shares upon exercise of outstanding warrants and options.Substantially all of the shares subject to outstanding warrants and optionswill, when issued upon exercise, be available for immediate resale in thepublic market pursuant to currently effective registration statements under theSecurities Act of 1933, as amended, or pursuant to Rule 701 or Rule 144promulgated thereunder. Some of the shares that are or will be eligible forfuture sale have been or will be issued at discounts to the market price of ourcommon stock on the date of issuance. In June 2003, we issuedapproximately 3,000,000 shares of common stock and warrants to purchase a totalof 20% of that number in connection with the conversion of all of theoutstanding shares of preferred stock. Resales or the prospect of resales ofthese shares may have an adverse effect on the market price of our commonstock.

In March 2004, we issued 1,012,500 shares ofcommon stock, warrants to purchase a total of 1,875,780 shares of common stockand senior notes convertible into a total of 2,239,034 shares. Resales or theprospect of resales of these shares may have an adverse effect on the marketprice of our common stock.

***Our substantialdependence on third-party relationships could impair our ability toachieve our business objectives and serve our customers.***   We rely on maintaining and developingrelationships with customers, academic and government institutions andbusinesses that provide content for our products and services and withcompanies that provide the Internet and related telecommunications servicesused to distribute our products and services to customers.

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We have relationships with a number of customers,academic institutions and businesses that provide us with course content forour online products and services. Some of the agreements we have entered intowith these content providers limit our use of their course content, some do notcover use of any future course content and most may be terminated by eitherparty upon breach or bankruptcy. Our ASP-based business model is not compatiblewith the business models of certain content providers which may lead them toterminate the future licensing of existing and new course content to us or failto make this content available to us at commercially reasonable rates or termsnecessary for success under our business model. Given our plans to introduceadditional online courses in the future, we will need to license new coursecontent from existing and prospective content providers. However we might notbe able to maintain and modify, if necessary, our existing agreements withcontent providers, or successfully negotiate agreements with prospectivecontent providers. If the fees we pay to acquire or distribute contentincrease, our operating costs and results of operations could be adverselyaffected. We might not be able to license course content at commerciallyreasonable rates or at all.

We have licensed a Learning Management System from athird party provider. We have signed an 18 month agreement. If the providerdoes not perform on the contract, does not continue to upgrade and maintain theLMS, does not renew the agreement with VCampus or in some other way impairs ourability to provide the LMS to our customers, our ability to compete would be adverselyaffected.

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 the customers,academic and government institutions and businesses that provide content forour products and services, the companies that provide the Internet and relatedtelecommunications services used to distribute our products and services tocustomers, and the web-site operators that provide links to our companyweb-sites, we cannot assure you that:

·                    theyregard their relationships with us as important to their own businesses andoperations;

·                    theywill not reassess their commitment to our products or services at any time inthe future;

·                    theywill not develop their own competitive products or services;

·                    theproducts or services by which they provide access or links to our products orservices will achieve market acceptance or commercial success; or

·                    ourrelationships with them will result in successful product or service offeringsor 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.

***We operate in ahighly competitive industry and may not be able to compete effectively.******  ***The market foreducational and training products and services is highly competitive and weexpect that competition will continue to intensify. There are no substantialbarriers to entry into our business, and we expect that established and newentities will enter the market for online educational and training products andservices in the 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 

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customers have demandedupgrades to our technology platform. Our relatively limited capital resourcesmight not afford us a full opportunity to meet these demands. Recently, we havenoticed that some of the more widely available online course offerings,particularly those targeted to the corporate training market, are increasinglycompeting primarily on price, which commoditization drives down margins for allcompetitors in our industry. In competing against us, our strategic partnerscould use information obtained from us to gain an additional competitiveadvantage over us. Our current and potential competitors might develop productsand services that are superior to ours or that achieve greater marketacceptance than 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.

***The loss ofservices of any member of our key personnel could prevent us from adequatelyexecuting on our business strategy.******  ***Our futuresuccess depends on the continued contributions of our key senior managementpersonnel, consisting of Narasimhan Kannan, Chief Executive Officer,Christopher Nelson, Chief Financial Officer, Ron Freedman, Senior VicePresident of Worldwide Sales and Marketing, and Leonard Pearson, Vice Presidentof Business Development, some of whom have worked together for only a shortperiod of time. We do not maintain “key man” life insurance on any of ourexecutive officers. The loss of services of any of our key managementpersonnel, whether through resignation or other causes, or the inability toattract qualified personnel as needed, could prevent us from adequatelyexecuting our business strategy.

***Our results ofoperations have fluctuated significantly from period to period, and a failureto meet the expectations of investors or the financial community at large couldresult 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:

·                    demandfor online education;

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

·                    seasonalityof revenues corresponding to academic calendars;

·                    capitalexpenditures and other costs relating to the expansion of operations;

·                    theintroduction of new products or services by us or our competitors;

·                    themix of the products and services sold and the channels through which thoseproducts and services are sold;

·                    pricingor accounting changes; and

·                    generaleconomic conditions.

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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 believethat period-to-period comparisons of our operating results should not be reliedupon as an indication of future performance. Due to all of the foregoingfactors, it is possible that in some future quarter, our operating results willbe below the expectations of public market analysts and investors. In suchevent, the price of our common stock would likely decline.

***We rely on significant customers, and if we fail tomaintain and develop relationships with such customers, we might not generaterevenues necessary to achieve our business objectives.***   A significant portion of our revenues is 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.

VCampus has been notified that Park University intendsto enter contract negotiations with another vendor to begin providing theire-learning services as of May 2004. This will likely mean that ParkUniversity will terminate its relationship with VCampus as of May 2004 orsoon thereafter. Park University represented 36% of VCampus revenues in 2003and 28% in 2002. In addition to the loss of the revenue from Park University,our ability to compete effectively in the higher education market space couldbe adversely impacted by the loss of this customer.

The GSA (General Services Administration of the UnitedStates) terminated its VCampus contract in April 2003. This terminationdecision was reached to enable GSA to comply with a request from the OPM(Office of Personnel Management) and the OMB (Office of Management and Budget)that GSA consolidate its e-learning with e-learning campus hosted by acompetitor. Revenues from the terminated GSA contract represented 4.5%, 9.8%and less than 1% of our total revenues in 2001, 2002 and 2003, respectively. Asof the date of this report, no other federal government customers of VCampushave indicated that they intend to move their business to this government-approvedcompetitor; however, VCampus could face similar loss of government customersdue to the attempts by OPM and OMB to centralize the federal government’se-learning purchases with this competitor. Consequently, if we fail to maintainand develop relationships with significant customers, we might not be able togenerate revenues necessary to achieve our business objectives.

***System failures andcapacity constraints could interfere with our efforts to attract customers andattain 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 commercially reasonablyterms would reduce the attractiveness of our products and services. We alsodepend on web browsers and Internet service providers for access to theirproducts and services, and users may experience difficulties due to systemfailures unrelated to our systems, products and services.

***If the security ofinformation stored in and transmitted through computer systems of VCampus andits end-users is not adequately secured, we could incur significantliability and potential customers might be deterred from using our products andservices.***   We include in our products certain securityprotocols that operate in conjunction with encryption and authenticationtechnology. Despite these technologies, our products may be vulnerable tobreak-ins and similar disruptive problems caused by online users. Such computerbreak-ins and 

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otherdisruptions would jeopardize the security of information stored in andtransmitted through our computer systems and the computer systems of end-users,which may result in significant liability for us and may also deter potentialcustomers. For example, computer “hackers” could remove or alter portions ofour online courseware. Persistent security problems continue to plague theInternet, the Web and other public and private data networks. Alleviatingproblems caused by third parties may require us to make significantexpenditures of capital and other resources and may cause interruptions, delaysor cessation of service to our customers and to us. Moreover, our security andprivacy concerns and those of existing and potential customers, as well asconcerns related to computer viruses, may inhibit the growth of the onlinemarketplace generally, and our customer base and revenues in particular. Weattempt to limit our liability to customers, including liability arising from afailure of the security features contained in our products, through contractualprovisions limiting warranties and disallowing damages in excess of the pricepaid for the products and services purchased. However, these limitations mightnot be enforceable. We maintain liability insurance to protect against theserisks however this insurance may be inadequate or may not apply in certainsituations.

***We might not besuccessful in responding to the changing market for our products and services.******  ***The market forour products and services is evolving in response to recent developmentsrelating to online technology. The market is characterized by evolving industrystandards and customer demands and an increasing number of market entrants whohave introduced 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 releases may contain undetected errors that require significantdesign modifications, resulting in a loss of customer confidence.

***We might not beable to adequately protect our intellectual property rights.******  ***We regard ourcopyrights, trademarks, trade dress, trade secrets and similar intellectualproperty as critical to our success, and we rely upon trademark and copyrightlaw, trade secret protection and confidentiality and/or license agreements withour employees, customers, partners and others to protect our proprietaryrights.

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 release delays,require us to redesign our products or services or require us to enter intoroyalty or licensing agreements, any of which could have a material adverseeffect upon us. These royalty or licensing agreements, if required, may not beavailable on terms acceptable to us or at all. Our means of protecting ourproprietary rights might not be adequate and our competitors mightindependently develop similar technology, duplicate our products or services ordesign around patents or other intellectual property rights we have. Inaddition, distributing our products through online networks makes our softwaremore susceptible than other software to unauthorized copying and use. Forexample, online delivery of our courseware makes it difficult to ensure thatothers comply with contractual restrictions, if any, as to the parties who mayaccess such courseware. If, as a result of changing legal interpretations ofliability for unauthorized use of our software or otherwise, users were tobecome less sensitive to avoiding copyright infringement, we might not be ableto realize the full value of our intellectual property rights.

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***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 the issuesthat these laws and regulations may cover include user privacy, pricing andcharacteristics and quality of products and services. The adoption of any suchlaws or regulations may decrease the growth of the Internet, which could inturn decrease the projected demand for our products and services or increaseour cost of doing business. The applicability to the Internet of existing 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.

***We could issuepreferred stock and take other actions that might discourage third parties fromacquiring us.******  ***Our board of directors has theauthority, without further action by the stockholders, to issue up to10,000,000 shares of preferred stock and to fix the rights, preferences,privileges and restrictions, including voting rights, of such shares. Werecently converted all outstanding shares of our preferred stock into commonstock. The rights of the holders of the common stock will be subject to, andmay be adversely affected by, the rights of the holders of any preferred stockthat we may issue in the future. Issuing preferred stock could have the effectof making 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.

***We might not beable to use net operating loss carryforwards.******  ***As of December 31,2003, we had net operating loss carryforwards for federal income tax purposesof approximately $60.1 million, which will expire at various dates through2023. Our ability to use these net operating loss and credit carryforwards tooffset future tax obligations, if any, may be limited by changes in ownership.Any limitation on the use of net operating loss carryforwards, to the extent itincreases the amount of federal income tax that we must actually pay, may havean adverse impact on our financial condition.

***We do not presently anticipate paying cash dividendson our common stock.******  ***We intend to retain all earnings,if any, for the foreseeable future for funding our business operations.Consequently, we do not anticipate paying any cash dividends on our commonstock for the foreseeable future, which could deter some investors from seekingto acquire our common stock.

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**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 courseware providers

·                    oursubstantial dependence on third-party relationships

·                    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. For a discussion of importantrisks of an investment in our common stock, including factors that could causeactual results to differ materially from results referred to in the forward-lookingstatements, see the “Risk Factors” section of this report. In light of therisks and uncertainties discussed in “Risk Factors” and elsewhere in thisreport, events referred to in forward-looking statements in this reportmight 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 2004 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 

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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 interest of $17,278. In October 2003, we appealed theassessment. In March 2004, we were notified that this appeal remains underreview. We do not have a firm estimate of the probability of liability for thisissue or the amount of anticipated legal costs, but have reason to believe thatthe potential liability will be reduced to the point where it will not beconsidered material. Accordingly, we cannot estimate at this time the amount ofliability to be incurred, if any. No amounts have been accrued in the financialstatements 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 the us and our licensees.

**Item 4. Submission of Matters toa Vote of Security Holders.**

Nomatters were submitted to a vote of security holders during the fourth quarterended December 31, 2003.

**ExecutiveOfficers**

As of March 30,2004, our executive officers were as follows:
| **Name**               | ** ** | ** ** | ** ** | ** **                                                        | **Age** | ** ** | ** ** | **Positions** |
|------------------------|------------|------------|------------|-------------------------------------------------------------------|---------|------------|------------|---------------|
| Nat Kannan             |       | 55         |       | Chief Executive Officer                                           |
| Christopher  L. Nelson |       | 41         |       | Chief Financial  Officer, Chief Information Officer and Secretary |
| Ronald  E. Freedman    |       | 55         |       | Senior Vice President, Worldwide Sales and Marketing              |
| Leonard J. Pearson     |       | 49         |       | Vice  President, Business Development                             |

* *

*Narasimhan“Nat” Kannan** *hasserved as VCampus’ Chairman of the Board of Directors since he founded VCampusin 1994 and he resumed the Chief Executive Officer position in December 2002,a position he formerly held from 1984 to 2000. Prior to founding VCampus, hefounded IMSATT Corporation in 1984 and co-founded Ganesa Group, Inc., adeveloper of interactive graphics and modeling software, in 1981. He alsoserved as a consultant to Booz Allen and Hamilton, Inc., the MITRECorporation, The Ministry of Industry of the French Government, the Brookhavenand Lawrence Livermore National Laboratories, the White House Domestic PolicyCommittee on Energy and Control Data Corporation. He holds a B.S. inEngineering from the Indian Institute of Technology in Madras, India, and heperformed advanced graduate work in business and engineering at DartmouthCollege.

*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 has held positionsas CEO, COO and CFO of niche, high tech companies in the Internet space overthe past several years (including Kignet, Inc., Monumental NetworkSystems, and IMA Software, Inc.) during which he has developed particularexpertise in bringing companies to cash flow positive positions. Mr. Nelsonhas also held executive positions at NTT/Verio, as well as sales and marketingand manufacturing positions at IBM Corporation. Mr. Nelson holds a Masterof Business Administration from The Wharton School at the University ofPennsylvania and a Bachelor of 

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Science degree in ChemicalEngineering from the University of Delaware. Mr. Nelson also previouslyserved as a George Mason Fellow, acting as an advisor to start-up and earlystage technology companies on a volunteer basis through the TechVenturePartnership at George Mason University.

*RonaldE. 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,strategic planning, 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 andManager, Strategic Planning and Business Development. He also served as aPresidential appointee, on loan to The White House from General Electric,responsible for developing contingency plans as part of the Continuity ofGovernment Program. He received a Presidential Commendation for outstandingservice during that assignment. Mr. Freedman holds a BA in Economics fromNortheastern University in Boston and an MBA in Management from Babson Collegein Wellesley, MA.

*LeonardJ. Pearson *is responsible for sales and marketingprograms at VCampus with a particular focus on the corporate and outsourcingmarkets. In early 2004, Mr. Pearson came to VCampus from CavalierTelephone, LLC, a provider of voice and data communication services, where hewas Area Sales Director. At Cavalier, Mr. Pearson’s responsibilitiesincluded the deployment and sales of services in the company’s key Mid-Atlanticregion. Prior to joining Cavalier, Mr. Pearson was Vice President of Salesand Marketing for ColoSafe, LLC, a provider and builder of collocationfacilities. Before joining ColoSafe, Mr. Pearson was Regional VicePresident for WinStar Wireless, where he was responsible for all aspects of thecompany’s sales and marketing of wide area networking solutions in the easternUnited States from 1998 to 2001. Mr. Pearson has also held executivepositions with Frontier Communications, Cable & Wireless NorthAmerica, and Sprint. Mr. Pearson holds a BS in Business from DuquesneUniversity in Pittsburgh.

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**PART II**

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

*(a)*   Price Range of Common Stock

Our common stock is currently listed on the NasdaqSmallCap Market under the symbol “VCMP.” For each full fiscal quarter since thebeginning of 2002, the high and low bid quotations for our common stock,adjusted to reflect the one-for-ten reverse stock split which occurred in July 2002and as reported by Nasdaq, were as follows:
| ** **     | ** ** | **High** | ** ** | **Low** | ** ** |
|----------------|------------|----------|------------|---------|------------|
| **2002**       |       |     |       |    |       |
| First quarter  |       | $        | 7.70       |    | $          | 2.40 |   |
| Second quarter |       | $        | 6.50       |    | $          | 2.20 |   |
| Third quarter  |       | $        | 3.90       |    | $          | 2.06 |   |
| Fourth quarter |       | $        | 5.50       |    | $          | 2.25 |   |
| **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 |   |

 

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 assurancethat there will be an active public market for our common stock in the future.The market price of the common stock could be subject to significantfluctuations in response to future announcements concerning us or our partnersor competitors, 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, 2003 to December 31,2003, VCampus issued the following unregistered securities:

(1)   77,220 and 5,405 shares of common stock at apurchase price of $2.59 per share to accredited investors, and aplacement agent, respectively. Under the terms of this financing, VCampus alsoissued three-year fully vested warrants topurchase 77,220 and 5,405 shares of common stock at $2.59 per share to the sameaccredited investors and placement agent, respectively.

(2)   116,785 and 8,175 shares of common stock toaccredited investors, and a placement agent, respectively. Under the terms ofthe September and October 2003 financings, because VCampus did notraise an additional $2,000,000 in equity financing by November 15, 2003,on that date the unit holders became entitled to receive the foregoingadditional shares of common stock as if the purchase price per share of commonstock equaled $2.00 when the units were purchased.

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 

19

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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.

*(b)*   Approximate Number of Equity Security Holders

Asof March 25, 2004, the number of record holders of our Common Stock was152 and we believe that the number of beneficial owners was approximately1,120.

*(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.

**Item 6. Selected Financial Data.**

The following table sets forth selected financial dataof VCampus. The selected financial data presented below has been derived fromVCampus’ consolidated financial statements which have been audited by ReznickFedder & Silverman for the year ended December 31, 2003 and Ernst &Young LLP for the years ended December 31, 1999 through 2002, and shouldbe read in conjunction with Management’s Discussion and Analysis of FinancialCondition and Results of Operations, and the Consolidated Financial Statementsand accompanying footnotes included in this Annual Report of Form 10-K.

Certain revenues andcorresponding expenses included in these selected and supplementary financialdata have been reclassified from the presentation in prior periods. While thisreclassification causes revenues and expenses reported herein to be lower thanpreviously reported, it has no impact on previously reported assets,liabilities or net loss.

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Theeffect of this reclassification was to reduce Revenues, and Sales and MarketingExpenses by $179,834 for the six months ended June 30, 2003, $275,528 forthe year ended December 31, 2002; $163,479 for the year ended December 31,2001; and $137,162 for the year ended December 31, 2000.

**Statement of Operations Data:**
| ** **                                                                     | ** ** | **1999**                                                        | ** ** | **2000** | ** ** | **2001** | ** ** | **2002** | ** ** | **2003** | ** ** |
|--------------------------------------------------------------------------------|------------|-----------------------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|----------|------------|
| ** **                                                                     | ** ** | **In thousands except per share data** | ** ** |
| Net revenues:                                                                  |       |                                                            |       |     |       |     |       |     |       |     |       |
| Online tuition revenues                                                        |       | $                                                               | 3,835      |     | $          | 4,928    |       | $        | 5,782      |     | $          | 5,330 |   | $ | 5,508 |   |
| Virtual campus software revenues                                               |       | 216                                                             |       | 115      |       | 72       |       | —   |       | —   |       |
| Online development and other revenues                                          |       | 977                                                             |       | 1,022    |       | 687      |       | 496      |       | 448      |       |
| Product sales revenues                                                         |       | 1,222                                                           |       | 414      |       | 45       |       | —   |       | —   |       |
| Other service revenues                                                         |       | 305                                                             |       | 175      |       | 122      |       | 100      |       | 110      |       |
| Instructor-led training revenues                                               |       | 4,992                                                           |       | 2,665    |       | 102      |       | —   |       | —   |       |
| Total net revenues                                                             |       | 11,547                                                          |       | 9,319    |       | 6,810    |       | 5,926    |       | 6,066    |       |
| Costs and expenses:                                                            |       |                                                            |       |     |       |     |       |     |       |     |       |
| Cost of revenues                                                               |       | 5,749                                                           |       | 3,296    |       | 1,093    |       | 1,462    |       | 1,718    |       |
| Sales and marketing                                                            |       | 4,286                                                           |       | 6,105    |       | 4,554    |       | 2,689    |       | 2,138    |       |
| Product development and operations                                             |       | 2,241                                                           |       | 3,555    |       | 2,273    |       | 2,536    |       | 2,475    |       |
| General and administrative                                                     |       | 2,633                                                           |       | 2,761    |       | 2,045    |       | 1,693    |       | 1,910    |       |
| Depreciation and amortization                                                  |       | 2,956                                                           |       | 2,916    |       | 2,154    |       | 1,356    |       | 880      |       |
| Compensation expense in connection with the  acquisition of HTR, Inc           |       | 1,089                                                           |       | 654      |       | —   |       | —   |       | —   |       |
| Reorganization and other non-recurring charges                                 |       | 360                                                             |       | 2,261    |       | 188      |       | 192      |       | 173      |       |
| Stock-based compensation                                                       |       | —                                                          |       | 361      |       | 441      |       | 76       |       | 126      |       |
| Total costs and expenses                                                       |       | 19,314                                                          |       | 21,909   |       | 12,748   |       | 10,004   |       | 9,420    |       |
| Loss from operations                                                           |       | (7,767                                                          | )          | (12,590  | )          | (5,938   | )          | (4,078   | )          | (3,354   | )          |
| Other income (expense):                                                        |       |                                                            |       |     |       |     |       |     |       |     |       |
| Gain on sale of subsidiaries                                                   |       | 1                                                               |       | —   |       | —   |       | —   |       | —   |       |
| Other income                                                                   |       | —                                                          |       | —   |       | —   |       | 422      |       | 207      |       |
| Interest income (expense)                                                      |       | (721                                                            | )          | 166      |       | 5        |       | (220     | )          | (112     | )          |
| Loss on debt extinguishments                                                   |       | —                                                          |       | —   |       | —   |       | (503     | )          | —   |       |
| Cumulative effect of accounting change                                         |       | —                                                          |       | (461     | )          | —   |       | —   |       | —   |       |
| Net loss                                                                       |       | $                                                               | (8,487     | )        | $          | (12,885  | )          | $        | (5,933     | )        | $          | (4,379 | ) | $ | (3,259 | ) |
| Dividends to preferred stockholders                                            |       | (448                                                            | )          | (1,153   | )          | (649     | )          | (2,768   | )          | (2,927   | )          |
| Net loss attributable to common stockholders                                   |       | $                                                               | (8,935     | )        | $          | (14,038  | )          | $        | (6,582     | )        | $          | (7,147 | ) | $ | (6,186 | ) |
| Net loss per share before cumulative effect of  change in accounting principle |       | $                                                               | (19.10     | )        | $          | (17.07   | )          | $        | (5.23      | )        | $          | (4.79 | ) | $ | (1.81 | ) |
| Cumulative effect  of change in accounting principle                           |       | —                                                          |       | (0.58    | )          | —   |       | —   |       | —   |       |
| Net loss per share                                                             |       | $                                                               | (19.10     | )        | $          | (17.65   | )          | $        | (5.23      | )        | $          | (4.79 | ) | $ | (1.81 | ) |
| Net loss per  share—assuming dilution                                     |       | $                                                               | (19.10     | )        | $          | (17.65   | )          | $        | (5.23      | )        | $          | (4.79 | ) | $ | (1.81 | ) |

 

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| ** **                       | ** ** | **1999** | ** ** | **2000** | ** ** | **2001** | ** ** | **2002** | ** ** | **2003** | ** ** |
|----------------------------------|------------|----------|------------|----------|------------|----------|------------|----------|------------|----------|------------|
| **Balance Sheet Data:**          |       |     |       |     |       |     |       |     |       |     |       |
| Working capital deficit          |       | $        | (5,155     | )        | $          | (2,036   | )          | $        | (885       | )        | $          | (828 | ) | $ | (1,187 | ) |
| Total assets                     |       | 10,668   |       | 6,652    |       | 7,012    |       | 4,373    |       | 4,864    |       |
| Total liabilities                |       | 8,646    |       | 3,620    |       | 4,198    |       | 2,725    |       | 2,828    |       |
| Accumulated deficit              |       | (56,632  | )          | (70,585  | )          | (77,060  | )          | (84,207  | )          | (90,393  | )          |
| Total  stockholders’ equity |       | 2,022    |       | 3,031    |       | 2,814    |       | 1,648    |       | 2,035    |       |
|                                  |            |          |            |          |            |          |            |          |            |          |            |  |  |  |  |  |

 

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

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

The following discussion of financial condition andresults of operations should be read in conjunction with VCampus’ consolidatedfinancial statements and related notes thereto included elsewhere in thisreport.

**Overview**

Ourrevenues are derived from three primary sources:

·       onlinetuition revenues;

·       developmentrevenues; and

·       otherservice revenues.

Online tuition revenuesare generated primarily from online tuition derived from corporate, government,and higher education customers. Development revenues consist primarily of feespaid to us for creating and developing new online courseware and web-enablingexisting courseware. Other service revenues consist primarily of monthly feesgenerated by the maintenance of the CYBIS courseware under contract with theU.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 practices, information provided by ourcustomers 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 revenuesfrom the following sources—online tuition revenues, other service revenues anddevelopment and other revenues.

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Revenue is recognized inaccordance with either SEC Staff Accounting Bulletin No. 104, *Revenue Recognition* (SAB 104), orStatement of Position 97-2, *Software RevenueRecognition* (“SOP 97-2”), as amended. Both SAB 104 and SOP 97-2generally require that four basic criteria must be met before revenue can berecognized: (1) persuasive evidence of an arrangement exists; (2) deliveryhas occurred or services rendered; (3) the fee is fixed and determinable:and (4) collectibility is reasonably assured. Determination of criteria (3) and(4) are based on management’s judgments regarding the fixed nature of thefee charged for services rendered and the collectibility of those fees. Shouldchanges in conditions cause management to determine these criteria are not metfor certain sales, revenue recognized for any reporting period could beadversely affected. Development and other revenues earned under coursewareconversion contracts are recognized based on the ratio that total costsincurred to date bear to the total estimated costs of the contract. Management’sestimates of total costs to complete contracts may be revised in future periodsresulting in adjustments to revenue and profit recognized in the period therevisions are made.

*Allowance forDoubtful Accounts*

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.

*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 are subjectto an annual impairment review. We may determine through the impairment reviewprocess that goodwill or other indefinite-lived intangibles have beenimpaired, resulting in an impairment charge in the period the review iscompleted.

**Reclassification ofRevenues and Sales and Marketing Expenses**

This report includes financial statements for 2003reflecting a different classification of certain revenues and correspondingexpenses from classifications in prior periods relating to our relationshipwith one of our largest customers. Amounts within the financial statements for2001 and 2002 have been reclassified to conform to the new classification.

While this reclassification causes revenues andexpenses reported herein to be lower than previously reported, it has no impacton our current or previously reported assets, liabilities or net loss.

In 1996, we entered into an agreement with one of ourlargest higher education customers, pursuant to which we provide thetechnological platform and support for administering and delivering thiscustomer’s online degree program to its students. This customer pays us a feefor each student registered in the program. Upon achieving certain studentregistration milestones under the program, pursuant to the terms of our renewalof this customer contract in 2000, we thereafter contribute a fixed dollaramount per additional registration thereunder to a marketing and developmentfund jointly administered by us and our 

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customer. The developmentfund’s primary goal is to fund marketing and development to grow onlinerevenues for both that customer in the form of course registration fees and usin additional online tuition fees. Our treatment for this arrangement had beento recognize as revenue the entire portion of the online tuition fees receivedfrom this customer and then deduct the entire portion of our contributions tothe development fund as a marketing expense. Based in part upon a financialanalysis performed by management regarding the relative benefits received by usand our customer from the development fund, and based in part on management’sassessment of the market price for the services we provide to our customer,assuming such services are provided with and then without the involvement ofthe development fund, we have determined that we should treat 50% of the fundcontributions as a reduction to revenue and the remaining 50% of the fundcontributions as a sales and marketing expense. It is management’s belief thatthe apportionment to revenues is appropriate based on our analysis.

The effect of thistreatment was to reduce Revenues, and Sales and Marketing Expenses for theperiods prior to the reclassification as follows: by $275,528 and $163,479 forthe years ended December 31, 2002 and 2001, respectively, and by $179,834for the six months ended June 30, 2003. This had no effect on our currentor previously reported assets, liabilities, or net loss. Because we expect ourrelationship with this customer to terminate by May 2004, we do not expectto recognize revenues from this client or pursuant to this arrangement afterthat date.

**Results ofOperations**

Thefollowing table sets forth certain statement of operations data as a percentageof total net revenues for the periods indicated:
| ** **                                                                   | ** ** | **Year Ended December 31,** | ** ** |
|------------------------------------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                                                   | ** ** | **2001**                                   | ** ** | **2002** | ** ** | **2003** | ** ** |
| Statement of  Operations Data:                                               |       |                                       |       |   |   |   |   |
| Revenues:                                                                    |       |                                       |       |   |   |   |   |
| Online tuition revenues                                                      |       | 84.9                                       | %          | 90.0 | % | 90.8 | % |
| Virtual campus software revenues                                             |       | 1.1                                        |       | 0.0 |   | 0.0 |   |
| Development and other revenues                                               |       | 10.1                                       |       | 8.3 |   | 7.4 |   |
| Product sales revenues                                                       |       | 0.7                                        |       | 0.0 |   | 0.0 |   |
| Other service revenues                                                       |       | 1.7                                        |       | 1.7 |   | 1.8 |   |
| Instructor-led training revenues                                             |       | 1.5                                        |       | 0.0 |   | 0.0 |   |
| Total net revenues                                                           |       | 100.0                                      |       | 100.0 |   | 100.0 |   |
| Costs and expenses:                                                          |       |                                       |       |   |   |   |   |
| Cost of revenues                                                             |       | 16.1                                       |       | 24.7 |   | 28.3 |   |
| Sales and marketing                                                          |       | 66.9                                       |       | 45.4 |   | 35.2 |   |
| Product development and operations                                           |       | 33.4                                       |       | 42.8 |   | 40.8 |   |
| General and administrative                                                   |       | 30.0                                       |       | 28.5 |   | 31.5 |   |
| Depreciation and amortization                                                |       | 31.6                                       |       | 22.9 |   | 14.5 |   |
| Reorganization and other non-recurring charges  and stock based compensation |       | 9.2                                        |       | 4.5 |   | 5.0 |   |
| Total costs and expenses                                                     |       | 187.2                                      |       | 168.8 |   | 155.3 |   |
| Loss from operations                                                         |       | (87.2                                      | )          | (68.8 | ) | (55.3 | ) |
| Other income (expense):                                                      |       |                                       |       |   |   |   |   |
| Other income                                                                 |       | —                                     |       | 7.1 |   | 3.4 |   |
| Interest income (expense)                                                    |       | 0.1                                        |       | (3.7 | ) | (1.8 | ) |
| Loss on debt extinguishment                                                  |       | —                                     |       | (8.5 | ) | — |   |
| Net loss                                                                     |       | (87.1                                      | )%         | (73.9 | )% | (53.7 | )% |

 

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*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) in 2002.The decrease in the net loss in 2003 as compared to 2002 was due primarily to adecrease in sales and marketing and depreciation and amortization expenses andthe absence of loss on debt extinguishment in 2003 ($503,246 of such loss wasincluded in the net loss attributable to common stockholders for 2002).

The following table setsforth 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 $495,425 in2002. The decrease is primarily due to a decline in course development andprofessional 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.

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*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 VCampus and one of our larger customers asrequired pursuant to the terms of our contract with that customer. TheDevelopment Fund’s primary goal is to fund marketing and development to growonline revenues for both that customer and derivatively for us in the form ofcourse registration fees. Amounts required to be contributed by VCampus to theDevelopment Fund are determined under the contract based on meeting orexceeding certain thresholds in course registrations on that customer’s virtualcampus, which is hosted by VCampus. Currently, we record 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 accountfor 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 in 2002.The decrease was due primarily to the fact that a significant portion of ourfixed 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.

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**2002 Compared to2001**

*Summary*

Weincurred a net loss attributable to common stockholders of $7,147,305 (or $4.79per share) in 2002 as compared to a net loss attributable to commonstockholders of $6,582,040 (or $5.23 per share) in 2001. Excluding certain non-recurringitems in both years, we incurred a net loss attributable to common stockholdersof $6,955,305 (or $4.66 per share) in 2002 as compared to a net lossattributable to common stockholders of $6,394,278 (or $5.08 per share) in 2001.Non-recurring items for 2002 amounted to $192,000 (or $0.13 per share) incurredin connection with the closure of our training facility in Rockville, Maryland.Non-recurring items for 2001 amounted to $187,762 (or $0.15 per share) incurredin connection with the termination of the employment agreement between us andour founder.

Thefollowing table sets forth selected financial data:
| ** **                                      | ** ** | **For the Year Ended December 31,** | ** ** |
|-------------------------------------------------|------------|--------------------------------------------------------------|------------|
| ** **                                      | ** ** | **2001**                                                     | ** ** | **2002** | ** ** |
| Revenues                                        |       | $                                                            | 6,809,752  |   | 100.0 | % | $ | 5,926,146 |   | 100.0 | % |
| Cost of revenues                                |       | 1,093,285                                                    |       | 16.1 |   | 1,461,663 |   | 24.7 |   |
| Sales and  marketing                            |       | 4,553,250                                                    |       | 66.9 |   | 2,689,136 |   | 45.4 |   |
| Product  development                            |       | 2,273,145                                                    |       | 33.4 |   | 2,535,849 |   | 42.8 |   |
| General and  administrative                     |       | 2,044,716                                                    |       | 30.0 |   | 1,692,851 |   | 28.5 |   |
| Depreciation and  amortization                  |       | 2,154,152                                                    |       | 31.6 |   | 1,355,837 |   | 22.9 |   |
| Reorganization  and other non-recurring charges |       | 187,762                                                      |       | 2.8 |   | 192,000 |   | 3.2 |   |
| Stock-based  compensation                       |       | 440,898                                                      |       | 6.5 |   | 76,172 |   | 1.3 |   |
| Loss from  operations                           |       | (5,937,456                                                   | )          | (187.2 | ) | (4,077,362 | ) | (68.8 | ) |
| Other expense                                   |       | —                                                       |       | — |   | 421,842 |   | 7.1 |   |
| Interest income  (expense)                      |       | 4,563                                                        |       | (0.1 | ) | (220,145 | ) | (3.7 | ) |
| Loss on debt  extinguishment                    |       | —                                                       |       | — |   | (503,246 | ) | (8.5 | ) |
| Net loss                                        |       | (5,932,893                                                   | )          | (187.1 | ) | (4,378,911 | ) | (73.9 | ) |
| Dividends to  preferred stockholders            |       | (649,147                                                     | )          | (9.6 | ) | (2,768,394 | ) | (46.7 | ) |
| Net loss to common  stockholders                |       | $                                                            | (6,582,040 | ) | (96.7 | )% | $ | (7,147,305 | ) | (120.6 | )% |

 
| ** **                             | ** ** | **For the Year Ended December 31,** | ** ** |
|----------------------------------------|------------|--------------------------------------------------------------|------------|
| ** **                             | ** ** | **2001**                                                     | ** ** | **2002** | ** ** |
| Online tuition  revenues               |       | $                                                            | 5,781,285  |   | 84.9 | % | $ | 5,330,686 |   | 89.9 | % |
| Virtual campus  software revenues      |       | 71,863                                                       |       | 1.1 |   | — |   | — |   |
| Online development  and other revenues |       | 687,232                                                      |       | 10.1 |   | 495,425 |   | 8.4 |   |
| Product sales  revenues                |       | 45,038                                                       |       | 0.7 |   | — |   | — |   |
| Other service  revenues                |       | 121,750                                                      |       | 1.8 |   | 100,035 |   | 1.6 |   |
| Instructor-led  training revenues      |       | 102,584                                                      |       | 1.5 |   | — |   | — |   |
| Total net revenues                     |       | $                                                            | 6,809,752  |   | 100.0 | % | $ | 5,926,146 |   | 100.0 | % |

 

Total revenues in 2002were $5,926,146 as compared to $6,809,752 for 2001. The decrease in revenueswas primarily due to decreases in online tuition revenues and development andother revenues. Online tuition revenues decreased primarily due to a decreasein revenues from customers within the telecommunications industry. Developmentand other revenues decreased primarily due to a decrease in course developmentorders. Excluding the non-recurring items described above, total costs and expenseswere $9,811,508 in 2002 as compared to costs of $12,559,446 for 2001. Thedecrease was due primarily to decreases in sales and marketing, general andadministrative and depreciation and amortization expenses, partially offset byan increase in the cost of online tuition revenues.

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*Net Revenues*

Total net revenuesdecreased 13.0% from $6,809,752 in 2001 to $5,926,146 in 2002. Online tuitionrevenues decreased from $5,781,285 (84.9% of net revenues) in 2001 to$5,330,686 (90.0% of net revenues) in 2002. The decrease in online tuitionrevenues was primarily due to a decrease in revenues from customers primarilywithin the telecommunications and other industries (approximately $900,000 and$800,000, respectively). This decrease was partially offset by an increase inrevenues due to increased course usage by some of our older higher educationand government customers (approximately $200,000 and $475,000, respectively)and the addition of a new government customer (approximately $600,000). Onlinedevelopment and other revenues decreased from $687,232 (10.1% of net revenues)in 2001 to $495,425 (8.3% of net revenues) in 2002. Development revenues wereprimarily related to developing online courseware for customers in both years.We recognized no virtual campus software revenues, product sales revenues, orinstructor-led training revenues in 2002 and only $100,000 in other servicerevenues due to our continued move to an exclusive online business focus.

*Cost of Revenues*

Total cost of revenuesincreased 33.7% from $1,093,285 (16.1% of net revenues) in 2001 to $1,461,663(24.7% of net revenues) in 2002. The increase was primarily due to the sale ofcourses with relatively high associated royalties under one of our largecustomer contracts, which was renewed in June 2003.

*Operating Expenses*

*Sales and Marketing.**  *Sales andmarketing expenses decreased 40.9% from $4,553,250 (66.9% of net revenues) in2001 to $2,689,136 (45.4% of net revenues) in 2002. Although we increased oursales headcount during the third quarter of 2002, compared to headcount in thatarea earlier in 2002, sales and marketing expenses for 2002, nonetheless,decreased as compared to 2001 primarily due a comparatively lower headcountthroughout the year and lower direct marketing costs. During 2002 and 2001, wecontributed $551,056 and $326,959, respectively, to a marketing and developmentfund (the “Development Fund”) jointly administered by us and one of our largercustomers as required pursuant to the terms of VCampus’ contract with thatcustomer. The Development Fund’s primary goal is 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 us to the Development Fund are determined under the contract based onmeeting or exceeding certain thresholds in course registrations on thatcustomer’s virtual campus, which is hosted by VCampus. Based upon ouraccounting reclassifications as described above, 50% of these contributions arerecorded as a marketing expense in the same period as we recognize revenue fromsuch registrations and the remaining 50% of the contributions are recorded as areduction to revenue. Contributions to the Development Fund that we account foras a marketing expense represented 16.7% and 14.4% of the recognized revenuesattributable to that customer for 2002 and 2001, respectively.

*Product Development and Operations.**  *Productdevelopment and operations expenses increased 11.6% from $2,273,145 (33.4% ofnet revenues) in 2001 to $2,535,849 (42.8% of net revenues) in 2002. Productdevelopment and operations expenses consist primarily of certain costsassociated with the design, programming, testing, documenting and support ofour new and existing courseware and software. The increase was primarily due tothe write off of $276,535 (which has been included in product development costsin the 2002 statements of operations) in capitalized software and coursewaredevelopment costs for courses within the telecommunications industry segmentdetermined to have no future value.

*General and Administrative.**  *General andadministrative expenses decreased 17.2% from $2,044,716 (30.0% of net revenues)in 2001 to $1,692,851 (28.6% of net revenues) in 2002. General andadministrative expenses consist primarily of personnel costs, facilities andrelated costs, as well as legal, accounting and 

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other costs. The decreasewas due to our cost cutting initiatives primarily in headcount and associatedoverhead.

*Depreciation and Amortization.**  *Depreciation andamortization expense decreased 37.1% from $2,154,152 (31.6% of net revenues) in2001 to $1,355,837 (22.9% of net revenues) in 2002. The decrease was dueprimarily to the fact that certain of our fixed, as well as intangible, assetshave been fully depreciated and amortized, respectively. In addition, upon theadoption of FAS 142 on January 1, 2002, we ceased amortization ofgoodwill. We recognized $128,447 of amortization expense related to goodwill in2001.

*Reorganization and Other Non-Recurring Charges.**  *Reorganizationand other non-recurring charges were $192,000 in 2002 and represent the minimumamount due under a lease for office space we are no longer using. In December 2001,the employment agreement between us and Mr. Kannan was terminated and Mr. Kannanbecame a consultant, resulting in $187,762 of severance related expense, mostof which was paid out in 2002. During 2002, Mr. Kannan subsequentlyreassumed his employment with us.

*Stock Based Compensation.**  *Stock-basedcompensation expense was $76,172 in 2002 and consists primarily of the fairvalue of stock issued as a sign-on bonus to our newly appointed CFO and ascustomary payment to certain of our non-employee directors for theirparticipation in Board of Directors meetings. Stock based compensation was$440,898 in 2001 and included the final vesting of warrants issued to QwestInvestment Company (approximately $166,000) related to their equity investmentin VCampus in the second quarter of 2000 and compensatory stock options andstock warrants issued in connection with the issuance of debt to two of ourdirectors and the subsequent extinguishment of that debt. The fair value of thewarrants and options was estimated at $212,750 and $47,150, respectively, usingthe Black-Scholes option pricing model and has been included in stock-basedcompensation in the consolidated statements of operations.

*Other income.**  *Other income was$421,842 in 2002 and consists of the extinguishment of liabilities comprised ofcustomer deposits and prepayments. These prepayments and deposits were receivedprior to December 31, 2000 and were for classroom training to be deliveredby HTR and per the terms of the arrangement with customers, they were nonrefundable. Our HTR subsidiary ceased operations in December 2000.

*Interest expense.**  *Interest expensein 2002 consists primarily of debt discount and deferred debt offering costsamortization related to remaining balance of the $825,000 and $100,000convertible promissory notes issued in December 2001 and January 2002,respectively. Interest income in 2001 was primarily derived from income earnedon divestiture related notes receivable.

*Loss on debtextinguishment.**  *During 2002, we issued 1,458,413and 5,878 shares of Series F-1 and F-2 Preferred Stock,respectively, plus five-year fully vested warrants to purchase 20,462 shares ofcommon stock at $4.00 per share in exchange for the cancellation of twoconvertible promissory notes in the aggregate principal and accrued interestamount of $716,175. The excess of the fair value of the Preferred Stock andwarrants over the carrying value of the notes plus the write-off of deferreddebt issuance costs amounted to $503,246 and was recorded as loss on debtextinguishments in 2002.

**Liquidity and Capital Resources**

At December 31, 2003, we had $534,984 in cash andcash equivalents. Since our inception, we have financed our operating cash flowneeds primarily through offerings of equity and debt securities and, to alesser extent, borrowings. Cash utilized in operating activities was $2,032,108in 2003 and $2,661,629 in 2002. Use of cash was primarily attributable to thenet loss recorded.

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Cash utilized in investing activities was $1,657,352in 2003 and $422,438 in 2002. The use of cash for investing activities wasprimarily attributable to purchases of equipment and investments in softwareand courseware development.

Cash provided by financing activities was $3,496,978in 2003 and $1,783,762 in 2002.

In February 2003, we raised $400,000 through theissuance of 10,125 and 226 shares of Series G Preferred Stock at apurchase price of $39.50 per share to accredited investors and a placementagent, respectively. Under the terms of this financing, we also issuedfive-year fully vested warrants to purchase 25,313 and 564 shares of commonstock at $4.35 per share to the same accredited investors and placement agent,respectively. In March 2003, we raised $500,000 through the issuance of 18,370shares of Series G Preferred Stock at a purchase price of $27.22 per shareto accredited investors. Under the terms of this financing, we also issuedfive-year fully vested warrants to purchase 45,925 shares of common stock at$2.99 per share to the same accredited investors.

In May 2003, we raised approximately $1,800,000through the issuance of 7,503 shares of Series H Preferred Stock at apurchase price of $240.00 per share to accredited investors. Under the terms ofthis financing, we also issued five-year fully vested warrants to purchase187,575 shares of common stock at $5.00 per share to the same accreditedinvestors.

In September 2003, we raised $825,330 through theprivate placement of 318,660 units, at a purchase price of $2.59 per unit. Eachunit 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.In October 2003, we raised an additional $200,000 through the sale of anadditional 77,220 units at $2.59 per unit. In connection with this financing,we paid a placement agent a fee equivalent to 7% of the amount raised, paid inunits. Under the terms of the financing, because we did not raise an additional$2,000,000 in equity financing by November 15, 2003, on that date the unitholders became entitled to receive additional shares of common stock as if thepurchase price per share of common stock had equaled $2.00 when the units werepurchased, and the exercise price of the warrants decreased to $2.00 per share.

In March 2004, VCampus raised $5,000,000 in grosscash proceeds 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 consists of 50,000 sharesof common stock (initially priced at $1.63 per share), a Series A seniorsecured convertible note in the original principal amount of $118,500 and afive-year warrant to purchase 61,350 shares of common stock. We issued anadditional $250,000 of Series B senior secured notes in exchange forcancellation of existing short-term indebtedness in that amount. We issued tothe Series B noteholders  five-yearwarrants to purchase an aggregate of 383,439 shares of common stock. Theinitial exercise price for the warrants is $2.386 which is equal to the averageclosing price of VCampus’ common stock for the five trading days prior to thedate of the closing. Upon shareholder approval of the private placement, theexercise price of the warrants would adjust to $1.63 per share.

Upon approval of the private placement by VCampus’stockholders, $18,500 of principal of each of the Series A notes wouldautomatically convert into common stock at $1.63 per share and $100,000, or50%, in principal of each of the Series B notes would automaticallyconvert into common stock at $1.63 per share. The total principal amount forboth Series to be converted upon approval of the stockholders would be$999,625. Therefore, assuming shareholder approval, a total of $2,650,000 ofthe placement would be categorized as equity and $2,650,000 as senior debt. Thenotes mature on April 1, 2009 and bear interest at the rate of 8% perannum payable quarterly in cash or stock (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. The notes do notbecome convertible into common stock unless and until stockholder approval isobtained. The notes are subject to immediate redemption if stockholder approvalis not obtained within 60 days of closing.

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We have sustained continuing operating losses in 2003and had an accumulated deficit of $90.4 million as of December 31,2003. We expect negative cash flow from operations to continue until the onlinerevenue stream matures. We believe we have adequate capital from the March 2004financing and access to adequate additional resources to fund operations untiloperations reach cash flow positive. However, in the event revenues do not meetanticipated levels or we are unable to raise additional funding to meet workingcapital requirements, we may need to further reduce operating expenses. If weare unable to raise additional funding to meet working capital requirements, wemay be unable to maintain compliance with Nasdaq SmallCap Market listingrequirements and we might not be able to achieve our business objectives.VCampus believes it has available capital on hand and sources for additionaldebt or equity capital in amounts necessary to meet its cash needs through 2004and into 2005. However, such capital, if needed and available, may not haveterms favorable to us or our current stockholders. Furthermore, the terms ofthe debt and equity financing conducted in March 2004, which includesantidilution protection, may significantly hinder our ability to raise furthercapital in the future.

If we do not address our capital and 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, maintenance and renewal of customer contracts,customer demands for technology upgrades, the types of arrangements that we mayenter into with customers and agents, and the extent to which we invest in newtechnology and research and development projects.

As of December 31,2003, we had net operating loss carryforwards of approximately$60.1 million for federal income tax purposes, which will expire atvarious dates through 2023. 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*

Our future liquidity and capital resources will beaffected by our contractual obligations. Our significant contractualobligations as of December 31, 2003 are for debt and operating leases andpurchase obligations. These obligations are summarized as follows:
| ** **                       | ** ** | **Payments Due by Period** | ** ** |
|----------------------------------|------------|-------------------------------------------|------------|
| **Contractual Obligations** | ** ** | ** **                                | ** ** | **Total** | ** ** | **Less than one  year** | ** ** | **1-3 years** | ** ** | **4-5 years** | ** ** | **After 5  Years** | ** ** |
| Notes payable(1)                 |       | $                                         | 225,000    |   |   | $ | 225,000 |   |   | $ | — |   | $ | — |   | $ | — |   |
| Operating leases                 |       | 3,396,143                                 |       |   | 509,735 |   |   | 1,622,806 |   | 1,164,634 |   | 98,968 |   |
| Purchase  obligation(2)          |       | 160,624                                   |       |   | 128,499 |   |   | 32,125 |   | — |   | — |   |
| Total contractual  obligations   |       | $                                         | 3,781,767  |   |   | $ | 863,234 |   |   | $ | 1,654,931 |   | $ | 1,164,634 |   | $ | 98,968 |   |
|                                  |            |                                           |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

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(1)          In December 2001and January 2002, we raised $825,000 and $100,000 through the issuance of8% debentures together with five-year, fully vested warrants to purchase132,143 shares of common stock at $4.00 per share. We allocated the proceeds ofthe offering to the debentures and the warrants based on their relative fairvalues. The amount allocated to the warrants was recorded as a debt discountand is being amortized to interest expense over the period the debentures areexpected to be outstanding. In March 2002, we 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, we issued of 5,878 shares of Series F-2 PreferredStock plus a warrant to purchase 5,878 shares of common stock at $4.00 pershare, in exchange for the cancellation of a convertible promissory note in theprincipal and accrued interest amount of $205,730. The unamortized debt 

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discount at December 31,2003 was $0. The remaining $225,000 of principal and accrued interest under thedebentures was due and payable at December 31, 2003. The $225,000 of debtwas paid off in full in March 2004.

(2)          In December 2000,we entered 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 31,2003, we were required to generate sales sufficient to generate royalties of$158,985 prior to December 31, 2004.

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

**Item 7A. Quantitative andQualitative Disclosures About Market Risk.**

In the normal course ofbusiness, the Company is exposed to a variety of risks including market riskassociated with interest rate movements. The Company’s exposure to market riskfor changes in interest rates relates primarily to any investments the Companymay hold at various times and also related to its long-term debt. Wheninvesting, the Company’s purchases consist of highly liquid investments withmaturities at the date of purchase generally no greater than twelve months,thus, due to the short-term nature of such investments and the Company’s usualintention to hold these investments until maturity, the impact of interest ratechanges would not have a material impact on the Company’s results ofoperations. In addition, all of the Company’s long-term debt obligations are atfixed interest rates. Given the fixed rate nature of the debt, the impact ofinterest rate changes also would not have a material impact on the Company’sresults of operations.

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

The information requiredby this item is included in this Report at pages F-1 through F-35.See Index to Consolidated Financial Statements on page F-1.

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

On September 16, 2003 we announced that Ernst &Young LLP (“E&Y”), our independent auditor, notified us that it intended toresign as our independent auditor following completion of its review of thethird quarter financial statements and our filing of same with the SEC on orabout November 14, 2003. E&Y determined, based solely on its ownbusiness reasons, that it was no longer in the best interest of E&Y orVCampus for E&Y to continue to serve as our independent auditor beyond thatdate. Following the completion of E&Y’s review of the third quarterfinancials and the filing of our quarterly report for the period ended September 30,2003, E&Y’s engagement as our independent auditor was terminated effectiveupon its resignation on November 20, 2003.

The decision to change independent auditors was notrecommended by our Audit Committee, but in response to the notification, theAudit Committee did approve the change and authorized the initiation of asearch for a new independent auditor. After a thorough search and interviewprocess, the Audit Committee selected and engaged the firm of Reznick Fedderand Silverman to serve as our new independent auditor, effective on November 21,2003. We did not, during our two most recent fiscal years or any subsequentinterim period prior to the new engagement, consult our newly-appointed auditorregarding: (1) the application of accounting principles to a specifiedtransaction, either completed or proposed, or the type of audit opinion thatmight be rendered on our financial statements, or (2) any matter that waseither the subject of a disagreement (as defined in paragraph 304(a)(1)(iv) ofRegulation S-K and the related instructions to Item 304) or a reportable event(as described in paragraph 304(a)(1)(v) of Regulation S-K).

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The reports of E&Y on our consolidated financialstatements as of and for the fiscal years ended December 31, 2001 and 2002contained no adverse opinion or disclaimer of opinion, nor were the reportsmodified or qualified as to uncertainty, audit scope or accounting principles.

In connection with E&Y’saudits for the fiscal years ended December 31, 2001 and December 31,2002, and during the subsequent interim period preceding its resignation, therewere no disagreements with E&Y on any matter of accounting principles orpractices, financial statement disclosure, or auditing scope or procedure,which disagreements, if they had occurred and not been resolved to thesatisfaction of E&Y, would have caused E&Y to make reference to suchdisagreements in its reports on the consolidated financial statements for thoseyears.

**Item 9A. Controls andProcedures.**

(a)   DisclosureControls and Procedures: Disclosure controls and procedures (as defined inExchange Act Rule 13a-15(e)) are designed only to provide reasonableassurance that they will meet their objectives. As of the end of the periodcovered by this report, the Company carried out an evaluation, under thesupervision and with the participation of the Company’s management, includingthe Company’s Chief Executive Officer and Chief Financial Officer, of theeffectiveness of the Company’s disclosure controls and procedures pursuant toExchange Act Rule 13a-15(b). Based upon that evaluation, the Company’sChief Executive Officer and Chief Financial Officer have concluded that theCompany’s disclosure controls and procedures are effective to provide thereasonable assurance discussed above.

(b)   Internal Control Over Financial Reporting: No change in theCompany’s internal control over financial reporting occurred during the Company’slast fiscal quarter that has material affected, or is reasonably likely tomaterially affect, the Company’s internal control over financial reporting.

**(c) PART III**

Certaininformation required by Part III is omitted from this report because theRegistrant intends to file a definitive proxy statement for its 2004 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. Directors and ExecutiveOfficers 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 Martin Maleska is an “audit committee financial expert” asdefined in Item 401(h) of Regulation 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 writtenrequest to VCampus Corporation, 1850 Centennial Park Drive, Suite 200,Reston, VA 20191, Attention: Chief Financial Officer.

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

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**Item 11. Executive Compensation.**

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

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. Certain Relationshipsand 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. Controls and Procedures**

The information requiredby Item 14 of Form 10-K is incorporated by reference to theinformation under the heading “Other Information—Report of the Audit Committee”and “—Fees Paid to the Independent Auditors” in the Proxy Statement.

**PART IV**

**Item 15. Exhibits, FinancialStatement Schedules, and Reports on Form 8-K.**

(a)   The following Financial Statements, FinancialStatement Schedules and Exhibits are filed as part of this report orincorporated herein by reference:

(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.

 

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(3)   Exhibits.
| **Exhibit No.** | ** ** | **Description**                                                                                                                                                 |
|----------------------|------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 3.1(a)               |       | 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.                                                                                                                          |
| 10.30(b)             |       | Series C Preferred Stock and Warrant Purchase Agreement.                                                                                                   |
| 10.32(b)             |       | Series D Preferred Stock Purchase Agreement dated June 29,  1998.                                                                                     |
| 10.34(b)             |       | Certificate of Designations, Preferences and Rights of Series D  Convertible Preferred Stock dated June 26, 1998.                                     |
| 10.35(c)             |       | Certificate of Designations, Preferences and Rights of Series C  Convertible Preferred Stock dated June 25, 1998.                                     |
| 10.42(d)             |       | Certificate of Designations, Preferences and Rights of Series E  Convertible Preferred Stock.                                                              |
| 10.47(e)             |       | Stock Purchase Agreement dated as of January 11, 2000 by and among  the Registrant and Mastech Corporation (now iGate Capital Corporation).                |
| 10.48(e)             |       | Registration Rights Agreement dated as of January 11, 2000 by and  among the Registrant and Mastech Corporation (now iGate Capital Corporation).           |
| 10.49(e)             |       | Warrant issued to Mastech Corporation (now iGate Capital Corporation),  dated as of January 11, 2000.                                                      |
| 10.50(f)             |       | Subscription Agreement dated as of April 20, 2000, by and between  the Registrant and US West Internet Ventures, Inc, now Qwest Investment  Company        |
| 10.51(f)             |       | Registration Rights Agreement dated as of April 20, 2000 by and  between the Registrant and US West Internet Ventures, Inc, now Qwest  Investment Company. |
| 10.52(f)             |       | Warrant issued to US West Internet Ventures, Inc., now Qwest Investment  Company, dated as of April 20, 2000.                                         |
| 10.54(g)*            |       | Application Hosting Agreement dated April 20, 2000 between VCampus  and US West Interprise America, Inc.                                              |
| 10.57(i)*            |       | Contract with the General Services Administration dated April 18,  2001                                                                                    |
| 10.58(j)             |       | Form of Subscription Agreement dated as of May 29, 2001 by  and between the registrant and the Purchasers.                                            |
| 10.59(j)             |       | Form of Registration Rights Agreement dated as of May 29,  2001 by and between the registrant and the Purchasers.                                     |
| 10.60(j)             |       | Warrant issued to the purchasers dated as of May 29, 2001.                                                                                                 |
| 10.61(j)             |       | Warrant issued to the placement agent for the May 29, 2001 private  placement.                                                                             |
| 10.62(k)             |       | Termination of Employment Agreement with Narasimhan P. Kannan, dated  December 31, 2001                                                                    |
| 10.63(l)             |       | Certificate of  Designations for the Series F-1 Preferred Stock, as filed in Delaware on  March 28, 2002                                              |
| 10.64(l)             |       | Certificate of  Designations for the Series F-2 Preferred Stock, as filed in Delaware on  May 8, 2002                                                 |
| 10.65(l)             |       | Form of  purchase agreement for the issuance of Series F, F-1 and F-2 preferred  stock                                                                |

35

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| 10.66(l) |   | Form of  registration rights agreement covering the Series F, F-1 and F-2  preferred stock                                                   |
|----------|--------|--------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.67(l) |   | Form of  warrant issued in connection with the Series F, F-1 and F-2 preferred  stock financings                                             |
| 10.68(m) |   | Employment Agreement, dated June 3, 2002, with Christopher L.  Nelson                                                                             |
| 10.69(n) |   | Certificate of  Correction of Series C Convertible Preferred Stock filed in Delaware on  July 2, 2002,                                       |
| 10.70(n) |   | Certificate of  Correction of Series D Convertible Preferred Stock filed in Delaware on  July 2, 2002.                                       |
| 10.71(n) |   | Certificate of  Correction of Series E Convertible Preferred Stock filed in Delaware on  July 2, 2002.                                       |
| 10.72(n) |   | Certificate of  Correction of Series F Convertible Preferred Stock filed in Delaware on  July 2, 2002.                                       |
| 10.73(n) |   | Certificate of  Correction of Series F-1 Convertible Preferred Stock filed in Delaware  on July 2, 2002.                                     |
| 10.74(n) |   | Certificate of  Correction of Series F-2 Convertible Preferred Stock filed in Delaware  on July 10, 2002.                                    |
| 10.75(n) |   | Certificate of  Amendment of Amended and Restated Certificate of Incorporation filed in  Delaware on July 3, 2002.                                |
| 10.76(o) |   | Certificate of  Designations for the Series G Preferred Stock filed with the Delaware  Secretary of State on September 27, 2002.             |
| 10.77(o) |   | Form of  Securities Purchase Agreement dated September 30, 2002 between the  Registrant and the purchasers of Series G Preferred Stock. |
| 10.78(o) |   | Form of  Registration Rights Agreement dated September 30, 2002 between the  Registrant and the purchasers of Series G Preferred Stock  |
| 10.79(o) |   | Form of  Warrant issued on September 30, 2002 to the purchasers of Series G  Preferred Stock.                                           |
| 10.80(p) |   | Amended and  Restated Employment Agreement, dated December 18, 2002, with Daniel J.  Neal.                                                        |
| 10.81(p) |   | Employment  Agreement, effective January 1, 2003, with Narasimhan P. Kannan                                                                       |
| 10.82(r) |   | Certificate of  Designations for the Series H Preferred Stock filed in Delaware on  May 12, 2003.                                            |
| 10.83(r) |   | Securities  Purchase Agreement dated May 13, 2003 relating to the sale of  Series H Preferred Stock and warrants.                            |
| 10.84(r) |   | Form of  warrant issued to the Series H holders on May 13, 2003.                                                                        |
| 10.85(r) |   | Registration  Rights Agreement dated May 13, 2003 relating to the Series H  financing.                                                       |
| 10.86(s) |   | Amendment to the  Certificate of Designations for the Series D Preferred Stock filed in  Delaware on June 11, 2003.                          |
| 10.87(s) |   | Amended  employment agreement between VCampus and Narasimhan P. Kannan dated  June 25, 2003.                                                 |
| 10.88(s) |   | Amended  employment agreement between VCampus and Christopher L. Nelson dated June 25,  2003.                                                |
| 10.89(s) |   | Form of  Notice of Conversion of VCampus preferred stock.                                                                                         |

36

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| 10.90(s) |   | 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 |
| 10.96    |   | Security  Agreement dated March 23, 2004 entered into in connection with the $5.3  million private placement            |
| 21.1     |   | List of  Subsidiaries                                                                                                        |
| 23.1     |   | Consent of  Reznick, Fedder & Silverman, Independent Auditors                                                       |
| 23.2     |   | Consent of  Ernst & Young LLP, Independent Auditors                                                                 |
| 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.                      |
| 99.1(q)  |   | Securities Purchase Agreement dated December 28, 2001 between the  Registrant and the Purchasers                        |
| 99.2(q)  |   | Form of Convertible Note issued December 28, 2001                                                                  |
| 99.3(q)  |   | Certificate of Designations for the Series F Preferred Stock filed  in Delaware on December 28, 2001               |
| 99.4(q)  |   | Form of Warrant issued to the Series F holders on  December 28, 2001                                          |
| 99.5(q)  |   | Form of Warrant issued to the convertible noteholders on  December 28, 2001                                        |
| 99.6(q)  |   | Form of Registration Rights Agreement dated December 28, 2001                                                      |
| 99.7(j)  |   | Audit Committee Charter                                                                                                      |

----

*                    Confidential treatment granted.

(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 identically numbered Exhibit to the Registrant’sQuarterly Report on Form 10-Q for the quarter ended March 31,1998.

(c)           Incorporatedby reference to the identically numbered Exhibit to the Registrant’sQuarterly Report on Form 10-Q for the quarter ended June 30,1998.

(d)          Incorporatedby reference to the corresponding appendix filed with the Registrant’spreliminary proxy materials on Schedule 14A dated July 16, 1999 for its1999 annual meeting of stockholders.

(e)           Incorporatedby reference to the similarly numbered Exhibit to the Registrant’s currentReport on Form 8-K filed January 13, 2000.

37

----

(f)             Incorporatedby reference to the similarly numbered Exhibit to the Registrant’s currentReport on Form 8-K filed May 1, 2000.

(g)           Incorporatedby reference to the similarly numbered Exhibit to the Registrant’sQuarterly Report on Form 10-Q filed May 15, 2000.

(h)          Incorporatedby reference to the similarly numbered Exhibit to the Registrant’s AnnualReport on Form 10-K for the year ended December 31, 2000.

(i)             Incorporatedby reference to the similarly numbered Exhibit to the Registrant’sQuarterly Report on Form 10-Q filed May 15, 2001.

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

(k)          Incorporatedby reference to the similarly numbered Exhibit to the Registrant’s AnnualReport on Form 10-K filed April 1, 2002.

(l)             Incorporatedby reference to the similarly numbered Exhibit to the Registrant’s QuarterlyReport on Form 10-Q filed May 15, 2002.

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

(n)          Incorporatedby reference to the similarly numbered Exhibit to the Registrant’sQuarterly Report on Form 10-Q filed August 9, 2002.

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

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

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

(r)            Incorporatedby reference to the similarly numbered Exhibit to the Registrant’sQuarterly Report on Form 10-Q filed May 15, 2003.

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

(t)             Incorporated by referenceto the similarly numbered Exhibit to the Registrant’s Amendment No. 1to Registration Statement on Form S-1 (File No. 333-108380).

(u)          Incorporated byreference to the similarly numbered Exhibit to the Registrant’s CurrentReport on Form 8-K/A filed on November 21, 2003.

38

----

 

**SIGNATURES**

Pursuantto the requirements of Section 13 or 15(d) of the Securities andExchange Act of 1934, the Registrant has duly caused this report to be signedon its behalf by the undersigned, thereunto duly authorized.
|   | VCAMPUS CORPORATION |
|--------|---------------------|
|   | By:                 | /s/  Narasimhan P. Kannan |
|   |                | Narasimhan P. Kannan, Chief  Executive Officer |

 

Date: March 30, 2004

Pursuantto the requirements of the Securities Exchange Act of 1934, this report hasbeen signed below by the following person on behalf of the Registrant and in thecapacities and on the dates indicated.
| ** **                 | **Signature** | ** **                                    | ** ** | ** **          | **Capacity** | ** ** | ** ** | ** ** | **Date** | ** ** |
|----------------------------|---------------|-----------------------------------------------|------------|---------------------|--------------|------------|------------|------------|----------|------------|
| /s/  Narasimhan P. Kannan  |          | Chairman  and Chief  Executive Officer   |       | March 30, 2004 |
| Narasimhan P. Kannan       |          | (Principal Executive  Officer)           |       |                |
| /s/  Christopher L. Nelson |          | Chief  Financial Officer                      |       | March 30, 2004 |
| Christopher L. Nelson      |          | (Principal Financial and  Accounting Officer) |       |                |
| /s/  Edson D. deCastro     |          | Director                                      |       | March 30, 2004 |
| Edson D. deCastro          |          |                                          |       |                |
| /s/  William E. Kimberly   |          | Director                                      |       | March 30, 2004 |
| William E. Kimberly        |          |                                          |       |                |
| /s/  Martin E. Maleska     |          | Director                                      |       | March 30, 2004 |
| Martin E. Maleska          |          |                                          |       |                |
| /s/  John D. Sears         |          | Director                                      |       | March 30, 2004 |
| John D. Sears              |          |                                          |       |                |
| /s/  Dennis J. Fischer     |          | Director                                      |       | March 30, 2004 |
| Dennis J. Fischer          |          |                                          |       |                |

 

39

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**VCAMPUSCORPORATION**

**INDEX TOCONSOLIDATED FINANCIAL STATEMENTS**
| Report  of Reznick Fedder & Silverman, Independent Auditors                                             |   | F-2  |   |
|------------------------------------------------------------------------------------------------------------------|--------|------|--------|
| Report  of Ernst & Young LLP, Independent Auditors                                                      |   | F-3  |   |
| Consolidated Balance Sheets as of  December 31, 2002 and 2003                                               |   | F-4  |   |
| Consolidated Statements of  Operations for the years ended December 31, 2001, 2002 and 2003                 |   | F-5  |   |
| Consolidated  Statements of Stockholders’ Equity for the years ended December 31,  2001, 2002 and 2003 |   | F-6  |   |
| Consolidated Statements of Cash  Flows for the years ended December 31, 2001, 2002 and 2003                 |   | F-10 |   |
| Notes to Consolidated Financial  Statements                                                                      |   | F-11 |   |
| Schedule  II—Valuation and Qualifying Account and Reserve                                                   |   | F-35 |   |

 

----

**INDEPENDENT AUDITORS’ REPORT**

Board of DirectorsVCampus Corporation

We have audited the accompanying consolidated balancesheet of VCampus Corporation and subsidiaries as of December 31, 2003, andthe related consolidated statements of operations, stockholders’ equity andcash flows for the year then ended. Our audit also included the financialstatement schedule for the year ended December 31, 2003 as listed inItem 15(a)2. These financial statements and schedule are theresponsibility of the Company’s management. Our responsibility is to express anopinion on these financial statements and schedule based on our audit. Thefinancial statements and financial statement schedule of the VCampusCorporation and subsidiaries as of December 31, 2002 and for each of thetwo years in the period ended December 31, 2002 were audited by other auditorswhose report dated March 14, 2003, except for Note 17, as to which datewas March 28, 2003, expressed an unqualified opinion on those statements.

We conducted our audit in accordance with auditingstandards generally accepted in the United States of America. Those standards requirethat we plan and perform the audit to obtain reasonable assurance about whetherthe financial statements are free of material misstatement. An audit includesexamining, on a test basis, evidence supporting the amounts and disclosures inthe financial statements and schedule. An audit also includes assessing theaccounting principles used and significant estimates made by management, andevaluating the overall presentation of the financial statements and schedule.We believe that our audit provides a reasonable basis for our opinion.

In our opinion, the consolidatedfinancial statements referred to above present fairly, in all materialrespects, the financial position of VCampus Corporation and subsidiaries at December 31,2003, and the results of their operations and their cash flows for the yearthen ended in conformity with accounting principles generally accepted in theUnited States of America. In addition, in our opinion, the financial statementschedule for the year ended December 31, 2003 presents fairly, in allmaterial respects, the information set forth therein.
|   | /s/ Reznick,  Fedder & Silverman |
|--------|--------------------------------------|

 

Bethesda, MarylandMarch 5, 2004, except for note 15, as to which the date is March 23,2004

F-2

----

**REPORT OF ERNST & YOUNG LLP, INDEPENDENTAUDITORS**

Board of DirectorsVCampus Corporation

We have audited the accompanying consolidated balancesheets of VCampus Corporation as of December 31, 2002, and the relatedconsolidated statements of operations, stockholders’ equity, and cash flows foreach of the two years in the period ended December 31, 2002. Our auditsalso included the financial statement schedule listed in the Index atItem 15(a). These financial statements and schedule are the responsibilityof the Company’s management. Our responsibility is to express an opinion onthese financial statements and schedule based on our audits.

We conducted our audits in accordance with auditingstandards generally accepted in the United States. Those standards require thatwe plan and perform the audit to obtain reasonable assurance about whether thefinancial statements are free of material misstatement. 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 financial statements referred toabove present fairly, in all material respects, the consolidated financialposition of VCampus Corporation at December 31, 2002, and the consolidatedresults of its operations and its cash flows for each of the two years in theperiod ended December 31, 2002, in conformity with accounting principlesgenerally accepted in the United States. Also, in our opinion, the relatedfinancial statement schedule, when considered in relation to the basicfinancial statements taken as a whole, presents fairly in all material respectsthe information set forth therein.

As discussed in Note 2and Note 6 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.” As discussed in Note 2,effective April 1, 2002, VCampus Corporation adopted Statement ofFinancial Accounting Standards, No. 145 “Rescission of FASB Statements No. 4,44 and 64, Amendment of FASB Statement No. 13 and Technical Corrections.”

**/s/ ERNST & YOUNG LLP**

McLean, VirginiaMarch 14, 2003, except for Note 17, as to which the date is March 28,2003

F-3

----

**VCAMPUSCORPORATIONCONSOLIDATED BALANCE SHEETS**
| ** **                                                                                                                                                                                                                                                                                                     | ** ** | **December 31  2002** | ** ** | **December 31  2003** | ** ** |
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|----------------------------|------------|----------------------------|------------|
| ASSETS                                                                                                                                                                                                                                                                                                         |       |                       |       |                       |       |
| Current assets:                                                                                                                                                                                                                                                                                                |       |                       |       |                       |       |
| Cash and cash  equivalents                                                                                                                                                                                                                                                                                     |       | $                          | 727,466    |                       | $          | 534,984 |   |
| Accounts  receivable, less allowance of $31,000 and $5,000 at December 31, 2002  and 2003, respectively                                                                                                                                                                                                   |       | 354,340                    |       | 290,530                    |       |
| Loans receivable  from related party                                                                                                                                                                                                                                                                           |       | 116,753                    |       | 83,745                     |       |
| Loans receivable—current                                                                                                                                                                                                                                                                                  |       | 38,689                     |       | 40,526                     |       |
| Prepaid expenses  and other current assets                                                                                                                                                                                                                                                                     |       | 659,587                    |       | 691,781                    |       |
| Total current  assets                                                                                                                                                                                                                                                                                          |       | 1,896,835                  |       | 1,641,566                  |       |
| Property and  equipment, net                                                                                                                                                                                                                                                                                   |       | 328,296                    |       | 509,662                    |       |
| Capitalized  software costs and courseware development costs, net                                                                                                                                                                                                                                              |       | 814,730                    |       | 1,653,295                  |       |
| Loans receivable—less  current portion                                                                                                                                                                                                                                                                    |       | 65,502                     |       | 33,726                     |       |
| Other assets                                                                                                                                                                                                                                                                                                   |       | 190,446                    |       | 127,598                    |       |
| Other intangible  assets, net                                                                                                                                                                                                                                                                                  |       | 748,492                    |       | 569,494                    |       |
| Goodwill                                                                                                                                                                                                                                                                                                       |       | 328,317                    |       | 328,317                    |       |
| Total assets                                                                                                                                                                                                                                                                                                   |       | $                          | 4,372,618  |                       | $          | 4,863,658 |   |
| LIABILITIES AND STOCKHOLDERS’ EQUITY                                                                                                                                                                                                                                                                      |       |                       |       |                       |       |
| Current liabilities:                                                                                                                                                                                                                                                                                           |       |                       |       |                       |       |
| Accounts payable                                                                                                                                                                                                                                                                                               |       | $                          | 950,262    |                       | $          | 1,222,987 |   |
| Accrued expenses                                                                                                                                                                                                                                                                                               |       | 827,860                    |       | 369,763                    |       |
| Capital lease obligation                                                                                                                                                                                                                                                                                       |       | 23,529                     |       | —                     |       |
| Notes payable                                                                                                                                                                                                                                                                                                  |       | 140,159                    |       | 225,000                    |       |
| Deferred revenues                                                                                                                                                                                                                                                                                              |       | 783,003                    |       | 1,010,563                  |       |
| Total current  liabilities                                                                                                                                                                                                                                                                                     |       | 2,724,813                  |       | 2,828,313                  |       |
| Commitments and  contingencies:                                                                                                                                                                                                                                                                                |       | —                     |       | —                     |       |
| Stockholders’ equity:                                                                                                                                                                                                                                                                                     |       |                       |       |                       |       |
| Series C  convertible Preferred Stock, $0.01 par value per share; aggregate liquidation  preference of $7,910,172 and $0 at December 31, 2002 and 2003,  respectively; 1,000,000 shares authorized; 623,339 and 0 shares issued and  outstanding at December 31, 2002 and 2003, respectively    |       | 6,233                      |       | —                     |       |
| Series D  convertible Preferred Stock, $0.01 par value per share; aggregate liquidation  preference of $8,363,924 and $0 at December 31, 2002 and 2003,  respectively; 1,200,000 shares authorized; 1,013,809 and 0 shares issued and  outstanding at December 31, 2002 and 2003, respectively  |       | 10,138                     |       | —                     |       |
| Series E  convertible Preferred Stock, $0.01 par value per share; aggregate liquidation  preference of $1,816,668 and $0 at December 31, 2002 and 2003,  respectively; 3,000,000 shares authorized; 574,895 and 0 shares issued and  outstanding at December 31, 2002 and 2003, respectively    |       | 5,749                      |       | —                     |       |
| Series F  convertible Preferred Stock, $0.01 par value per share; aggregate liquidation  preference of $1,050,000 and $0 at December 31, 2002 and 2003,  respectively; 3,000,000 shares authorized; 3,000,000 and 0 shares issued and  outstanding at December 31, 2002 and 2003, respectively  |       | 30,000                     |       | —                     |       |
| Series F-1  convertible Preferred Stock, $0.01 par value per share; aggregate liquidation  preference of $510,445 and $0 at December 31, 2002 and 2003,  respectively; 1,458,413 shares authorized; 1,458,413 and 0 shares issued and  outstanding at December 31, 2002 and, 2003, respectively |       | 14,584                     |       | —                     |       |
| Series F-2  convertible Preferred Stock, $0.01 par value per share; aggregate liquidation  preference of $965,230 and $0 at December 31, 2002 and 2003,  respectively; 60,000 shares authorized; 27,578 and 0 shares issued and  outstanding at December 31, 2002 and 2003, respectively        |       | 276                        |       | —                     |       |
| Series G  convertible Preferred Stock, $0.01 par value per share; aggregate liquidation  preference of $1,091,652 and $0 at December 31, 2002 and 2003,  respectively; 80,000 shares authorized; 49,320 and 0 shares issued and  outstanding at December 31, 2002 and 2003, respectively        |       | 492                        |       | —                     |       |
| Common Stock,  $0.01 par value per share; 36,000,000 shares authorized; 1,573,904 and  5,167,000 shares issued and outstanding at December 31, 2002 and 2003,  respectively                                                                                                                               |       | 15,739                     |       | 51,670                     |       |
| Additional paid-in  capital                                                                                                                                                                                                                                                                                    |       | 85,771,622                 |       | 92,376,579                 |       |
| Accumulated  deficit                                                                                                                                                                                                                                                                                           |       | (84,207,028                | )          | (90,392,904                | )          |
| Total  stockholders’ equity                                                                                                                                                                                                                                                                               |       | 1,647,805                  |       | 2,035,345                  |       |
| Total liabilities  and stockholders’ equity                                                                                                                                                                                                                                                               |       | $                          | 4,372,618  |                       | $          | 4,863,658 |   |

 

The accompanyingnotes are an integral part of the consolidated financial statements.

F-4

----

 

**VCAMPUS CORPORATIONCONSOLIDATED STATEMENTS OF OPERATIONS**
| ** **                                     | ** ** | **Years ended December 31,** | ** ** |
|------------------------------------------------|------------|---------------------------------------------|------------|
| ** **                                     | ** ** | **2001**                                    | ** ** | **2002** | ** ** | **2003** | ** ** |
| Revenues:                                      |       |                                        |       |   |   |   |   |
| Online tuition revenues                        |       | $                                           | 5,781,285  |   | $ | 5,330,686 |   | $ | 5,508,154 |   |
| Virtual campus software revenues               |       | 71,863                                      |       | — |   | — |   |
| Online development and other revenues          |       | 687,232                                     |       | 495,425 |   | 448,082 |   |
| Product sales revenues                         |       | 45,038                                      |       | — |   | — |   |
| Other service revenues                         |       | 121,750                                     |       | 100,035 |   | 109,799 |   |
| Instructor-led training revenues               |       | 102,584                                     |       | — |   | — |   |
| Net revenues                                   |       | 6,809,752                                   |       | 5,926,146 |   | 6,066,035 |   |
| Costs and expenses:                            |       |                                        |       |   |   |   |   |
| Cost of revenues                               |       | 1,093,285                                   |       | 1,461,663 |   | 1,718,340 |   |
| Sales and marketing                            |       | 4,553,250                                   |       | 2,689,136 |   | 2,137,791 |   |
| Product development and operations             |       | 2,273,145                                   |       | 2,535,849 |   | 2,474,856 |   |
| General and administrative                     |       | 2,044,716                                   |       | 1,692,851 |   | 1,909,814 |   |
| Depreciation and amortization                  |       | 2,154,152                                   |       | 1,355,837 |   | 879,966 |   |
| Reorganization and other non-recurring charges |       | 187,762                                     |       | 192,000 |   | 172,729 |   |
| Stock-based compensation                       |       | 440,898                                     |       | 76,172 |   | 126,056 |   |
| Total costs and  expenses                      |       | 12,747,208                                  |       | 10,003,508 |   | 9,419,552 |   |
| Loss from  operations                          |       | (5,937,456                                  | )          | (4,077,362 | ) | (3,353,517 | ) |
| Other income                                   |       | —                                      |       | 421,842 |   | 207,138 |   |
| Interest income  (expense)                     |       | 4,563                                       |       | (220,145 | ) | (112,644 | ) |
| Loss on debt  extinguishment                   |       | —                                      |       | (503,246 | ) | — |   |
| Net loss                                       |       | (5,932,893                                  | )          | (4,378,911 | ) | (3,259,023 | ) |
| Dividends to  preferred stockholders           |       | (649,147                                    | )          | (2,768,394 | ) | (2,926,854 | ) |
| Net loss  attributable to common stockholders  |       | $                                           | (6,582,040 | ) | $ | (7,147,305 | ) | $ | (6,185,877 | ) |
| Basic and diluted net  loss per share          |       | $                                           | (5.23      | ) | $ | (4.79 | ) | $ | (1.81 | ) |

 

The accompanying notes are an integral part of the consolidatedfinancial statements.

F-5

----

 

**VCAMPUSCORPORATIONCONSOLIDATED 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, 2000                                                                               |       | 623,339                                              |       | $                                                    | 6,233      |                                                 | 1,070,643  |   | $ | 10,706 |   | 574,557 |   | $ | 5,746 |   |
| Issuance of Series E convertible Preferred Stock                                                           |       | —                                               |       | —                                               |       | —                                               |       | — |   | 187,500 |   | 1,875 |   |
| Issuance of Preferred Stock-Series E  dividends                                                            |       | —                                               |       | —                                               |       | —                                               |       | — |   | 89,472 |   | 895 |   |
| Issuance of Series F convertible Preferred Stock                                                           |       | —                                               |       | —                                               |       | —                                               |       | — |   | — |   | — |   |
| Issuance of Common Stock                                                                                        |       | —                                               |       | —                                               |       | —                                               |       | — |   | — |   | — |   |
| Conversion of Preferred Stock to Common Stock                                                                   |       | —                                               |       | —                                               |       | (56,834                                              | )          | (568 | ) | (306,454 | ) | (3,065 | ) |
| Issuance of Common Stock primarily in connection with  conversion of debt to equity                             |       | —                                               |       | —                                               |       | —                                               |       | — |   | — |   | — |   |
| Issuance of common stock-Series D  dividends                                                               |       | —                                               |       | —                                               |       | —                                               |       | — |   | — |   | — |   |
| Exercise of options and warrants                                                                                |       | —                                               |       | —                                               |       | —                                               |       | — |   | — |   | — |   |
| Stock, stock options and warrants issued for services  and in connection with debt and equity offerings         |       | —                                               |       | —                                               |       | —                                               |       | — |   | — |   | — |   |
| Net loss                                                                                                        |       | —                                               |       | —                                               |       | —                                               |       | — |   | — |   | — |   |
| Dividends on convertible preferred stock                                                                        |       | —                                               |       | —                                               |       | —                                               |       | — |   | — |   | — |   |
| 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                                                                              |       | —                                               |       | $                                                    | —     |                                                 | —     |   | $ | — |   | — |   | $ | — |   |

 

F-6

----

 

**VCAMPUS CORPORATIONCONSOLIDATED 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, 2000                                                                               |       | —                                               |       | $                                                      | —     |                                                   | —     |   | $ | — |   | — |   |   | $ | — |   |   |
| Issuance of Series E convertible Preferred Stock                                                           |       | —                                               |       | —                                                 |       | —                                                 |       | — |   | — |   |   | — |   |   |
| Issuance of Preferred Stock-Series E  dividends                                                            |       | —                                               |       | —                                                 |       | —                                                 |       | — |   | — |   |   | — |   |   |
| Issuance of Series F convertible Preferred Stock                                                           |       | 2,642,836                                            |       | 26,428                                                 |       | —                                                 |       | — |   | — |   |   | — |   |   |
| Issuance of Common Stock                                                                                        |       | —                                               |       | —                                                 |       | —                                                 |       | — |   | — |   |   | — |   |   |
| Conversion of Preferred Stock to Common Stock                                                                   |       | —                                               |       | —                                                 |       | —                                                 |       | — |   | — |   |   | — |   |   |
| Issuance of Common Stock primarily in connection with  conversion of debt to equity                             |       | —                                               |       | —                                                 |       | —                                                 |       | — |   | — |   |   | — |   |   |
| Issuance of common stock-Series D dividends                                                                |       | —                                               |       | —                                                 |       | —                                                 |       | — |   | — |   |   | — |   |   |
| Exercise of options and warrants                                                                                |       | —                                               |       | —                                                 |       | —                                                 |       | — |   | — |   |   | — |   |   |
| Stock, stock options and warrants issued for services  and in connection with debt and equity offerings         |       | —                                               |       | —                                                 |       | —                                                 |       | — |   | — |   |   | — |   |   |
| Net loss                                                                                                        |       | —                                               |       | —                                                 |       | —                                                 |       | — |   | — |   |   | — |   |   |
| Dividends on convertible preferred stock                                                                        |       | —                                               |       | —                                                 |       | —                                                 |       | — |   | — |   |   | — |   |   |
| 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                                                                              |       | —                                               |       | $                                                      | —     |                                                   | —     |   | $ | — |   | — |   |   | $ | — |   |   |

 

F-7

----

 

**VCAMPUS CORPORATIONCONSOLIDATED 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, 2000                                                                               |       | —                         |       |                           | $          | —                |       |             | —     |          |       | $ | — |   |   | 951,006 |   | $ | 9,510 |   | $ | 73,584,602 |   | $ | — |   |
| Issuance of  Series E convertible Preferred Stock                                                           |       | —                         |       |                           | —     |                  |       | —           |       |          | —     |   |   | — |   | — |   | 186,453 |   | — |   |
| Issuance of  Preferred Stock-Series E dividends                                                             |       | —                         |       |                           | —     |                  |       | —           |       |          | —     |   |   | — |   | — |   | (895 | ) | — |   |
| Issuance of  Series F convertible Preferred Stock                                                           |       | —                         |       |                           | —     |                  |       | —           |       |          | —     |   |   | — |   | — |   | 750,214 |   | (100,000 | ) |
| Issuance of Common  Stock                                                                                        |       | —                         |       |                           | —     |                  |       | —           |       |          | —     |   |   | 313,738 |   | 3,137 |   | 2,912,565 |   | — |   |
| Conversion of  Preferred Stock to Common Stock                                                                   |       | —                         |       |                           | —     |                  |       | —           |       |          | —     |   |   | 36,328 |   | 363 |   | 3,270 |   | — |   |
| Issuance of Common  Stock primarily in connection with conversion of debt to equity                              |       | —                         |       |                           | —     |                  |       | —           |       |          | —     |   |   | 118,378 |   | 1,184 |   | 1,156,554 |   | — |   |
| Issuance of common  stock-Series D dividends                                                                |       | —                         |       |                           | —     |                  |       | —           |       |          | —     |   |   | 49,461 |   | 495 |   | 278,298 |   | — |   |
| Exercise of  options and warrants                                                                                |       | —                         |       |                           | —     |                  |       | —           |       |          | —     |   |   | 85 |   | 1 |   | 101 |   | — |   |
| Stock, stock  options and warrants issued for services and in connection with debt and  equity offerings         |       | —                         |       |                           | —     |                  |       | —           |       |          | —     |   |   | 872 |   | 9 |   | 1,001,730 |   | — |   |
| Net loss                                                                                                         |       | —                         |       |                           | —     |                  |       | —           |       |          | —     |   |   | — |   | — |   | — |   | — |   |
| Dividends on  convertible preferred stock                                                                        |       | —                         |       |                           | —     |                  |       | —           |       |          | —     |   |   | — |   | — |   | 37,615 |   | — |   |
| 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 |   | $ | — |   |

 

F-8

----

 

**VCAMPUS CORPORATIONCONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY (Continued)**
| ** **                                                                                                       | ** ** | **Accumulated   Deficit** | ** **  | **Total   Stockholders’   Equity** | ** ** |
|------------------------------------------------------------------------------------------------------------------|------------|--------------------------------|-------------|---------------------------------------------------|------------|
| Balance at  December 31, 2000                                                                               |       | $                              | (70,585,416 | )                                                 | $          | 3,031,381 |   |
| Issuance of Series E  convertible Preferred Stock                                                           |       | —                         |        | 188,328                                           |       |
| Issuance of  Preferred Stock-Series E dividends                                                             |       | —                         |        | —                                            |       |
| Issuance of  Series F convertible Preferred Stock                                                           |       | —                         |        | 676,642                                           |       |
| Issuance of  Common Stock                                                                                        |       | —                         |        | 2,915,702                                         |       |
| Conversion of  Preferred Stock to Common Stock                                                                   |       | —                         |        | —                                            |       |
| Issuance of  Common Stock primarily in connection with conversion of debt to equity                              |       | —                         |        | 1,157,738                                         |       |
| Issuance of  common stock-Series D dividends                                                                |       | —                         |        | 278,793                                           |       |
| Exercise of  options and warrants                                                                                |       | —                         |        | 102                                               |       |
| Stock, stock  options and warrants issued for services and in connection with debt and  equity offerings         |       | (225,000                       | )           | 776,739                                           |       |
| Net loss                                                                                                         |       | (5,932,893                     | )           | (5,932,893                                        | )          |
| Dividends on  convertible preferred stock                                                                        |       | (316,414                       | )           | (278,799                                          | )          |
| 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 |   |

 

The accompanying notes are an integral part of the consolidatedfinancial statements.

F-9

----

**CAMPUS CORPORATIONCONSOLIDATED STATEMENTS OF CASH FLOWS**
| ** **                                                                                        | ** ** | **Years ended December 31,** | ** ** |
|---------------------------------------------------------------------------------------------------|------------|---------------------------------------------|------------|
| ** **                                                                                        | ** ** | **2001**                                    | ** ** | **2002** | ** ** | **2003** | ** ** |
| **Operating Activities**                                                                          |       |                                        |       |   |   |   |   |
| Net loss                                                                                          |       | $                                           | (5,932,893 | ) | $ | (4,378,911 | ) | $ | (3,259,023 | ) |
| Adjustments to reconcile  net loss to net cash used in operating activities:                      |       |                                        |       |   |   |   |   |
| Depreciation                                                                                      |       | 1,095,703                                   |       | 694,998 |   | 283,354 |   |
| Amortization                                                                                      |       | 1,058,449                                   |       | 660,839 |   | 596,611 |   |
| 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                                                   |       | 444,090                                     |       | 76,172 |   | 126,056 |   |
| Write-off of note receivable                                                                      |       | —                                      |       | 120,693 |   | — |   |
| Debt discount amortization                                                                        |       | —                                      |       | 214,574 |   | 84,841 |   |
| Decrease in allowance for doubtful accounts                                                       |       | (118,471                                    | )          | (68,386 | ) | (26,019 | ) |
| Changes  in operating assets and liabilities:                                                     |       |                                        |       |   |   |   |   |
| Accounts receivable                                                                               |       | 156,266                                     |       | 382,225 |   | 81,20789,829 |   |
| Prepaid expenses and other current assets                                                         |       | 93,746                                      |       | (438,353 | ) | (32,194 | ) |
| Other assets                                                                                      |       | 7,798                                       |       | 52,440 |   | 62,848 |   |
| Accounts payable and accrued expenses                                                             |       | (296,903                                    | )          | (543,645 | ) | (185,971 | ) |
| Deferred revenues                                                                                 |       | 238,322                                     |       | (220,889 | ) | 227,560 |   |
| Net cash used in operating activities                                                             |       | (3,253,893                                  | )          | (2,661,629 | ) | (2,032,108 | ) |
| **Investing Activities**                                                                          |       |                                        |       |   |   |   |   |
| Purchases of property and equipment                                                               |       | (32,863                                     | )          | (85,539 | ) | (464,720 | ) |
| Capitalized software and courseware development costs                                             |       | (453,257                                    | )          | (383,789 | ) | (1,255,579 | ) |
| Proceeds from loans receivable from related party                                                 |       | —                                      |       | 23,097 |   | 36,000 |   |
| Interest on loans receivable from related party                                                   |       | (8,001                                      | )          | (6,500 | ) | (2,992 | ) |
| Proceeds from loans receivable                                                                    |       | 63,267                                      |       | 37,085 |   | 35,000 |   |
| Advances under loans receivable                                                                   |       | (10,199                                     | )          | (6,792 | ) | (5,061 | ) |
| Net cash used in investing activities                                                             |       | (441,053                                    | )          | (422,438 | ) | (1,657,352 | ) |
| **Financing Activities**                                                                          |       |                                        |       |   |   |   |   |
| Proceeds from issuance of Common Stock                                                            |       | 2,763,701                                   |       | 1,096 |   | 905,330 |   |
| Proceeds from the issuance of Series E  convertible Preferred Stock                          |       | 188,328                                     |       | — |   | — |   |
| Proceeds from the issuance of Series F  convertible Preferred Stock, net of offering costs   |       | 752,642                                     |       | 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                                                             |       | (127,799                                    | )          | (206,069 | ) | (23,529 | ) |
| Proceeds from notes payable                                                                       |       | 1,902,641                                   |       | 100,000 |   | — |   |
| Net cash provided by financing activities                                                         |       | 5,479,513                                   |       | 1,783,762 |   | 3,496,978 |   |
| Net increase (decrease) in cash and cash equivalents                                              |       | 1,784,567                                   |       | (1,300,305 | ) | (192,482 | ) |
| Cash and cash equivalents at the beginning of the  year                                           |       | 243,204                                     |       | 2,027,771 |   | 727,466 |   |
| Cash and cash equivalents at the end of the year                                                  |       | $                                           | 2,027,771  |   | $ | 727,466 |   | 534,984 |   |
| **Supplemental  cash flow information:**                                                          |       |                                        |       |   |   |   |   |
| Interest paid                                                                                     |       | $                                           | —     |   | $ | — |   | $ | — |   |

 

The accompanying notes are an integral part of theconsolidated financial statements.

F-10

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**VCAMPUSCORPORATIONNOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

**1. Organization andNature of Operations**

VCampus Corporation (the “Company”)was incorporated in Virginia in 1984 and reincorporated in Delaware in 1985. TheCompany is an e-learning Application Services Provider, or ASP, that managesand hosts turnkey, Internet-based learning environments for corporations,government agencies, institutions of higher education, and associations. TheCompany has developed proprietary software for the creation and hosting of avirtual campus, or “vcampus,” that enables its customers to offer Internet-basedtraining to their customers, sales channel partners, employees and students. TheCompany’s services cover a broad range of e-learning programs, from enrollmentand payment to course development and delivery, as well as tracking of students’progress and reporting of the results.

**2. Summary ofSignificant Accounting Policies**

*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 accepted accountingprinciples requires management to make estimates and assumptions that affectthe reported amounts of assets and liabilities and disclosure of contingentassets and liabilities at the date of the consolidated financial statements andthe reported amounts of revenues and expenses during the reporting period.Actual results could differ from those estimates.

*Cash Equivalents*

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

*Non-Cash FinancingActivities*

In August 2001, the Company issued 10,000 sharesof its common stock with a value of $152,000 to a third party who assisted theCompany with its financing activities. Upon completion of the December 2001debt and equity financing, $76,000 of the total value of the shares wasallocated to the Series F Preferred Stock offering as an equity issuancecost. The remaining amount was allocated to the 8% debentures as deferred debtissuance costs and was recognized as interest expense over the period thedebentures were outstanding.

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 shares of Series G Preferred Stock with anaggregate value of $8,927 and five-year fully vested warrants to purchase 564shares of common stock with an exercise price of $2.99 per share to a placementagent in connection with private placement of its Series G Preferred 

F-11

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Stock. As this was aplacement of preferred stock, the fair value of the common stock and warrantsissued to the placement agent was accounted for as cost of capital.

In September andOctober 2003, the Company issued an aggregate of 27,711 shares ofits common stock with an aggregate value of $71,771 and three-year fully vestedwarrants to purchase 27,711 shares of common stock with an exercise price of$2.59 per share to a placement agent in connection with the financingscompleted in that period. As this was a placement of common stock, the fairvalue of the common stock and warrants issued to the placement agent wasaccounted for as 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.

*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 for the years ended December 31, 2001, 2002 and 2003.

*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 or estimateduseful life. Depreciation expense onequipment 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.

*CapitalizedSoftware and Courseware Development Costs*

During 2001, 2002 and 2003, theCompany capitalized certain software and courseware development costs. TheCompany capitalizes the cost of software used for internal operationsonce technological feasibility of the software has been demonstrated. The Company capitalizes costs incurred during thedevelopment process, including payroll costs for employees who are directlyassociated with the development process and services performed by consultants.Amortization of such costs is based on the greater of (1) the ratio ofcurrent gross revenues to the sum of current and anticipated gross revenues, or(2) the straight-line method over the remaining economic life of thevcampus or courseware, typically two to three years. It is possible that thoseanticipated gross revenues, the remaining economic life of the products, orboth, may be reduced as a result of future events. During 2001, 2002 and 2003,the Company recognized amortization of capitalized software and coursewaredevelopment costs of $533,931, $438,754 and $417,613, respectively. During2002, the Company wrote off $276,535 in capitalized software and coursewaredevelopment costs for courses within the telecommunications industry segmentdetermined to have no future value. The write-off, 

F-12

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which represents the carrying value of the courses, hasbeen included in product development costs in 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”). The implementation of EITF 00-2 did not have amaterial impact on the Company’s financial position or results of operations.In 2001, 2002 and 2003 all web site development costs were incurred in theoperating stage, including maintenance and minor enhancements and upgrades, andwere 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 goodwill. Amortization of goodwill, including goodwill previouslyidentified as a workforce intangible, ceased on January 1, 2002. TheCompany does not have any indefinite-lived intangibles. In accordancewith SFAS 142, the Company reviewed the useful lives of its intangibleassets 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 each reportingunit. The Company then determined the fair value of the reporting unit andcompared 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 31,2003, and concluded that no impairment charge was required.

*Impairment ofLong-Lived Assets*

The Companyaccounts for long-lived assets in accordance with the provisions of SFAS No. 144,*Accounting for the Impairment or Disposal ofLong-Lived Assets* (SFAS No. 144). SFAS No. 144 requiresthat long-lived assets and certain identifiable intangibles be reviewed forimpairment whenever events or changes in circumstances indicate that thecarrying amount of an asset may not be recoverable. 

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Recoverability of assetsis measured by comparing the carrying amount of an asset to future undiscountednet cash flows expected to be generated by the asset. If such assets areconsidered to be impaired, the impairment to be recognized is measured by theamount by which the carrying amount of the assets exceeds the fair value of theassets. Assets to be disposed of by sale are reflected at the lower of theircarrying amount or fair value 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 corporate 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. 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 2001 and 2002 two customers individuallyrepresented 17% and 11% and 28% and 12%, respectively, of net revenues. In2003, three customers individually accounted for approximately 36%, 18% and15%, respectively, of net 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”).

F-14

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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.

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.
| ** **                                                                                                          | ** ** | **2001**   | ** **  | **2002**   | ** ** | **2003**    | ** ** |
|---------------------------------------------------------------------------------------------------------------------|------------|------------|-------------|------------|------------|-------------|------------|
| Pro forma net  loss:                                                                                                |       |       |        |       |       |        |       |
| As reported                                                                                                         |       | $          | (6,582,040  | )          | $          | (7,147,305  | )          | $ | (6,185,877 | ) |
| Add: Non cash stock compensation included in  reported net loss attributable to common stockholders                 |       | 440,898    |        | 76,172     |       | 126,056     |       |
| Deduct: Total employee non cash stock compensation  expense determined under fair value based method for all awards |       | (5,501,385 | )           | (4,996,214 | )          | (5,486,954  | )          |
| Pro forma net  loss                                                                                                 |       | $          | (11,642,527 | )          | $          | (12,067,347 | )          | $ | (11,546,775 | ) |
| Net loss per  common share:                                                                                         |       |       |        |       |       |        |       |
| Basic and diluted—as reported                                                                                  |       | $          | (5.23       | )          | $          | (4.79       | )          | $ | (1.81 | ) |
| Basic and diluted—pro  forma                                                                                   |       | $          | (9.25       | )          | $          | (8.08       | )          | $ | (3.37 | ) |

 

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:
| ** **                       | ** ** | **2001** | ** ** | **2002** | ** ** | **2003** | ** ** |
|----------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Dividend yield                   |       | 0        | %          | 0        | %          | 0        | %          |
| Volatility                       |       | 133      | %          | 133      | %          | 126      | %          |
| Average risk-free  interest rate |       | 4.78     | %          | 4.39     | %          | 3.52     | %          |
| Expected term                    |       | 7 years  |       | 7 years  |       | 7 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.

One customer represented19% of accounts receivable at December 31, 2002. Three customersrepresented 18%, 13% and 26% of accounts receivable at December 31, 2003.

*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.

F-15

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*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.

Royalties are classifiedas a cost of revenues and amounted to approximately $675,000, $1,325,000 and$1,530,000 during the years ended December 31, 2001, 2002 and 2003,respectively.

*Advertising Costs*

The Company expensesadvertising costs as incurred. Advertising costs amounted to approximately$49,000, $0 and $0 for the years ended December 31, 2001, 2002, and 2003respectively.

*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*

The Company follows theprovisions of SFAS No. 128, *Earningsper Share* (“SFAS No. 128”) which requires the Company topresent basic and diluted earnings per share. Basic earnings per share is basedon the weighted-average shares outstanding and excludes any dilutiveeffects of options, warrants and convertible securities. Diluted earnings pershare increases the shares used in the basic calculation by the dilutive effectof stock options, warrants, and convertible preferred stock. For all yearspresented, common stock equivalents related to stock options, warrants, and convertiblepreferred stock have been excluded from diluted earnings per share becausetheir effect is anti-dilutive.

*Recent AccountingPronouncements*

In April 2003, the FASB issued SFAS No. 149(“SFAS No. 149”), *Amendment of Statement 133on Derivative Instruments and Hedging Activities*. SFAS No. 149amends and clarifies financial accounting and reporting for derivativeinstruments, including certain derivative instruments embedded in othercontracts (collectively referred to as derivatives) and for hedging activitiesunder SFAS No. 133. SFAS No. 149 is effective for contracts enteredinto or modified after June 30, 2003, and hedging relations designatedafter June 30, 2003, except for those provisions of SFAS No. 149,which relate to SFAS No. 133 implementation issues that have beeneffective for fiscal quarters that began prior to June 15, 2003. For thoseissues, the provisions that are currently in effect should continue to beapplied in accordance with their respective effective dates. In addition,certain provisions of SFAS No. 149, which relate to forward purchases orsales of when-issued securities or other securities that do not yet exist,should be applied to both existing contracts and new contracts entered intoafter June 30, 2003. The adoption of SFAS No. 149 did not have amaterial effect the Company’s consolidated financial statements.

In May 2003, the FASB issued SFAS No. 150 (“SFASNo. 150”), *Accounting for Certain Instruments withCharacteristics of both Liabilities and Equity*. SFAS No. 150establishes standards for how an issuer classifies and measures certainfinancial instruments with characteristics of both liabilities and equity. 

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SFAS No. 150 requiresthat an issuer classify a financial instrument that is within the scope of SFASNo. 150 as a liability. SFAS No. 150 is effective for financialinstruments entered into or modified after May 31, 2003, and otherwise iseffective for the Company beginning September 1, 2003. The adoption ofSFAS No. 150 did not have a material effect on the Company’s consolidatedfinancial statements.

In July 2003, the EITF reached a consensus onIssue 03-7 ( EITF 03-7 ), *Accounting for theSettlement of the Equity-Settled Portion of a Convertible Debt Instrument thatPermits or Requires the Conversion Spread to be Settled in Stock*(Instrument C of EITF Issue No. 90-19, Convertible Bonds with IssuerOption to Settle for Cash upon Conversion ). The consensus was reached thatupon settlement of a security with the characteristics of Instrument C in Issue90-19 by payment of the accreted value of the obligation (recognizedliability) in cash and settlement of the conversion spread (unrecognized equityinstrument) with stock, only the cash payment should be considered in thecomputation of gain or loss on extinguishment of the recognized liability. Thatis, any shares transferred to settle the embedded equity instrument (referredto as the excess conversion spread in Issue 90-19) would not beconsidered in the settlement of the debt component. This consensus is effectivefor settlement transactions entered into on or after the beginning of the Company’sfirst interim period beginning after August 13, 2003. The Company does notexpect the adoption of EITF 03-7 to have a material impact on itsfinancial position or results of operations.

In December 2003, theSEC issued Staff Accounting Bulletin No. 104, *Revenue Recognition* (“SAB 104”) which revises or rescindscertain sections of Staff Accounting Bulletin No. 101, *Revenue Recognition in**Financial Statements*(“SAB 101”), in order to make this interpretive guidance consistent withcurrent authoritative accounting and auditing guidance and SEC rules andregulations. The changes noted in SAB 104 did not have a material effect on theCompany’s financial position and results of operations.

*Risks anduncertainties*

The Company is subject toall of the risks inherent in a company that operates in the intenselycompetitive Internet industry, providing a service is relatively new andconstantly evolving. These risks include, but are not limited to**,**market acceptance of the Company’sproducts and services, and reliance on third-party software incorporated in theCompany’s products. the Company’s operating results may be materially affectedby the foregoing factors.

*Management’s Plans*

The Company has incurred significant losses in thecurrent and prior periods. The Company expects negative cash flow fromoperations to continue until the online revenue stream matures. The Companybelieves it has adequate capital from the March 2004 financing and accessto adequate additional resources to fund operations through 2004 and into 2005.However, in the event revenues do not meet anticipated levels or the Company isunable to raise additional funding to meet working capital requirements, theCompany may need to further reduce operating expenses. If the Company is unableto raise additional funding to meet working capital requirements, it may beunable to maintain compliance with Nasdaq SmallCap market listing requirements.The Company believes it has available capital on hand and sources foradditional debt or equity capital in amounts necessary to, in addition tooperating sources, meet its cash needs through 2004. However, such capital, ifneeded and available may not have terms favorable to the Company or its currentstockholders. Furthermore, the terms of the debt and equity financing conductedin March 2004, which includes antidilution protection, may significantlyhinder the Company’s ability to raise further capital in the future. SeeNote 15.

If the Company does notaddress 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 services,customer demands for technology upgrades, the 

F-17

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types ofarrangements that the Company may enter into with customers and agents, and theextent to which the Company invests in new technology and research anddevelopment projects.

*Reclassifications*

Certain revenues and corresponding expenses includedin these financial statements have been reclassified from the presentation inprior periods.

While this reclassification causes revenues andexpenses reported herein to be lower than previously reported, it has no impacton previously reported assets, liabilities or net loss.

The effect of thisreclassification was to reduce Revenues, and Sales and Marketing Expenses by $275,528and $163,479 for the years ended December 31, 2002 and 2001, respectively.

**3. Property and Equipment**

Propertyand equipment consisted of the following:
| ** **                     | ** ** | **December 31,** | ** ** |
|--------------------------------|------------|-----------------------|------------|
| ** **                     | ** ** | **2002**              | ** ** | **2003** | ** ** |
| Equipment                      |       | $                     | 3,265,065  |   | $ | 3,396,281 |   |
| Computer software              |       | 973,286               |       | 1,304,550 |   |
| Leasehold  improvements        |       | 152,118               |       | 154,358 |   |
| Furniture and  fixtures        |       | 572,218               |       | 572,218 |   |
|                           |       | 4,962,687             |       | 5,427,407 |   |
| Less accumulated  depreciation |       | (4,634,391            | )          | (4,917,745 | ) |
| Total                          |       | $                     | 328,296    |   | $ | 509,662 |   |

 

Equipment recorded undercapital lease obligations aggregated $387,662 at December 31, 2002.Accumulated depreciation of assets under capital lease obligations totaled$325,932 at December 31, 2002. At December 31, 2003, the Company hadno equipment under capital lease obligations.

**4. Capitalized Softwareand Courseware Development Costs**

Capitalizedsoftware and courseware development costs consisted of the following:
| ** **                                | ** ** | **December 31,** | ** ** |
|-------------------------------------------|------------|-----------------------|------------|
| ** **                                | ** ** | **2002**              | ** ** | **2003** | ** ** |
| Capitalized software costs                |       | $                     | 3,584,243  |   | $ | 4,678,902 |   |
| Capitalized  courseware development costs |       | 937,724               |       | 1,098,644 |   |
|                                      |       | 4,521,967             |       | 5,777,546 |   |
| Less accumulated  amortization            |       | (3,707,237            | )          | (4,124,251 | ) |
| Total                                     |       | $                     | 814,730    |   | $ | 1,653,295 |   |

 

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**5. Goodwill and OtherIntangible Assets**

Otherintangible assets were comprised of:
| ** **                     | ** ** | **December 31,** | ** ** |
|--------------------------------|------------|-----------------------|------------|
| ** **                     | ** ** | **2002**              | ** ** | **2003** | ** ** |
| 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 |       | (984,848              | )          | (1,163,846 | ) |
|                           |       | $                     | 748,492    |   | $ | 569,494 |   |

 

Amortizationexpense for other intangible assets is expected to be as follows:
| 2004       |   | $178,991 |    |
|------------|--------|----------|---------|
| 2005       |   | 133,490  |    |
| 2006       |   | 110,740  |    |
| 2007       |   | 66,078   |    |
| 2008       |   | 43,747   |    |
| Thereafter |   | 36,448   |    |
|       |   | $        | 569,494 |   |
|            |        |          |         |  |

 

Amortization expense related to intangible assetssubject to amortization totaled $361,693, $215,855 and $178,998 at December 31,2001 2002 and 2003, respectively.

Withthe adoption of SFAS 142, amortization of goodwill was discontinued as of January 1,2002. The following information reconciles reported net loss attributable tocommon stockholders to adjusted net loss, including goodwill amortizationpreviously recorded.
| ** **                                                  | ** ** | **2001** | ** ** |
|-------------------------------------------------------------|------------|----------|------------|
| Pro forma net  loss:                                        |       |     |       |
| As reported                                                 |       | $        | (6,582,040 | ) |
| Impact of SFAS 142                                          |       | 128,447  |       |
| Pro forma net  loss                                         |       | $        | (6,453,593 | ) |
| Pro forma net  loss per common share—basic and diluted |       | $        | (5.13      | ) |

 

**6. Restructuring ofOperations and Other Non-Recurring Items**

During 2000, the Company implemented a plan to closecertain office facilities related to HTR’s non-online business. The planresulted in the closure of the Company’s facilities located in Dallas, Texas,Rockville, Maryland and Washington, D.C. As a result, the Company recorded arestructuring charge of approximately $335,000 in 2000 included inreorganization and other non-recurring charges in the 2000 statement ofoperations. The restructuring charge included expenses related to facilitieslease cancellations and write-down of assets no longer in use. During 2000, theCompany paid no cash under the restructuring accrual. Included in accountspayable and accrued expenses at December 31, 2000 is approximately$335,000, primarily representing future lease termination payments. Alltermination fees were paid in the second quarter of 2001. The operatingactivities of the discontinued operations were not tracked separately by theCompany. During 2002, the Company recorded an additional expense of $192,000 toadjust its accrual related to the minimum amount due under a lease for HTR’sRockville, Maryland facility. In June 2003, the Company and the landlordat its Rockville, Maryland facility agreed to a settlement 

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regarding the leased spacethat the Company vacated in December 2000. During 2003, the Company paidthe landlord a total of $300,000 (plus a $24,000 security deposit retained bythe landlord) to terminate the lease agreement.

In December 2001, the employment agreementbetween the Company and its Chairman was terminated, resulting in $187,762 ofseverance related expense.

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.

**7. Loans Receivable fromRelated Party**

Loans receivable from aCompany officer are unsecured and amounted to $116,753 and $83,745 as of December 31,2002 and 2003, respectively. The Company accrues interest on the loansreceivable at a rate of prime less 1%. Interest income related to loansreceivable amounted to $8,001, $6,384 and $2,992 during the years ended December 31,2001, 2002 and 2003, respectively. Amounts repaid on loans receivable fromrelated parties were $0, $23,097 and $36,000 in 2001, 2002 and 2003,respectively.

**8. Notes Payable**

In February 2001, the Company secured $1,150,000of debt financing through the issuance of short-term notes bearing interest at10% to two directors of the Company. In connection with this financing, theCompany granted stock options for the purchase of 5,750 shares of common stockat $9.38 per share to the directors. The fair value of the options wasestimated at $47,150 using the Black-Scholes option pricing model and hasbeen included in stock-based compensation in the 2001 consolidatedstatement of operations. These notes were cancelled in March 2001 inexchange for an aggregate of 118,378 shares of common stock at a purchase priceof $9.78 per share and warrants to purchase an aggregate of 28,750 shares ofcommon stock at an exercise price of $10.76 per share. The warrants have athree year term and were fully vested upon issuance. The fair value of thewarrants was estimated at $212,750 using the Black-Scholes option pricingmodel and has been included in stock-based compensation in the 2001consolidated statements of operations.

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 debentures wereoutstanding. 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. The unamortizeddebt discount at December 31, 2002 and 2003 was $84,841 and $0,respectively. Principal and accrued interest under the debentures is due andpayable at December 31, 2003. The debentures are convertible into sharesof the Company’s common stock at the election of the holders at a conversionprice of $3.50 per share. Principal and accrued interest of $225,000 andapproximately $40,000 under the debentures were repaid in March 2004. SeeNote 15.

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**9. Commitments andContingencies**

*Leases*

The Company leases office space and office equipmentunder non-cancelable operating lease agreements with various renewal options.Future minimum lease payments may be periodically adjusted based on changes inthe lessors’ operating charges. Rent expense for the years ended December 31,2001, 2002 and 2003 was $486,479, $521,953 and $520,743, respectively.

As of December 31,2003, payments due under non-cancelable operating leases were as follows:
| 2004       |   | $       | 509,735   |   |
|------------|--------|---------|-----------|--------|
| 2005       |   | 525,027 |      |
| 2006       |   | 540,778 |      |
| 2007       |   | 557,001 |      |
| 2008       |   | 573,711 |      |
| Thereafter |   | 689,890 |      |
|       |   | $       | 3,396,143 |   |

 

*EmploymentAgreements*

The Company has enteredinto employment agreements with certain members of management. These agreementsspecify minimum annual salaries as well as discretionary bonus amounts to be paidover the next year.

*Purchase Commitment*

Effective December 15,2000 the Company entered into a three-year (subsequently amended to afour-year) agreement with a vendor to resell certain software. The agreement,as amended, specifies a minimum contract commitment of $650,000 over thefour-year period. Amounts paid under the agreement during the years ended December 31,2001, 2002 and 2003 were $143,000, $144,697 and $201,552, respectively.

*Litigation*

In June 2002, a former employee (separated in June 1998)filed suit against the Company in Dallas County, Texas. To avoid furtherlitigation expenses and the risk of an adverse ruling, in June 2003 theCompany paid the employee $99,999 in full settlement of all the claims,including the plaintiff’s attorneys’ fees.

In June 2003, the Company and the landlord at itsRockville, Maryland facility agreed to a settlement regarding the leased spacethat we had vacated in December 2000. The Company paid the landlord atotal of $300,000 (plus a $24,000 security deposit retained by the landlord) toterminate the lease agreement. As of December 31, 2002 the Company hadaccrued $253,051 for this liability on its balance sheet.

In 2002, the VirginiaDepartment of Taxation completed an audit of the Company’s sales and use taxpayments 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 

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July 2003,the assessment 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.

**10. Accrued Expenses**

Accruedexpenses consisted of the following:
| ** **                                      | ** ** | **December 31,** | ** ** |
|-------------------------------------------------|------------|-----------------------|------------|
| ** **                                      | ** ** | **2002**              | ** ** | **2003** | ** ** |
| Accrued royalties                               |       | $                     | 230,679    |   | — |   |
| Accrued payroll  and payroll taxes              |       | 62,333                |       | 23,010 |   |
| Accrued  reorganization and non recurring costs |       | 276,103               |       | — |   |
| Accrued vacation                                |       | 41,063                |       | 59,230 |   |
| Other                                           |       | 217,682               |       | 287,523 |   |
|                                            |       | $                     | 827,860    |   | 369,763 |   |

 

Accrued payroll as of December 31, 2002 and 2003primarily consists of earned but unpaid commissions and bonuses.

Accrued reorganization andnon recurring costs as of December 31, 2002 primarily consist of anaccrual in connection with the minimum payment due under a lease for HTR’sRockville, Maryland lease. See Note 6.

**11. Stockholders’ Equity**

*Stock Split*

On June 18, 2002, theCompany’s Board of Directors approved a one-for-ten reverse stock split of theCompany’s common stock. The reverse stock split became effective as of theopening of business on July 8, 2002. Stockholders’ equity has beenrestated to give retroactive recognition to the stock split for all periodspresented by reclassifying the excess par value resulting from the reducedaggregate number of shares from common stock to paid-in capital. All referencesto common shares and per share amounts for all periods presented have beenretroactively restated to reflect the stock split.

*Conversion ofPreferred Stock*

On June 6, 2003,pursuant to approvals obtained at its annual meeting of stockholders, togetherwith agreements signed by holders of its preferred stock, the Company convertedof all of the outstanding shares of each of its eight classes of preferredstock into a total of 3,007,453 shares of common stock. The conversions wereeffective on June 6, 2003 at conversion prices ranging from $2.196 to$69.82 per share. This recapitalization removed a total of approximately $24.3million of preferred stock liquidation preference that was formerly senior tothe outstanding common stock and released the Company from the obligation topay future dividends on the converted shares. As an incentive to induce theconversions, the Company issued warrants to the preferred stockholders topurchase a total of 451,445 shares of common stock at $3.85 per share. TheCompany valued the warrants using the Black-Scholes option pricing model andrecognized a deemed dividend of $1,042,838, which represents the excess of thefair value of the warrants issued over the fair value of the stock issuablepursuant to the original conversion terms of the 

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securities.As part 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 CPreferred Stock*

In March 1998, theCompany raised net proceeds of approximately $5,300,000 in a private placementof Series C Preferred Stock and warrants (the “Series C PreferredStock”). In this transaction, the Company issued approximately 626,300 sharesof the Series C Preferred Stock, which are convertible into approximately75,910 shares of common stock. The Company also issued five-year warrants,which were fully vested, to purchase approximately 62,630 shares of commonstock at an exercise price of $84.60 per share. The Series C Preferredstockholders were entitled to receive dividends if and when declared by theBoard 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 dividends ofapproximately $207,000 due to the Series C Preferred Stock beingconvertible to common stock at a discount from fair value on the date ofissuance. In 1999, 2,954 shares of Series C Preferred Stock were convertedinto 358 shares of common stock. In January 2003, 11,817 shares of Series CPreferred Stock were converted into 1,433 shares of common stock. On June 6,2003 the remaining 611,522 shares of Series C Preferred Stock wereconverted into 74,122 shares of common stock.

*Series DPreferred Stock*

In June 1998, the Company raised approximately$5,200,000 in net proceeds through its private placement of Series DPreferred Stock (the “Series D Preferred Stock”). In this transaction, theCompany issued 1,082,625 shares of the Series D Preferred Stock, which areconvertible to 108,263 common shares. The holders of Series D PreferredStock were entitled to receive a 5% annual dividend compounded and paidsemi-annually. Such dividends were payable, at the option of the Company,either in cash or in common stock. The Series D Preferred Stock had aliquidation preference of $8.25 per share plus all declared but unpaiddividends upon sale or liquidation of the Company.

In 2000 and 2001, 2,727 and 56,834 shares of Series DPreferred Stock were converted into 273 and 5,683 shares of common stock,respectively. No shares were converted during 2002. On June 6, 2003 theremaining 1,013,809 shares of Series D Preferred Stock were converted into101,381 shares of common stock.

In 2001 and 2002, theCompany issued 49,461 and 81,325 shares of common stock, respectively, to the Series DPreferred Stock holders as payment for accrued dividends. The number of sharesissued as payment of the dividends was determined based on the fair marketvalue of the Company’s common stock on the date of issuance. The value of suchshares amounted to $278,798 and $278,765 for 2001 and 2002, respectively.

*Series EPreferred Stock*

The Company entered into a Private Equity Line ofCredit Agreement (the “Equity Line Agreement”), as amended, with Hambrecht &Quist Guaranty Finance, LLC (“H&QGF”) effective May 4, 1999. Under theEquity Line Agreement, the Company had the right, subject to certainconditions, to issue and sell to H&QGF, from time to time, shares of its Series EConvertible Preferred Stock (“Series E Preferred Stock”), for cashconsideration of up to an aggregate of $7.0 million, subject toavailability. The Company had the right to sell to H&QGF shares of its Series EPreferred Stock at a price 

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equal to 85% of the lowerof (1) the closing market price of the Company’s common stock on the dateof issuance and (2) the average of the lowest intra-day prices of theCompany’s common stock over the five-day period ending on the date of issuance.Each ten shares of Series E Preferred Stock were convertible into oneshare of common stock. The holders of Series E Preferred Stock wereentitled to monthly dividends paid in Series E Preferred Stock, equal to0.5% of the number of shares of Series E Preferred Stock held. The valueof Series E Preferred Stock issued as dividends amounted to $107,733,$10,954 and $3,348 for 2001, 2002 and 2003, respectively.

In connection with the Equity Line Agreement, theCompany issued seven-year warrants, which were fully vested, to purchase100,000 shares of its Series E Preferred Stock to H&QGF at $2.50 pershare (subsequently adjusted to 1,138,440 shares at $0.2196 per share pursuantto anti-dilution rights), and ten-year warrants, which were fully vested, topurchase 10,000 shares of its common stock at $40.00 per share to a thirdparty. In March 2000, the Company granted H&QGF fully vested warrantsto purchase 43,632 shares of Series E Preferred Stock at an exercise priceof $8.50 per share (subsequently adjusted to 384,960 shares at $0.2196 pershare pursuant to anti-dilution rights) in exchange for an increase in capacityand extension of the equity line. These warrants expire in November 2006.In October 2000, the Company granted H&QGF fully vested, seven-yearwarrants to purchase 15,000 shares of Series E Preferred Stock at anexercise price of $1.94 per share (subsequently adjusted to 132,350 shares at$0.2196 per share pursuant to anti-dilution rights) in exchange for a furtherincrease and extension of the equity line.

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.

On June 6,2003 the remaining 584,835 shares of Series E Preferred Stock wereconverted into 58,484 shares of common stock. Additionally, the Companyissued a warrant to H&QGF to purchase 166,155 shares of common stock at$2.20 per share in exchange for the cancellation of H&QGF’s warrant topurchase an equivalent number of shares of Series E preferred stock at theequivalent exercise price.

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*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 1/10th of a share ofcommon 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 liquidationpreference of $0.35 per share plus all declared but unpaid dividends upon saleor liquidation 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 1/10th of a share ofcommon stock at any time at the election of the holder. The excess of the fairvalue of the Preferred Stock and warrants over the carrying value of the noteamounted to $267,488 and was recognized as a loss on debt extinguishment in March 2002.The carrying value of the debt at the time of its conversion was $324,392,excluding accrued interest of $10,445. The extinguishment of the debt resultedin the write-off of $50,121 in deferred debt issuance costs. The excess of thevalue of common stock into which the Series F Preferred Stock isconvertible over the amount allocated to the Preferred Stock amounted to$44,282. Such amount represented a beneficial conversion feature discount andwas 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 $48,128 based on the Black-Scholesoption-pricing model.

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 

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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 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 the debtresulted 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 1/10th ofa share of common stock at any time at the election of the holder. The proceedswere allocated to the Preferred Stock and the warrants based on their relativefair 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 $17,685. 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.

On June 6, 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 ofcommon stock at $2.42 per share. Each share of Series G Preferred Stockwas initially 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 

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Preferred Stock triggeredan antidilution adjustment in the conversion price of the Series F, F-1and F-2 Preferred Stock from $3.50 to $2.196. As result, the number ofcommon shares potentially issuable upon conversion of the Series F, F-1and F-2 Preferred Stock was increased from 721,620 to 1,150,124. theCompany recorded a deemed dividend of $1,499,762 in connection with thisadjustment.

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 theterms of this financing, the Company also issued five-year fully vested warrants to purchase 25,313 and 564 shares ofcommon stock at $4.35 per share to the same accredited investors and placementagent, 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 amount representeda beneficial 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 $82,267 using the Black-Scholes option pricing model.

In March 2003,the Company issued 18,370 shares of Series GPreferred Stock at a purchase price of $27.22 per share to accreditedinvestors. Under the terms of this financing, the Company also issued five-year fully vested warrants to purchase 45,925shares of common stock at $2.99 per share to the same accredited investors. Eachshare 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 intowhich the Series G Preferred Stock was convertible over the proceedsallocated to the Preferred Stock amounted to $198,312. Such amount representeda beneficial 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 $129,967 using the Black-Scholes option pricing model. Theissuance of the Series G Preferred Stock in March 2003 triggered anantidilution adjustment in the conversion price of the Series G PreferredStock issued in February 2003 from $3.95 to $2.72. As a result, the numberof common shares potentially issuable upon conversion of the Series GPreferred Stock issued in February 2003 increased from 103,527 to 150,229.The Company recorded a deemed dividend of $184,481 in connection with thisadjustment.

On June 6, 2003 the78,041 shares of Series G Preferred Stock outstanding were converted into873,022 shares of common stock.

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*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.

On June 6, 2003 the7,503 shares of Series H Preferred Stock outstanding were converted into750,300 shares of common stock.

*Common Stock*

In May and June 2001, the Company issued303,892 shares of common stock at a purchase price of $10.60 per share in aprivate placement. Under the terms of this financing, the Company also issuedfive-year, fully vested warrants to purchase 93,848 shares of common stock at$17.90 per share.

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.

On June 6, 2003, pursuant to approvals obtainedat its annual meeting of stockholders, together with agreements signed byholders of its preferred stock, the Company converted all of the outstandingshares of each of its eight classes of preferred stock into a total of3,007,453 shares of common stock.

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. Aggregateproceeds from these private placements, net of $120,000 in financing costs,amounted to $905,330. In connection with these financings, the Company paid aplacement agent a fee equivalent to 7% of the amount raised, paid in units.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 

F-28

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directors in lieu of cashcompensation for their services. The Company recorded $51,487 of compensationexpense in connection with these issuances.

During 2003, theCompany issued 12,041 shares of its common stock at an average price of $2.49(equal to the fair market value of the stock of the date of each transaction)to a financial advisor as a retainer fee. The Company recorded an expenserelated to the stock issuance of $30,000.

*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,** | ** ** |
|------------------------------------------|------------|---------------------------------------------|------------|
| ** **                               | ** ** | **2001**                                    | ** ** | **2002** | ** ** | **2003** | ** ** |
| ** **                               | ** ** | **Shares**                                  | ** ** | **Weighted  Average  Exercise  Price** | ** ** | **Shares** | ** ** | **Weighted  Average  Exercise  Price** | ** ** | **Shares** | ** ** | **Weighted  Average  Exercise  Price** | ** ** |
| Outstanding at the beginning of the Year |       | 245,964                                     |       |   | $ | 71.40 |   |   | 325,637 |   |   | $ | 18.95 |   |   | 299,865 |   |   | $ | 15.03 |   |   |
| Granted                                  |       | 302,741                                     |       |   | 6.50 |   |   | 111,222 |   |   | 3.71 |   |   | 307,469 |   |   | 2.50 |   |   |
| Exercised                                |       | (85                                         | )          |   | 0.10 |   |   | (25,576 | ) |   | 3.36 |   |   | (35,659 | ) |   | 2.29 |   |   |
| Canceled or  expired                     |       | (222,983                                    | )          |   | 60.00 |   |   | (111,418 | ) |   | 17.87 |   |   | (42,432 | ) |   | 28.83 |   |   |
| Outstanding at  the end of the Year      |       | 325,637                                     |       |   | 18.95 |   |   | 299,865 |   |   | 15.03 |   |   | 529,243 |   |   | 7.50 |   |   |
| Options exercisable at  year-end         |       | 140,739                                     |       |   | $ | 19.50 |   |   | 198,829 |   |   | $ | 13.06 |   |   | 240,442 |   |   | $ | 11.99 |   |   |

 

As of December 31, 2003, 78,416 shares wereavailable for issuance under the 1996 Plan.

The following tablesummarizes information about fixed-price stock options outstanding at December 31,2003:
| ** **                                  | ** ** | **Options Outstanding** | ** ** | **Options Exercisable**                             | ** ** |
|---------------------------------------------|------------|------------------------------|------------|----------------------------------------------------------|------------|
| **Range of Exercise Prices** | ** ** | ** **                   | ** ** | **Number  Outstanding at  December 31,  2003** | ** ** | **Average  Remaining  Contractual  Life** | ** ** | **Weighted-  Average  Exercise  Price** | ** ** | **Number  Exercisable at  December 31,  2003** | ** ** | **Weighted-  Average  Exercise  Price** | ** ** |
| Less than $1.50                             |       |                         | 135,500    |                                                     |       |   | 10.0 |   |   |   | $ | 1.40 |   |   |   | 0 |   |   |   | $ | — |   |   |
| $1.51 -  $3.00                              |       |                         | 154,570    |                                                     |       |   | 8.2 |   |   |   | 2.68 |   |   |   | 134,877 |   |   |   | 2.69 |   |   |
| $3.01 -  $5.00                              |       |                         | 162,980    |                                                     |       |   | 8.8 |   |   |   | 3.79 |   |   |   | 41,049 |   |   |   | 3.88 |   |   |
| $5.01 -  $7.50                              |       |                         | 5,000      |                                                     |       |   | 7.7 |   |   |   | 6.00 |   |   |   | 2,812 |   |   |   | 6.00 |   |   |
| $7.51 -  $10.00                             |       |                         | 16,577     |                                                     |       |   | 3.0 |   |   |   | 9.39 |   |   |   | 16,077 |   |   |   | 9.41 |   |   |
| $10.01 -  $20.00                            |       |                         | 18,652     |                                                     |       |   | 6.8 |   |   |   | 13.11 |   |   |   | 13,567 |   |   |   | 13.05 |   |   |
| $20.01 -  $180.00                           |       |                         | 35,964     |                                                     |       |   | 5.4 |   |   |   | 63.77 |   |   |   | 32,060 |   |   |   | 62.85 |   |   |
|                                        |       |                         | 529,243    |                                                     |       |   | 8.4 |   |   |   | $ | 7.46 |   |   |   | 240,442 |   |   |   | $ | 11.99 |   |   |
|                                             |            |                              |            |                                                          |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

F-29

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The weighted average fair values of the optionsgranted in 2001 with a stock price equal to the exercise price was $6.50. Theweighted average fair values of the options granted in 2002 with a stock priceequal to the exercise price was $3.71. The weighted average fair values of theoptions granted in 2003 with a stock price equal to the exercise price was$2.50

On June 15, 2001, theCompany cancelled options to purchase 81,038 shares of common stock and agreedto issue an equal number of new options on December 17, 2001 with anexercise price equal to the then-current fair market value. The employees whoseoptions were cancelled had not received options in the six months prior to thecancellation date. On December 17, 2001, the Company issued 73,803replacement options to employees who participated in the exchange program, withan exercise price equal to the fair market value on that date.

*Warrants*

TheCompany has also granted warrants to purchase Common Stock to variousinvestors, employees and outside vendors. Warrant activity was as follows forthe periods indicated:
| ** **                               | ** ** | **Years Ended December 31,** | ** ** |
|------------------------------------------|------------|---------------------------------------------|------------|
| ** **                               | ** ** | **2001**                                    | ** ** | **2002** | ** ** | **2003** | ** ** |
| Outstanding at the beginning of the year |       | 377,414                                     |       | 635,388 |   | 1,108,911 |   |
| Granted                                  |       | 389,630                                     |       | 551,492 |   | 1,924,159 |   |
| Exercised                                |       | —                                      |       | — |   | — |   |
| Canceled or  expired                     |       | (131,656                                    | )          | (77,969 | ) | (657,954 | ) |
| Outstanding at the end of  the year      |       | 635,388                                     |       | 1,108,911 |   | 2,375,116 |   |

 

Exercise prices on theoutstanding warrants range from $2.00 to $70.00 per share. The weighted averagegrant date fair value of warrants issued in 2003 was $2.99. 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 2001, 2002 and 2003, the number of shares and exercise prices ofcertain warrants were adjusted to satisfy certain anti-dilution rightspreviously granted.

*Reserve forIssuance*

As of December 31,2003, the Company had reserved 2,904,359 shares of Common Stock for issuanceupon the exercise of outstanding options and warrants.

**12. RetirementPlans**

The VCampus Corporation401(k) plan (adopted in 1997) allows employees to elect an amount between 1%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 2001, 2002 and 2003,there were no discretionary Company contributions made to the plan.

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**13. Income Taxes**

Incometax expense for the years ended December 31, 2001, 2002 and 2003 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** | ** **       |
|------------------------------------------------|------------|----------------------|------------------|
| ** **                                     | ** ** | **2001**             | ** **       | **2002** | ** ** | **2003** | ** ** |
| Tax benefit at  federal statutory rate         |       | $                    |  (2,017,000 | ) | $ | (1,489,000 | ) | $ | (1,108,000 | ) |
| State income  taxes, net of federal tax effect |       | (287,000             | )                | (212,000 | ) | (158,000 | ) |
| Increase in  valuation allowance               |       | 2,319,000            |             | 1,571,000 |   | 1,240,000 |   |
| Other                                          |       | 15,000               |             | 130,000 |   | 36,000 |   |
| 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 to utilize the deferred tax assets. The valuation allowance fordeferred taxes increased $2,319,000, $1,571,000 and $1,240,000 in the yearsended December 31, 2001, 2002 and 2003. Significant components of the Company’snet deferred tax assets were as follows:
| ** **                         | ** ** | **December 31,** | ** ** |
|------------------------------------|------------|-----------------------|------------|
| ** **                         | ** ** | **2002**              | ** ** | **2003** | ** ** |
| Net operating loss carryforwards   |       | $                     | 22,647,000 |   | $ | 24,023,000 |   |
| Accrued payroll                    |       | 16,000                |       | 25,000 |   |
| Other accruals                     |       | 285,000               |       | 73,000 |   |
| Other assets and  liabilities, net |       | 1,722,000             |       | 1,789,000 |   |
| Total deferred  tax assets         |       | 24,670,000            |       | 25,910,000 |   |
| Valuation  allowance               |       | (24,670,000           | )          | (25,910,000 | ) |
| Net deferred tax assets            |       | $                     | —     |   | $ | — |   |

 

As of December 31, 2002 and 2003, the Company hadnet operating loss carryforwards for federal income tax purposes ofapproximately $56,610,000 and $60,051,000, respectively, which will expire atvarious dates through 2023. The Company may have had changes in ownership whichmay impose limitations on its ability to utilize net operating losscarryforwards under Section 382 of the Internal Revenue Code.

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**14. Net Loss PerShare**

Thefollowing table sets forth the computation of basic and diluted net loss pershare:
| ** **                                                                        | ** ** | **Years Ended December 31,** | ** ** |
|-----------------------------------------------------------------------------------|------------|---------------------------------------------|------------|
| ** **                                                                        | ** ** | **2001**                                    | ** ** | **2002** | ** ** | **2003** | ** ** |
| Numerator:                                                                        |       |                                        |       |   |   |   |   |
| Net loss                                                                          |       | $                                           | (5,932,893 | ) | $ | (4,378,911 | ) | $ | (3,259,023 | ) |
| Less: Dividends  accruing to preferred stockholders                               |       | (649,147                                    | )          | (2,768,394 | ) | (2,926,854 | ) |
| Net loss  available to common stockholders                                        |       | $                                           | (6,582,040 | ) | $ | (7,147,305 | ) | $ | (6,185,877 | ) |
| Denominator:                                                                      |       |                                        |       |   |   |   |   |
| Denominator for  basic earnings per share—weighted-average shares            |       | 1,258,610                                   |       | 1,493,643 |   | 3,423,056 |   |
| Denominator for diluted earnings per share—adjusted  weighted-average shares |       | 1,258,610                                   |       | 1,493,643 |   | 3,423,056 |   |
| Basic and diluted  loss per share:                                                |       |                                        |       |   |   |   |   |
| Net loss per share  available to common stockholders                              |       | $                                           | (5.23      | ) | $ | (4.79 | ) | $ | (1.81 | ) |

 

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,** | ** ** |
|-------------------------------|------------|--------------------------------------------|------------|
| ** **                    | ** ** | **2001**                                   | ** ** | **2002** | ** ** | **2003** | ** ** |
| Convertible notes payable:    |       | 49,235                                     |       | 64,285 |   | 64,285 |   |
| Convertible preferred  stock: |       |                                       |       |   |   |   |   |
| Series C                 |       | 75,554                                     |       | 75,554 |   | — |   |
| Series D                 |       | 101,380                                    |       | 101,380 |   | — |   |
| Series E                 |       | 54,508                                     |       | 57,490 |   | — |   |
| Series F                 |       | 264,284                                    |       | 478,142 |   | — |   |
| Series F-1               |       | —                                     |       | 232,443 |   | — |   |
| Series F-2               |       | —                                     |       | 439,540 |   | — |   |
| Series G                 |       | —                                     |       | 493,200 |   | — |   |
| Stock options                 |       | 325,637                                    |       | 299,865 |   | 529,243 |   |
| Warrants                      |       | 635,388                                    |       | 1,108,911 |   | 2,375,116 |   |

 

**15. SubsequentEvents**

In February 2004, Park University notified theCompany that it intends to negotiate with another vendor to provide e-learningservices as of May 2004. Accordingly, the Company does not expect tocontinue to derive revenues from Park University, its largest customer in 2002and 2003, beyond that point. Park University represented 36% of the Companyrevenues in 2003 and 28% in 2002.

In March 2004, the Company raised $5,000,000 ingross cash receipts through the private placement of 20 units, at a purchaseprice of $200,000 per unit, and $1,000,000 in principal amount of Series Bsenior secured convertible notes. Each unit consists of 50,000 shares of commonstock (initially priced at $1.63 per share), a Series A senior securedconvertible note in the original principal amount of $118,500 and a five-yearwarrant to purchase 61,350 shares of common stock with an initial exerciseprice of $2.386 (subject to adjustment) per share (“Units”). The Company issuedan additional $250,000 of Series B senior secured notes in exchange forcancellation of existing short-term indebtedness in that amount. The 

F-32

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Company issued to the Series Bnoteholders five-year warrants to purchase an aggregate of 383,459 sharesof common stock with an initial exercise price of $2.386 (subject toadjustment) per share. An additional one quarter unit was issued to the leadinvestor’s counsel as payment for legal services in connection with the privateplacement

Upon approval of the private placement by the Company’sstockholders, $18,500 of principal of each of the Series A notes wouldautomatically convert into common stock at $1.63 per share and $100,000, or50%, in principal of each of the Series B notes would automaticallyconvert into common stock at $1.63 per share. The total principal amount forboth Series to be converted upon approval of the stockholders would be$999,625. The notes mature on April 1, 2009 and bear interest at the rateof 8% per annum payable quarterly in cash or stock (at the conversion price) atthe Company’s option for the first year. Principal and interest on the notesare payable in cash over the following four years in quarterly installments.The initial exercise price for the warrants is equal to the average closingprice of the Company’s common stock for the five trading days prior to the dateof the private placement. Upon shareholder approval of the private placement,the exercise price of the warrants would be adjusted to $1.63 per share.

The warrants are first exercisable commencing on theearlier of six months from the closing date of the private placement or thedate on which the Company’s shareholders approve the private placement.

The terms of the financing include a provision that inthe event that the Company does not achieve a certain business milestone by September 30,2004, and following the date of shareholder approval referenced above, (i) theCompany shall issue to each purchaser, for each Unit purchased by such purchaser,an additional 9,058 shares of common stock and an additional 11,113 warrants;and (ii) the conversion price with respect to the notes and the warrant pricewith respect to the warrants, shall be reset to $1.38 in accordance with theterms of the notes and the warrants. In the event such shareholder approval occursprior to September 30, 2004 and the milestone is not achieved on or beforeSeptember 30, 2004, the number of shares issuable upon the mandatoryconversion of the notes occurring automatically on the date of shareholderapproval shall be adjusted prospectively as of September 30, 2004 toreflect a conversion price of $1.38 (subject to any adjustments required as ofthe mandatory conversion date) and such additional shares shall be issued tothe holders of Series A notes on or before October 10, 2004. Similarly, inthe event such shareholder approval occurs prior to September 30, 2004 andthe milestone is not achieved on or before September 30, 2004, the numberof shares issuable upon the mandatory conversion of the Series B notes shall beadjusted prospectively as of September 30, 2004 to reflect a conversionprice of $1.38 (subject to any required adjustments) and such additional sharesshall be issued and delivered to the holders of the Series B notes on or beforeOctober 10, 2004.

The terms of the financing include antidilutionprovisions to the effect that if and whenever in the period commencing afterthe issuance date and ending 24 months thereafter (the “Antidilution Period”),the Company issues or sells, or is deemed to have issued or sold, any shares ofcommon stock, with the exception of specific issuances which are excluded, fora consideration per share less than the conversion price in effect immediatelyprior to such time for the relevant shares then concurrent with such dilutiveissuance, the conversion price for the notes then in effect shall be reduced toan amount equal to the new securities issuance price.

The Company allocated the proceeds from the issuanceof the notes to the debentures and to that subset of warrants allocated to thenotes on a pro-rata basis 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 and will be amortized to interest expense over theperiod the debentures are expected to be outstanding. Upon approval of theprivate placement by its shareholders, the Company intends to record anadditional $2,187,087 of debt discount for the instruments’ beneficialconversion feature. As the debt instruments would then be immediatelyconvertible to equity, the discount related to the beneficial 

F-33

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conversion feature wouldbe expensed immediately. The fair value of the warrants allocated to the commonstock on a pro-rata basis will be accounted for as cost of capital.

Thefollowing table sets forth selected balance sheet data as of December 31,2003, on a pro forma basis, after giving effect to the March 2004financing. This table is disclosed to demonstrate the Company’s compliance, ona pro forma basis, with the minimum $2.5 million of stockholders’ equityrequired for continued listing on the Nasdaq SmallCap Market.
| ** **                       | ** ** | **December 31,  2003** | ** ** | **Pro forma  Adjustments** | ** ** | **Pro forma as of  December 31,  2003** | ** ** |
|----------------------------------|------------|-----------------------------|------------|---------------------------------|------------|-------------------------------------------------------------|------------|
| ** **                       | ** ** | ** **                  | ** ** | ** **                      | ** ** | **(Unaudited)**                                             | ** ** |
| Cash                             |       | $                           | 534,984    |                            | $          | 5,250,000                                                   |       | $ | 5,784,984 |   |
| Total assets                     |       | 4,863,658                   |       | 6,001,905                       |       | 10,865,563                                                  |       |
| Notes Payable                    |       | 225,000                     |       | 2,187,087                       |       | 2,412,087                                                   |       |
| Total liabilities                |       | 2,823,313                   |       | 3,039,587                       |       | 5,867,900                                                   |       |
| Accumulated  deficit             |       | (90,392,904                 | )          | —                          |       | (90,392,904                                                 | )          |
| Total stockholders’  equity |       | $                           | 2,035,345  |                            | 2,962,318  |                                                        | 4,997,663  |   |
|                                  |            |                             |            |                                 |            |                                                             |            |  |  |  |

 

In March 2004, theCompany paid off in full the principal and interest on the remaining debenturesissued in December 2001 and January 2002. Principal and interest onthe debentures amounted to $261,000 and $40,167, respectively. The debentureswere due on December 31, 2003; any events of default that might haveoccurred under the debentures were irrevocably waived by the debenture holders.

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

Thefollowing table presents the quarterly results for VCampus Corporation and itssubsidiaries for the years ended December 31, 2002 and 2003:
| ** **                                    | ** ** | **1st Quarter** | ** ** | **2nd Quarter** | ** ** | **3rd Quarter** | ** ** | **4th Quarter** | ** ** |
|-----------------------------------------------|------------|----------------------|------------|----------------------|------------|----------------------|------------|----------------------|------------|
| **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 | ) |
| **2002**                                      |       |                 |       |                 |       |                 |       |                 |       |
| Revenue                                       |       | $                    | 1,409,187  | *                    | $          | 1,566,493            | *          | $                    | 1,660,636  | * | $ | 1,289,830 | * |
| Loss from  operations                         |       | (959,751             | )          | (672,138             | )          | (1,101,971           | )          | (1,343,502           | )          |
| Net loss  attributable to common stockholders |       | (1,511,052           | )          | (1,806,500           | )          | (2,794,858           | )          | (1,034,895           | )          |
| Net loss per share,  basic and diluted        |       | $                    | (1.03      | )                    | $          | (1.23                | )          | $                    | (1.83      | ) | $ | (0.68 | ) |

----

*                    Certainrevenues and corresponding expenses included in the quarterly results have beenreclassified from the presentation in prior periods. While this reclassificationcauses revenues and expenses reported in the consolidated financial statementsto be lower than previously reported, it has no impact on previously reportedassets, liabilities or net loss.

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**SCHEDULE II—VALUATION AND QUALIFYING ACCOUNT ANDRESERVE(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, 2001 |       |       | 218        |                                           |       |          | 52         |           |       |                                         | (171       | )(1) |   |   | 99 |   |   |
| Year ended  December 31, 2002 |       |       | 99         |                                           |       |          | 12         |           |       |                                         | (80        | )(1) |   |   | 31 |   |   |
| Year ended  December 31, 2003 |       |       | 31         |                                           |       |          | 9          |           |       |                                         | (35        | )(1) |   |   | 5 |   |   |

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(1)          Uncollectible amountswritten off. Net of recoveries.

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