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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-Q

Commission file number 0-28977

VARSITY GROUP INC.

Registrant’s telephone number, including area code: (202) 667-3400

(Former Name, Former Address and Former Fiscal Year, if Changed, Since Last Report.)

     Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No______

APPLICABLE ONLY TO ISSUERS INVOLVED IN BANKRUPTCY PROCEEDINGS
DURING THE PRECEDING FIVE YEARS:

     Indicate by check mark whether the registrant has filed all documents and reports required to be filed by Sections 12, 13 or 15 (d) of the Securities Exchange Act of 1934 subsequent to the distribution of securities under a plan confirmed by a court. Yes______No______

     As of August 1, 2002, the registrant had 16,116,916 shares of common stock outstanding.

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VARSITY GROUP INC. AND SUBSIDIARIES

QUARTERLY REPORT ON FORM 10-Q
For the quarter ended June 30, 2002

INDEX

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PART I.
FINANCIAL INFORMATION

Item 1: Financial Statements

VARSITY GROUP INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except share and per share data)
(unaudited)

See accompanying notes to condensed consolidated financial statements.

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VARSITY GROUP INC.

CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands, except share and per share data)

ASSETS

See accompanying notes to condensed consolidated financial statements.

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VARSITY GROUP INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(unaudited)

See accompanying notes to consolidated financial statements

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VARSITY GROUP INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

Note 1: Description of Operations

Varsity Group Inc. (the “Company”) is an Internet retailer of textbooks and educational materials targeting private middle and high schools, small colleges and distance and continuing education markets. Varsity Group Inc. was incorporated on December 16, 1997 and launched its website in August 1998, at which time the Company began generating revenues. In August 1999, the Company established two wholly-owned subsidiaries, CollegeImpact.com, Inc. and VarsityBooks.com, LLC to assist in the overall management of its marketing and retailing activities, respectively.

The Company is an online retailer of textbooks and educational materials, targeting private middle and high schools, small colleges and distance and continuing education markets through its eduPartners program. As an Internet-based retailer of textbooks, the Company uses its website, www.varsitybooks.com, to sell textbooks and other learning materials to students nationwide.

In February 2000, the Company completed an initial public offering. Net proceeds to the Company from the initial public offering totaled $36.0 million. Effective upon the closing of the offering, all shares of the Company’s preferred stock converted into 8,966,879 shares of the Company’s common stock.

Note 2: Basis of Presentation

The condensed consolidated financial statements of Varsity Group Inc. and subsidiaries included herein have been prepared by the Company without audit, pursuant to the rules and regulations of the Securities and Exchange Commission and reflect all adjustments which are, in the opinion of management, necessary for a fair presentation of the results for the interim period in conformity with generally accepted accounting principles.

Certain information and footnote disclosure normally included in the financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted. The interim financial statements should be read in conjunction with the consolidated financial statements and notes thereto included in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2001. Operating results for the interim periods are not necessarily indicative of results for an entire year.

Certain reclassifications of prior year amounts have been made to conform with the current year presentation.

Item 2: Management’s Discussion and Analysis of Financial Condition and Results of Operations

Forward Looking Statements

This document contains forward-looking statements. These statements relate to future events or our future financial performance. In some cases, you can identify forward-looking statements by terminology such as “may,” “will,” “should,” “except,” “plan,” “anticipate,” “expect,” “believe,” “estimate,” “predict,” “potential” or “continue,” the negative of such terms or other comparable terminology. These statements are only predictions. Actual events or results may differ materially.

Although we believe that the expectations reflected in the forward-looking statements are reasonable, we cannot guarantee future results, levels of activity, performance or achievements. Moreover, neither we nor any other person assumes responsibility for the accuracy and completeness of the forward-looking statements. We are under no duty to update any of the forward-looking statements after the date of this report to conform such statements to actual results or to changes in our expectations.

Readers are also urged to carefully review and consider the various disclosures made by us that attempt to advise interested parties of the factors which affect our business, including without limitation the disclosures made under the caption “Management’s Discussion and Analysis of Financial Condition and Results of Operations” included herein and under the captions “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and “Risk Factors” included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2001 and other reports and filings made with the Securities and Exchange Commission.

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Overview

We are a leading online retailer of textbooks and educational materials targeting private middle and high schools, colleges and distance and continuing education markets. Through eduPartners, our program serving schools and organizations directly, we provide an opportunity for educational institutions to maximize their resources and offer increased convenience and value to their students by outsourcing to us the sale of textbooks and other learning materials.

We were incorporated in December 1997 and began offering books for sale on our website on August 10, 1998. To date, our revenues have consisted primarily of sales of textbooks. In January 1999 we created eduPartners, whereby we became the exclusive provider of new books and learning materials to a variety of learning institutions. This program is a cost-effective model that enables us to increase the number of customers to our website and generate book sales and does not require the significant marketing and brand building expenses associated with our earlier model.

During 2000, we began to focus resources on the growth and development of our eduPartners program and we extended that focus throughout 2001. In the quarter ending September 30, 2001, revenues from eduPartners accounted for approximately 97% of our overall sales of books, an increase from the 69% share of total book revenues eduPartners represented during the quarter ending September 30, 2000. We expect eduPartners to remain the primary source of textbook revenues moving forward. Net sales consist of sales of books and charges to customers for outbound shipping and are net of allowances for returns, promotional discounts and coupons. Revenues from sales of textbooks are recognized at the time products are received by the customer.

Presently, we are the exclusive new textbook supplier for approximately 135 educational institutions in our eduPartners program. This represents a growth of approximately 50% from the 90 institutions we served during calendar year 2001. At these institutions we are endorsed as the school’s official bookstore and gain direct access and exposure to their students. Benefits of this business model include significantly lower marketing and customer acquisition costs than our historical college-focused retail book business, greater sales visibility, higher margins and attractive sell-through or penetration per school account. We are able to reduce the overhead typically associated with textbook sales because we do not maintain individual on-site stores and we outsource our ordering, inventory, warehousing and fulfillment needs with Baker & Taylor, a leading distributor of books, videos and music products. In addition to providing textbooks at competitive prices, we are committed to providing top quality customer service and account management support.

The Company has also provided marketing services for other businesses seeking to reach the college and private middle and high school demographics by marketing to students online through its website and on college campuses utilizing a nationwide network of student marketing representatives. During 2001, we made a strategic decision to focus resources on the growth and development of the eduPartners program. We determined that the eduPartners model presented the greatest prospects for long-term growth and shareholder value creation and elected to concentrate the resources and energy of the entire organization on maximizing this opportunity. We completed all outstanding on-campus marketing services contracts during 2001 and ceased new development of on-campus marketing services programs. We anticipate future marketing services revenue, if any, will likely represent a relatively small percentage of textbook revenues and will be focused on delivering solutions compatible with our target eduPartners market. Revenues from our marketing programs are recognized straight-line over the contract term, provided that no significant performance obligations remain and the collection of the related receivable is probable. Costs associated with our marketing programs are recognized as incurred.

Throughout 2001, our business priorities, focus and resources adapted to meet the changing market dynamics and economic realities. We successfully lowered overall expenses and increased the margins of our retail book business to accelerate our path to profitability. In addition, we made significant reductions in the marketing and sales overhead expenses associated with our business. As a result, during the three months ending September 30, 2001, we recorded the first profitable fiscal period in our history, posting over $1 million in net operating profits. We also recognized positive cash flows from operations of $0.4 million for the year ended December 31, 2001.

Although our margins have increased and our overall expenses have been lowered significantly, our ability to reach annual operating profitability depends on our ability to generate and sustain higher net revenues. We base our current and future expense levels on our operating plans and estimates of future revenues. In view of the rapidly evolving nature of our business and our limited operating history, we have limited experience forecasting our revenues. Therefore we believe that period-to-period comparisons of our financial results might not necessarily be meaningful and you should not rely on them as an indication of future performance. If we cannot achieve and sustain profitability or positive cash flow from operations, we may be unable to meet our working capital requirements or to obtain additional financing, which would adversely affect our business and my cause us to discontinue operations.

We have incurred losses in every fiscal year since inception. For the year ended December 31, 2001, we incurred a loss from operations of approximately $2.8 million and positive cash flows from operations of $0.4 million. For the year ended December 31, 2000, we incurred a loss from operations of approximately $34.8 million and negative cash flows from operations of $27.5 million. For the year ended December 31, 1999, we incurred a loss from operations of approximately $31.9 million and negative cash flows from operations of $29.4 million. As of December 31, 2000 and 2001 we had accumulated deficits of approximately $68.2 million and $70.5 million, respectively.

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However, during the three months ending September 30, 2001, the Company recorded the first profitable fiscal period in its history with a net profit of approximately $1.0 million in the critical back-to-school textbook buying season. We also achieved positive cash flows from operations of $0.4 million for the year ended December 31, 2001. The operating profits from this quarter were not sufficient to reverse the losses recorded in the other three fiscal quarters of 2001, resulting in a net loss of approximately $2.2 million for the year ended December 31, 2001.

During the six months ending June 30, 2002 the Company reported a net loss of approximately $0.8 million, down from a net loss of $2.3 million for the same period in 2001. Cash used in operating activities during the six months ending June 30, 2002 was approximately $0.4 million, down from $0.6 million for the six months ending June 30, 2001.

We expect that operating losses and negative cash flows from operations will likely continue until our seasonally critical back-to-school buying season in the third quarter of 2002. Based upon our current cost structure and recent growth levels within the eduPartners program, we believe we are positioned to improve upon the financial performance of 2001. We intend to increase spending on the development of eduPartners and relationships with other related businesses. Failure to generate sufficient revenues, raise additional capital or, if necessary, reduce discretionary spending could harm our results of operations and financial condition.

Three Months Ended June 30, 2002
compared to
Three Months Ended June 30, 2001

Net Sales

Net sales decreased to $0.3 million for the three months ended June 30, 2002 from $0.8 million for the three months ended June 30, 2001. This decrease was primarily attributable to the Company’s focus on building core revenues within the eduPartners program. Consistent with this eduPartners focus, the Company significantly reduced marketing expenditures for non-eduPartners sales, resulting in a decrease in traditional retail textbook sales and marketing services revenues. There were no marketing services revenues recognized during the three months ended June 30, 2002, a decrease from the $516,000 recognized in the same period in 2001. This decrease was attributable to our decision to close our on-campus marketing services business. No new marketing services contracts were signed during the three months ending June 30, 2002.

Operating Expenses

Cost of Books — Related Party (Baker & Taylor). Cost of books — related party consists of the cost of books sold to customers. Cost of books-related party decreased to approximately $0.2 million for the three months ended June 30, 2002 from $0.3 million for the three months ended June 30, 2001. This decrease was primarily attributable to our decreased sales volume.

Cost of Shipping — Related Party (Baker & Taylor). Cost of shipping — related party consists of outbound shipping to the customer. Cost of shipping increased to approximately $42,000 for the three months ended June 30, 2002 from approximately $29,000 for the three months ended June 30, 2001.

Cost of Marketing Services— Cost of marketing services includes personnel costs associated with the implementation of our on-campus marketing programs and other directly identifiable costs associated with our online advertising and on-campus promotions. We did not incur any marketing services costs during the three months ended June 30, 2002. This decrease from approximately $14,000 for the three months ended June 30, 2001 was attributable to lack of any on-campus marketing programs.

Marketing and Sales — Marketing and sales expense consists primarily of advertising and promotional expenditures and payroll and related expenses for personnel engaged in marketing and the expansion of eduPartners. Marketing and sales expense was $0.3 million for the three months ended June 30, 2002 , a nominal decrease from $0.2 million for the three months ended June 30, 2001.

Product Development — Product development expense consists of payroll and related expenses for development and systems personnel and consultants. Product development expense decreased to approximately $43,000 for the three months ended June 30, 2002 from $77,000 for the three months ended June 30, 2001. This decrease was primarily attributable to decreased web development, consulting and personnel costs between periods.

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General and Administrative — General and administrative expense consists of payroll and related expenses for executive and administrative personnel, facilities expenses, professional services expenses, travel and other general corporate expenses. General and administrative expense decreased to $0.3 million for the three months ended June 30, 2002 from $1.2 million for the three months ended June 30, 2001. This decrease was primarily attributable to non-recurring charges taken during 2001 for fixed asset write off expense associated with underutilized assets and lease buyout expenses.

Non-Cash Compensation — Non-cash compensation expense consists of expenses related to the granting of employee options and restricted stock grants measured based on the intrinsic value of the stock option or grant. Non-cash compensation expense decreased to $0.1 million for the three months ended June 30, 2002 from $0.2 million for the three months ended June 30, 2001. This decrease was primarily attributable to lower amortized compensation expense for options issued before the Company’s initial public offering. Non-cash compensation expense is amortized based upon an accelerated expense schedule, resulting in higher than average expenses in the early years and lower than average expenses in the later years.

Other income, net

Other income, net consists primarily of interest income on our cash and cash equivalents and investments and gains or losses associated with the disposal of fixed assets. Other income was $0.4 million for the three months ended June 30, 2002 compared to $0.2 million for the three months ended June 30, 2001. Interest income decreased to $112,000 for the three months ended June 30, 2002 from $181,000 for the three months ended June 30, 2001 largely due to lower rates of return compared to the previous period. During the three months ended June 30, 2002, the Company received a $252,000 payment for a prepaid marketing balance that was previously written off as uncollectable.

Income Taxes

As of June 30, 2002, we had net operating loss carryforwards for federal income tax purposes of approximately $60 million, which expire beginning in 2018. We have provided a full valuation allowance on the resulting deferred tax asset because of uncertainty regarding its realizability. For the three months ended June 30, 2002, no income tax expense was recognized because the reduction in the deferred tax asset related to net operating losses was offset by a related reduction in the valuation allowance.

Six Months Ended June 30, 2002
compared to
Six Months Ended June 30, 2001

Net Sales

Net sales decreased to $1.1 million for the six months ended June 30, 2002 from $2.4 million for the six months ended June 30, 2001. This decrease was primarily attributable to the Company’s focus on building core revenues within the eduPartners program. Consistent with this eduPartners focus, the Company significantly reduced marketing expenditures for non-eduPartners sales, resulting in a decrease in traditional retail textbook sales and marketing services revenues. There were $14,000 of marketing services revenues recognized during the six months ended June 30, 2002, a decrease from the $0.8 million recognized in the same period in 2001. This decrease was attributable to our decision to close our on-campus marketing services business. No new significant marketing services contracts were signed during the six months ending June 30, 2002.

Operating Expenses

Cost of Books — Related Party (Baker & Taylor). Cost of books — related party consists of the cost of books sold to customers. Cost of books-related party decreased to approximately $0.7 million for the six months ended June 30, 2002 from $1.3 million for the six months ended June 30, 2001. This decrease was primarily attributable to our decreased sales volume.

Cost of Shipping — Related Party (Baker & Taylor). Cost of shipping — related party consists of outbound shipping to the customer. Cost of shipping increased to approximately $88,000 for the six months ended June 30, 2002 from approximately $125,000 for the six months ended June 30, 2001. This decrease was primarily attributable to our decreased sales volume.

Cost of Marketing Services— Cost of marketing services includes personnel costs associated with the implementation of our on campus marketing programs and other directly identifiable costs associated with our online advertising and on campus promotions. We did not incur any marketing services costs during the six months ended June 30, 2002. This decrease from approximately $39,000 for the six months ended June 30, 2001 was attributable to lack of any on-campus marketing programs.

Marketing and Sales — Marketing and sales expense consists primarily of advertising and promotional expenditures and payroll and related expenses for personnel engaged in marketing and the expansion of eduPartners. Marketing and sales expense was $0.6 million for the six months ended June 30, 2002 , a nominal increase from $0.5 million for the six months ended June 30, 2001.

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Product Development — Product development expense consists of payroll and related expenses for development and systems personnel and consultants. Product development expense decreased to approximately $78,000 for the six months ended June 30, 2002 from $0.2 million for the six months ended June 30, 2001. This decrease was primarily attributable to decreased web development, consulting and personnel costs between periods.

General and Administrative — General and administrative expense consists of payroll and related expenses for executive and administrative personnel, facilities expenses, professional services expenses, travel and other general corporate expenses. General and administrative expense decreased to $0.7 million for the six months ended June 30, 2002 from $2.4 million for the six months ended June 30, 2001. This decrease was primarily attributable to non-recurring charges taken during 2001 for fixed asset write off expense associated with underutilized assets and lease buyout expenses.

Non-Cash Compensation — Non-cash compensation expense consists of expenses related to the granting of employee options and restricted stock grants measured based on the intrinsic value of the stock option or grant. Non-cash compensation expense decreased to $0.2 million for the six months ended June 30, 2002 from $0.5 million for the six months ended June 30, 2001. This decrease was primarily attributable to lower amortized compensation expense for options issued before the Company’s initial public offering. Non-cash compensation expense is amortized based upon an accelerated expense schedule, resulting in higher than average expenses in the early years and lower than average expenses in the later years.

Other income, net

Other income, net consists primarily of interest income on our cash and cash equivalents and investments and gains or losses associated with the disposal of fixed assets. Other income was $0.4 million for the six months ended June 30, 2002, consistent with the $0.4 million recognized for the six months ended June 30, 2001. Interest income decreased to $0.2 million for the six months ended June 30, 2002 from $0.4 million for the six months ended June 30, 2001 largely due to lower rates of return compared to the previous period. During the three months ended June 30, 2002, the Company received a $252,000 payment for a prepaid marketing balance that was previously written off as uncollectable.

Income Taxes

As of June 30, 2002, we had net operating loss carryforwards for federal income tax purposes of approximately $60 million, which expire beginning in 2018. We have provided a full valuation allowance on the resulting deferred tax asset because of uncertainty regarding its realizability. For the six months ended June 30, 2002, no income tax expense was recognized because the reduction in the deferred tax asset related to net operating losses was offset by a related reduction in the valuation allowance.

Liquidity and Capital Resources

As of June 30, 2002, we had $16.4 million of cash, cash equivalents and short term investments. As of that date, our principal commitments consisted of obligations outstanding, accounts payable and accrued liabilities. Although we have no material commitments for capital expenditures, we may experience increases in our capital expenditures and lease commitments consistent with anticipated growth in operations, infrastructure and personnel.

Net cash used in operating activities was $0.4 million for the six months ended June 30, 2002 compared to $0.6 million net cash used in operations for the six months ended June 30, 2001. This decrease was largely attributable to reduced operating losses adjusted for changes in accounts receivable, accounts payable and accrued expenses.

Net cash used in investing activities was $3.0 million for the six months ended June 30, 2002 compared to net cash provided by investing activities of $42,000 for the six months ended June 30, 2001. This increase was largely due to the purchase of high-grade short-term investments.

Net cash provided by financing activities was $12,000 for the six months ended June 30, 2002 and $0.7 million the six months ended June 30, 2001. Net cash provided by financing activities during the six months ending June 30, 2002, consisted primarily of net proceeds from the exercise of employee stock options. Net cash provided by financing activities during the six months ending June 30, 2001, consisted primarily of net proceeds from warrant subscription receivables.

We intend to increase spending on the development of eduPartners and relationships with other businesses. Our failure to generate sufficient revenues, raise additional capital or, if necessary, reduce discretionary spending could harm our results of operations and financial condition.

We currently anticipate that our available funds will be sufficient to meet our anticipated needs for working capital and capital expenditures until such time as we achieve annual operating profitability. We may need to raise additional funds prior to the

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expiration of such period if, for example, we pursue new business, technology or intellectual property acquisitions or experience net losses that exceed our current expectations. Any required additional financing may be unavailable on terms favorable to us, or at all.

Item 3. Quantitative and Qualitative Disclosures About Market Risk

The Company is subject to interest rate risk on its cash and cash equivalents, short-term investments and credit facility. If market rates were to increase immediately and uniformly by 10% from the level at June 30, 2002, the change to the Company’s interest sensitive assets and liabilities would have an immaterial effect on the Company’s financial position, results of operations and cash flows over the next fiscal year.

PART II.
OTHER INFORMATION

Item 1: Legal Proceedings

	Not Applicable

Item 2: Changes in Securities

	Not Applicable

Item 3: Defaults Upon Senior Securities

	Not Applicable

Item 4: Submission of Matters to a Vote of Security Holders
               The Annual Meeting of Stockholders was held on June 25, 2002. All of the proposals presented for the stockholders’ consideration at the Annual Meeting were approved.

               Proposal 1 – Election of Director – Mr. Eric J. Kuhn was elected to a new term expiring in 2005. Mr. John T. Kernan was elected to a term expiring in 2004. Other directors whose terms continued after the Annual Meeting include Mr. Andrew J. Oleszczuk, Mr. Allen L. Morgan and Mr. James S. Ulsamer.

               Proposal 2 – Ratification of the appointment of PriceWaterhouseCoopers LLP as the independent auditors of the Company for the fiscal year ending December 31, 2002.

Item 5: Other Information

	Not Applicable

Item 6: Exhibits and Reports on Form 8-K

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

Date: August 14, 2002

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CERTIFICATION PURSUANT TO
18 U.S.C. SECTION 1350,
AS ADOPTED PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002

In connection with the Quarterly Report of Varsity Group Inc. (the Company) on Form 10-Q for the period ending June 30, 2002 as filed with the Securities and Exchange Commission on the date hereof (the Report), I, Eric J. Kuhn, Chief Executive Officer of the Company, certify, pursuant to 18 U.S.C. § 1350, as adopted pursuant to § 906 of the Sarbanes-Oxley Act of 2002, that:

	(1)		The Report fully complies with the requirements of section 13(a) or 15(d) of the Securities Exchange Act of 1934; and
	(2)		The information contained in the Report fairly presents, in all material respects, the financial condition and result of operations of the Company.

CERTIFICATION PURSUANT TO
18 U.S.C. SECTION 1350,
AS ADOPTED PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002

In connection with the Quarterly Report of Varsity Group Inc. (the Company) on Form 10-Q for the period ending June 30, 2002 as filed with the Securities and Exchange Commission on the date hereof (the Report), I, Jack M Benson, Chief Financial Officer of the Company, certify, pursuant to 18 U.S.C. § 1350, as adopted pursuant to § 906 of the Sarbanes-Oxley Act of 2002, that:

	(1)		The Report fully complies with the requirements of section 13(a) or 15(d) of the Securities Exchange Act of 1934; and
	(2)		The information contained in the Report fairly presents, in all material respects, the financial condition and result of operations of the Company.

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