VCAMPUS CORP - 10-K Annual Report

NOTE REGARDING FORWARD-LOOKING STATEMENTS

Statements in this Annual Report on Form 10-K that are not descriptions of historical facts are forward-looking statements that are subject to risks and uncertainties. Actual events or results could differ materially from those currently anticipated due to a number of factors, including those set forth herein and in VCampus’ other SEC filings, and including, in particular: continuing losses and negative operating cash flows; future capital needs and uncertainty of additional funding; intense and increasing competition; dependence on significant customers, developing market, rapid technological changes and new products; dependence on online distribution; substantial dependence on courseware and third party courseware providers; substantial dependence on third party technology; risks associated with potential failure to maintain our Nasdaq SmallCap listing and our dependence on key personnel.

PART I

Item 1. Business

Executive Summary

VCampus Corporation is a provider of outsourced e-Learning services. We develop courseware and manage and host Internet-based learning environments for professional credentialing and certification organizations, corporations, government agencies, and associations. Our services cover a broad range of e-Learning programs, from registration, enrollment and payment processing to course development and delivery, as well as tracking of students’ progress, reporting of results and production of certificates of completion. VCampus was incorporated in Virginia in July 1984 and reincorporated in Delaware in March 1985.

Through proprietary software, we provide customers with comprehensive services on an outsourced, or hosted, basis. Our goal is to be the leading service provider of integrated e-Learning services by helping customers improve their performance and achieve their goals. We believe that our outsourced hosting approach to web-based e-Learning services provides significant business advantages to our customers.

During the past year, we shifted our emphasis to focus on our Select Partner™ program business model and away from our former, or Legacy, business model. Under the Select Partner program, we develop online courses for Select Partners that provide professional credentials or certifications or the training for such credentials and certifications that are demanded by the markets served by their members or target audiences. We design and build courses based upon each Select Partner’s existing course materials and/or content, which they have historically delivered or published in a traditional textbook or classroom-based manner, and convert them into interactive, e-Learning courses at our expense. In return, each Select Partner generally enters into an exclusive, long-term contract for VCampus to host and deliver the courses to the Select Partner’s members or target audience. As part of this program, we share the gross revenue generated from these courses with the Select Partner.

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

Under the Select Partner model, we target the market for professional and technical credentials, certifications and continuing education supporting those certifications and credentials. Our primary marketing goals are to identify and partner with certification and credentialing organizations with:

(1) 10,000 or more memberships; (2) successful instructor-led education programs; and (3) minimal online education presence. We offer these organizations the opportunity to grow their revenues by leveraging and scaling their existing instructor-led programs through our outsourced e-Learning offering. Under a typical Select Partner agreement, we enter into an exclusive e-Learning relationship with the partner for five years, and we typically share the revenue from online sales equally with the partner in return for our development of the courses from the partner’s content. Typically, there is no charge to the partner for the course development except for the cost of providing subject matter experts to assist in design, development and review of the online course. VCampus and the partner typically co-own the completed online course. The Select Partners can therefore repurpose their highly-demanded training courses for online delivery to enhance and support their professional development programs. The Select Partners benefit from our expert course development, publishing, hosting, e-commerce, reporting and account support and marketing services at little to no upfront cost to them. We enable these organizations to add online learning quickly, efficiently and inexpensively. The Select Partner program enables us to reach these targeted markets through courses exclusively available on our platform. We believe our application service provider, or ASP, model is particularly well suited to our target audience, because most learners are “outside the firewall.” In contrast, most other popular learning management systems, or LMS, are built for “behind the firewall” use, and thus require capital and operating expenses not required for our usage-priced ASP system.

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

Under our Legacy business model, our primary target markets are the corporate, government and association member training markets. Since we are phasing out of and plan to ultimately exit the Legacy model, we no longer devote significant resources to marketing to this market broadly. Instead, we focus our sales efforts on expanding revenue from our current Legacy customers as well as pursuing promising leads and referrals that come to our attention.

As of March 2005, under the Legacy model we offer more than 5,000 online course titles and have delivered more than 2.9 million courses to more than 920,000 desktops/users since inception of the program in 1997.

We believe our market strengths to be:

· minimal upfront investment required for customers;

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

· consistent delivery of high-quality courseware;

· proven system performance and scalability;

· exceptional customer service and relationships; and

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

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

Diversified business base. We serve customers from a wide variety of market sectors—including corporations, government agencies, associations and professional credentialing and certification organizations. As such, we are able to provide our customers with a unique ability to participate in communities of learning. The VCampus platform enables our customers to share content, thereby creating

cross-sale opportunities from customer to customer. Several of our customers successfully sell their content to other VCampus customers simply by offering their content on the advanced VCampus platform.

Open technology. Our technology affords customers a number of advantages in terms of its ability to rapidly and cost-effectively implement a comprehensive and secure e-Learning and training environment. Our content-neutral, open architecture platform allows for access to a wide range of aggregated content and the ability to quickly add new functionality, leverage new technology and to support a vast number of users. Our web services capabilities enable customers to easily integrate our technology with other existing systems (including enterprise resource planning systems and human resource information systems).

Extensive experience. We have delivered over 2.9 million courses over the past nine years to more than 920,000 desktops/users. We have operated in the e-Learning space for more than eight years. We maintain solid, long-term relationships with established customers and benefit from a highly experienced and knowledgeable management team.

Expansive library of content aggregated from leading sources. Our existing content library includes publicly-available online courses from more than 40 publishers, including SkillSoft, ElementK, American Media, Vital Learning and Crisp Learning (Course Technology). We also have agreements to distribute some courseware that has been developed by our customers, such as the New York Institute of Finance, to other VCampus customers. Our wholly-owned library of telecommunications and desktop publishing courses are marketed under the Teletutor and VCampus brand names. Finally, our Select Partner program gives our customers the ability to sell or use credentialing and certification courseware appropriate to their market and/or employee-based demographics.

Courseware Development Experience. We have significant courseware development experience, built over the past nine years. We have experienced instructional designers and project managers on staff supplemented by offshore courseware development firms. We develop high quality courseware, implementing the latest designs for optimization of adult learning, quickly and cost effectively. The scalability of our courseware development infrastructure enables us to meet the growing demands of our Select Partners.

Flexibility. Our technology and implementation process is flexible to respond to diverse customer needs. We offer rapid implementation on a content-neutral platform that allows access to both off-the-shelf and proprietary courseware. We offer customization of our products and services for each customer, as well as rapid incorporation of new technologies. Our technology and services are designed to be scaleable on demand to meet customer needs.

Comprehensive Services. We offer a completely hosted system, accessible by virtually any web browser. Our offerings include a leading edge Learning Management System, Course Management System, and Courseware Delivery Engine. Our technology and service have been proven and tested through successful implementations for scores of customers, through which thousands of students have experienced VCampus-based e-Learning for up to seven years. Additionally, we continue to introduce new technology to provide additional features for our customers.

Company Strategy

Our goal is to be the leading service provider of integrated e-Learning services by helping customers improve their performance and achieve their goals. Our strategies to achieve this objective include continuing to: create partnerships with leading credentialing and certification organizations; develop high quality courseware quickly for our Select Partners; provide superior customer service; and develop new and upgrade existing technologies. Our strategy also includes increasing revenue from each customer by converting more of each customer’s proprietary instructor-led content to online distribution through the

VCampus platform. We also intend to grow the cross-selling of content between various customers. The intended result is increased penetration and enhanced customer loyalty.

Create Partnerships with Leading Credentialing Organizations

The Select Partner program is our core focus to expand the business. Under this strategy, we seek to partner with organizations that provide highly-sought credentialing or certification services to large addressable markets. Our target partners currently provide most, if not all, of their educational programs through instructor-led programs, thus leaving an under-addressed market opportunity for end users who seek the credentialing or certification through an online course. By developing online courses under our Select Parmer program, we are able to address this market opportunity jointly with these partners.

During 2004, we formed new relationships with the following seven Select Partners, the majority of which offer credentials or training for learners interested in obtaining credentials: the Association for Financial Professionals, PCI Global, Inc., the National Council of State Boards of Nursing, the National Contract Management Association, the American College of Forensic Examiners International, the New York Institute of Finance and Kiplinger Washington Editors, Inc.

Develop High Quality Courseware Quickly for Select Partners

Addressing the market opportunity swiftly is essential to a successful Select Partner strategy. With nearly a decade experience in the budding e-Learning industry, we have developed the capabilities and expertise to fulfill the course development needs of our current and new partners quickly while delivering superior quality. As such, we are able to work with our Select Partners to transform their traditional, instructor-led content into high-quality online courses while the market opportunity is still ripe.

Provide Superior Customer Service

Our core customer service principle is to deliver uniquely superior service through creative, committed and well-trained employees who work as a team. Each VCampus employee has defined roles and responsibilities for monitoring and supporting the health and growth of our customer relationships. Furthermore, each team is responsible for continuous review of its customers’ content needs, introduction of existing and new VCampus services, recommendation of suitable additional content, identification of the potential need for custom courseware development and recommendation of platform configurations for customer-specific business processes.

Develop and Upgrade Proprietary Technology

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

During 2003 and early 2004, we announced the introduction of VCampus’ enhanced web-based Course Management System to support both self-paced and instructor-managed online learning. The VCampus Course Management System (CMS) 5.0 delivers important features including a newly designed Gradebook that tracks multiple student activities, integrated course discussion boards, a built-in testing and assessment engine as well as powerful communications tools. This CMS release marks the implementation of a new Java-based enterprise architecture designed for highly reliable, hosted e-Learning. CMS 5.0 also includes a newly-designed course authoring tool.

Early in 2004, we introduced a new Learning Management System (LMS). This LMS, which we license from a third-party provider, provides our customers with the ability to support and manage online, live and blended learning. Capabilities include advanced LMS features, live chat, skills assessment and multilingual capabilities. The LMS provides learners with convenient access to course-specific data, supporting information and communications functions, all in one convenient location on the desktop. The system also includes a personal calendar, reminder notes and other tools that make learning more efficient. The system is fully customizable and allows our clients to obtain their own look, feel and features on a hosted basis. The new LMS integrates with human resource, enterprise resource planning and customer relationship management and other enterprise systems.

VCampus also developed VNexus™, a next generation integration platform which made us the first e-Learning company to launch a fully SOAP-compliant Learning Management platform with superior web services capabilities. By standardizing on the SOAP protocol, VNexus employs XML, a recognized universal standard, to communicate with an organization’s information technology infrastructure. XML provides inherent flexibility because it can operate across any operating system or platform, thereby reducing possible barriers to integration. Recognizing that some organizations have not standardized on XML, we also offer other communication formats with VNexus.

Existing Courseware Library

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

Strategically Developed Courses

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

COTS Library

The majority of the online courses delivered from our library through our e-leaning system are commercial off-the-shelf, or COTS courses. The current library was built from a combination of acquisitions, our own development efforts and relationships with leading content providers such as SkillSoft, Infosource, Vital Learning, Crisp Publications Inc. (Course Technology), Aztec Software and American Media, Inc. Although we do not provide accreditation or certification itself, a number of our current courses provide either accreditation or certification through our content providers.

Custom Library

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

become commoditized. We believe the growth of this custom library is evidence of customer satisfaction with our authoring and delivery products.

Customers

Our primary target markets for our Select Partner program are professional credentialing and certification organizations, corporations, government agencies, and associations. In 2003 and 2004, our online tuition revenues were balanced fairly equally among the government, corporate training and higher education distance learning segments. In 2004, the amount of revenues we derived from professional credentialing and certification organizations was relatively small, approximately 4% of our total revenues, but we expect it to represent a significantly larger percentage of our total revenues in the coming years. In 2004, three customers, the U.S. Department of Veterans Affairs, Park University and a large insurance company accounted for approximately 27%, 25% and 21% of our revenues, respectively. We anticipate that future revenues may be derived from sales to a limited number of customers. Accordingly, the cancellation, non-renewal or deferral of a small number of contracts could have a material adverse effect on us. For example, in May 2004, Park University elected not to renew its relationship with us. Park University represented 25%, 36% and 28% of our revenues in the years ended December 31, 2004, 2003 and 2002, respectively. See the “Risks and Uncertainties” section of this report for a discussion of the risks of such customer concentration.

Sales and Marketing

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

In the Legacy business, our sales and marketing efforts are limited and focused. Our primary target markets are the corporate, government and association member training markets. Since we are phasing out of and ultimately exiting the Legacy model, we no longer devote significant resources to marketing to this market broadly. Instead, we focus our sales efforts on expanding revenue from our current Legacy customers as well as pursuing promising leads and referrals that come to our attention.

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

Competition

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

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

threaded discussion and electronic conferencing, as well as other delivery methods such as satellite communications and audio and videotapes.

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

Most of our competitors have significantly greater financial, technical and marketing resources than we do. We will require additional financing to compete effectively in this evolving market. In addition, any of these competitors may be able to respond more quickly than us to new or emerging technologies and to devote greater resources to the development, promotion and sale of their services. A number of our current customers and partners have also established relationships with some of our competitors, and future customers and partners may establish similar relationships. In addition, our partners could use information obtained from us to gain an additional competitive advantage over us. Our competitors may have or may develop products and services that are superior to those of VCampus or that 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 as critical to our success, and we rely upon federal statutory as well as common law copyright and trademark law, trade secret protection and confidentiality and/or license agreements with our employees, customers, partners and others to protect our proprietary rights. We own registered trademarks in the United States for: Courseware Construction Set, Pointpage, Content Matters, V (& design), and VCampus. We have filed intent-to-use applications for the following: VCampus Your e-Learning Partner, VCampus (& design), Pointpage and Govlearn. We have licensed the right to use the web address www.vcmp.com.

Employees

As of March 1, 2005, we had 37 employees, consisting of 10 full-time employees in general business operations, nine full-time employees in sales and marketing, 12 full-time employees in product development, and six full-time employees in finance and administration. None of our employees is represented by a union and there have been no work stoppages. We believe that our employee relations are good.

Where you can find additional information

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

Risks and Uncertainties

This report contains forward-looking statements that involve risks and uncertainties. Our actual results could differ materially from those discussed in this report. Factors that could cause or contribute to these differences include, but are not limited to, those discussed below and elsewhere in this report and in any documents incorporated in this report by reference.

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

We have incurred losses and anticipate future losses, which could have an adverse impact on the trading price of our common stock. We have incurred significant losses since our inception in 1984, including net losses attributable to common stockholders of $7.1 million, $6.2 million and $6.6 million for the years ended December 31, 2002, 2003 and 2004. As of December 31, 2004, we had an accumulated deficit of $97.0 million, stockholders’ equity of $4.8 million and a working capital of $1.8 million. We expect losses from operations to continue until our online revenue stream matures. For these and other reasons, we cannot assure you that we will ever operate profitably, which could have an adverse impact on the trading price of the shares held by our stockholders.

If we do not have the resources to meet our business objective, we might not survive or be successful. Our key objective is to be one of the leading providers of outsourced e-Learning services. Pursuing this objective may significantly strain our administrative, operational and financial resources. We cannot assure you that we will have the operational, financial and 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 when needed, could prevent us from executing our business strategy and could prevent us from maintaining compliance with Nasdaq listing standards. If we are not able to generate sufficient cash for ongoing operations, we will need to raise additional funds through public or private sale of our equity or debt securities or from other sources for the following purposes:

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

· to fund our operating expenses; and

· to maintain compliance with Nasdaq listing requirements.

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

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

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

If we fail to maintain compliance with our Nasdaq SmallCap Market listing, the value and liquidity of our shares could be impaired. Our common stock is currently listed on the Nasdaq SmallCap Market. Nasdaq has certain requirements that a company must meet in order to remain listed on the Nasdaq

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

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

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

The large number of our shares eligible for future sale could have an adverse impact on the market price of our common stock. A large number of shares of common stock already outstanding, along with shares issuable upon exercise of options or warrants or conversion of convertible notes, are eligible for resale, which may adversely affect the market price of our common stock. As of March 1, 2005, we had 8,507,804 shares of common stock outstanding, another 1,311,354 shares were issuable upon conversion of convertible notes and another 4,375,457 shares were issuable upon exercise of outstanding warrants and options. Substantially all of the shares subject to outstanding warrants and options will, when issued upon exercise, be available for immediate resale in the public market pursuant to currently effective registration statements under the Securities Act of 1933, as amended, or pursuant to Rule 701 or Rule 144 promulgated thereunder. Some of the shares that are or will be eligible for future sale have been or will be issued at discounts to the market price of our common stock on the date of issuance.

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

Our substantial dependence on third-party relationships could impair our ability to achieve our business objectives and serve our customers. We rely on maintaining and developing relationships with customers, professional credentialing and certification organizations and other businesses that provide content for our products and services, corporations, government agencies, and associations and with companies that provide the Internet and related telecommunications services used to distribute our products and services to customers.

We have relationships with a number of customers, professional credentialing and certification organizations and other businesses that provide us with course content for our online products and services, as well as access to their members who are the ultimate end users of our products. Some of the agreements we have entered into with these content providers limit our use of their course content, some do not cover use of any future course content and most may be terminated by either party upon breach of the agreement by the other party or bankruptcy of the other party. Our ASP-based business model is not compatible with the business models of certain content providers which may lead them to terminate the

future licensing of existing and new course content to us or fail to make this content available to us at commercially reasonable rates or terms necessary for success under our business model. Given our plans to introduce additional online courses in the future, we will need to license new course content from existing and prospective content providers. However we might not be able to maintain and modify, if necessary, our existing agreements with content providers, or successfully negotiate agreements with prospective content providers. If the fees we pay and/or the expenses we incur to acquire or distribute content increase, our operating costs and results of operations could be adversely affected. We might not be able to license or otherwise acquire course content at commercially reasonable rates or at all.

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

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

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

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

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

· they will not develop their own competitive products or services;

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

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

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

We operate in a highly competitive industry and may not be able to compete effectively. The market for educational and training products and services is highly competitive and we expect that competition will continue to intensify. There are no substantial barriers to entry into our business, and we expect that established and new entities will enter the market for online educational and training products and services in the near future.

A number of our existing competitors, as well as a number of potential new competitors (including some of our strategic partners), have longer operating histories, greater name recognition, larger customer bases, more diversified lines of products and services and significantly greater resources than we do. Such competitors may be able to undertake more extensive marketing campaigns, adopt more aggressive pricing policies and make more attractive offers to potential customers. In the past few years, a number of our customers have demanded upgrades to our technology platform. Our relatively limited capital resources might not afford us a full opportunity to meet these demands. Recently, we have noticed that some of the more widely available online course offerings, particularly those targeted to the corporate training market,

are increasingly competing primarily on price, which commoditization drives down margins for all competitors in our industry. In competing against us, our strategic partners could use information obtained from us to gain an additional competitive advantage over us. Our current and potential competitors might develop products and services that are superior to ours or that achieve greater market acceptance than ours. We might not compete effectively and competitive pressures might prevent us from acquiring and maintaining the customer base necessary for us to be successful.

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

The loss of services of any member of our key personnel could prevent us from adequately executing on our business strategy. Our future success depends on the continued contributions of our key senior management personnel, consisting of Narasimhan Kannan, Chief Executive Officer, Christopher Nelson, Chief Financial Officer, Ronald Freedman, Senior Vice President of Worldwide Sales and Marketing, Laura Friedman, Vice President—Co-Publishing and Tamer Ali, Vice President of Technology, some of whom have worked together for only a short period of time. We do not maintain “key man” life insurance on any of our executive officers. The loss of services of any of our key management personnel, whether through resignation or other causes, or the inability to attract qualified personnel as needed, could prevent us from adequately executing our business strategy.

Our results of operations have fluctuated significantly from period to period, and a failure to meet the expectations of investors or the financial community at large could result in a decline in our stock price. Our expense levels are based in part on our expectations as to future revenues. Quarterly sales and operating results generally depend on the online revenues and development and other revenues, which are difficult to forecast. In addition, past results have shown our business to be subject to a material adverse seasonality associated with the large number of holidays in the calendar fourth quarter. We may not be able to adjust spending in a timely manner to compensate for any unexpected revenue shortfall. Accordingly, any significant revenue shortfall would have an immediate adverse impact on our business and financial condition.

Our operating results may fluctuate significantly in the future as a result of a variety of factors, some of which are outside of our control. These factors include:

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

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

· seasonality of revenues corresponding to holidays in the United States;

· capital expenditures and other costs relating to the expansion of operations;

· the introduction of new products or services by us or our competitors;

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

· pricing or accounting changes; and

· general economic conditions.

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

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

We rely on significant customers, and if we fail to maintain and develop relationships with such customers, we might not generate revenues necessary to achieve our business objectives. A significant portion of our revenues is generated by a limited number of customers. We expect that we will continue to depend on large contracts with a limited number of significant customers through the near future. This situation can cause our revenue and earnings to fluctuate between quarters based on the timing of contracts. Most of our customers have no obligation to purchase additional products or services from us.

Park University elected not to renew its relationship with VCampus as of May 2004. Park University represented 25% of VCampus revenues in 2004 and 36% in 2003. In addition to the loss of the revenue from Park University, our ability to compete effectively in the higher education market space could be adversely impacted by the loss of this customer.

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

System failures and capacity constraints could interfere with our efforts to attract customers and attain market acceptance of our products and services. A key element of our strategy is to generate a high volume of online traffic to our products and services. Accordingly, the performance of our products and services is critical to our reputation, our ability to attract customers and attain market acceptance of our products and services. Any system failure that causes interruptions in the availability or increases response time of our products and services would result in less usage of our products and services and, especially if sustained or repeated, would reduce the attractiveness of our products and services. An increase in the volume of use of our products and services could strain the capacity of the software or hardware we use or the capacity of our network infrastructure, which could lead to slower response time. Any failure to expand the capacity of our hardware or network infrastructure on a timely basis or on commercially reasonably terms would reduce the attractiveness of our products and services. We also depend on web browsers and Internet service providers for access to their products and services, and users may experience difficulties due to system failures unrelated to our systems, products and services.

If the security of information stored in and transmitted through computer systems of VCampus and its end-users is not adequately secured, we could incur significant liability and potential customers might be deterred from using our products and services. We include in our products certain security protocols that operate in conjunction with encryption and authentication technology. Despite these technologies, our products may be vulnerable to break-ins and similar disruptive problems caused by online users. Such computer break-ins and other disruptions would jeopardize the security of information stored in and transmitted through our computer systems and the computer systems of end-users, which may result in significant liability for us and may also deter potential customers. For example, computer “hackers” could remove or alter portions of our online courseware. Persistent security problems continue to plague the Internet, the Web and other public and private data networks. Alleviating problems caused by third parties may require us to make significant expenditures of capital and other resources and may cause interruptions, delays or cessation of service to our customers and to us. Moreover, our security and privacy concerns and those of existing and potential customers, as well as concerns related to computer viruses, may inhibit the growth of the online marketplace generally, and our customer base and revenues in particular. We attempt to limit our liability to customers, including liability arising from a failure of the security features contained in our products, through contractual provisions

limiting warranties and disallowing damages in excess of the price paid for the products and services purchased. However, these limitations might not be enforceable. We maintain liability insurance to protect against these risks however this insurance may be inadequate or may not apply in some situations.

We might not be successful in responding to the changing market for our products and services. The market for our products and services is evolving in response to recent developments relating to online technology. The market is characterized by evolving industry standards and customer demands and an increasing number of market entrants who have introduced or developed online products and services. It is difficult to predict the size and growth rate, if any, of this market. As is typical in the case of a rapidly evolving industry, demand and market acceptance for recently introduced products and services are subject to a high level of uncertainty. Our future success will depend in significant part on our ability to continue to improve the performance, features and reliability of our products and services in response to both evolving demands of the marketplace and competitive product offerings, and we cannot assure that we will be successful in developing, integrating or marketing such products or services. In addition, our new product and courseware releases may contain undetected errors that require significant design modifications, resulting in a loss of customer confidence.

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

We have had certain trademark applications denied and may have more denied in the future. We will continue to evaluate the need for registration of additional marks as appropriate. Despite our efforts to protect our proprietary rights, unauthorized parties may attempt to copy aspects of our products or services or to obtain and use information that we regard as proprietary. In addition, the laws of some foreign countries do not protect proprietary rights to as great an extent as do the laws of the United States. Litigation may be necessary to protect our proprietary technology. Any such litigation may be time-consuming and costly, cause product release delays, require us to redesign our products or services or require us to enter into royalty or licensing agreements, any of which could have a material adverse effect upon us. For example, we were forced to pursue legal action during 2004 to prevent unauthorized use of the web address www. vcampus.us. These royalty or licensing agreements, if required, may not be available on terms acceptable to us or at all. Our means of protecting our proprietary rights might not be adequate and our competitors might independently develop similar technology, duplicate our products or services or design around patents or other intellectual property rights we have. In addition, distributing our products through online networks makes our software more susceptible than other software to unauthorized copying and use. For example, online delivery of our courseware makes it difficult to ensure that others comply with contractual restrictions, if any, as to the parties who may access such courseware. If, as a result of changing legal interpretations of liability for unauthorized use of our software or otherwise, users were to become less sensitive to avoiding copyright infringement, we might not be able to realize the full value of our intellectual property rights.

Government regulation of business conducted on the Internet could decrease the demand for our products and services or increase our cost of doing business. There are currently few laws or regulations that directly apply to activities on the Internet. We believe that we are not currently subject to direct regulation by any government agency in the United States, other than regulations that are generally applicable to all businesses. A number of legislative and regulatory proposals are under consideration by federal and state lawmakers and regulatory bodies and may be adopted with respect to the Internet and/or online delivery of course content. Some of the issues that these laws and regulations may cover include user privacy, pricing and characteristics and quality of products and services. The adoption of any such laws or regulations may decrease the growth of the Internet, which could in turn decrease the projected demand for our products and services or increase our 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 existing laws, could decrease online demand for our products and services or increase our costs.

We could issue preferred stock and take other actions that might discourage third parties from acquiring us. Our board of directors has the authority, without further action by the stockholders, to issue shares of preferred stock and to fix the rights, preferences, privileges and restrictions, including voting rights, of such shares. In 2003, we successfully converted all outstanding shares of our preferred stock into common stock. The rights of the holders of the common stock will be subject to, and may be adversely affected by, the rights of the holders of any preferred stock that we may issue in the future. Issuing preferred stock could have the effect of making it more difficult for a third party to acquire a majority of our outstanding voting stock, thereby delaying, deferring or preventing a change in control of our company. Furthermore, the preferred stock may have other rights, including economic rights, senior to our common stock, and as a result, issuing preferred stock could decrease the market value of our common stock.

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

We might not be able to use net operating loss carryforwards. As of December 31, 2004, we had net operating loss carryforwards for federal income tax purposes of approximately $65.0 million, which will expire at various dates through 2024. Our ability to use these net operating loss and credit carryforwards to offset 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 it increases the amount of federal income tax that we must actually pay, may have an adverse impact on our financial condition.

We do not presently anticipate paying cash dividends on 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 common stock for the foreseeable future, which could deter some investors from seeking to acquire our common stock.

PART II

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

(a) Price Range of Common Stock

Our common stock is currently listed and trades on the Nasdaq SmallCap Market under the symbol “VCMP.” For each full fiscal quarter since the beginning of 2003, the high and low bid quotations for our common stock, as reported by Nasdaq, were as follows:

	High		Low
2003
First quarter	$	4.04	$	2.29
Second quarter	$	3.81	$	2.24
Third quarter	$	3.19	$	1.25
Fourth quarter	$	2.68	$	1.20
2004
First quarter	$	3.74	$	1.42
Second quarter	$	10.00	$	1.95
Third quarter	$	3.20	$	1.03
Fourth quarter	$	2.95	$	1.04

The foregoing bid quotations reflect inter-dealer prices, without retail mark-ups, mark-downs or commissions, and may not represent actual transactions.

Since our IPO in late 1996, the public market for our common stock has been characterized by low and/or erratic trading volume, often resulting in price volatility. There can be no assurance that 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 significant fluctuations in response to future announcements concerning us or our partners or competitors, the introduction of new products or changes in product pricing policies by us or our competitors, proprietary rights or other litigation, general conditions in the e-Learning market, developments in the financial markets and other factors. In addition, the stock market has, from time to time, experienced extreme price and volume fluctuations that have particularly affected the market prices for technology companies and which have often been unrelated to the operating performance of the affected companies. Broad market fluctuations of this type may adversely affect the future market price of the common stock. See “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations—Liquidity and Capital Resources.”

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

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

The sales of the above securities were deemed to be exempt from registration under Section 4(2) of the Securities Act of 1933, as amended (the “Act”), in reliance upon the Act, or Regulation D promulgated thereunder, as transactions by an issuer not involving a public offering. Recipients of the securities in each such transaction represented their intentions to acquire such securities for investment only and not with a view to or for sale in connection with any distribution thereof and appropriate legends were affixed to the instruments issued in such transactions. All recipients had adequate access to information about VCampus.

(b) Approximate Number of Equity Security Holders

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

We have never paid a cash dividend on our common stock and we do not anticipate paying cash dividends in the foreseeable future. Moreover, any preferred stock that we could issue in the future and any future credit facilities might contain restrictions on our ability to declare and pay dividends on our common stock. We plan to retain all earnings, if any, for the foreseeable future for use in the operation of our business and to fund the pursuit of future growth. Future dividends, if any, will depend on, among other things, our results of operations, capital requirements and on such other factors as our Board of Directors, in its discretion, may consider relevant.

Item 6. Selected Financial Data.

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

Statement of Operations Data:

In thousands except per share data

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

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

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

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

The following discussion of financial condition and results of operations should be read in conjunction with VCampus’ consolidated financial statements and related notes thereto included elsewhere in this report.

Overview

Our revenues are derived from three primary sources:

· online tuition revenues;

· development revenues; and

· other service revenues.

Online tuition revenues are generated primarily from online tuition derived from corporate, government, and higher education customers and sales of our Select Partner courseware. Development revenues consist primarily of fees paid to us for creating and developing new online courseware and web-enabling existing courseware. Other service revenues consisted primarily of monthly fees generated by the maintenance of the CYBIS courseware under contract with the U.S. Army.

On June 18, 2002, our Board of Directors approved a one-for-ten reverse stock split of our common stock. The reverse stock split became effective as of the opening of trading on July 8, 2002. Stockholders’ equity has been restated to give retroactive recognition to the reverse stock split for all periods presented by reclassifying the excess par value resulting from the reduced number of shares from common stock to paid-in-capital. All references to common share and per-share amounts for all periods presented have been retroactively restated to reflect the stock split.

Critical Accounting Policies

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

Revenue Recognition

We derive our revenues from the following sources—online tuition revenues, other service revenues and development and other revenues.

Revenue is recognized in accordance with either SEC Staff Accounting Bulletin No. 104, Revenue Recognition (SAB 104), or Statement of Position 97-2, Software Revenue Recognition (“SOP 97-2”), as amended. Both SAB 104 and SOP 97-2 generally require that four basic criteria must be met before revenue can be recognized: (1) persuasive evidence of an arrangement exists; (2) delivery has 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 the fee charged for services rendered and the collectibility of those fees. Should changes in conditions cause management to determine these criteria are not met for certain sales, revenue recognized for any reporting period could be adversely affected. Online tuition revenues are generated primarily through

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

Development and other revenues earned under courseware conversion contracts are recognized relative to our proportionate performance based on the ratio that total costs incurred to date bear to the total estimated costs of the contract. Provisions for losses on contracts are made in the period in which they are determined.

Prior to the third quarter of 2004, we had also been recognizing revenues for other services. Revenues for other services were being recognized as the services were delivered. We have ceased providing these other services.

Allowance for Doubtful Accounts

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

Capitalized Software and Courseware Development Costs

During 2002, 2003 and 2004, we capitalized certain software and courseware development costs. We capitalize the cost of software used for internal operations once technological feasibility of the software has been demonstrated. We capitalize costs incurred during the development process, including payroll costs for employees who are directly associated with the development process and services performed by consultants. Amortization of such costs is based on the greater of (1) the ratio of current gross revenues to the sum of current and anticipated gross revenues, or (2) the straight-line method over the remaining economic life of the vcampus or courseware, typically two to three years. It is possible that those anticipated gross revenues, the remaining economic life of the products, or both, may be reduced as a result of future events.

Goodwill and Other Identifiable Intangibles

Management assesses the recoverability of goodwill and other identifiable intangibles whenever events or changes in circumstances indicate that the carrying value may not be recoverable. When management determines that the carrying value of goodwill or other identifiable intangibles is not recoverable, an impairment loss is recognized to the extent the carrying value of the asset exceeds its fair value. Fair value can be estimated using a number of techniques including quoted market prices, valuations by third parties and discounted cash flow analysis. The fair value of the asset could be different using different estimates and assumptions in these valuation techniques.

In accordance with Statement of Financial Accounting Standards No. 142, “Goodwill and Other Intangibles,” we ceased amortizing goodwill and other indefinite-lived intangibles on January 1, 2002. In lieu of amortization, these assets are subject to an annual impairment review. We may determine through the impairment review process that goodwill or other indefinite-lived intangibles have been impaired, resulting in an impairment charge in the period the review is completed.

Results of Operations

The following table sets forth certain statement of operations data as a percentage of total net revenues for the periods indicated:

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

2004 Compared to 2003

Summary

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

The following table sets forth selected financial data:

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

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

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

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

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

Cost of Revenues

Cost of revenues decreased 21.0% to $1,356,699 in 2004 as compared to $1,718,340 in 2003. The decrease was primarily due to the sale of a higher percentage of courses with relatively lower associated royalty costs.

Operating Expenses

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

Product Development and Operations. Product development and operations expenses increased 10.1% to $2,725,155 in 2004 compared to $2,474,856 in 2003. The increase was due to the fact that following the release of our new course management system in the first quarter of 2004, we did not capitalize any software development costs (due to their nature) in the last three quarters of 2004, whereas in 2003, software development costs had been capitalized.

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

Depreciation and Amortization. Depreciation and amortization expense increased 39.4% to $1,227,089 in 2004 as compared to $879,966 in 2003. The increase was primarily due to the release of our new Course Management System in the first quarter of 2004 as well as the release of a number of Select Partner courses, as a result of which we began amortizing costs we had capitalized for their development.

Stock-based Compensation. Stock-based compensation expense for 2004 and 2003 consists of the fair value of stock issued as customary payment to our non-employee directors for their participation in Board of Directors and Board Committee meetings and the fair market value of stock issued to consultants.

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

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

2003 Compared to 2002

Summary

We incurred a net loss attributable to common stockholders of $6,185,877 (or $1.81 per share) in 2003 as compared to a net loss 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 a decrease in sales and

marketing and depreciation and amortization expenses and the absence of loss on debt extinguishment in 2003 ($503,246 of such loss was included in the net loss attributable to common stockholders for 2002).

The following table sets forth selected financial data:

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

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

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

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

Cost of Revenues

Cost of revenues increased 17.6% to $1,718,340 in 2003 as compared to $1,461,663 in 2002. The increase was primarily due to an increase in the sale of courses with relatively high associated content costs under one of our large customer contracts.

Operating Expenses

Sales and Marketing. Sales and marketing expenses decreased 20.5% to $2,137,791 in 2003 compared to $2,689,136 in 2002. The decrease was primarily due to a reduction in headcount in the sales and marketing department and related costs. During 2003 and 2002, we contributed $740,288 and $551,056, respectively, to a marketing and development fund (the “Development Fund”) jointly administered by

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

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

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

Depreciation and Amortization. Depreciation and amortization expense 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 our fixed and intangible assets have been fully depreciated and amortized, respectively.

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

Stock-based Compensation. Stock-based compensation expense in 2003 and 2002 consists of the fair value of stock options (using the Black-Scholes valuation method) issued to consultants and the fair value of stock issued as customary payment to our non-employee directors for their participation in Board of Directors and Board Committee meetings.

Interest Expense. Interest expense in 2003 and 2002 primarily consists of debt discount and amortization of deferred debt offering costs related to the remaining balance of the $925,000 of convertible promissory notes we issued in December 2001.

Other Income. Other income in 2003 consists of the write-off of royalty obligations to one of our former content providers following the expiration of the relevant statute of limitations for bringing any action to enforce the obligations. Other income in 2002 consists of the extinguishment of liabilities comprised of customer deposits and prepayments. These prepayments and deposits were received prior to December 31, 2000 and were for classroom training to be delivered by HTR and per the terms of the arrangement with customers, they were non refundable. Our HTR subsidiary ceased operations in December 2000.

Liquidity and Capital Resources

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

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

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

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

In March 2004, we raised $5,000,000 in gross cash 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 the aggregate principal amount of $1,000,000. Each unit consisted of 50,000 shares of common stock at $1.63 per share, a Series A senior secured convertible note in the original principal amount of $118,500 and a five-year warrant to purchase 61,350 shares of common stock. We issued an additional $250,000 of Series B senior secured notes in exchange for cancellation of existing short-term indebtedness in that amount. We issued to the Series B noteholders five-year warrants to purchase an aggregate of 383,439 shares of common stock. The exercise price for the warrants, as adjusted upon shareholder approval in May 2004, is $1.63 per share

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

During 2004, an additional $512,500 of Series A and Series B senior secured convertible note principal was converted into 314,420 shares of common stock, resulting in $1,512,125 of aggregate principal from this financing converted as of the end of 2004. During 2004, we issued 1,132,617 shares of common stock upon the exercise of warrants and options. Net cash proceeds to us from these exercises amounted to $1,944,283.

In March 2005, we raised $995,950 in gross proceeds through the issuance of 611,012 shares of common stock at a purchase price of $1.63 per share to 12 accredited investors. Under the terms of this financing, we also issued five-year warrants to purchase 763,765 shares of common stock with an exercise price of $1.63 per share to the same accredited investors. In connection with this financing, we paid a placement agent a fee equivalent to 5% of the amount raised, paid in common stock. As this was a placement of common stock, the fair value of the warrants issued was accounted for as cost of capital.

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

Partner program to continue in 2005. Management has also instituted cost cutting measures and operates under an approved budget, which is closely monitored. Management is committed to maintaining operations at current levels to meet projected sales levels. However, in the event revenues do not meet anticipated levels or we are unable to raise additional funding to meet working capital requirements, we may need to further significantly reduce operating expenses.

If we are not able to address our funding needs, we will be materially adversely affected. Our future capital requirements will depend on many factors, including, but not limited to, acceptance of and demand for our products and services including the Select Partner business model, customer demands for technology upgrades, the types of arrangements that we may enter into with customers and agents, and the extent to which the we invest in new technology and research and development projects. While we believe we have the ability to raise additional capital, our ability to raise capital in the near term is uncertain. If we are unable to raise additional funding to meet working capital requirements, we may unable to maintain compliance with Nasdaq SmallCap Market listing requirements and we might not be able to achieve our business objectives. VCampus believes it has available capital on hand and sources for additional debt and equity capital in amounts necessary to meet its cash needs into 2006. However, such capital, if needed and available, may not have terms favorable to us or our current stockholders.

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

Contractual Obligations

Our future liquidity and capital resources will be affected by our contractual obligations. Our significant contractual obligations as of December 31, 2004 are for debt and operating leases and purchase obligations. These obligations are summarized as follows:

	Payments Due by Period
Contractual Obligations	Total		2005		2006 - 2008		2009 - 2011			2012 and Thereafter
Notes payable(1)	$	2,137,500	$	267,188	$	1,603,125		$	267,187		$	—
Operating leases	2,886,407		525,027		1,671,490			689,890			—
Purchase obligation(2)	32,125		32,125		—			—			—
Total contractual obligations	$	5,056,032	$	824,340	$	3,274,615		$	957,077		$	—

(1) In March 2004, we raised $5,000,000 in gross cash 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 the aggregate principal amount of $1,000,000. Each unit consisted of 50,000 shares of common stock (initially priced at $1.63 per share), a Series A senior secured convertible note in the original principal amount of $118,500 and a five-year warrant to purchase 61,350 shares of common stock. We issued an additional $250,000 of Series B senior secured notes in exchange for cancellation of existing short-term indebtedness in that amount. Upon approval of the private placement by VCampus’ stockholders at our annual meeting on May 18, 2004, $18,500 of principal of each of the Series A notes was converted into common stock at $1.63 per share and $100,000, or 50%, in principal of each of the Series B notes was converted into common stock at $1.63 per share. The total principal amount for both Series converted upon approval of the stockholders was $999,625. Therefore, following stockholder approval, a total of $2,650,000 of the placement was recorded as equity and $2,650,000 as senior debt. The notes mature on April 1, 2009 and bear interest at the rate of 8% per annum payable

quarterly in cash or stock (valued at the conversion price) at VCampus’ option for the first year. Principal and interest on the notes are payable in cash over the following four years in quarterly installments. During 2004, an additional $512,500 of Series A and Series B senior secured convertible note principal was converted into 314,420 shares of common stock, resulting in $1,512,125 of aggregate principal from this financing converted as of the end of 2004.

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

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

Recent Accounting Pronouncements

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

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

In December 2003, the SEC issued Staff Accounting Bulletin No. 104, Revenue Recognition, which updates the guidance in SAB No. 101, integrates the related set of Frequently Asked Questions, and recognizes the role of EITF 00-21. The adoption of SAB No. 104 did not have a material effect on our consolidated financial statements.

Item 7A. Quantitative and Qualitative Disclosures About Market Risk.

In the normal course of business, we are exposed to a variety of risks including market risk associated with interest rate movements. Our exposure to market risk for changes in interest rates relates primarily to any investments we may hold at various times and also related to its long-term debt. When investing, our purchases consist of highly liquid investments with maturities at the date of purchase generally no greater than twelve months, thus, due to the short-term nature of such investments and our usual intention to hold these investments until maturity, the impact of interest rate changes would not have a material impact on our results of operations. In addition, all of our long-term debt obligations are at fixed interest rates. Given the fixed rate nature of the debt, the impact of interest rate changes also would not have a material impact

on our results of operations. If we receive payments in local currencies when delivering courses in overseas markets, we could experience losses in connection with currency translation.

Item 8. Financial Statements and Supplementary Data.

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

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

Not applicable.

Item 9A. Controls and Procedures.

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

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

Item 9B. Other Information.

None.

PART III

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

Item 10. Directors and Executive Officers of the Registrant.

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

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

The Board of Directors has adopted 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 Executive Officer, Chief Financial Officer and Controller, or persons performing similar functions. We will provide copies of our codes of conduct without charge upon request. To obtain a copy of our codes of conduct, please send your written request to VCampus Corporation, 1850 Centennial Park Drive, Suite 200, Reston, VA 20191, Attention: Chief Financial Officer.

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

Item 11. Executive Compensation.

The information required by Item 11 of Form 10-K is incorporated by reference to the information under the heading “Proposal No. 1—Election of Directors—Information Concerning the Board of Directors and Its Committees”, “Other Information—Executive Compensation”, “—Compensation of Directors”, “—Report of the Compensation Committee on Executive Compensation”, “—Compensation Committee Interlocks and Insider Participation” and “—Performance Graph” in the Proxy Statement.

Item 12. Security Ownership of Certain Beneficial Owners and Management.

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

Item 13. Certain Relationships and Related Transactions.

The information required by Item 13 of Form 10-K is incorporated by reference to the information under the heading “Other Information—Certain Transactions” in the Proxy Statement.

Item 14. Principal Accountant Fees and Services

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

VCAMPUS CORPORATION
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY

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

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

F-6

VCAMPUS CORPORATION
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY (Continued)

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

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

F-7

VCAMPUS CORPORATION
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY (Continued)

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

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

F-8

VCAMPUS CORPORATION
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY (Continued)

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

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

F-9

VCAMPUS CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS

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

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

F-10

VCAMPUS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

1. Organization and Nature of Operations

VCampus Corporation (the “Company”) was incorporated in Virginia in 1984 and reincorporated in Delaware in 1985. VCampus Corporation is a provider of outsourced e-Learning services. The Company develops courseware and manages and hosts Internet-based learning environments for professional credentialing and certification organizations, corporations, government agencies, and associations. The Company’s services cover a broad range of e-Learning programs, from registration, enrollment and payment processing to course development and delivery, as well as tracking of students’ progress and reporting of results.

Management’s Plans to Address Operating Conditions

The Company has incurred significant losses since inception. The Company expects negative cash flow from operations to continue until the online revenue stream matures. In addition, the Company has experienced declining revenues in the current and prior periods, including the loss of a major customer in 2004 which represented 25% of revenues in 2004.

Management’s plans to address these conditions include sales to new customers through the Select Partner program which have partially replaced the sales related to the customer lost in 2004. Management anticipates the increase in sales seen in the current and prior periods under the Select Partner program to continue in 2005. Management has also instituted cost cutting measures and operates under an approved budget which is closely monitored. Management is committed to maintaining operations at current levels to meet projected sales levels.

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

2. Summary of Significant Accounting Policies

Principles of Consolidation

The consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries. All significant intercompany accounts and transactions have been eliminated.

Use of Estimates

The preparation of the consolidated financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.

F-11

Cash Equivalents

Cash equivalents, which are stated at cost, consist of highly liquid investments with original maturities of three months or less.

Non-Cash Financing Activities

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

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

In September and October 2003, the Company issued an aggregate of 27,711 shares of its common stock with an aggregate value of $71,771 and three-year fully vested warrants 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 financings completed in that period. As this was a placement of common stock, the fair value of the common stock and warrants issued to the placement agent was accounted for as cost of capital.

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

In March and May 2004, the Company issued 76,688 shares of common stock with a value of $189,419 and five-year fully vested warrants to purchase 250,000 shares of common stock at $1.63 per share valued at $545,000 in satisfaction of accrued financing costs related to the March 2004 private placement. The Company allocated $505,730 of the total value of the shares and warrants to deferred debt issuance costs which will be recognized as interest expense over the period the notes are expected to be outstanding. The remaining amount was accounted for as a cost of capital. In addition, the Company issued one quarter unit of the March 2004 private placement with an aggregate value of $50,000 to the lead investor’s counsel as payment for legal services in connection with the private placement. The Company allocated $34,430 of the total value of the one quarter unit to deferred debt issuance costs which will be recognized as interest expense over the period the notes are expected to be outstanding. The remaining amount was accounted for as a cost of capital.

Accounts Receivable

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

F-12

Loans Receivable

The Company periodically assesses the collectibility of its loans receivable and records balances due at the 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’s Knowledgeworks business totaling approximately $123,000. During 2002, the Company determined that the loan receivable was impaired and wrote off the remaining balance totaling approximately $121,000. No interest income was recognized on that note for the years ended December 31, 2002, 2003 and 2004.

Property and Equipment

Property and equipment are stated at cost less accumulated depreciation. Depreciation is computed using the 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 estimated useful life. Depreciation expense on equipment obtained under capital lease obligations is included with depreciation expense for similar types of equipment. Repairs and maintenance that do not improve or extend the lives of the respective assets are expensed in the period incurred. Depreciation expense was $694,998, $283,354 and $290,050 for 2002, 2003 and 2004, respectively.

Capitalized Software and Courseware Development Costs

During 2002, 2003 and 2004, the Company capitalized certain software and courseware development costs. The Company capitalizes the cost of software used for internal operations once technological feasibility of the software has been demonstrated. The Company capitalizes costs incurred during the development process, including payroll costs for employees who are directly associated with the development process and services performed by consultants. Amortization of such costs is based on the greater of (1) the ratio of current gross revenues to the sum of current and anticipated gross revenues, or (2) the straight-line method over the remaining economic life of the vcampus or courseware, typically two to three years. It is possible that those anticipated gross revenues, the remaining economic life of the products, or both, may be reduced as a result of future events. During 2002, 2003 and 2004, the Company recognized amortization of capitalized software and courseware development costs of $438,754, $417,613 and $758,047, respectively. During 2002, the Company wrote off $276,535 in capitalized software and courseware development costs for courses within the telecommunications industry segment determined to have no future value. The write-off, which represents the carrying value of the courses, has been included in product development costs in the 2002 statement of operations.

Web Site Development Costs

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

Goodwill and Other Intangible Assets

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

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

F-13

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

In connection with the adoption of SFAS 142, the Company performed an assessment of whether there were indicators that goodwill was impaired at the date of adoption. To accomplish this, the Company identified its reporting units and determined the carrying value of each reporting unit. The Company then determined the fair value of the reporting unit and compared it to the reporting unit’s carrying amount. To the extent the reporting unit’s carrying amount exceeds its fair value, an indication exists that the reporting unit’s goodwill may be impaired and the Company must perform the second step of the impairment test. In the second step, the Company must compare the implied fair value of the reporting unit’s goodwill, determined by allocating the reporting unit’s fair value to all of its assets and liabilities in a manner similar to a purchase price allocation in accordance with SFAS 141, to its carrying amount, both of which would be measured as of the date of adoption.

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

Impairment of Long-Lived Assets

The Company accounts for long-lived assets in accordance with the provisions of SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets (SFAS No. 144). SFAS No. 144 requires that long-lived assets and certain identifiable intangibles be reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable.

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

During 2002, the Company wrote off $276,535 in capitalized software and courseware development costs for courses within the telecommunications industry segment, as a result of an impairment analysis. The write-off has been included in product development costs in the 2002 statement of operations.

Revenue Recognition

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

Online tuition revenues are generated primarily through three types of contracts: (i) contracts with higher education partners, (ii) corporate subscriptions, and (iii) corporate usage. For higher education partner contracts and corporate subscriptions, revenue is recognized ratably (on a straight-line basis) over the semester term and subscription period, respectively. For usage contracts, revenue is recognized upon enrollment in a course. Once a student has enrolled in a course, he cannot cancel delivery of a course or

F-14

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

Development and other revenues earned under courseware conversion contracts are recognized relative to the Company’s proportionate performance based on the ratio that total costs incurred to date bear to the total estimated costs of the contract. Provisions for losses on contracts are made in the period in which they are determined.

Revenues for other services are recognized as the services are delivered.

The Company accounts for cash received from customers as prepayments for future services as deferred revenue. The Company recognizes revenue associated with those cash receipts in accordance with the above policies.

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

Stock-Based Compensation

The Company applies the intrinsic-value-based method of accounting prescribed by Accounting Principles Board Opinion No. 25 (“APB 25”), Accounting for Stock Issued to Employees, and related interpretations including FASB Interpretation No. 44 (“FIN 44”), Accounting for Certain Transactions Involving Stock Compensation, an interpretation of APB 25, issued in March 2000, to account for its fixed-plan stock options. Under this method, compensation expense is recorded only if the current market price of the underlying stock exceeded the exercise price on the date of the grant. Statement of Financial Accounting Standards No. 123 (“SFAS 123”), Accounting for Stock-Based Compensation, established accounting and disclosure requirements using a fair-value-based method of accounting for stock-based employee compensation plans. As allowed by SFAS 123, the Company has elected to continue to apply the intrinsic-value-based method of accounting described above, and has adopted only the disclosure requirements of SFAS 123 as amended by Statement of Financial Accounting Standards No. 148, Accounting for Stock-Based Compensation—Transition and Disclosure, Amendment of SFAS 123 (“SFAS 148”).

Stock options and warrants granted to non-employees are accounted for using the fair value method in accordance with the SFAS No. 123 and EITF 96-18, Accounting for Equity Instruments That Are Issued to Other Than Employees for Acquiring, or in Conjunction with Selling, Goods or Services.

F-15

The following table illustrates the pro forma effect on net loss attributable to common stockholders (net loss) and pro forma net loss per common share as if the Company had applied the fair value recognition provisions of SFAS No. 123 to stock-based compensation.

	2002			2003			2004
Pro forma net loss:
As reported	$	(7,147,305	)	$	(6,185,877	)	$	(6,579,416	)
Add: Non cash stock compensation included in reported net loss attributable to common stockholders	76,172			126,056			153,973
Deduct: Total employee non cash stock compensation expense determined under fair value based method for all awards	(4,996,214		)	(5,486,954		)	(3,212,044		)
Pro forma net loss	$	(12,067,347	)	$	(11,546,775	)	$	(9,637,487	)
Net loss per common share:
Basic and diluted—as reported	$	(4.79	)	$	(1.81	)	$	(0.97	)
Basic and diluted—pro forma	$	(8.08	)	$	(3.37	)	$	(1.42	)

The effect of applying SFAS No. 123 on a pro forma net loss as stated above is not necessarily representative of the effects on reported net loss for future years due to, among other things, the vesting period of the stock options and the fair value of additional options to be granted in the future years.

The fair value of each option grant is estimated on the date of grant using the Black-Scholes option-pricing fair value model with the following assumptions:

	2002		2003		2004
Dividend yield	0	%	0	%	0	%
Volatility	133	%	126	%	130	%
Average risk-free interest rate	4.39	%	3.52	%	3.87	%
Expected term	7 years		7 years		8 years

Concentration of Credit Risk

The Company performs ongoing credit evaluations of its customers’ financial condition and generally does not require collateral. The Company maintains reserves for credit losses, and such losses have been within management’s expectations.

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

Financial Instruments

The carrying value of the Company’s financial instruments, including cash and cash equivalents, accounts receivable, loans receivable, accounts payable, accrued expenses, deferred revenues and notes payable approximated their fair values based on the short-term maturities of these instruments.

Royalties

Royalties are due and payable by the Company upon the sale of certain courses for which the Company has acquired or otherwise licensed the online publishing rights. In addition, the Company may be obligated to pay certain royalties related to courses which a customer may have converted to an online format and elected to distribute to all the Company’s customers. Royalties accrue at a rate of 10% to 85% of the tuition fees received with respect to certain courses.

F-16

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

Advertising Costs

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

Income Taxes

The Company provides for income taxes in accordance with the liability method. Under this method, deferred tax assets and liabilities are determined based on differences between financial reporting and tax bases of assets and liabilities and are measured using the enacted tax rates and laws that are expected to be in effect when the differences are expected to reverse. Because the realization of tax benefits related to the Company’s net deferred tax asset is uncertain, a full valuation allowance has been provided against the net deferred tax asset.

Net Loss Per Share

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

Recent Accounting Pronouncements

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

SFAS 123(R) allows the use of both closed form models (e.g., Black-Scholes Model) and open form models (e.g., lattice models) to measure the fair value of the share-based payment as long as that model is capable of incorporating all of the substantive characteristics unique to share-based awards. In accordance with the transition provisions of SFAS 123(R), the expense attributable to an award will be measured in accordance with the Company’s measurement model at that award’s date of grant.

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

F-17

Risks and uncertainties

The Company is subject to all of the risks inherent in a company that operates in the intensely competitive Internet industry, providing a service that is relatively new and constantly evolving. These risks include, but are not limited to, market acceptance of the Company’s products and services, and reliance on third-party software incorporated in the Company’s products. The Company’s operating results may be materially affected by these foregoing factors.

Reclassifications

Certain amounts presented in the 2003 consolidated financial statements have been reclassified to conform with the 2004 presentation.

3. Property and Equipment

Property and equipment consisted of the following:

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

At December 31, 2003 and 2004, the Company had no equipment under capital lease obligations.

4. Capitalized Software and Courseware Development Costs

Capitalized software and courseware development costs consisted of the following:

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

F-18

5. Goodwill and Other Intangible Assets

Other intangible assets were comprised of:

	December 31,
	2003			2004
Developed content	$	523,800		$	523,800
Trademarks and names	904,720			904,720
Customer base	304,820			304,820
	1,733,340			1,733,340
Less accumulated amortization	(1,163,846		)	(1,342,838		)
	$	569,494		$	390,502

Amortization expense for other intangible assets is expected to be as follows:

2005	133,490
2006	110,740
2007	66,078
2008	43,747
2009	36,447
	$	390,502

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

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

6. Restructuring of Operations and Other Non-Recurring Items

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

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

F-19

7. Loans Receivable from Related Party

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

8. Notes Payable

In December 2001 and January 2002, the Company raised $925,000 through the issuance of 8% debentures together with five-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 the debentures and the warrants based on their relative fair values using the Black-Scholes option pricing model. The amount allocated to the warrants ($335,841 and $40,708 for the 2001 and 2002 funding, respectively), was recorded as a debt discount and was amortized to interest expense over the period the debentures were outstanding. In March 2002, the Company issued 1,458,413 shares of Series F-1 Preferred Stock and five-year fully vested warrants to purchase 14,584 shares of common stock at $4.00 per share in exchange for the cancellation of a note in 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-2 Preferred 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 promissory note in the principal and accrued interest amount of $205,730. Upon shareholder approval of the debt financing, the Company recorded an additional $91,563 of debt discount for the instruments’ beneficial conversion feature. The unamortized debt discount at December 31, 2003 and 2004 was $0. Principal and accrued interest under the debentures was due and payable at December 31, 2003. The debentures were convertible into shares of the Company’s common stock at the election of the holders at a conversion price of $3.50 per share. Principal and accrued interest of $225,000 and approximately $40,000 under the debentures were repaid in March 2004.

In March 2004, the Company raised $5,000,000 in gross cash 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 the aggregate principal amount of $1,000,000. Each unit consisted of 50,000 shares of common stock (initially priced at $1.63 per share), a Series A senior secured convertible note in the original principal amount of $118,500 and a five-year warrant to purchase 61,350 shares of common stock. The Company issued an additional $250,000 of Series B senior secured notes in exchange for cancellation of existing short-term indebtedness in that amount. The Company issued to the Series B noteholders five-year warrants to purchase an aggregate of 383,439 shares of common stock. The exercise price for the warrants is $1.63 per share. Additionally, the Company issued one quarter unit to the lead investor’s counsel as payment for legal services. The Company allocated the proceeds from the issuance of the notes to the notes and to that subset of warrants allocated to the notes based on their relative fair values using the Black-Scholes option pricing model. The amount allocated to the warrants ($1,462,538) was recorded as a debt discount to be amortized to interest expense over the period the notes are expected to be outstanding. The notes are convertible into shares of the Company’s common stock at the election of the holders at a conversion price of $1.63 per share. Total shares of common stock issued in connection with this private placement were 1,012,500. The fair value of the warrants allocated to the common stock on a pro-rata basis has been accounted for as cost of capital.

The terms of the financing include antidilution provisions to the effect that if and whenever in the period commencing after the issuance date (March 23, 2004) and ending 24 months thereafter (March 22, 2006) (the Antidilution Period), the Company issues or sells, or is deemed to have issued or sold, any shares of common stock, with the exception of specific customary issuances which are excluded, for a consideration per share less than the conversion price or exercise price in effect immediately prior to such

F-20

time for the relevant shares, then concurrent with such dilutive issuance, the conversion price or exercise price for the notes and warrants, as the case may be, then in effect shall be reduced to an equal amount to the new securities issuance price.

Upon stockholder approval of the private placement the Company recorded an additional $2,187,087 of debt discount for the instrument’s beneficial conversion feature. In addition, $18,500 of principal of each of the Series A notes was converted into common stock at $1.63 per share and $100,000, or 50%, in principal of each of the Series B notes was converted into common stock at $1.63 per share. The total principal amount for both Series converted upon approval of the stockholders was $999,625, resulting in the issuance of 613,276 shares of common stock. The Company recorded a total of $2,650,000 of the placement as equity and $2,650,000 as senior debt. The notes mature on April 1, 2009 and bear interest at the rate of 8% per annum payable quarterly in cash or stock (valued at the conversion price) at VCampus’ option for the first year. Principal and interest on the notes are payable in cash over the following four years in quarterly installments.

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

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

As of December 31, 2004, future maturities of long-term debt obligations were as follows:

2005	$	267,188
2006	534,375
2007	534,375
2008	534,375
2009	267,187
	$	2,137,500

9. Commitments and Contingencies

Leases

The Company leases office space and office equipment under non-cancelable operating lease agreements with various renewal options. Future minimum lease payments may be periodically adjusted based on changes in the lessors’ operating charges. Rent expense for the years ended December 31, 2002, 2003 and 2004 was $521,953, $520,743 and $520,710, respectively.

As of December 31, 2004, payments due under non-cancelable operating leases were as follows:

2005	$	525,027
2006	540,778
2007	557,001
2008	573,711
2009	590,923
Thereafter	98,968
	$	2,886,408

F-21

Employment Agreements

The Company has entered into employment agreements with certain members of management. These agreements specify minimum annual salaries as well as discretionary bonus amounts to be paid over the next year.

Purchase Commitment

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

Litigation

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

In 2002, the Virginia Department of Taxation completed an audit of the Company’s sales and use tax payments from August 1998 through October 2001. In July 2002, the Company received a draft assessment which contemplated a payment of taxes, penalties and interest by the Company of $212,719, primarily associated with the Company’s alleged failure to assess use tax on third-party royalties paid by the Company to content providers for courses we delivered online. The Company paid the sales and use tax and interest on non-contested items, which amounted to $18,928 out of the $212,719. The Company has formally contested the remaining items covered by the draft assessment, including the assessment of use tax on the royalties paid by the Company to content providers for courses the Company delivered online as well as the methodology used by the Virginia Department of Taxation to estimate the royalties. In July 2003, the assessment was reduced by the Virginia Department of Taxation to $86,678 including interest of $17,278. In October 2003, the Company appealed the assessment. In March 2004, the Company was notified that this appeal remains under review. The Company does not have a firm estimate of the probability of liability for this issue or the amount of anticipated legal costs, but has reason to believe that the potential liability will be reduced to the point where it will not be considered material. Accordingly, the Company cannot estimate at this time the amount of liability to be incurred, if any. No amounts have been accrued in the consolidated financial statements for this potential liability.

F-22

10. Accrued Expenses

Accrued expenses consisted of the following:

	December 31,
	2003		2004
Accrued payroll and payroll taxes	$	23,010	$	37,665
Accrued vacation	59,230		27,952
Other	287,523		252,861
	$	369,763	$	318,478

Accrued payroll as of December 31, 2003 and 2004 primarily consists of earned but unpaid commissions.

11. Stockholders’ Equity

Stock Split

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

Conversion of Preferred Stock

In June 2003, pursuant to approvals obtained at its annual meeting of stockholders, together with agreements signed by holders of its preferred stock, the Company converted all of the outstanding shares of each of its eight classes of preferred stock into a total of 3,007,453 shares of common stock. The conversions were effective on June 6, 2003 at conversion prices ranging from $2.196 to $69.82 per share. This recapitalization removed a total of approximately $24.3 million of preferred stock liquidation preference that was formerly senior to the outstanding common stock and released the Company from the obligation to pay future dividends on the converted shares. As an incentive to induce the conversions, the Company issued warrants to the preferred stockholders to purchase a total of 451,445 shares of common stock at $3.85 per share. The Company valued the warrants using the Black-Scholes option pricing model and recognized a deemed dividend of $1,042,838, which represents the excess of the fair value of the warrants issued over the fair value of the stock issuable pursuant to the original conversion terms of the securities. As part of the recapitalization, the Company also issued a warrant to a preferred shareholder to purchase 166,155 shares of common stock at $2.20 per share in exchange for the cancellation of that shareholder’s warrant to purchase an equivalent number of shares of Series E preferred stock at the equivalent exercise price. The Company valued the warrants using the Black-Scholes option pricing model and recognized a deemed dividend of $12,211 upon the cancellation of the warrants to purchase shares of Series E preferred stock.

Series C Preferred Stock

In March 1998, the Company raised net proceeds of approximately $5,300,000 in a private placement of Series C Preferred Stock and warrants (the “Series C Preferred Stock”). In this transaction, the Company issued approximately 626,300 shares of the Series C Preferred Stock, which were convertible into approximately 75,910 shares of common stock. The Company also issued five-year warrants, which were fully vested, to purchase approximately 62,630 shares of common stock at an exercise price of $84.60 per share. The Series C Preferred stockholders were entitled to receive dividends if and when declared by the Board of Directors. The Series C Preferred Stock had a liquidation preference of $12.69 per share plus all declared but unpaid dividends upon sale or liquidation of the Company. The Company recorded deemed

F-23

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

Series D Preferred Stock

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

In 2000 and 2001, 2,727 and 56,834 shares of Series D Preferred Stock were converted into 273 and 5,683 shares of common stock, respectively. No shares were converted during 2002. In June 2003, the remaining 1,013,809 shares of Series D Preferred Stock were converted into 101,381 shares of common stock.

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

Series E Preferred Stock

The Company entered into a Private Equity Line of Credit Agreement (the “Equity Line Agreement”), as amended, with Hambrecht & Quist Guaranty Finance, LLC (“H&QGF”) in May 1999. Under the Equity Line Agreement, the Company had the right, subject to certain conditions, to issue and sell to H&QGF, from time to time, shares of its Series E Convertible Preferred Stock (“Series E Preferred Stock”), for cash consideration of up to an aggregate of $7.0 million, subject to availability. The Company had the right to sell to H&QGF shares of its Series E Preferred Stock at a price equal to 85% of the lower of (1) the closing market price of the Company’s common stock on the date of issuance and (2) the average of the lowest intra-day prices of the Company’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 one share of common stock. The holders of Series E Preferred Stock were entitled to monthly dividends paid in Series E Preferred Stock, equal to 0.5% of the number of shares of Series E Preferred Stock held. The value of Series E Preferred Stock issued as dividends amounted to $10,954 and $3,348 for 2002 and 2003, respectively.

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

F-24

In March 2003, the Company issued 18,370 shares of Series G Preferred Stock at a purchase price of $27.22 per share to accredited investors. Under the terms of this financing, the Company also issued five-year fully vested warrants to purchase 45,925 shares of common stock at $2.99 per share to the same accredited investors. Each share of Series G Preferred Stock was initially convertible into 10 shares of common stock at any time at the election of the holder. The excess of the value of common stock into which the Series G Preferred Stock was convertible over the proceeds allocated to the Preferred Stock amounted to $198,312. Such amount represented a beneficial conversion feature discount and was immediately recognized as a deemed dividend to preferred stockholders. The fair value of the preferred stock was estimated at the closing price of the Company’s common stock on the trading date prior to the issuance date and the fair value of the warrants was estimated at $129,967 using the Black-Scholes option pricing model. The issuance of the Series G Preferred Stock in March 2003 triggered an antidilution adjustment in the conversion price of the Series G Preferred Stock issued in February 2003 from $3.95 to $2.72. As a result, the number of common shares potentially issuable upon conversion of the Series G Preferred Stock issued in February 2003 increased from 103,527 to 150,229. The Company recorded a deemed dividend of $184,481 in connection with this adjustment.

In June 2003, the 78,041 shares of Series G Preferred Stock outstanding were converted into 873,022 shares of common stock.

Series H Preferred Stock

In May 2003, the Company issued 7,503 shares of Series H Preferred Stock at a purchase price of $240.00 per share to accredited investors. Under the terms of this financing, the Company also issued five-year fully vested warrants to purchase 187,575 shares of common stock at $5.00 per share to the same accredited investors. Each share of Series H Preferred Stock was initially convertible into 100 shares of common stock at any time at the election of the holder. The excess of the value of common stock into which the Series H Preferred Stock was convertible over the proceeds allocated to the Preferred Stock amounted to $776,862. Such amount represented a beneficial conversion feature discount and was immediately recognized as a deemed dividend to preferred stockholders. The fair value of the preferred stock was estimated at the closing price of the Company’s common stock on the trading date prior to the issuance date and the fair value of the warrants was estimated at $455,807 using the Black-Scholes option pricing model. The issuance of the Series H Preferred Stock in May 2003 triggered an antidilution adjustment in the conversion price of the Series G Preferred Stock issued in November 2002 and 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 potentially issuable upon conversion of the Series G Preferred Stock issued in those periods increased from 363,114 to 409,020. The Company recorded a deemed dividend of $124,676 in connection with this adjustment.

In June 2003, the 7,503 shares of Series H Preferred Stock outstanding were converted into 750,300 shares of common stock.

Common Stock

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

F-28

On September 30, 2003, the Company raised $825,330 through the private placement of 318,660 units, at a purchase price of $2.59 per unit. On October 9, 2003, the Company raised $200,000 through the 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 to purchase one share of common stock with an exercise price of $2.59 per share. Aggregate proceeds from these private placements, net of $120,000 in financing costs, amounted to $905,330. In connection with these financings, the Company paid a placement 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 an additional $2,000,000 in equity financing by November 15, 2003, on that date the unit holders became entitled to receive additional shares of common stock as if the purchase price per share of common stock had equaled $2.00 when the 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 the warrants issued was accounted for as cost of capital.

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

During 2003, the Company 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 expense related to the stock issuance of $30,000.

During 2004, the Company issued an additional 314,420 and 72,388 shares of common stock upon the conversion of $512,500 of Series A and Series B senior secured convertible note principal and $117,992 of interest thereon, respectively.

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

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

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

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

F-29

Stock Option Plans

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

During 1996, the Company’s Board of Directors approved a 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 Plan are generally granted at prices which the Company’s Board of Directors believes approximates the fair market value of its common stock at the date of grant. Individual grants generally become exercisable ratably over a period of four to five years from the date of grant. The contractual terms of the options range from three to ten years from the date of grant.

Common stock option activity was as follows for the periods indicated:

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

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

The following table summarizes information about fixed-price stock options outstanding at December 31, 2004:

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

The weighted average fair values of the options granted in 2002 with a stock price equal to the exercise price was $3.71. The weighted average fair values of the options granted in 2003 with a stock price equal to the exercise price was $2.50. The weighted average fair values of the options granted in 2004 with a stock price equal to the exercise price was $1.94.

F-30

Warrants

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

	Years Ended December 31,
	2002		2003		2004
Outstanding at the beginning of the year	635,388		1,108,911		2,375,116
Granted	551,492		1,924,159		3,751,560
Exercised	—		—		(1,111,942	)
Canceled or expired	(77,969	)	(657,954	)	(2,053,324	)
Outstanding at the end of the year	1,108,911		2,375,116		2,961,410

Exercise prices on the outstanding warrants range from $1.63 to $70.00 per share. The weighted average grant date fair value of warrants issued in 2004 was $2.01. The fair value of each warrant grant is estimated on the date of grant using the Black-Scholes option-pricing fair value model with the following ranges of assumptions: dividend yield of 0%; expected volatility of 69% to 133%; risk-free interest rate of 4.39% to 6.50%; and expected life of the warrant term of three to seven years. During 2002 the number of shares and exercise prices of certain warrants were adjusted to satisfy certain anti-dilution rights previously granted.

Reserve for Issuance

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

12. Retirement Plans

The VCampus Corporation 401(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-time employees are eligible to make participation elections at any time while employed by the Company. There is a graduated vesting schedule for employer contributions in which contributions fully vest over a period of four years. The plan allows discretionary Company contributions. In 2002, 2003 and 2004, there were no discretionary Company contributions made to the plan.

13. Income Taxes

Income tax expense for the years ended December 31, 2002, 2003 and 2004 is different from the amount computed by applying the statutory federal income tax rates to losses before income tax expense. The reconciliation of these differences is as follows:

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

Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting and income tax purposes. The Company has recognized a full valuation allowance against the deferred tax assets because it is more likely than not that sufficient taxable income will not be generated during the carryforward period available under the tax law

F-31

to utilize the deferred tax assets. The valuation allowance for deferred taxes increased $1,571,000, $1,240,000 and $1,844,000 in the years ended December 31, 2002, 2003 and 2004. Significant components of the Company’s net deferred tax assets were as follows:

	December 31,
	2003			2004
Net operating loss carryforwards	$	24,023,000		$	26,279,000
Accrued payroll	25,000			35,000
Other accruals	73,000			53,000
Other assets and liabilities, net	1,789,000			1,387,000
Total deferred tax assets	25,910,000			25,754,000
Valuation allowance	(25,910,000		)	(27,754,000		)
Net deferred tax assets	$	—		$	—

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

14. Net Loss Per Share

The following table sets forth the computation of basic and diluted net loss per share:

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

F-32

The following equity instruments (with underlying common share numbers show in the table) were not included in the diluted net loss per share calculation because their effect would have been anti-dilutive:

	Year ended December 31,
	2002	2003	2004
Convertible notes payable:	64,285	64,285	1,311,354
Convertible preferred stock:
Series C	75,554	—	—
Series D	101,380	—	—
Series E	57,490	—	—
Series F	478,142	—	—
Series F-1	232,443	—	—
Series F-2	439,540	—	—
Series G	493,200	—	—
Stock options	299,865	529,243	1,414,047
Warrants	1,108,911	2,375,116	2,961,410

15. Subsequent Events

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

16. Quarterly Sales and Earnings Data—Unaudited

The following table presents the quarterly results for VCampus Corporation and its subsidiaries for the years ended December 31, 2003and 2004

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

* Certain revenues and corresponding expenses included in the quarterly results have been reclassified from the presentation in prior periods. While this reclassification causes revenues and expenses reported in the consolidated financial statements to be lower than previously reported, it has no impact on previously reported assets, liabilities or net loss.

F-33

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

Name	Age	Positions
Nat Kannan	55	Chairman and Chief Executive Officer
Christopher L. Nelson	42	Chief Financial Officer, Chief Information Officer and Secretary
Ronald E. Freedman	55	Senior Vice President, Worldwide Sales and Marketing
Laura B. Friedman	43	Vice President, Co-Publishing
Tamer A. Ali	32	Vice President, Technology

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

10.96		Security Agreement dated March 23, 2004 entered into in connection with the $5.3 million private placement
10.97	(k)*	Content Client License Agreement between VCampus and Net Dimensions Limited dated February 24, 2004
10.98	(k)	Settlement Agreement and Release between VCampus and Park University dated May 3, 2004
10.99	(l)	VCampus’ standard form of Online Content Conversion and Distribution Agreement (also known as the form of Select Partner Agreement)
21.1		List of Subsidiaries
23.1		Consent of Reznick Group, P.C., Independent Registered Public Accounting Firm
23.2		Consent of Ernst & Young LLP, Independent Registered Public Accounting Firm
31.1		Certification of Chief Executive Officer pursuant to Rule 13a-14(a).
31.2		Certification of Chief Financial Officer pursuant to Rule 13a-14(a).
32.1		Chief Executive Officer Certification pursuant to Section 906 of the Sarbanes/Oxley Act of 2002.
32.2		Chief Financial Officer Certification pursuant to Section 906 of the Sarbanes/Oxley Act of 2002.
99.4	(h)	Form of Warrant issued to the Series F holders on December 28, 2001
99.5	(h)	Form of Warrant issued to the convertible noteholders on December 28, 2001
99.7	(b)	Audit Committee Charter

	VCAMPUS CORPORATION
	By:	/s/ NARASIMHAN P. KANNAN
		Narasimhan P. Kannan, Chief Executive Officer
Date: March 29, 2005

	Signature		Capacity		Date
/s/ NARASIMHAN P. KANNAN		Chairman and Chief Executive Officer		March 29, 2005
Narasimhan P. Kannan		(Principal Executive Officer)
/s/ CHRISTOPHER L. NELSON		Chief Financial Officer		March 29, 2005
Christopher L. Nelson		(Principal Financial and Accounting Officer)
/s/ EDSON D. DECASTRO		Director		March 28, 2005
Edson D. deCastro
/s/ MARTIN E. MALESKA		Director		March 28, 2005
Martin E. Maleska
/s/ JOHN D. SEARS		Director		March 28, 2005
John D. Sears

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

/s/ REZNICK GROUP, P.C.
Bethesda, Maryland
March 11, 2005, except for note 15, as to which the date is March 30, 2005

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

Classification	Balance at Beginning of Period			Additions			Deductions				Balance at End of Period
Allowance for doubtful accounts:
Year ended December 31, 2002		$	99		$	12		$	(80	)(1)		$	31
Year ended December 31, 2003		31			9			(35		)(1)		5
Year ended December 31, 2004		5			—			—				5