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UNITED STATES SECURITIES AND EXCHANGE COMMISSION



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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 September 30, 2002

OR

[    ] TRANSITION REPORT PURSUANT TO SECTION 13 or 15(d) OF THE SECURITIES
EXCHANGE

ACT OF 1934

For the transition period from to .



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Commission file number 0-28977



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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 October 15, 2002, the registrant had 16,116,916 shares of common
stock outstanding.

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1



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##### 



VARSITY GROUP INC. AND SUBSIDIARIES

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

INDEX

|        |  |                                                                                                                 |  |            
|------- |  | --------------------------------------------------------------------------------------------------------------- |  | -----------
|        |  |                                                                                                                 |  | Page Number
|        |  |                                                                                                                 |  |            
|        |  | PART I. FINANCIAL INFORMATION                                                                                   |  |            
|       
|Item 1. |  | Financial Statements                                                                                            |  |            
|       
|        |  | Condensed consolidated statements of operations for the
three and nine months ended September 30, 2001 and 2002 |  | 3          
|       
|        |  | Condensed consolidated balance sheets as of December 31,
2001 and September 30, 2002                            |  | 4          
|       
|        |  | Condensed consolidated statements of cash flows for the
nine months ended September 30, 2001 and 2002           |  | 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                                                      |  | 10         
|       
|Item 4. |  | Controls & Procedures                                                                                           |  | 10         
|       
|        |  | 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                                                                                               |  | 11         
|       
|Item 6. |  | Exhibits and Reports on Form 8-K                                                                                |  | 11         

2



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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 |       | Nine Months Ended
|                                |                                                                                                                                   |                          |       | September 30,      |       | September 30,    
|                                |                                                                                                                                   |                          |       |                    |       |                  
|                                |                                                                                                                                   |                          |       | 2001               |       | 2002              |       | 2001       |        | 2002
|                                |                                                                                                                                   |                          |       |                    |       |                   |       |            |        |     
|Net sales:                      |                                                                                                                                   |                          |       |                    |       |                   |       |            |        |      |        |            |        |   |       |           
|                                | Product                                                                                                                           |                          | $     | 8,687              |       |                   | $     | 13,291     |        |      | $      | 10,156     |        |   | $     | 14,298     |       
|                                | Shipping                                                                                                                          |                          |       | 659                |       |                   |       | 1,091      |        |      |        | 835        |        |   |       | 1,207      |       
|                                | Marketing services                                                                                                                |                          |       | 71                 |       |                   |       |           |        |      |        | 834        |        |   |       | 14         |       
|                                |                                                                                                                                   |                          |       |                    |       |                   |       |            |        |      |        |            |        |   |       |           
|                                |                                                                                                                                   | Total net sales          |       |                    | 9,417 |                   |       |            | 14,382 |      |        |            | 11,825 |   |       |            | 15,519 | 
|                                |                                                                                                                                   |                          |       |                    |       |                   |       |            |        |      |        |            |        |   |       |           
|Operating expenses              |                                                                                                                                   |                          |       |                    |       |                   |       |            |        |      |        |            |        |   |       |           
|                                | Cost of books  related party                                                                                                     |                          |       | 6,188              |       |                   |       | 9,037      |        |      |        | 7,452      |        |   |       | 9,726      |       
|                                | Cost of shipping  related party                                                                                                  |                          |       | 487                |       |                   |       | 812        |        |      |        | 612        |        |   |       | 901        |       
|                                | Cost of marketing services                                                                                                        |                          |       | 2                  |       |                   |       |           |        |      |        | 41         |        |   |       |           |       
|                                | Marketing and sales (including
$905 and $960 with related
party for three and nine months
ended September 30, 2002,
respectively) |                          |       | 933                |       |                   |       | 1,534      |        |      |        | 1,479      |        |   |       | 2,113      |       
|                                | Product development                                                                                                               |                          |       | 25                 |       |                   |       | 70         |        |      |        | 238        |        |   |       | 148        |       
|                                | General and administrative                                                                                                        |                          |       | 750                |       |                   |       | 750        |        |      |        | 3,193      |        |   |       | 1,418      |       
|                                | Non-cash compensation                                                                                                             |                          |       | 163                |       |                   |       | 100        |        |      |        | 646        |        |   |       | 313        |       
|                                |                                                                                                                                   |                          |       |                    |       |                   |       |            |        |      |        |            |        |   |       |           
|                                |                                                                                                                                   | Total operating expenses |       |                    | 8,548 |                   |       |            | 12,303 |      |        |            | 13,661 |   |       |            | 14,619 | 
|                                |                                                                                                                                   |                          |       |                    |       |                   |       |            |        |      |        |            |        |   |       |           
|Profit / (loss) from operations |                                                                                                                                   |                          | 869   |                    |       |                   | 2,079 |            |        |      | (1,836 | )          |        |   | 900   |           
|                                |                                                                                                                                   |                          |       |                    |       |                   |       |            |        |      |        |            |        |   |       |           
|Other income, net:              |                                                                                                                                   |                          |       |                    |       |                   |       |            |        |      |        |            |        |   |       |           
|                                | Interest income                                                                                                                   |                          |       | 155                |       |                   |       | 71         |        |      |        | 524        |        |   |       | 239        |       
|                                | Other income                                                                                                                      |                          |       | 2                  |       |                   |       | (2         | )      |      |        | 54         |        |   |       | 253        |       
|                                |                                                                                                                                   |                          |       |                    |       |                   |       |            |        |      |        |            |        |   |       |           
|                                | Other income, net                                                                                                                 |                          |       | 157                |       |                   |       | 69         |        |      |        | 578        |        |   |       | 492        |       
|                                |                                                                                                                                   |                          |       |                    |       |                   |       |            |        |      |        |            |        |   |       |           
|Net profit / (loss)             |                                                                                                                                   | $                        | 1,026 |                    |       | $                 | 2,148 |            |        | $    | (1,258 | )          |        | $ | 1,392 |           
|                                |                                                                                                                                   |                          |       |                    |       |                   |       |            |        |      |        |            |        |   |       |           
|Net profit / (loss) per share:  |                                                                                                                                   |                          |       |                    |       |                   |       |            |        |      |        |            |        |   |       |           
|                                | Basic: Net profit / (loss)                                                                                                        |                          | $     | 0.06               |       |                   | $     | 0.13       |        |      | $      | (0.08      | )      |   | $     | 0.09       |       
|                                |                                                                                                                                   |                          |       |                    |       |                   |       |            |        |      |        |            |        |   |       |           
|                                | Diluted: Net profit / (loss)                                                                                                      |                          | $     | 0.06               |       |                   | $     | 0.13       |        |      | $      | (0.08      | )      |   | $     | 0.09       |       
|                                |                                                                                                                                   |                          |       |                    |       |                   |       |            |        |      |        |            |        |   |       |           
|Weighted average shares:        |                                                                                                                                   |                          |       |                    |       |                   |       |            |        |      |        |            |        |   |       |           
|                                | Basic                                                                                                                             |                          |       | 16,614,721         |       |                   |       | 16,116,916 |        |      |        | 16,684,012 |        |   |       | 16,069,410 |       
|                                |                                                                                                                                   |                          |       |                    |       |                   |       |            |        |      |        |            |        |   |       |           
|                                | Diluted                                                                                                                           |                          |       | 16,779,215         |       |                   |       | 16,971,310 |        |      |        | 16,684,012 |        |   |       | 16,354,208 |       
|                                |                                                                                                                                   |                          |       |                    |       |                   |       |            |        |      |        |            |        |   |       |           

See accompanying notes to condensed consolidated financial statements.

3



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##### 



VARSITY GROUP INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(in thousands, except share and per share data)

ASSETS

|                |                                                                                                                      |              |   |                   |        |                    |   |             |        | 
|--------------- | -------------------------------------------------------------------------------------------------------------------- | ------------ | - | ----------------- | ------ | ------------------ | - | ----------- | ------ | 
|                |                                                                                                                      |              |   | December 31, 2001 |        | September 30, 2002
|                |                                                                                                                      |              |   |                   |        |                   
|                |                                                                                                                      |              |   |                   |        |                    |   | (unaudited)
|Current assets: |                                                                                                                      |              |   |                   |        |                    |   |            
|                | Cash and cash equivalents                                                                                            |              | $ | 16,811            |        |                    | $ | 14,826      |       
|                | Short-term investments                                                                                               |              |   |                  |        |                    |   | 3,000       |       
|                | Accounts receivable, net
of allowance of doubtful
accounts of $48 at
December 31, 2001 and
$29 at September 30,
2002 |              |   | 71                |        |                    |   | 2,116       |       
|                | Other current assets                                                                                                 |              |   | 432               |        |                    |   | 481         |       
|                |                                                                                                                      |              |   |                   |        |                    |   |            
|                | Total current assets                                                                                                 |              |   | 17,314            |        |                    |   | 20,423      |       
|                | Fixed assets, net                                                                                                    |              |   | 204               |        |                    |   | 65          |       
|                | Other assets                                                                                                         |              |   | 79                |        |                    |   | 15          |       
|                |                                                                                                                      |              |   |                   |        |                    |   |            
|                |                                                                                                                      | Total assets |   | $                 | 17,597 |                    |   | $           | 20,503 | 
|                |                                                                                                                      |              |   |                   |        |                    |   |            

LIABILITIES AND STOCKHOLDERS EQUITY

|                      |                                                                                                                                                                                 |                                            |   |         |        |   |   |         |        | 
|--------------------- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- | ------------------------------------------ | - | ------- | ------ | - | - | ------- | ------ | 
|Current liabilities:  |                                                                                                                                                                                 |                                            |   |         |        |   |   |        
|                      |                                                                                                                                                                                 |                                            |   |         |        | $ |   |        
|                      | Accounts payable                                                                                                                                                                |                                            | $ | 222     |        |   |   | 414     |       
|                      | Other accrued expenses and
other current liabilities                                                                                                                            |                                            |   | 196     |        |   |   | 862     |       
|                      | Sales taxes payable                                                                                                                                                             |                                            |   | 1,281   |        |   |   | 1,612   |       
|                      |                                                                                                                                                                                 |                                            |   |         |        |   |   |        
|                      |                                                                                                                                                                                 | Total current liabilities                  |   |         | 1,699  |   |   |         | 2,888  | 
|Long-term liabilities |                                                                                                                                                                                 |                                            |  |         |        |   |  |        
|                      |                                                                                                                                                                                 |                                            |   |         |        |   |   |        
|                      |                                                                                                                                                                                 | Total liabilities                          |   |         | 1,699  |   |   |         | 2,888  | 
|                      |                                                                                                                                                                                 |                                            |   |         |        |   |   |        
|Stockholders equity: |                                                                                                                                                                                 |                                            |   |         |        |   |   |        
|                      | Preferred stock: $.0001 par value, 20,000,000
shares authorized; 0 shares issued and outstanding
at December 31, 2001 and September 30, 2002                                    |                                            |   |        |        |   |   |        |       
|                      | Common stock: $.0001 par value, 60,000,000 shares
authorized, 16,871,062 and 17,073,979 shares issued
and outstanding at December 31, 2001 and September
30, 2002, respectively |                                            |   | 2       |        |   |   | 2       |       
|                      | Additional paid-in capital                                                                                                                                                      |                                            |   | 87,458  |        |   |   | 87,601  |       
|                      | Deferred compensation                                                                                                                                                           |                                            |   | (527    | )      |   |   | (345    | )     
|                      | Accumulated deficit                                                                                                                                                             |                                            |   | (70,461 | )      |   |   | (69,069 | )     
|                      | Treasury Stock, $.0001 par value, 957,063 shares at
December 31, 2001 and September 30, 2002                                                                                    |                                            |   | (574    | )      |   |   | (574    | )     
|                      |                                                                                                                                                                                 |                                            |   |         |        |   |   |        
|                      |                                                                                                                                                                                 | Total stockholders equity                 |   |         | 15,898 |   |   |         | 17,615 | 
|                      |                                                                                                                                                                                 |                                            |   |         |        |   |   |        
|                      |                                                                                                                                                                                 | Total liabilities and stockholders equity |   | $       | 17,597 |   |   | $       | 20,503 | 
|                      |                                                                                                                                                                                 |                                            |   |         |        |   |   |        

See accompanying notes to condensed consolidated financial statements.

4



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VARSITY GROUP INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)
(unaudited)

|                                                                            |                                                                        |                                                      |                                                       |        |                   |     |        |        |        |        |  
|--------------------------------------------------------------------------- | ---------------------------------------------------------------------- | ---------------------------------------------------- | ----------------------------------------------------- | ------ | ----------------- | --- | ------ | ------ | ------ | ------ | -
|                                                                            |                                                                        |                                                      |                                                       |        | Nine Months Ended
|                                                                            |                                                                        |                                                      |                                                       |        | September 30,    
|                                                                            |                                                                        |                                                      |                                                       |        |                  
|                                                                            |                                                                        |                                                      |                                                       |        | 2001              |     | 2002  
|                                                                            |                                                                        |                                                      |                                                       |        |                   |     |       
|Operating activities:                                                       |                                                                        |                                                      |                                                       |        |                   |     |        |       
|                                                                            | Net profit / (loss)                                                    |                                                      | $                                                     | (1,258 | )                 |     | $      | 1,392  |       
|Adjustments to reconcile net loss to net cash used in operating activities: |                                                                        |                                                      |                                                       |        |                   |     |        |       
|                                                                            | Depreciation and amortization                                          |                                                      |                                                       | 600    |                   |     |        | 151    |       
|                                                                            | Bad debt expense                                                       |                                                      |                                                       | (40    | )                 |     |        | 10     |       
|                                                                            | Loss on disposal of fixed assets and write off of underutilized assets |                                                      |                                                       | 438    |                   |     |        |       |       
|                                                                            | Non-cash compensation                                                  |                                                      |                                                       | 710    |                   |     |        | 313    |       
|                                                                            | Changes in operating assets and liabilities:                           |                                                      |                                                       |        |                   |     |        |        |       
|                                                                            |                                                                        | Accounts receivable                                  |                                                       |        | 98                |     |        |        | (2,055 | )     
|                                                                            |                                                                        | Other current assets                                 |                                                       |        | 214               |     |        |        | (49    | )     
|                                                                            |                                                                        | Accounts payable                                     |                                                       |        | (659              | )   |        |        | 192    |       
|                                                                            |                                                                        | Lease liability                                      |                                                       |        | (368              | )   |        |        |       |       
|                                                                            |                                                                        | Deferred revenue                                     |                                                       |        | (174              | )   |        |        |       |       
|                                                                            |                                                                        | Other accrued expenses and other current liabilities |                                                       |        | (56               | )   |        |        | 666    |       
|                                                                            |                                                                        | Taxes payable                                        |                                                       |        | 493               |     |        |        | 331    |       
|                                                                            |                                                                        | Other non-current liabilities                        |                                                       |        | (131              | )   |        |        |       |       
|                                                                            |                                                                        | Other non-current assets                             |                                                       |        | 250               |     |        |        | 64     |       
|                                                                            |                                                                        |                                                      |                                                       |        |                   |     |        |       
|                                                                            |                                                                        |                                                      | Net cash provided by operating activities             |        |                   | 117 |        |        |        | 1,015  |  
|                                                                            |                                                                        |                                                      |                                                       |        |                   |     |        |       
|Investing activities:                                                       |                                                                        |                                                      |                                                       |        |                   |     |        |       
|                                                                            | Additions to fixed assets                                              |                                                      |                                                       | (18    | )                 |     |        | (23    | )     
|                                                                            | Increase in short-term investments                                     |                                                      |                                                       |       |                   |     |        | (3,000 | )     
|                                                                            | Decrease in short-term investments                                     |                                                      |                                                       | 480    |                   |     |        |       |       
|                                                                            | Proceeds from sale of fixed assets                                     |                                                      |                                                       | 62     |                   |     |        | 11     |       
|                                                                            |                                                                        |                                                      |                                                       |        |                   |     |        |       
|                                                                            |                                                                        |                                                      | Net cash provided by / (used in) investing activities |        |                   | 524 |        |        |        | (3,012 | )
|                                                                            |                                                                        |                                                      |                                                       |        |                   |     |        |       
|Financing activities:                                                       |                                                                        |                                                      |                                                       |        |                   |     |        |       
|                                                                            | Proceeds from exercise of stock options                                |                                                      |                                                       | 13     |                   |     |        | 12     |       
|                                                                            | Proceeds from note receivable, shareholder                             |                                                      |                                                       | 62     |                   |     |        |       |       
|                                                                            | Proceeds from warrant subscription receivable                          |                                                      |                                                       | 707    |                   |     |        |       |       
|                                                                            |                                                                        |                                                      |                                                       |        |                   |     |        |       
|                                                                            |                                                                        |                                                      | Net cash provided by financing activities             |        |                   | 782 |        |        |        | 12     |  
|                                                                            |                                                                        |                                                      |                                                       |        |                   |     |        |       
|Net decrease in cash and cash equivalents                                   |                                                                        |                                                      | 1,423                                                 |        |                   |     | (1,985 | )     
|Cash and cash equivalents at beginning of period                            |                                                                        |                                                      | 15,710                                                |        |                   |     | 16,811 |       
|                                                                            |                                                                        |                                                      |                                                       |        |                   |     |        |       
|Cash and cash equivalents at end of period                                  |                                                                        | $                                                    | 17,133                                                |        |                   | $   | 14,826 |       
|                                                                            |                                                                        |                                                      |                                                       |        |                   |     |        |       
|Supplemental disclosure of cash flow information:                           |                                                                        |                                                      |                                                       |        |                   |     |        |       
|                                                                            | Cash paid for income taxes and interest                                |                                                      | $                                                     | 37     |                   |     | $      |       |       
|                                                                            |                                                                        |                                                      |                                                       |        |                   |     |        |       

See accompanying notes to consolidated financial statements

5



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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.

6



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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, 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 significant marketing and brand building expenses.

In the quarter ending September 30, 2002, revenues from eduPartners accounted
for approximately 99% of our overall sales of books, an increase from the 97%
share recognized in the quarter ending September 30, 2001 and 69% share
recognized in 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 over 140 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 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.

Throughout 2002, we have continued to adapt our business priorities, focus and
resources to meet changing market dynamics and economic realities. We have
successfully grown eduPartners while containing overall expenses and increasing
the margins of our retail book business to accelerate our path to
profitability. During the three months ending September 30, 2002 the Company
recorded record net sales of $14.4 million and net profit of $2.1 million.

Our ability to reach and sustain annual operating profitability depends, in
part, on our ability to generate higher net revenues while maintaining or
improving current margin levels. 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.

During the nine months ending September 30, 2002 the Company reported a net
profit of approximately $1.4 million compared to a net loss of $1.3 million for
the same period in 2001. Cash provided by operating activities during the nine
months ending September 30, 2002 was approximately $1.0 million, up from $0.1
million for the nine months ending September 30, 2001.

Based upon the strength of our performance through the nine months ending
September 30, 2002, we expect to record the first profitable fiscal year in the
Companys history in 2002. 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 for
at least the next fiscal year. We may need to raise additional funds prior to
the expiration of such period if, for example, we pursue new businesses,
technology or intellectual property acquisitions. Any required additional
financing may be unavailable on terms favorable to us, or at all.

7



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

Net Sales

Net sales increased to $14.4 million for the three months ended September 30,
2002 from $9.4 million for the three months ended September 30, 2001. This
increase was primarily attributable to the Companys success growing revenues
within the eduPartners program. There were no marketing services revenues
recognized during the three months ended September 30, 2002, a decrease from
the $71,000 recognized in the same period in 2001. This decrease was largely
attributable to our decision to close our on-campus marketing services
business.

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 $9.0 million for the three months ended September
30, 2002 from $6.2 million for the three months ended September 30, 2001. 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 $0.8 million for the three months ended September 30, 2002
from approximately $0.5 million for the three months ended September 30, 2001.
This increase was primarily attributable to our increased 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 three months ended September 30, 2002. This decrease from approximately
$2,000 for the three months ended September 30, 2001 was attributable to lack
of any on-campus marketing programs during 2002.

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 $1.5 million for the three months ended September 30, 2002,
an increase from $0.9 million for the three months ended September 30, 2001.
This was largely attributable to increased sales volumes and associated costs
with our agreement with Baker and Taylor and sales incentives for eduPartners
schools.

Product Development Product development expense consists of payroll and
related expenses for development and systems personnel and consultants. Product
development expense increased to approximately $70,000 for the three months
ended September 30, 2002 from $25,000 for the three months ended September 30,
2001. This increase 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,
facilities expenses, professional services expenses, travel and other general
corporate expenses. General and administrative expense remained at $0.8 million
for the three months ended September 30, 2002, consistent with the $0.8 million
recorded for the three months ended September 30, 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 $0.1 million for the three months ended
September 30, 2002 from $0.2 million for the three months ended September 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 $0.1 million for the three months ended
September 30, 2002 compared to $0.2 million for the three months ended
September 30, 2001. Interest income decreased to $71,000 for the three months
ended September 30, 2002 from $155,000 for the three months ended September 30,
2001 largely due to lower rates of return compared to the previous period.

Income Taxes

8



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As of September 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 September 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.

Nine Months Ended September 30, 2002
compared to
Nine Months Ended September 30, 2001

Net Sales

Net sales increased to $15.5 million for the nine months ended September 30,
2002 from $11.8 million for the nine months ended September 30, 2001. This
increase was primarily attributable to the Companys success growing revenues
within the eduPartners program. There were $14,000 of marketing services
revenues recognized during the nine months ended September 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

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 $9.7 million for the nine months ended September 30,
2002 from $7.5 million for the nine months ended September 30, 2001. This
decrease 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 $0.9 million for the nine months ended September 30, 2002 from
approximately $0.6 million for the nine months ended September 30, 2001. This
increase was primarily attributable to our increased 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 nine months ended September 30, 2002. This decrease from approximately
$41,000 for the nine months ended September 30, 2001 was attributable to lack
of any on-campus marketing programs during 2002.

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 $2.1 million for the nine months ended September 30, 2002, an
increase from $1.5 million for the nine months ended September 30, 2001. This
was largely attributable to increased sales volumes and associated costs with
our agreement with Baker and Taylor and sales incentives for eduPartners
schools.

Product Development Product development expense consists of payroll and
related expenses for development and systems personnel and consultants. Product
development expense decreased to approximately $0.1 million for the nine months
ended September 30, 2002 from $0.2 million for the nine months ended September
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 $1.4
million for the nine months ended September 30, 2002 from $3.2 million for the
nine months ended September 30, 2001. This decrease was primarily attributable
to lower depreciation expense and 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 $0.3 million for the nine months ended
September 30, 2002 from $0.6 million for the nine months ended September 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 $0.5 million for the nine months ended September
30, 2002, a

9



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slight decrease from the $0.6 million recognized for the nine months ended
September 30, 2001. Interest income decreased to $0.2 million for the nine
months ended September 30, 2002 from $0.5 million for the nine months ended
September 30, 2001 largely due to lower rates of return compared to the
previous period. During the nine months ended September 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 September 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 nine months
ended September 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 September 30, 2002, we had $17.8 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 provided by operating activities was $1.0 million for the nine months
ended September 30, 2002 compared to $0.1 million net cash used in operations
for the nine months ended September 30, 2001. This increase was primarily
attributable to the recording of $1.4 million in operating profit for the nine
months ended September 30, 2002 compared to $1.3 million of operating losses
recognized in the nine months ended September 30, 2001.

Net cash used in investing activities was $3.0 million for the nine months
ended September 30, 2002 compared to net cash provided by investing activities
of $0.5 million for the nine months ended September 30, 2001. This increase
was largely due to the purchase of high-grade short-term investments during the
nine months ended September 30, 2002 compared to the maturation of
approximately $0.5 million of short-term investments during the nine months
ended September 30, 2001.

Net cash provided by financing activities was $12,000 for the nine months ended
September 30, 2002 and $0.8 million the nine months ended September 30, 2001.
Net cash provided by financing activities during the nine months ending
September 30, 2002, consisted primarily of net proceeds from the exercise of
employee stock options. Net cash provided by financing activities during the
nine months ending September 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 for at least the
next fiscal year. 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. 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 September 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.

Item 4.Controls and Procedures

Evaluation of Disclosure Controls and Procedures  During the 90 days prior
to the date of this report, the Company carried out an evaluation, under the
supervision and with the participation of the Companys management, including
the Companys Chief Executive Officer and Chief Financial Officer, of the
effectiveness of the design and operation of the Companys disclosure controls
and procedures pursuant to Exchange Act Rule 13a-14. Based upon that
evaluation, the Chief Executive Officer and Chief Financial Officer concluded
that the Companys disclosure controls and procedures are effective in timely
alerting them to material information relating to the Company (including its
consolidated subsidiaries) required to be included in the Companys periodic
SEC filings.

10



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Disclosure controls and procedures are our controls and other procedures that
are designed to ensure that information required to be disclosed by us in the
reports that we file or submit under the Exchange Act is recorded, processed,
summarized and reported, within the time periods specified in the Securities
and Exchange Commissions rules and forms. Disclosure control and procedures
include, but are limited to, controls and procedures designed to ensure that
information required to be disclosed by us in the reports that we file under
the Exchange Act is accumulated and communicated to our management, including
our Chief Executive Officer and Chief Financial Officer, as appropriate to
allow timely decisions regarding required disclosure.

Changes in Internal Controls  There have been no significant changes in the
Companys internal controls or in other factors which could significantly
affect internal controls subsequent to the date the Company carried out its
evaluation. There were no significant deficiencies or material weaknesses
identified in the evaluation and therefore, no corrective actions were taken.

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

Not Applicable

Item 5:Other Information

On September 27, 2002, the Company signed a lease for 4,358 square feet of
rentable office space for its principal executive offices located in
Washington, D.C. under a noncancelable operating lease. The term of the lease
commences on November 15, 2002 and ends on November 14, 2004. The lease
includes a provision for annual rent escalation of 3.0% for the second year of
the lease. Total lease payments are $135,098 and $139,151 for the first and
second years of the lease, respectively.

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: October 24, 2002



|                   |  |                                                       
|------------------ |  | ------------------------------------------------------
|Varsity Group Inc. |  |                                                       
|                  
|By:                |  | /s/ JACK M BENSONJack M Benson
Chief Financial Officer



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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 September 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 results of operations of the
Company.

|                        |  |                                     
|----------------------- |  | ------------------------------------
|Dated: October 24, 2002 |  | Eric J. Kuhn
Chief Executive Officer

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 September 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 results of operations of the
Company.

|                        |  |                                      
|----------------------- |  | -------------------------------------
|Dated: October 24, 2002 |  | Jack M Benson
Chief Financial Officer

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CERTIFICATION PURSUANT TO
SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002

I, Eric J. Kuhn, certify that:



| | 1. |  | I have reviewed this quarterly report on Form 10-Q of Varsity Group
Inc.;                                                                                                                                                                                                                                                     
| | -- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| | 2. |  | Based on my knowledge, this quarterly report does not contain any
untrue statement of a material fact or omit to state a material fact
necessary to make the statements made, in light of the circumstances
under which such statements were made, not misleading with respect to
the period covered by this quarterly report;
|
| | 3. |  | Based on my knowledge, the financial statements, and other
financial information included in this quarterly report, fairly present
in all material respects the financial condition, results of operations
and cash flows of the registrant as of, and for, the periods presented
in this quarterly report;                   
|
| | 4. |  | The registrants other certifying officers and I are responsible
for establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and
we have:                                                                                                     

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| | 5. |  | The registrants other certifying officers and I have disclosed,
based on our most recent evaluation, to the registrants auditors and
the audit committee of registrants board of directors (or persons
performing the equivalent function):
| | -- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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|                        |  |                                     
|----------------------- |  | ------------------------------------
|Dated: October 24, 2002 |  | Eric J. Kuhn
Chief Executive Officer

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CERTIFICATION PURSUANT TO
SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002

I, Jack M Benson, certify that:



| | 7.  |  | I have reviewed this quarterly report on Form 10-Q of Varsity Group
Inc.;                                                                                                                                                                                                                                                     
| | --- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| | 8.  |  | Based on my knowledge, this quarterly report does not contain any
untrue statement of a material fact or omit to state a material fact
necessary to make the statements made, in light of the circumstances
under which such statements were made, not misleading with respect to
the period covered by this quarterly report;
|
| | 9.  |  | Based on my knowledge, the financial statements, and other
financial information included in this quarterly report, fairly present
in all material respects the financial condition, results of operations
and cash flows of the registrant as of, and for, the periods presented
in this quarterly report;                   
|
| | 10. |  | The registrants other certifying officers and I are responsible
for establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and
we have:                                                                                                     

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|

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|                        |  |                                      
|----------------------- |  | -------------------------------------
|Dated: October 24, 2002 |  |                                      
|                       
|                        |  | Jack M Benson
Chief Financial Officer

14