Varsity (VSTY) 10-Q 2001 Q2 Quarterly report

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

FORM 10-Q

(MARK ONE)

[X]	QUARTERLY REPORT PURSUANT TO SECTION 13 or 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
	For the quarterly period ended June 30, 2001                                                     OR
[   ]	TRANSITION REPORT PURSUANT TO SECTION 13 or 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
	For the transition period from ________ to ________.

_______________

Commission file number 0-28977

_______________

VARSITY GROUP INC.
(Exact Name of Registrant as Specified in Its Charter)

Delaware	54-1876848
(State of Incorporation)	IRS Employer (Identification
	Number)
1130 Connecticut Ave., Suite 350	20036
Washington, D.C	(Zip Code)
(Address of Principal Executive
Offices)

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 13, 2001, the registrant had 16,871,062 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, 2001

INDEX

		Page Number
	PART I. FINANCIAL INFORMATION
Item 1.	Financial Statements
	Condensed consolidated statements of operations for the three and six months ended June 30, 2000 and 2001		3
	Condensed consolidated balance sheets as of December 31, 2000 and June 30, 2001		4
	Condensed consolidated statements of cash flows for the six months ended June 30, 2000 and 2001		5
	Notes to condensed consolidated financial statements		6
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations		6
Item 3.	Quantitative and Qualitative Disclosures About Market Risk		11
	PART II. OTHER INFORMATION
Item 1.	Legal Proceedings		11
Item 2.	Changes in Securities		11
Item 3.	Defaults Upon Senior Securities		11
Item 4.	Submission of Matters to a Vote of Security Holders		11
Item 5.	Other Information		12
Item 6.	Exhibits and Reports on Form 8-K		12

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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)

						Three Months Ended											Six Months Ended
						June 30,											June 30,
						2000					2001						2000						2001
Net Sales:
	Product					$	2,080				$	334					$	13,086					$	1,469
	Shipping						141					37						1,043						176
	Marketing Services						41					516						341						763
		Total net sales					2,262					887						14,470						2,408
Operating Expenses      Cost of books – related party							1,758					253						12,202						1,264
	Cost of shipping – related party						227					27						1,409						125
	Cost of marketing services						—					14						—						39
	Marketing and sales:
			Non-cash compensation	$	281				$	10				$	1,019					$	18
			Other marketing and sales (including $63 and $73 with related party for three and six months ended June 30, 2001 respectively		3,813		4,094			206		216			16,656			17,675			546			564
	Product development:
			Non-cash compensation		14					2					(24	)					(2	)
			Other product development		1,270		1,284			77		79			3,357			3,333			213			211
	General and administrative:
			Non-cash compensation		588					196					2,184						467
			Other general and administrative		1,739		2,327			1,231		1,427			4,149			6,333			2,443			2,910
			Total operating expenses				9,690					2,016						40,952						5,113
Loss from operations							(7,428	)				(1,129	)					(26,482	)					(2,705	)
Other income (expense), net:
	Interest income						489					181						717						369
	Interest expense						(121	)				—						(138	)					—
	Other income						(58	)				(6	)					(58	)					52
	Other income (expense), net						310					175						521						421
Net loss						$	(7,118	)			$	(954	)				$	(25,961	)				$	(2,284	)
Net loss per share (basic and diluted):
	Net loss					$	(0.45	)			$	(0.06	)				$	(2.09	)				$	(0.14	)
Weighted average shares:
	Basic and diluted						15,703,416					16,438,652						12,393,816						16,297,607

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VARSITY GROUP INC.

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

ASSETS

					December 31, 2000			June 30, 2001
								(unaudited)
Current assets:
	Cash and cash equivalents				$	15,446		$	15,863
	Restricted cash					264			—
	Short-term investments					480			480
	Accounts receivable, net of allowance of doubtful accounts of $236 at
			December 31, 2000 and $185 at June 30, 2001			1,244			251
	Other					715			440
			Total current assets			18,149			17,034
Fixed assets, net						1,436			423
Other assets						396			225
			Total assets		$	19,981		$	17,682
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
		Accounts payable			$	910		$	389
		Accrued marketing expenses				44			39
		Deferred revenue				201			14
		Other accrued expenses and other current liabilities				301			117
		Lease liability				368			—
		Sales taxes payable				821			998
		Accrued employee compensation and benefits				91			29
				Total current liabilities		2,736			1,586
Long-term liabilities						131			—
				Total liabilities		2,867			1,586
Stockholders’ equity:
		Series A convertible preferred stock: $.0001 par value, 2,071,420 shares authorized; 0
		shares issued and outstanding				—			—
		Series B convertible preferred stock: $.0001 par value, 6,933,806 shares authorized; 0
		shares issued and outstanding				—			—
		Series C convertible preferred stock: $.0001 par value, 9,755,633 shares authorized; 0
		shares issued and outstanding				—			—
		Preferred stock: $.0001 par value, 20,000,000 shares authorized; 0 shares issued
				and outstanding		—			—
		Common stock: $.0001 par value, 27,932,927 and 60,000,000 shares authorized,
				16,152,218 and 16,454,395 shares issued and outstanding at December 31, 2000
				and June 30, 2001, respectively		2			2
		Additional paid-in capital				87,287			87,326
		Warrant subscription receivable and other				(707	)		—
		Notes receivable from stockholders				(124	)		(62	)
		Deferred compensation				(1,123	)		(665	)
		Accumulated deficit				(68,221	)		(70,505	)
				Total stockholders’ equity		17,114			16,096
				Total liabilities and stockholders’ equity	$	19,981			17,682

See accompanying notes to condensed consolidated financial statements.

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VARSITY GROUP INC.

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

					Six Months Ended
					June 30,
					2000			2001
Operating activities:
		Net loss			$	(25,961	)	$	(2,284	)
Adjustments to reconcile net loss to net cash used in operating activities:
	Depreciation and amortization					575			532
	Bad debt expense					—			(51	)
	Loss on disposal of fixed assets and write off of underutilized assets					58			439
	Non-cash compensation					3,179			546
	Equity transactions with related party and interest expense related to warrants					120			—
	Changes in operating assets and liabilities:
			Accounts receivable, net			(116	)		1,044
			Deferred charge			1,024			—
			Other current assets			1,873			275
			Accounts payable			(857	)		(521	)
			Accrued marketing expenses			151			(5	)
			Lease liability			—			(368	)
			Deferred revenue			—			(187	)
			Other accrued expenses and other current liabilities			(847	)		(184	)
			Sales taxes payable			349			177
			Accrued employee compensation and benefits			223			(62	)
			Long term liabilities			52			(131	)
			Other assets			—			171
				Net cash used in operating activities		(20,177	)		(609	)
Investing activities:
		Additions to fixed assets				(1,234	)		(16	)
		Proceeds from sale of fixed assets				100			58
				Net cash used in investing activities		(1,134	)		42
Financing activities:
		Proceeds from issuance of common stock				35,930			—
		Proceeds from exercise of stock options				—			13
		Proceeds from notes payable				2,500			—
		Repayment of notes payable				(2,500	)		—
		Proceeds from warrant subscription receivable				250			707
				Net cash provided by financing activities		36,180			720
Net increase in cash and cash equivalents						14,869			153
Cash and cash equivalents at beginning of period						7,813			15,710
Cash and cash equivalents at end of period					$	22,682		$	15,863
Supplemental disclosure of cash flow information:
		Cash paid for income taxes and interest			$	17		$	16
		Warrant subscription receivable and other			$	2,693		$	—

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., a leading online retailer of new textbooks and a provider of marketing services for businesses interested in reaching the college and private middle and high school markets, 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 (formerly CollegeOps.com LLC), to assist in the overall management of its marketing and retailing activities, respectively.

            In February 2000, we issued 4,000,000 shares of Common Stock at an initial public offering price of $10.00 per share. In March 2000, we sold an additional 35,000 shares pursuant to the exercise of the underwriters’ over-allotment option at $10.00 per share. Total net proceeds were approximately $35.9 million.

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, 2000. 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.

Note 3: Fixed Assets

            For the six months ending June 30, 2001 the Company recorded approximately $0.5 million of fixed asset write off expense associated with underutilized assets no longer critical to supporting our business. These charges consisted primarily of the removal of certain computer servers and equipment from service and capitalized web site development no longer integrated within the www.varsitybooks.com web site.

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

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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, 2000 and other reports and filings made with the Securities and Exchange Commission.

Overview

           We are a leading online retailer of new textbooks and we provide marketing services to other businesses interested in reaching the nation’s 15 million college students and 2.5 million private middle and secondary school students.

      We were incorporated in December 1997 and began offering books for sale on our Web site on August 10, 1998. For the period from inception through August 9,1998, our primary activities consisted of:

• developing our business model;

• establishing, negotiating and consummating a relationship with our supplier, Baker & Taylor;

• initial planning and development of our Web site;

• developing our information systems infrastructure;

• developing our marketing plans; and

• establishing finance and administrative functions.

We began to generate sales when we launched our Web site in August 1998. To date, our revenues have consisted primarily of sales of new textbooks. In January 1999 we created eduPartners, whereby we become the exclusive provider of new books and learning materials to a variety of learning institutions. This program is a cost-effective method for us to increase the number of customers to our Web site and generate book sales. Presently, we have about 90 educational institutions in our eduPartners program.

We also generate revenue from online marketing agreements, as well as offline marketing service agreements for which we use College Impact, our student representative network. During the fourth quarter of fiscal 1999, we began generating revenues from marketing programs. We have signed marketing services agreements with a number of public and private companies, including AT&T Wireless Services, Inc., Palm, Inc., Papa John’s International, Inc. and Ben & Jerry’s Homemade, Inc. We continue to develop marketing services agreements with businesses that are seeking to reach the college and private middle and high school markets.

In addition, we have continued to successfully lower the overall expenses of our retail book business through various means, including the imposition of increased retail pricing. 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 little 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 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 may cause us to discontinue operations.

We have incurred losses from operations in every fiscal period since our inception. For the year ended December 31, 1998, we incurred a loss from operations of approximately $2.7 million and negative cash flows from operations of $1.2 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. For the year ended December 31, 2000, we incurred a loss from operations of approximately $34.6 million and negative cash flows from operations of $27.5 million. As of December 31, 1998, 1999 and 2000 we had accumulated deficits of approximately $2.7 million, $34.2 million and $68.2 million, respectively. Net loss for the quarter ended June 30, 2001 was $1.0 million compared to a net loss of $7.1 million for the quarter ended June 30, 2000. Net loss for the six months ended June 30, 2001 was $2.3 million compared to a net loss of $26.0 million for the six months ended June 30, 2000. As part of the increased emphasis on eduPartners, we anticipate that costs and expenses related to brand development, marketing and other promotional activities associated with our traditional retail book business will continue to decrease from historical levels. Although, in the short-term, this has and may continue to result in decreased revenues from the sales of new textbooks, we believe, in the aggregate, that this has and will continue to reduce the losses and negative cash flows from our sales of new textbooks.

Results of Operations

            The following table and discussion provides information which management believes is relevant to an assessment and understanding of the Company’s consolidated results of operations and financial condition. The discussion should be read in conjunction with the condensed consolidated financial statements and accompanying notes thereto-included elsewhere herein.

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Percentage of Total Net Sales

			Three Months Ended									Six Months Ended
			June 30,									June 30,
			2000					2001				2000				2001
Net Sales Books				92.0		%			37.7		%		90.4		%		61.0		%
	Shipping			6.2					4.2				7.2				7.3
	Marketing services			1.8					58.1				2.4				31.7
		Total net sales		100.0					100.0				100.0				100.0
Operating Expenses       Cost of books – related party				77.7					28.5				84.3				52.5
	Cost of shipping – related party			10.0					3.0				9.7				5.2
	Cost of marketing services			—					1.6				—				1.6
	Marketing and sales			181.0					24.4				122.2				23.4
	Product development			56.8					8.9				23.0				8.8
	General and administrative			102.9					160.9				43.8				120.8
		Total operating expenses		428.4					227.3				283.0				212.3
Loss from operations				(328.4	)				(127.3	)			(183.0	)			(112.3	)
Other income, net				13.7					19.7				3.6				17.5
Net loss				(314.7	)		%		(107.6	)	%		(179.4	)	%		(94.8	)	%

Three Months Ended June 30, 2001
compared to
Three Months Ended June 30, 2000

Net Sales

            Net sales decreased to $0.9 million for the three months ended June 30, 2001 from $2.3 million for the three months ended June 30, 2000. This decrease was primarily attributable to the Company’s focus on eduPartners, a seasonal business centered around the back-to-school months of July, August and September. Marketing services sales totaled $0.5 million for the three months ended June 30, 2001, an increase from the $41,000 recognized in the same period in 2000. This increase in marketing services revenue was primarily attributable to revenues associated with the completion of contracts initiated during the third quarter of 2000 and second quarter of 2001.

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 $0.3 million for the three months ended June 30, 2001 from $1.8 million for the three months ended June 30, 2000. 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. Cost of shipping decreased to approximately $27,000 for the three months ended June 30, 2001 from approximately $0.2 million for the three months ended June 30, 2000. This decrease was primarily attributable to our decreased sales volume. Also for the three months ended June 30, 2001, shipping revenue exceeded cost of shipping—related party by approximately $10,000 or 27%. For the three months ended June 30, 2000, cost of shipping—related party exceeded shipping revenue by approximately $86,000, or 61.0%. This transition to shipping profitability was primarily attributable to an increase in the shipping rates charged to our customers that was instituted in the third quarter of 2000.

      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. Cost of marketing services totaled $14,000 for the three months ended June 30, 2001. There were no costs of marketing services for the three months ended June 30, 2000.

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      Marketing and Sales. Marketing and sales expense consists primarily of advertising and promotional expenditures and payroll and related expenses such as the amortization of deferred compensation for personnel engaged in marketing and management of our nationwide network of student representatives. Marketing and sales expense decreased to $0.2 million for the three months ended June 30, 2001 from $4.1 million for the three months ended June 30, 2000. This decrease was primarily attributable to decreased marketing with respect to the national college-focused retail book business and decreased personnel and related expenses. Included in marketing and sales is $10,000 and $0.3 million of non-cash charges for the three months ended June 30, 2001 and 2000, respectively.

      Product Development. Product development expense consists of payroll and related expenses such as the amortization of deferred compensation for development and systems personnel and consultants. Product development expense decreased to approximately $79,000 for the three months ended June 30, 2001 from $1.3 million for the three months ended June 30, 2000. 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 such as the amortization of deferred compensation, facilities expenses, professional services expenses, travel and other general corporate expenses. General and administrative expense decreased to $1.4 million for the three months ended June 30, 2001 from $2.3 million for the three months ended June 30, 2000. This decrease was primarily attributable to decreased personnel and professional services expenses between years. During the three months ending June 30, 2001 the Company recorded $0.5 million in fixed asset write off expense associated with underutilized assets no longer critical to supporting our business. Included in general and administrative expenses is approximately $0.2 million and $0.6 million of non-cash charges for the three months ended June 30, 2001 and 2000, respectively. Non-cash charges decreased primarily as a result of a reduction in the number of employees.

      Other income (expense), net.

      Other income (expense), 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 $0.2 million for the three months ended June 30, 2001 compared to $0.3 million for the three months ended June 30, 2000. Interest income decreased due largely to lower average cash, cash equivalent and short-term investment balances and lower rates of return compared to the previous period.

      Income Taxes.

      As of June 30, 2001, we had net operating loss carryforwards for federal income tax purposes of approximately $56 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.

Six Months Ended June 30, 2001
compared to
Six Months Ended June 30, 2000

Net Sales

            Net sales decreased to $2.4 million for the six months ended June 30, 2001 from $14.5 million for the six months ended June 30, 2000. This decrease was primarily attributable to the Company’s focus on eduPartners, a seasonal business centered around the back-to-school months of July, August and September. Marketing services sales totaled $0.8 million for the six months ended June 30, 2001, an increase from the $0.3 million recognized in the same period in 2000. This increase in marketing services revenue was primarily attributable to revenues associated with the completion of contracts initiated during the third quarter of 2000 and second quarter of 2001.

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 $1.3 million for the six months ended June 30, 2001 from $12.2 million for the six months ended June 30, 2000. 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. Cost of shipping decreased to approximately $0.1 million for the six months ended June 30, 2001 from approximately $1.4 million for the six months ended June 30, 2000. This decrease was primarily attributable to our decreased sales volume. Also for the

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six months ended June 30, 2001, shipping revenue exceeded cost of shipping—related party by approximately $51,000 or 29%. For the six months ended June 30, 2000, cost of shipping—related party exceeded shipping revenue by approximately $0.4 million, or 35%. This transition to shipping profitability was primarily attributable to an increase in the shipping rates charged to our customers that was instituted in the third quarter of 2000.

      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. Cost of marketing services totaled $39,000 for the six months ended June 30, 2001. There were no costs of marketing services for the six months ended June 30, 2000.

      Marketing and Sales. Marketing and sales expense consists primarily of advertising and promotional expenditures and payroll and related expenses such as the amortization of deferred compensation for personnel engaged in marketing and management of our nationwide network of student representatives. Marketing and sales expense decreased to $0.6 million for the six months ended June 30, 2001 from $17.7 million for the six months ended June 30, 2000. This decrease was primarily attributable to decreased marketing with respect to the national college-focused retail book business and decreased personnel and related expenses. Included in marketing and sales is $18,000 and $1.0 million of non-cash charges for the six months ended June 30, 2001 and 2000, respectively.

      Product Development. Product development expense consists of payroll and related expenses such as the amortization of deferred compensation for development and systems personnel and consultants. Product development expense decreased to approximately $0.2 million for the six months ended June 30, 2001 from $3.3 million for the six months ended June 30, 2000. 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 such as the amortization of deferred compensation, facilities expenses, professional services expenses, travel and other general corporate expenses. General and administrative expense decreased to $2.9 million for the six months ended June 30, 2001 from $6.3 million for the six months ended June 30, 2000. This decrease was primarily attributable to decreased personnel and professional services expenses between years. During the six months ending June 20, 2001 the Company recorded $0.5 million in fixed asset write off expense associated with underutilized assets no longer critical to supporting our business. Included in general and administrative expenses is approximately $0.5 million and $2.2 million of non-cash charges for the six months ended June 30, 2001 and 2000, respectively. Non-cash charges decreased primarily as a result of a reduction in the number of employees.

      Other income (expense), net.

      Other income (expense), 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, 2001 compared to $0.5 million for the six months ended June 30, 2000. Interest income decreased due largely to lower average cash, cash equivalent and short-term investment balances and lower rates of return compared to the previous period.

      Income Taxes.

      As of June 30, 2001, we had net operating loss carryforwards for federal income tax purposes of approximately $56 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.

Liquidity and Capital Resources

As of June 30, 2001, we had $15.9 million of cash and cash equivalents. 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 $0.6 million for the six months ended June 30, 2001, and $20.2 million for the six months ended June 30, 2000, consisting primarily of net losses adjusted for changes in accounts receivable, accounts payable and accrued expenses.

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Net cash gained from investing activities was $42,000 for the six months ended June 30, 2001 compared to net cash used in investing activities of $1.1 million the six months ended June 30, 2000, consisting primarily of purchases of fixed assets and net cash gained the sale of fixed assets, respectively.

Net cash provided by financing activities was $0.7 million for the six months ended June 30, 2001 and $36.2 million the six months ended June 30, 2000. Net cash provided by financing activities during the six months ending June 30, 2000, consisted primarily of net proceeds from the Company’s initial public offering. Net cash provided by financing activities during the six months ending June 30, 2001, consisted primarily of net proceeds from warrant subscription receivables.

As part of the increased emphasis on eduPartners, we anticipate that costs and expenses related to brand development, marketing and other promotional activities associated with our traditional retail book business will continue to decrease from recent levels. Although this may result in decreased revenues from the sales of new textbooks than would be the case if we continued to spend at or above our historical levels, we believe, in the aggregate, that this will reduce the losses and negative cash flows historically associated with our sales of new textbooks. We intend to increase spending on the development of eduPartners and relationships with other businesses. We believe that we can capture additional revenues, on which we expect to recognize higher gross margins, by increasing the number of businesses for whom we provide marketing services. 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 operating profitability. We may need to raise additional funds prior to the 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, 2001, 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 May 24, 2001. All of the proposals presented for the stockholders’ consideration at the Annual Meeting were approved. The following is a tabulation of the voting on each proposal presented at the Annual Meeting:

      Proposal 1 – Election if Director

Elected Directors	Term Expires	Votes For	Votes Against	Votes Withold	Votes Abstaining	Broker Non-Votes
Allen Morgan	2004	12,366,389	46,555	—	—	—

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      Other directors whose terms continued after the Annual Meeting include Mr. Eric J. Kuhn, Mr. Andrew J. Oleszczuk 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, 2001.

Votes For	Votes Against		Votes Withheld	Votes Abstaining		Broker Non Votes
12,394,364		7,930			10,650		—

Item 5:Other Information

      Not Applicable

Item 6:Exhibits and Reports on Form 8-K

(a)	Exhibits
	None.
(b)	Reports on Form 8-K
	None

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, 2001

Varsity Group Inc.
By:	/s/ ERIC J. KUHN
	Eric J. Kuhn Chairman, Chief Executive Officer and President

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