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UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549




FORM 10-Q

(MARK ONE)

þ
    
    QUARTERLY REPORT PURSUANT TO SECTION 13 or 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934For the quarterly period ended June 30, 2003


OR

o
    
    TRANSITION REPORT PURSUANT TO SECTION 13 or 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934For 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)1850 M Street, Suite 1150
    
    20036Washington, 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 þ 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, 2003, the registrant had 16,517,408 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, 2003

INDEX

Page NumberPART I. FINANCIAL INFORMATIONItem 1.
    
    Financial StatementsCondensed consolidated statements of operations for the
three and six months ended June 30, 2002 and 2003
    
    3Condensed consolidated balance sheets as of December 31,
2002 and June 30, 2003
    
    4Condensed consolidated statements of cash flows for the
six months ended June 30, 2002 and 2003
    
    5Notes to condensed consolidated financial statements
    
    6Item 2.
    
    Managements Discussion and Analysis of Financial
Condition and Results of Operations
    
    6Item 3.
    
    Quantitative and Qualitative Disclosures About Market Risk
    
    10PART II. OTHER INFORMATIONItem 1.
    
    Legal Proceedings
    
    11Item 2.
    
    Changes in Securities
    
    11Item 3.
    
    Defaults Upon Senior Securities
    
    11Item 4.
    
    Submission of Matters to a Vote of Security Holders
    
    11Item 5.
    
    Other Information
    
    11Item 6.
    
    Exhibits and Reports on Form 8-K
    
    11






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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 EndedJune 30,
    
    June 30,2002
    
    
    
    2003
    
    
    
    2002
    
    
    
    2003Net sales:Product
    
    $
    303
    
    
    $
    454
    
    
    $
    1,006
    
    
    $
    1,521Shipping
    
    
    34
    
    
    
    63
    
    
    
    116
    
    
    
    218Marketing services
    
    
    
    
    
    
    
    
    
    
    14
    
    
    
    Total net sales
    
    
    337
    
    
    
    517
    
    
    
    1,136
    
    
    
    1,739Operating expensesCost of books  related party
    
    
    188
    
    
    
    287
    
    
    
    689
    
    
    
    1,063Cost of shipping  related party
    
    
    42
    
    
    
    41
    
    
    
    88
    
    
    
    132Cost of marketing services
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Marketing and sales (including
$52 and $80 with related party
for three and six months ended
June 30, 2003, respectively)
    
    
    278
    
    
    
    362
    
    
    
    579
    
    
    
    763Product development
    
    
    43
    
    
    
    64
    
    
    
    78
    
    
    
    119General and administrative
    
    
    329
    
    
    
    361
    
    
    
    667
    
    
    
    711Tax related benefit
    
    
    
    
    
    
    (515
    )
    
    
    
    
    
    
    (515
    )Non-cash compensation
    
    
    113
    
    
    
    63
    
    
    
    213
    
    
    
    130Total operating expenses
    
    
    993
    
    
    
    663
    
    
    
    2,314
    
    
    
    2,403Loss from operations
    
    
    (656
    )
    
    
    (146
    )
    
    
    (1,178
    )
    
    
    (664
    )Other income, net:Interest income
    
    
    112
    
    
    
    58
    
    
    
    169
    
    
    
    134Other income
    
    
    252
    
    
    
    
    
    
    
    252
    
    
    
    Other income, net
    
    
    364
    
    
    
    58
    
    
    
    421
    
    
    
    134Net loss
    
    $
    (292
    )
    
    $
    (88
    )
    
    $
    (757
    )
    
    $
    (530
    )Net loss per share:Basic and diluted
    
    $
    (0.02
    )
    
    $
    (0.01
    )
    
    $
    (0.05
    )
    
    $
    (0.03
    )Weighted average shares:Basic and diluted
    
    
    16,115,231
    
    
    
    16,501,814
    
    
    
    16,045,263
    
    
    
    16,358,097


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

December 31, 2002
    
    June 30, 2003(unaudited)Current assets:Cash and cash equivalents
    
    $
    16,950
    
    
    $
    14,396Short-term investments
    
    
    1,500
    
    
    
    3,000Accounts receivable, net
of allowance of doubtful
accounts of $13 at
December 31, 2002 and at
June 30, 2003
    
    263
    
    
    
    189Other current assets
    
    
    297
    
    
    
    402Total current assets
    
    
    19,010
    
    
    
    17,987Fixed assets, net
    
    
    41
    
    
    
    128Other assets
    
    
    23
    
    
    
    23Total assets
    
    $
    19,074
    
    
    $
    18,138


LIABILITIES AND STOCKHOLDERS EQUITY

Current liabilities:Accounts payable (including $111 with related party
at December 31, 2002 and $124 at June 30, 2003)
    
    $
    203
    
    
    $
    158Other accrued expenses and other current liabilities
    
    
    573
    
    
    
    381Taxes payable
    
    
    1,286
    
    
    
    743Total current liabilities
    
    
    2,062
    
    
    
    1,282Long-term liabilities
    
    
    
    
    
    
    Total liabilities
    
    
    2,062
    
    
    
    1,282Stockholders equity:Preferred stock: $.0001 par value, 20,000,000 shares
authorized; 0 shares issued and outstanding at
December 31, 2002 and June 30, 2003
    
    
    
    
    
    
    Common stock: $.0001 par value, 60,000,000 shares
authorized, 17,098,666 and 17,472,220 shares issued
and outstanding at December 31, 2002 and June 30, 2003, respectively
    
    
    2
    
    
    
    2Additional paid-in capital
    
    
    87,638
    
    
    
    87,882Deferred compensation
    
    
    (254
    )
    
    
    (124
    )Accumulated deficit
    
    
    (69,800
    )
    
    
    (70,330
    )Treasury Stock, $.0001 par value, 957,063 shares at
December 31, 2002 and June 30, 2003
    
    
    (574
    )
    
    
    (574
    )Total stockholders equity
    
    
    17,012
    
    
    
    16,856Total liabilities and stockholders equity
    
    $
    19,074
    
    
    $
    18,138


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 EndedJune 30,2002
    
    2003Operating activities:Net loss
    
    $
    (757
    )
    
    $
    (530
    )Adjustments to reconcile net loss to net cash used in operating activities:Depreciation and amortization
    
    
    113
    
    
    
    20Bad debt expense
    
    
    (15
    )
    
    
    Non-cash compensation
    
    
    213
    
    
    
    130Tax related benefit
    
    
    
    
    
    
    (515
    )Changes in operating assets and liabilities:Accounts receivable, net
    
    
    36
    
    
    
    74Other current assets
    
    
    99
    
    
    
    (105
    )Accounts payable
    
    
    (79
    )
    
    
    (45
    )Other accrued expenses and other current liabilities
    
    
    (56
    )
    
    
    (192
    )Taxes payable
    
    
    11
    
    
    
    (29
    )Other non-current assets
    
    
    45
    
    
    
    Net cash used in operating activities
    
    
    (390
    )
    
    
    (1,192
    )Investing activities:Additions to fixed assets
    
    
    (11
    )
    
    
    (107
    )Increase in short-term investments
    
    
    (3,000
    )
    
    
    (1,500
    )Proceeds from sale of fixed assets
    
    
    11
    
    
    
    Net cash used in investing activities
    
    
    (3,000
    )
    
    
    (1,607
    )Financing activities:Proceeds from exercise of stock options
    
    
    12
    
    
    
    245Net cash provided by financing activities
    
    
    12
    
    
    
    245Net decrease in cash and cash equivalents
    
    
    (3,378
    )
    
    
    (2,554
    )Cash and cash equivalents at beginning of period
    
    
    16,811
    
    
    
    16,950Cash and cash equivalents at end of period
    
    $
    13,433
    
    
    $
    14,396


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 nationwide. 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 new textbooks and educational materials,
targeting private middle and high schools, small colleges and distance and
continuing education markets through its eduPartnersprogram. 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, 2002. 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: Tax Related Benefit

Tax related benefit consists of certain business taxes and related expenses or
accruals. During the three months ended June 30, 2003 the Company recorded
negative tax related expense of $0.5 million compared to no expense for the
three months ended June 30, 2002. This decrease was primarily attributable to
the release of earlier tax accruals recorded primarily between 1999 and 2001.

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, 2002 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 new textbooks and other learning
materials. 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 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 new 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 and generate book sales that does not
require the significant marketing and brand building expenses associated with
our earlier model which focused on building a broad consumer brand offering
promotions and deeply discounted textbook prices to entice college students to
visit our website and purchase their textbooks from us.

During 2000, we began to focus resources on the growth and development of our
eduPartners program and it is the foundation of our business today. In the
quarter ending September 30, 2002, revenues from eduPartners accounted for
approximately 98% of total book related revenues, an increase from the 69%
share of total book related revenues eduPartners represented during the quarter
ending September 30, 2000. The number of eduPartners schools has grown from
approximately 20 schools during the 1999 Fall back-to-school season to over 130
schools in 2002, representing an 86% compounded annual growth rate over the
last three years. As of August 2003, we were the exclusive new textbook
supplier for over 210 educational institutions through our eduPartners program.

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.

We are able to reduce the overhead 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. We fulfill most of our
textbook orders through Baker & Taylor with which we have a series of
agreements that extend through June 30, 2004. These agreements have a
provision allowing for their automatic renewal for an additional one-year
period unless either party provides the other party notice of their intent to
terminate the agreement at least 120 days prior to its expiration.

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.

Recording the first profitable fiscal year in the history of our Company, the
year ended December 31, 2002 marked a significant milestone for the Company.
This was accomplished through a combination of revenue growth, margin
enhancement and cost reduction efforts initiated during 2000. We have
successfully lowered our overall expense structure and improved the margins of
our retail book business while growing revenues. As a result, we recorded the
first profitable fiscal quarter in our history during the three months ending
September 30, 2001 and our first profitable fiscal year during the year ended
December 31, 2002. We have also now recorded two consecutive fiscal years with
positive cash flow from operations.

Prior to the fiscal year ended December 31, 2002, we had incurred substantial
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, 2001 and 2002 we had accumulated deficits of approximately $70.5
million and $69.8 million, respectively.

During the six months ending June 30, 2003 the Company reported a net loss of
approximately $0.5 million, down from a net loss of $0.8 million for the same
period in 2002. Cash used in operating activities during the six months ending
June 30, 2003 was approximately $1.2 million, up from approximately $0.4
million for the six months ending June 30, 2002.





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Based upon our current cost structure and recent growth levels of the
eduPartners program, we believe we are positioned to significantly improve upon
the financial performance of 2002. We intend to continue 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, 2003
compared to
Three Months Ended June 30, 2002

Net Sales

Net sales increased to $0.5 million for the three months ended June 30, 2003
from $0.3 million for the three months ended June 30, 2002. This increase was
primarily attributable to the Companys success building revenues within the
eduPartners program.

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
increased to approximately $0.3 million for the three months ended June 30,
2003 from $0.2 million for the three months ended June 30, 2002. This increase
was primarily attributable to our increased sales volume.

Cost of Shipping  Related Party (Baker & Taylor).Cost of shipping  related
party consists of outbound shipping to the customer. Cost of shipping was
approximately $41,000 for the three months ended June 30, 2003 compared to
approximately $42,000 for the three months ended June 30, 2002.

Marketing and Sales Marketing and sales expense consists primarily of
advertising and promotional expenditures, credit card processing fees and
payroll and related expenses for personnel engaged in the marketing and
expansion of eduPartners. Marketing and sales expense increased to $0.4 million
for the three months ended June 30, 2003, from approximately $0.3 million for
the three months ended June 30, 2002. This increase was primarily attributable
to higher costs associated with sales and marketing fees related to our
agreement with Baker & Taylor and higher sales staffing levels and related
expense.

Certain marketing and sales expenses associated with our agreement with Baker &
Taylor are the product of the classification of services such as website
content and customer database management as marketing and sales expense and we
expect these costs will increase in absolute dollars as we expand our business.

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
increased to approximately $64,000 for the three months ended June 30, 2003
from $43,000 for the three months ended June 30, 2002. This decrease was
primarily attributable to increased 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 was approximately $0.4 million for the three months
ended June 30, 2003 compared to $0.3 million for the three months ended June
30, 2002. This increase was primarily attributable to increased personnel, rent
and professional services expenses between periods.

Tax Related BenefitTax related benefit consists of certain business taxes and
related expenses or accruals. During the three months ended June 30, 2003 we
recorded negative tax related expense of $0.5 million compared to no expense
for the three months ended June 30, 2002. This decrease was primarily
attributable to the release of earlier tax accruals recorded primarily between
1999 and 2001.

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 approximately $63,000 for the three months
ended June 30, 2003 from $0.1 million for the three months ended June 30, 2002.
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 $58,000 for the three months ended June 30, 2003
compared to





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$0.4 million for the three months ended June 30, 2002. Interest income
decreased to $58,000 for the three months ended June 30, 2003 from $112,000 for
the three months ended June 30, 2002 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, 2003, we had net operating loss carryforwards for federal income
tax purposes of approximately $61.0 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, 2003, 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, 2003
compared to
Six Months Ended June 30, 2002

Net Sales

Net sales increased to $1.7 million for the six months ended June 30, 2003 from
$1.1 million for the six months ended June 30, 2002. This increase was
primarily attributable to the Companys success building revenues within the
eduPartners program. We did not record any marketing services revenue during
the six months ended June 30, 2003, a decrease from the $14,000 recognized in
the same period in 2002. No new significant marketing services contracts were
signed during the six months ending June 30, 2003.

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
increased to approximately $1.0 million for the six months ended June 30, 2003
from $0.7 million for the six months ended June 30, 2002. This increase was
primarily attributable to our increased 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 $0.1 million for the six months ended June 30, 2003 from
approximately $88,000 for the six months ended June 30, 2002. This increase was
primarily attributable to our increased sales volume.

Marketing and Sales Marketing and sales expense consists primarily of
advertising and promotional expenditures, credit card processing fees and
payroll and related expenses for personnel engaged in the marketing and
expansion of eduPartners. Marketing and sales expense increased to $0.8 million
for the six months ended June 30, 2003, from approximately $0.6 million for the
six months ended June 30, 2002. This increase was primarily attributable to
higher costs associated with sales and marketing fees related to our agreement
with Baker & Taylor and higher sales staffing levels and related expense.

Certain marketing and sales expenses associated with our agreement with Baker &
Taylor are the product of the classification of services such as website
content and customer database management as marketing and sales expense and we
expect these costs will increase in absolute dollars as we expand our business.

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
increased to approximately $0.1 million for the six months ended June 30, 2003
from $78,000 for the six months ended June 30, 2002. This decrease was
primarily attributable to increased 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 was approximately $0.7 million for the six months ended
June 30, 2003, similar to the $0.7 million expensed for the six months ended
June 30, 2002.

Tax Related BenefitTax related benefit consists of certain business taxes and
related expenses or accruals. During the six months ended June 30, 2003 we
recorded negative tax related expense of $0.5 million compared to no expense
for the six months ended June 30, 2002. This decrease was primarily
attributable to the release of earlier tax accruals recorded primarily between
1999 and 2001.

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





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##### 



decreased to approximately $0.1 million for the six months ended June 30, 2003
from $0.2 million for the six months ended June 30, 2002. 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 $0.1 million for the six months ended June 30,
2003 compared to $0.4 million for the six months ended June 30, 2002. Interest
income decreased to $134,000 for the six months ended June 30, 2003 from
$169,000 for the six months ended June 30, 2002 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, 2003, we had net operating loss carryforwards for federal income
tax purposes of approximately $61.0 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, 2003, 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, 2003, we had $17.4 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 $1.2 million for the six months ended
June 30, 2003 compared to $0.4 million net cash used in operations for the six
months ended June 30, 2002. This increase was largely attributable to
increases in payroll and related expenses and changes in accounts payable and
accrued expenses.

Net cash used in investing activities was $1.6 million for the six months ended
June 30, 2003 compared to net cash used in investing activities of $3.0 million
for the six months ended June 30, 2002. This decrease was largely to smaller
purchases of high-grade short-term investments during the period.

Net cash provided by financing activities was $0.2 million for the six months
ended June 30, 2003 and $12,000 for the six months ended June 30, 2002. Net
cash provided by financing activities during the six months ending June 30,
2003 and June 30, 2002 consisted primarily of net proceeds from the exercise of
employee stock options.

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.

Based upon our current and expected cost structure and recent growth levels
within the eduPartners program, we believe we are positioned to improve upon
the financial performance of 2002. However, we intend to increase spending on
the development of eduPartners and relationships with other related businesses.
Failure to generate sufficient revenues or, if necessary, reduce discretionary
spending could harm our results of operations and financial condition.

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, 2003, 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.





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PART II.
OTHER INFORMATION

Item 1:
    
    Legal ProceedingsNot ApplicableItem 2:
    
    Changes in SecuritiesNot ApplicableItem 3:
    
    Defaults Upon Senior SecuritiesNot ApplicableItem 4:
    
    Submission of Matters to a Vote of Security HoldersNot ApplicableItem 5:
    
    Other InformationNot ApplicableItem 6:
    
    Exhibits and Reports on Form 8-K(a)  ExhibitsNone(b)  Reports on Form 8-KNone


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 13, 2003

Varsity Group Inc.By:/s/ JACK M BENSONJack M BensonChief Financial Officer