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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549



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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 June 30, 2005



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)
|1850 M Street, Suite 1150 Washington, D.C. |  | 20036                               
|(Address of Principal Executive Offices)   |  | (Zip Code)                          



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 ̈



Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act)
Yes ̈No  x



As of August 1, 2005, the registrant had 17,042,714 shares of common stock outstanding.



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##### Table of Contents



VARSITY GROUP INC. AND
SUBSIDIARIES

QUARTERLY REPORT ON FORM 10-Q

For the quarter ended June 30, 2005



INDEX



|        |  |                                                                                                           |  |            
|------- |  | --------------------------------------------------------------------------------------------------------- |  | -----------
|        |  |                                                                                                           |  | Page Number
|        |  | PART I. FINANCIAL INFORMATION                                                                             |  |            
|        |  |                                                                                                          
|Item 1. |  | Financial Statements                                                                                      |  |            
|        |  |                                                                                                          
|        |  | Condensed consolidated balance sheets as of June 30, 2005 and December 31, 2004                           |  | 3          
|        |  |                                                                                                          
|        |  | Condensed consolidated statements of operations for the three and six months ended June 30, 2005 and 2004 |  | 4          
|        |  |                                                                                                          
|        |  | Condensed consolidated statements of cash flows for the six months ended June 30, 2005 and 2004           |  | 5          
|        |  |                                                                                                          
|        |  | Notes to condensed consolidated financial statements                                                      |  | 6          
|        |  |                                                                                                          
|Item 2. |  | Managements Discussion and Analysis of Financial Condition and Results of Operations                     |  | 11         
|        |  |                                                                                                          
|Item 3. |  | Quantitative and Qualitative Disclosures About Market Risk                                                |  | 18         
|        |  |                                                                                                          
|Item 4. |  | Controls and Procedures                                                                                   |  | 18         
|        |  |                                                                                                          
|        |  | PART II. OTHER INFORMATION                                                                                |  |            
|        |  |                                                                                                          
|Item 1. |  | Legal Proceedings                                                                                         |  | 19         
|        |  |                                                                                                          
|Item 2. |  | Changes in Securities                                                                                     |  | 19         
|        |  |                                                                                                          
|Item 3. |  | Defaults Upon Senior Securities                                                                           |  | 19         
|        |  |                                                                                                          
|Item 4. |  | Submission of Matters to a Vote of Security Holders                                                       |  | 19         
|        |  |                                                                                                          
|Item 5. |  | Other Information                                                                                         |  | 19         
|        |  |                                                                                                          
|Item 6. |  | Exhibits and Reports                                                                                      |  | 19         
|        |  |                                                                                                          
|        |  | Signatures                                                                                                |  | 20         



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PART I.

FINANCIAL INFORMATION



|Item 1: | Financial Statements
|------- | --------------------



VARSITY GROUP INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS (UNAUDITED)

(in thousands)



|                                                                                                                                                                                        |  |               |         |   |                   |   |         |  
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ------------- | ------- | - | ----------------- | - | ------- | -
|                                                                                                                                                                                        |  | June 30, 2005 |         |   | December 31, 2004 |  
|Assets                                                                                                                                                                                  |  |               |         |   |                   |   |         |  
|Current Assets:                                                                                                                                                                         |  |               |         |   |                   |   |         |  
|Cash and cash equivalents                                                                                                                                                               |  | $             | 3,345   |   |                   | $ | 4,865   |  
|Short-term investments                                                                                                                                                                  |  |               | 2,000   |   |                   |   | 7,000   |  
|Accounts receivable, net of allowance for doubtful accounts of $20 at June 30, 2005 and $15 at December 31, 2004, respectively                                                          |  |               | 846     |   |                   |   | 1,251   |  
|Inventory                                                                                                                                                                               |  |               | 11,262  |   |                   |   | 2,463   |  
|Other                                                                                                                                                                                   |  |               | 371     |   |                   |   | 1,248   |  
|                                                                                                                                                                                        |  |               |         |   |                   |   |         |  
|Total current assets                                                                                                                                                                    |  |               | 17,824  |   |                   |   | 16,827  |  
|Property, plant and equipment, net of depreciation                                                                                                                                      |  |               | 533     |   |                   |   | 252     |  
|Software developed for internal use, net of amortization                                                                                                                                |  |               | 1,017   |   |                   |   | 708     |  
|Intangible assets, net of amortization                                                                                                                                                  |  |               | 838     |   |                   |   |        |  
|Goodwill                                                                                                                                                                                |  |               | 2,368   |   |                   |   |        |  
|Deferred income taxes                                                                                                                                                                   |  |               | 6,708   |   |                   |   | 5,901   |  
|Long term investments                                                                                                                                                                   |  |               | 6,454   |   |                   |   | 6,993   |  
|Other assets                                                                                                                                                                            |  |               | 119     |   |                   |   | 31      |  
|                                                                                                                                                                                        |  |               |         |   |                   |   |         |  
|Total assets                                                                                                                                                                            |  |               | 35,861  |   |                   |   | 30,712  |  
|                                                                                                                                                                                        |  |               |         |   |                   |   |         |  
|Liabilities and Stockholders Equity                                                                                                                                                    |  |               |         |   |                   |   |         |  
|Current liabilities:                                                                                                                                                                    |  |               |         |   |                   |   |         |  
|Accounts payable                                                                                                                                                                        |  | $             | 6,956   |   |                   | $ | 696     |  
|Other accrued expenses and other current liabilities                                                                                                                                    |  |               | 948     |   |                   |   | 1,569   |  
|Taxes payable                                                                                                                                                                           |  |               | 446     |   |                   |   | 459     |  
|                                                                                                                                                                                        |  |               |         |   |                   |   |         |  
|Total current liabilities                                                                                                                                                               |  |               | 8,350   |   |                   |   | 2,724   |  
|Long-term liabilities:                                                                                                                                                                  |  |               |         |   |                   |   |         |  
|Other non current liabilities                                                                                                                                                           |  |               | 19      |   |                   |   |        |  
|                                                                                                                                                                                        |  |               |         |   |                   |   |         |  
|Total liabilities                                                                                                                                                                       |  |               | 8,369   |   |                   |   | 2,724   |  
|                                                                                                                                                                                        |  |               |         |   |                   |   |         |  
|Commitments and contingencies                                                                                                                                                           |  |               |         |   |                   |   |         |  
|Stockholders equity                                                                                                                                                                    |  |               |         |   |                   |   |         |  
|Preferred stock: $.0001 par value, 20,000 shares authorized; 0 shares issues and outstanding at June 30, 2005 and December 31, 2004,
respectively                                       |  |               |        |   |                   |   |        |  
|Common stock, $.0001 par value, 60,000 shares authorized, 18,240 and 17,969 shares issued and 17,025 and 16,754 shares outstanding at June 30,
2005 and December 31, 2004, respectively |  |               | 2       |   |                   |   | 2       |  
|Additional paid-in capital                                                                                                                                                              |  |               | 89,133  |   |                   |   | 88,273  |  
|Unrealized loss                                                                                                                                                                         |  |               | (46     | ) |                   |   | (7      | )
|Accumulated deficit                                                                                                                                                                     |  |               | (59,864 | ) |                   |   | (58,547 | )
|Treasury stock, $.001 par value, 1,215 shares at June 30, 2005 and December 31, 2004, respectively                                                                                      |  |               | (1,733  | ) |                   |   | (1,733  | )
|                                                                                                                                                                                        |  |               |         |   |                   |   |         |  
|Total stockholders equity                                                                                                                                                              |  |               | 27,492  |   |                   |   | 27,988  |  
|                                                                                                                                                                                        |  |               |         |   |                   |   |         |  
|Total liabilities and stockholders equity                                                                                                                                              |  | $             | 35,861  |   |                   | $ | 30,712  |  
|                                                                                                                                                                                        |  |               |         |   |                   |   |         |  



See accompanying notes
to condensed consolidated financial statements.



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VARSITY GROUP INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)

(in thousands, except per share data)



|                               |  |                             |        |   |                           |   |        |      |  |   |        |   |  |   |        |  
|------------------------------ |  | --------------------------- | ------ | - | ------------------------- | - | ------ | ---- |  | - | ------ | - |  | - | ------ | -
|                               |  | Three Months Ended June 30, |        |   | Six Months Ended June 30, |  
|                               |  | 2005                        |        |   | 2004                      |   |        | 2005 |  |   | 2004   |  
|Net sales:                     |  |                             |        |   |                           |   |        |      |  |   |        |   |  |   |        |  
|Textbook                       |  | $                           | 1,100  |   |                           | $ | 1,033  |      |  | $ | 3,246  |   |  | $ | 2,692  |  
|Uniforms                       |  |                             | 547    |   |                           |   |       |      |  |   | 547    |   |  |   |       |  
|Shipping                       |  |                             | 80     |   |                           |   | 64     |      |  |   | 278    |   |  |   | 232    |  
|                               |  |                             |        |   |                           |   |        |      |  |   |        |   |  |   |        |  
|Total net sales                |  |                             | 1,727  |   |                           |   | 1,097  |      |  |   | 4,071  |   |  |   | 2,924  |  
|                               |  |                             |        |   |                           |   |        |      |  |   |        |   |  |   |        |  
|Operating expenses:            |  |                             |        |   |                           |   |        |      |  |   |        |   |  |   |        |  
|Cost of textbook               |  |                             | 680    |   |                           |   | 633    |      |  |   | 2,116  |   |  |   | 1,832  |  
|Cost of uniforms               |  |                             | 219    |   |                           |   |       |      |  |   | 219    |   |  |   |       |  
|Cost of shipping               |  |                             | 62     |   |                           |   | 49     |      |  |   | 223    |   |  |   | 186    |  
|Sales and marketing            |  |                             | 1,242  |   |                           |   | 698    |      |  |   | 2,092  |   |  |   | 1,250  |  
|Product development            |  |                             | 96     |   |                           |   | 35     |      |  |   | 225    |   |  |   | 60     |  
|General and administrative     |  |                             | 838    |   |                           |   | 501    |      |  |   | 1,567  |   |  |   | 1,025  |  
|Amortization expense           |  |                             | 12     |   |                           |   |       |      |  |   | 12     |   |  |   |       |  
|Non-cash stock compensation    |  |                             |       |   |                           |   | 9      |      |  |   |       |   |  |   | 31     |  
|                               |  |                             |        |   |                           |   |        |      |  |   |        |   |  |   |        |  
|Total operating expenses       |  |                             | 3,149  |   |                           |   | 1,925  |      |  |   | 6,454  |   |  |   | 4,384  |  
|                               |  |                             |        |   |                           |   |        |      |  |   |        |   |  |   |        |  
|Loss from operations           |  |                             | (1,422 | ) |                           |   | (828   | )    |  |   | (2,383 | ) |  |   | (1,460 | )
|                               |  |                             |        |   |                           |   |        |      |  |   |        |   |  |   |        |  
|Other income, net:             |  |                             |        |   |                           |   |        |      |  |   |        |   |  |   |        |  
|Interest income (expense), net |  |                             | 122    |   |                           |   | 54     |      |  |   | 265    |   |  |   | 114    |  
|Other income (expense), net    |  |                             | (14    | ) |                           |   | (9     | )    |  |   | (6     | ) |  |   | (9     | )
|                               |  |                             |        |   |                           |   |        |      |  |   |        |   |  |   |        |  
|Other income, net              |  |                             | 108    |   |                           |   | 45     |      |  |   | 259    |   |  |   | 105    |  
|                               |  |                             |        |   |                           |   |        |      |  |   |        |   |  |   |        |  
|Loss before income taxes       |  |                             | (1,314 | ) |                           |   | (783   | )    |  |   | (2,124 | ) |  |   | (1,355 | )
|Income tax benefit             |  |                             | 499    |   |                           |   | 1,302  |      |  |   | 807    |   |  |   | 1,524  |  
|                               |  |                             |        |   |                           |   |        |      |  |   |        |   |  |   |        |  
|Net (loss) income              |  | $                           | (815   | ) |                           | $ | 519    |      |  | $ | (1,317 | ) |  | $ | 169    |  
|                               |  |                             |        |   |                           |   |        |      |  |   |        |   |  |   |        |  
|Net (loss) income per share:   |  |                             |        |   |                           |   |        |      |  |   |        |   |  |   |        |  
|Basic                          |  | $                           | (0.05  | ) |                           | $ | 0.03   |      |  | $ | (0.08  | ) |  | $ | 0.01   |  
|                               |  |                             |        |   |                           |   |        |      |  |   |        |   |  |   |        |  
|Diluted                        |  | $                           | (0.05  | ) |                           | $ | 0.03   |      |  | $ | (0.08  | ) |  | $ | 0.01   |  
|                               |  |                             |        |   |                           |   |        |      |  |   |        |   |  |   |        |  
|Weighted average shares:       |  |                             |        |   |                           |   |        |      |  |   |        |   |  |   |        |  
|Basic                          |  |                             | 16,862 |   |                           |   | 16,716 |      |  |   | 16,816 |   |  |   | 16,673 |  
|                               |  |                             |        |   |                           |   |        |      |  |   |        |   |  |   |        |  
|Diluted                        |  |                             | 16,862 |   |                           |   | 17,721 |      |  |   | 16,816 |   |  |   | 17,889 |  
|                               |  |                             |        |   |                           |   |        |      |  |   |        |   |  |   |        |  



See accompanying notes
to condensed consolidated financial statements.



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VARSITY GROUP INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOW (UNAUDITED)

(in thousands)



|                                                                                           |  |                          |        |   |      |   |        |  
|------------------------------------------------------------------------------------------ |  | ------------------------ | ------ | - | ---- | - | ------ | -
|                                                                                           |  | Six Month Ended June 30, |       
|                                                                                           |  | 2005                     |        |   | 2004 |  
|Cash Flows from Operating Activities:                                                      |  |                          |        |   |      |   |        |  
|Net (loss) income                                                                          |  | $                        | (1,317 | ) |      | $ | 169    |  
|Adjustments to reconcile net (loss) income to net cash used in operating activities:       |  |                          |        |   |      |   |        |  
|Depreciation and amortization                                                              |  |                          | 193    |   |      |   | 53     |  
|Bad debt expense                                                                           |  |                          | 29     |   |      |   |       |  
|Deferred income taxes                                                                      |  |                          | (807   | ) |      |   | (1,524 | )
|Non-cash stock compensation                                                                |  |                          |       |   |      |   | 31     |  
|Other                                                                                      |  |                          |       |   |      |   | (11    | )
|Changes in operating assets and liabilities:                                               |  |                          |        |   |      |   |        |  
|Accounts receivable, net                                                                   |  |                          | 376    |   |      |   | 230    |  
|Inventory                                                                                  |  |                          | (6,157 | ) |      |   | (1,840 | )
|Other current assets                                                                       |  |                          | 878    |   |      |   | (43    | )
|Other non current assets                                                                   |  |                          | (64    | ) |      |   |       |  
|Accounts payable                                                                           |  |                          | 4,353  |   |      |   | 1,324  |  
|Other accrued expenses and other current liabilities                                       |  |                          | (966   | ) |      |   | (597   | )
|Taxes payable                                                                              |  |                          | (13    | ) |      |   | (32    | )
|                                                                                           |  |                          |        |   |      |   |        |  
|Net cash used in operating activities                                                      |  |                          | (3,495 | ) |      |   | (2,240 | )
|                                                                                           |  |                          |        |   |      |   |        |  
|Cash Flows from Investing Activities:                                                      |  |                          |        |   |      |   |        |  
|Payments for Acquisition                                                                   |  |                          | (3,078 | ) |      |   |       |  
|Purchases of property, equipment and capitalization of software developed for internal use |  |                          | (612   | ) |      |   | (595   | )
|Sales of short-term investments                                                            |  |                          | 7,000  |   |      |   | 13,500 |  
|(Purchases) of long-term investments                                                       |  |                          | (1,500 | ) |      |   | (9,989 | )
|                                                                                           |  |                          |        |   |      |   |        |  
|Net cash provided by investing activities                                                  |  |                          | 1,810  |   |      |   | 2,916  |  
|                                                                                           |  |                          |        |   |      |   |        |  
|Cash Flows from Financing Activities:                                                      |  |                          |        |   |      |   |        |  
|Payments of capital lease obligations                                                      |  |                          | (1     | ) |      |   |       |  
|Proceeds from exercise of warrants and stock options                                       |  |                          | 166    |   |      |   | 116    |  
|                                                                                           |  |                          |        |   |      |   |        |  
|Net cash provided by financing activities                                                  |  |                          | 165    |   |      |   | 116    |  
|                                                                                           |  |                          |        |   |      |   |        |  
|Net (decrease) increase in cash and cash equivalents                                       |  |                          | (1,520 | ) |      |   | 792    |  
|Cash and cash equivalents at the beginning of period                                       |  |                          | 4,865  |   |      |   | 904    |  
|                                                                                           |  |                          |        |   |      |   |        |  
|Cash and cash equivalents at the end of period                                             |  | $                        | 3,345  |   |      | $ | 1,696  |  
|                                                                                           |  |                          |        |   |      |   |        |  



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-based retailer of textbooks and educational materials targeting private middle and high schools, small colleges and distance and continuing education markets nationwide and most recently, through its wholly owned subsidiary, Campus
Outfitters, a retailer of private elementary, middle and high school uniforms with physical retail locations in Indiana, Maryland, Michigan, North Carolina, New York, Ohio, Texas and Virginia.



Varsity Group Inc. was incorporated on December 16, 1997 and launched its website,
www.varsitybooks.com, in August 1998, at which time the Company began generating revenues. The Company drives online textbooks sales through exclusive contractual relationships it forges with private middle and high schools, small colleges,
distance, and continuing education institutions within its eduPartners program. Schools participating in the eduPartners program have partnered directly with the Company to outsource their traditional brick and mortar bookstore operations and sell
textbooks and learning materials directly to parents and students via the VarsityBooks.com website.



On May 26, 2005, the Company acquired substantially all of the assets of privately held Campus Outfitters, L.L.C. (Campus Outfitters,) a retailer of private elementary, middle and high school uniforms
based in College Park, Maryland, with additional retail locations in Rockville, MD; Fairfax, VA; Raleigh, NC; Buffalo, NY; Southfield, MI; Richardson, TX; Cincinnati, OH; and Indianapolis, IN. Similar to the eduPartners model, Campus Outfitters
forges exclusive relationships with schools to provide school logo embroidered uniforms to students and families directly via both physical retail locations and online via its website at www.campusoutfitters.com.



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, 2004. Our business is seasonal and thus operating
results for the interim periods are not necessarily indicative of results for an entire year.



Recent Accounting Standards



In November of 2004, FASB issued Statement No 151, Inventory Costs, an amendment of Accounting Research Bulletin No. 43, Chapter 4 (SFAS 151). The
amendments made by SFAS 151 clarify that abnormal amounts of idle facility expense, freight, handling costs, and wasted materials (spoilage) should be recognized as current period charges and require the allocation of fixed production overheads to
inventory based on the normal capacity of the production facilities. The FASBs goal is to promote convergence of accounting standards internationally by adopting language similar to that used in the International Accounting Standard 2,
Inventories adopted by the International Accounting Standards Board (IASB). The Boards noted that the wording of the original standards were similar but were concerned that the differences would lead to inconsistent application of those
similar requirements. The guidance is effective for inventory costs incurred during the fiscal year beginning January 1, 2006. We do not believe that the adoption of the new standard will have a material impact on our financial position.



In December 2004, the FASB issued SFAS No. 123 (revised 2004), Share-Based
Payment (SFAS No. 123R), which replaces SFAS No. 123 and supercedes APB Opinion No. 25 and requires all share-based payments to employees, including grants of employee stock options, to be recognized in the financial statements
based on their fair values. In April 2005, the Securities and Exchange Commission (SEC) delayed the effective date of SFAS No. 123R for public companies until fiscal years beginning after June 15, 2005. Accordingly, we expect to adopt
the standard on January 1, 2006. The pro forma disclosures previously permitted under SFAS 123 no longer will be an alternative to financial statement recognition. Under SFAS No. 123R, we must determine the appropriate fair value model to be used
for valuing share-based payments, the amortization method for compensation cost and the transition method to be used at date of adoption. The transition methods include modified prospective and modified retrospective adoption options. Under the
modified retrospective option, prior periods may be restated either as of the beginning of the year of adoption or for all periods presented. The modified prospective method requires that compensation expense be recorded for all unvested stock
options and restricted stock at the beginning of the first quarter of adoption of SFAS No. 123R, while the modified retrospective methods would record compensation expense for all unvested stock options and



6



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##### Table of Contents

restricted stock beginning with the first period restated. We are evaluating the requirements of SFAS No. 123R and we expect that the adoption of SFAS 123R
will materially impact our consolidated results of operations and earnings per share. We have not yet determined the method of adoption or the effect of adopting SFAS No. 123R, and have not determined whether the adoption will result in future
expenses that are similar to the current pro forma disclosures under SFAS No. 123.



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



Note 3: Stock-Based Compensation



The Company accounts for its stock-based compensation plans in accordance with Accounting Principles Board (APB) Opinion No. 25, Accounting for Stock
Issued to Employees, and related interpretations using the intrinsic value based method of accounting. If the Company accounted for its stock-based compensation plan using the fair value based method of accounting in accordance with the
provisions as required by Statement of Financial Accounting Standards No. 123 (SFAS 123), Accounting for Stock-Based Compensation, as amended by Statement of Financial Accounting Standards No. 148 (SFAS
148), Accounting for Stock-Based Compensation  Transition and Disclosure, the Companys net loss and loss per basic and diluted share amounts would have been as follows, in thousands:



|                                                   |  |                            |        |   |                          |   |      |      |  |   |        |   |  |   |       |  
|-------------------------------------------------- |  | -------------------------- | ------ | - | ------------------------ | - | ---- | ---- |  | - | ------ | - |  | - | ----- | -
|                                                   |  | Three Month Ended June 30, |        |   | Six Month Ended June 30, |  
|                                                   |  | 2005                       |        |   | 2004                     |   |      | 2005 |  |   | 2004   |  
|Net (loss) income as reported                      |  | $                          | (815   | ) |                          | $ | 519  |      |  | $ | (1,317 | ) |  | $ | 169   |  
|Add: SFAS No. 123 stock-based compensation expense |  |                            | (610   | ) |                          |   | (363 | )    |  |   | (1,367 | ) |  |   | (603  | )
|Less: APB No. 25 stock-based compensation expense  |  |                            |       |   |                          |   | 9    |      |  |   |       |   |  |   | 31    |  
|                                                   |  |                            |        |   |                          |   |      |      |  |   |        |   |  |   |       |  
|Pro forma net (loss) income                        |  | $                          | (1,425 | ) |                          | $ | 165  |      |  | $ | (2,684 | ) |  | $ | (403  | )
|                                                   |  |                            |        |   |                          |   |      |      |  |   |        |   |  |   |       |  
|Net (loss) income per share as reported            |  |                            |        |   |                          |   |      |      |  |   |        |   |  |   |       |  
|Basic                                              |  | $                          | (0.05  | ) |                          | $ | 0.03 |      |  | $ | (0.08  | ) |  | $ | 0.01  |  
|Diluted                                            |  | $                          | (0.05  | ) |                          | $ | 0.03 |      |  | $ | (0.08  | ) |  | $ | 0.01  |  
|Pro forma net (loss) income per share              |  |                            |        |   |                          |   |      |      |  |   |        |   |  |   |       |  
|Basic                                              |  | $                          | (0.08  | ) |                          | $ | 0.01 |      |  | $ | (0.16  | ) |  | $ | (0.02 | )
|Diluted                                            |  | $                          | (0.08  | ) |                          | $ | 0.01 |      |  | $ | (0.16  | ) |  | $ | (0.02 | )



The weighted-average fair value of
options granted during the three and six months ended June 30, 2005 was approximately, $2.37 and $2.39, respectively, compared to $2.83 and $2.70 for the three and six months ended June 30, 2004, respectively, based on the Black-Scholes
option-pricing model. The fair value of each option is estimated on the date of grant using the Black-Scholes option-pricing model. The following weighted-average assumptions used for grants during the three and six months ended:



| |  |  | 2005: dividend yield 0.0%; expected volatility 50.0%; risk-free interest rate 3.60%; expected term 2 to 6 years;
| | - |  | ----------------------------------------------------------------------------------------------------------------



| |  |  | 2004: dividend yield 0.0%; expected volatility 90.0%; risk-free interest rate 3.60%; expected term 2 to 6 years.
| | - |  | ----------------------------------------------------------------------------------------------------------------



Note 4: Net (Loss) Income Per Share



Basic (loss) income per share is computed using the weighted average number of shares of
common stock outstanding for the period. Diluted (loss) income per share is computed using the weighted average number of shares of common stock and, when dilutive, potential common shares from options and warrants to purchase common stock using the
treasury stock method. The effect of options and warrants for the three and six months ended June 30, 2005, were excluded from the calculation of diluted net loss per share because including these shares would be anti-dilutive due to the
Companys reported net loss.



7



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##### Table of Contents

The following table sets forth the computation of basic and diluted income per share (in thousands, except per share
data):



|                                                                                |  |                             |        |                           |      |   |        |  |   |        |   |  |   |       
|------------------------------------------------------------------------------- |  | --------------------------- | ------ | ------------------------- | ---- | - | ------ |  | - | ------ | - |  | - | ------
|                                                                                |  | Three Months Ended June 30, |        | Six Months Ended June 30,
|                                                                                |  | 2005                        |        |                           | 2004 |   | 2005   |  |   | 2004  
|Numerator:                                                                      |  |                             |        |                           |      |   |        |  |   |        |   |  |   |       
|Net income (loss)                                                               |  | $                           | (815   | )                         |      | $ | 519    |  | $ | (1,317 | ) |  | $ | 169   
|Denominator:                                                                    |  |                             |        |                           |      |   |        |  |   |        |   |  |   |       
|Denominator for basic income (loss) per share                                   |  |                             | 16,862 |                           |      |   | 16,716 |  |   | 16,816 |   |  |   | 16,673
|Weighted average shares outstanding                                             |  |                             |        |                           |      |   |        |  |   |        |   |  |   |       
|Employee stock options and other                                                |  |                             |       |                           |      |   | 1,005  |  |   |       |   |  |   | 1,216 
|                                                                                |  |                             |        |                           |      |   |        |  |   |        |   |  |   |       
|Denominator for diluted income (loss) per share                                 |  |                             |        |                           |      |   |        |  |   |        |   |  |   |       
|Adjusted weighted average shares, assuming exercise of common equivalent shares |  |                             | 16,862 |                           |      |   | 17,721 |  |   | 16,816 |   |  |   | 17,889
|Net income (loss) per share                                                     |  |                             |        |                           |      |   |        |  |   |        |   |  |   |       
|Basic                                                                           |  | $                           | (0.05  | )                         |      | $ | 0.03   |  | $ | (0.08  | ) |  | $ | 0.01  
|Diluted                                                                         |  | $                           | (0.05  | )                         |      | $ | 0.03   |  | $ | (0.08  | ) |  | $ | 0.01  



Note 5: Other Comprehensive Loss



Other comprehensive loss relates to unrealized losses on investments
short-term and long-term investments. The following table sets forth the comprehensive loss for the six months ended June 30, 2005 and 2004 (amounts in thousands):



|                                      |  |                             |      |                           |      |   |      |  |   |        |   |  |   |    
|------------------------------------- |  | --------------------------- | ---- | ------------------------- | ---- | - | ---- |  | - | ------ | - |  | - | ---
|                                      |  | Three Months Ended June 30, |      | Six Months Ended June 30,
|                                      |  | 2005                        |      |                           | 2004 |   | 2005 |  |   | 2004  
|Net loss as reported                  |  | $                           | (815 | )                         |      | $ | 519  |  | $ | (1,317 | ) |  | $ | 169
|Other comprehensive loss              |  |                             |     |                           |      |   |     |  |   |       |   |  |   |   
|Unrealized gain (loss) on investments |  |                             | 66   |                           |      |   |     |  |   | (39    | ) |  |   |   
|                                      |  |                             |      |                           |      |   |      |  |   |        |   |  |   |    
|Total comprehensive loss              |  | $                           | (749 | )                         |      | $ | 519  |  | $ | (1,356 | ) |  | $ | 169



Note 6: Intangible Assets and
Goodwill



Intangible assets as of June 30, 2005, based on the preliminary
purchase price allocation of the May 2005 acquisition were as follows (in thousands):



|                       |  |       |  |              |     |                          |   |            |  |   |    
|---------------------- |  | ----- |  | ------------ | --- | ------------------------ | - | ---------- |  | - | ---
|                       |  | Life  |  | Gross Assets |     | Accumulated Amortization |   | Net Assets
|June 30, 2005          |  |       |  |              |     |                          |   |            |  |   |    
|Trademark              |  | 7 yrs |  | $            | 300 |                          | $ | 4          |  | $ | 296
|Customer relationships |  | 7 yrs |  |              | 450 |                          |   | 5          |  |   | 445
|Non-compete agreement  |  | 3 yrs |  |              | 100 |                          |   | 3          |  |   | 97 
|                       |  |       |  |              |     |                          |   |            |  |   |    
|Total                  |  |       |  | $            | 850 |                          | $ | 12         |  | $ | 838



The changes in the amount of carrying
value of goodwill in the six months ended June 30, 2005 were as follows

(amounts in thousands):



|                                |  |            |      
|------------------------------- |  | ---------- | -----
|                                |  | Net Assets
|Balance as of December 31, 2004 |  | $          |     
|Campus Outfitter acquisition    |  |            | 2,368
|                                |  |            |      
|Balance as of June 30, 2005     |  | $          | 2,368



8



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##### Table of Contents

Amortization expense related to the Campus Outfitters intangible assets was $12 for the three and six months ended June
30, 2005. Estimated aggregate future amortization expense for intangible assets remaining as of June 30, 2005 is as follows: (amounts in thousands):



|                     |  |                                 |    |      |   |      |  |      |     |      |   |            |  |       |     |  |   |     |  |   |    
|-------------------- |  | ------------------------------- | -- | ---- | - | ---- |  | ---- | --- | ---- | - | ---------- |  | ----- | --- |  | - | --- |  | - | ---
|                     |  | Six Months Ending Dec. 31, 2005 |    | 2006 |   | 2007 |  | 2008 |     | 2009 |   | Thereafter |  | Total
|Amortization Expense |  | $                               | 70 |      | $ | 140  |  | $    | 140 |      | $ | 121        |  | $     | 107 |  | $ | 259 |  | $ | 838



Note 7: Acquisitions



On May 26, 2005, the Company acquired substantially all of the assets of
privately held Campus Outfitters, LLC, for cash of approximately $3.1 million and 123,967 shares of common stock valued at approximately $0.7 million, for an aggregate purchase price was approximately $3.8 million, plus the assumption of certain
liabilities. Campus Outfitters is based in College Park, MD, with additional retail locations in Rockville, MD; Fairfax, VA; Raleigh, NC; Buffalo, NY; Southfield, MI; Richardson, TX; Cincinnati, OH; and Indianapolis, IN and is a leading provider of
uniform needs for private schools. The Campus Outfitters acquisition adds another attractive, profitable product line targeting the private elementary, middle and high school marketplace which constitutes the vast majority of the Companys
eduPartner accounts today.



The results of operations for Campus Outfitters
have been included in the Companys operations since the acquisition date. The purchase price has been allocated to the assets acquired and liabilities assumed based on their estimated fair values at the acquisition date, which are subject to
change as additional information is obtained. The allocation of the purchase price is subject to final determination based upon estimates and other evaluations of fair market value, identification and valuation of intangible assets.



Note 8: Income Taxes



The Company accounts for income taxes in accordance with Statement of Financial Accounting Standards No. 109 (SFAS 109,)
Accounting for Income Taxes. Under SFAS No. 109, deferred tax assets and liabilities are determined based on differences between the financial reporting and tax basis of assets and liabilities and are measured using the enacted tax rates
and laws that will be in effect when the differences are expected to reverse. A deferred tax benefit is recorded during interim periods when we have an expectation of earnings for the annual period. A valuation allowance is established when
necessary to reduce deferred tax assets to the amount expected to be realized. In determining the need for a valuation allowance, the Companys management reviews both positive and negative evidence pursuant to the requirements of SFAS No. 109,
including current and historical results of operations, the annual limitation on utilization of net operating loss carry forwards pursuant to Internal Revenue Code section 382, future income projections and the overall prospects of our business.
Based upon managements assessment of all available evidence, including the Companys cumulative net income for recent fiscal years, estimates of current and future profitability and the overall prospects of our business, management
concluded in its fourth quarter of fiscal 2003 and again in its second and third quarters of 2004 that it was more likely than not that a portion of the recorded deferred tax benefits would be realized.



The Company will continue to monitor all available evidence and reassess the potential
realization of our deferred tax assets. If we continue to meet our financial projections and improve upon our results of operations, it is reasonably possible that we may release all, or a portion, of the remaining valuation allowance in the future.
Any such release would result in recording a tax benefit that would increase net income in the period the allowance is released.



Note 9: Inventories



Inventories, consisting of products available for sale, are accounted for using the FIFO method and are valued at the lower of cost or market value. The Companys inventory balance as of June 30, 2005 and
December 31, 2004 consists of (in thousands):



|                            |  |               |        |                   |   |      
|--------------------------- |  | ------------- | ------ | ----------------- | - | -----
|Inventory                   |  | June 30, 2005 |        | December 31, 2004
|New textbooks               |  | $             | 5,292  |                   | $ | 1,324
|Used textbooks              |  |               | 2,752  |                   |   | 621  
|On-campus textbooks         |  |               | 371    |                   |   | 518  
|Apparel  Campus Outfitters |  |               | 2,847  |                   |   |     
|                            |  |               |        |                   |   |      
|                            |  | $             | 11,262 |                   | $ | 2,463
|                            |  |               |        |                   |   |      



The components of inventory are as
follows:



| |  |  | New textbooks consist of new textbooks held at Baker & Taylor (B&T), our fulfillment partner, acquired in anticipation of the 2005 back to school selling season.
These textbooks represent titles that B&T will be unable to return for publisher credit after the fall back to school season. New textbooks also includes inventory held at Campus Outfitters retail locations and new textbooks held at other
locations;
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Used textbooks consist of used textbooks held at B&T, Campus Outfitters retail locations, or other locations;
| | - |  | -------------------------------------------------------------------------------------------------------------



9



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##### Table of Contents

| |  |  | On-campus textbooks consist mainly of new and used textbooks located at the Companys two on-campus bookstore facilities; and
| | - |  | -----------------------------------------------------------------------------------------------------------------------------



| |  |  | Apparel  Campus Outfitters consist of school uniforms held at our Campus Outfitters retail locations.
| | - |  | ------------------------------------------------------------------------------------------------------



Under the Companys agreement with B&T in which B&T provides the Companys
order fulfillment and drop shipment services, B&T generally assumes ownership of new textbooks that they are able to return to publishers for credit, which historically is about 90% of all new textbook inventories. B&T does not assume
ownership of the used products it processes for the Company and per the agreement with B&T, the Company purchases from B&T the cost of generally all new textbooks that B&T cannot return for publisher credit after the fall back to school
season. This inventory has typically been held by B&T for fulfillment in subsequent periods. The Company writes down its inventory for estimated excess and obsolete or unmarketable inventory equal to the difference between the cost of inventory
and the estimated market value based upon assumptions about future demand and market conditions on a quarterly basis.



Note 10: Related Party Transaction.



Connected with the acquisition of Campus Outfitters, the Company assumed eleven leases to Campus Outfitter retail stores, including the lease to the Campus Outfitters
16,800 square foot corporate headquarters building in College Park, MD. Campus Outfitters headquarters building is owned by 5112 Berwyn LLC, a Maryland limited liability company whose controlling shareholders are Adam Hanin, the founder of Campus
Outfitters and current Executive Vice President of Sales for Varsity Group, and Elliott Hanin, who was employed by Campus Outfitters prior to the acquisition and is a current employee of Varsity Group. Under terms of the lease, the Company is
obligated to pay 5112 Berwyn LLC $18,000 a month through May 2015. This lease obligation is included under contractual obligations in Managements Discussion and Analysis of Financial Condition and Results of Operations.



Note 11: Subsequent Events.



On July 27, 2005, the Company announced that it signed an amendment to its current agreement
with its fulfillment partner, B&T, extending the agreement to June 30, 2008. The agreement was originally scheduled to expire on June 30, 2006. Baker & Taylor, a leading distributor of books, videos and music products, has provided the
Companys order fulfillment and drop shipment services since its inception.



10



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##### Table of Contents

|Item 2: | Managements Discussion and Analysis of Financial Condition and Results of Operations
|------- | -------------------------------------------------------------------------------------



Forward Looking Statements



The following discussion and analysis of our financial condition and results of
operations should be read in conjunction with our consolidated financial statements and related notes included in our Annual Report on Form 10-K for the fiscal year ended December 31, 2004. This discussion contains forward-looking statements that
involve risks and uncertainties that could cause our actual results to differ materially. These statements relate to future events or our future financial performance and are based on information available to us as of the date hereof, and we assume
no obligation to update any forward-looking statement. In some cases, you can identify forward-looking statements by terminology such as may, will, should, except, plan,
anticipate, intend, seek, expect, believe, estimate, predict, potential or continue, the negative of such terms or other comparable
terminology. These statements are only predictions. Our actual results could differ materially from those anticipated in these forward-looking statements as a result of certain factors, including but not limited to, those discussed in Risk
Factors included in the Companys Annual Report on Form 10-K for the fiscal year ended December 31, 2004 and other reports and filings made with the Securities and Exchange Commission.



The following discussion provides additional information to the accompanying consolidated
financial statements and notes to help provide an understanding of our financial condition, changes in financial condition and results of operations. This discussion is organized as follows:



| |  |  | Overview. This section provides a general description of our business, economic and industry-wide factors relevant to us and material opportunities, challenges and risks in
our business.
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Critical Accounting Policies. This section discusses those accounting policies that contain uncertainties and require significant judgment in their application.
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Results of Operations. This section provides an analysis of our results of operations for all three years presented in the accompanying consolidated statements of operations.
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Liquidity and Capital Resources. This section provides an analysis of our sources and uses of cash, capital expenditures and the amount of financial capacity available to
fund our future commitments.
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



Overview



We are a leading online retailer of textbooks and educational materials targeting the
private middle and high school, college, distance, and continuing education markets nationwide and most recently, through our wholly owned subsidiary Campus Outfitters, a retailer of private elementary, middle and high school uniforms with physical
retail locations in Indiana, Maryland, Michigan, North Carolina, New York, Ohio, Texas and Virginia. Through eduPartners, our program serving schools and organizations directly, we provide an opportunity for educational institutions to maximize
their resources and offer increased convenience and value to their students by outsourcing to us the sale of textbooks and other learning materials.



Varsity Group Inc. was incorporated on December 16, 1997 and launched its website, www.varsitybooks.com, in August 1998, at which time the Company began generating
revenues. The Company drives online textbooks sales through exclusive contractual relationships it forges with private middle and high schools, small colleges, distance, and continuing education institutions within its eduPartners program. Schools
participating in the eduPartners program have partnered directly with the Company to outsource their traditional brick and mortar bookstore operations and sell textbooks and learning materials directly to parents and students via the
VarsityBooks.com website.



On May 26, 2005, the Company acquired substantially
all of the assets of privately held Campus Outfitters, a leading retailer of private elementary, middle and high school uniforms based in College Park, Maryland, with additional retail locations in Rockville, MD; Fairfax, VA; Raleigh, NC; Buffalo,
NY; Southfield, MI; Richardson, TX; Cincinnati, OH; and Indianapolis, IN. Similar to the eduPartners model, Campus Outfitters forges exclusive relationships with schools to provide school logo embroidered uniforms to students and families directly
via both physical retail locations and online via its website at www.campusoutfitters.com.



The Campus Outfitters acquisition adds another attractive, profitable product line targeting the private elementary, middle and high school marketplace which constitutes the vast majority of our eduPartner accounts
today. The Campus model shares many characteristics with our successful eduPartners platform in the private secondary school market:



| |  |  | similar sales process;
| | - |  | ----------------------



| |  |  | the product is a required purchase for the students; and
| | - |  | --------------------------------------------------------



| |  |  | the business is built upon exclusive relationships with schools.
| | - |  | ----------------------------------------------------------------



11



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##### Table of Contents

While the gross product margin on uniform sales are typically higher than those associated with new textbook sales, the
higher margin contribution is somewhat offset by the higher operating costs associated with building and maintaining a brick and mortar retail network.



Our ability to sustain or grow annual operating profitability depends on our ability to maintain and grow net revenues while containing expenses. 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.



CRITICAL ACCOUNTING POLICIES



The accompanying discussion and analysis of our financial condition and results of operations are based upon our unaudited condensed consolidated financial statements,
which have been prepared in accordance with accounting principles generally accepted in the United States. For a comprehensive discussion of our accounting policies, please refer to the audited financial statements and notes included in our Annual
Report on Form 10-K for the fiscal year ended December 31, 2004. We do not have any ownership interest in any special purpose or similar entities and do not have any significant related party transactions.



We have identified the accounting policies that are critical to understanding our historical
and future performance, as these policies affect the more significant areas involving managements judgments and estimates. These critical accounting policies relate to deferred income taxes and stock-based compensation plans. These policies,
and our procedures related to these policies, are described in detail below.



Revenue Recognition



We recognize revenue from textbook and
uniform sales, including sales under our eduPartners program, net of any discounts and coupons, when the textbooks and uniforms are received by our customers. For online sales of new textbooks, we take title to the textbooks sold upon transfer to
the shipper and assume the risks and rewards of ownership including the risk of loss for collection. We take title to used textbooks and inventory held at our two on-campus stores at the time of purchase from the publisher, supplier or buyback
customer and place them in inventory as available for sale. We do not function as an agent or broker for our supplier. Outbound shipping charges are included in net sales. We provide allowances for sales returns, promotional discounts and coupons
based on historical experience in the period of the sale. To date, our revenues have consisted primarily of sales of textbooks, however, with our acquisition of Campus Outfitters in May 2005 we expect this to change.



Deferred Income Taxes



We account for income taxes in accordance with Statement of Financial Accounting Standards No. 109 (SFAS 109), Accounting
for Income Taxes. Under SFAS No. 109, deferred tax assets and liabilities are determined based on differences between the financial reporting and tax basis of assets and liabilities and are measured using the enacted tax rates and laws that
will be in effect when the differences are expected to reverse. A deferred tax benefit is recorded during interim periods when we have an expectation of earnings for the annual period. A valuation allowance is established when necessary to reduce
deferred tax assets to the amount expected to be realized. In determining the current amount of a valuation allowance, management periodically reviews both positive and negative evidence pursuant to the requirements of SFAS No. 109, including
current and historical results of operations, the annual limitation on utilization of net operating loss carryforwards pursuant to Internal Revenue Code section 382, future income projections and the overall prospects of our business. Based upon
managements assessment of all available evidence, including our cumulative net income for fiscal 2002, 2003 and 2004, estimates of future profitability and the overall prospects of our business, we have concluded that it is more likely than
not that the recorded portion of the deferred tax benefits will be realized. We will continue to monitor all available evidence and reassess the potential realization of our deferred tax assets on an annual basis, coinciding with our fiscal year
end, or on an interim basis if circumstances change. If we continue to meet our financial projections and improve upon our results of operations, it is reasonably possible that we may release all, or a portion, of the remaining valuation allowance
in the future. Any such release would result in recording a tax benefit that would increase net income in the period the allowance is released.



Stock-Based Compensation Plans



We account for our stock-based compensation plans in accordance with Accounting Principles Board (ABP) Opinion No. 25, Accounting for Stock Issued to
Employees, and related interpretations using the intrinsic value based method of accounting. We estimate that if we used the fair value method outlined by Statement of Financial Accounting Standards No. 123 (SFAS 123),
Accounting for Stock-Based Compensation, and Statement of Financial Accounting Standards No. 148 (SFAS 148), Accounting for Stock-Based Compensation  Transition and Disclosure, our reported amounts of net
income would have been reduced by approximately $0.4 million and $0.6 million for the three and six months ended June 30, 2005, respectively, and by approximately $0.4 million and $0.6 million for the three and six months ended June 30, 2004,
respectively. Our reported amounts of net income per share would have been reduced by approximately $0.02 and $0.03 for the three and six months ended June 30, 2005, respectively, and by approximately $0.03 for the six months ended June 30, 2004
(see Note 3.)



12



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##### Table of Contents

Valuation of Inventories



Inventories, consisting of textbooks and uniforms available for sale, are accounted for using the FIFO method and are valued at the lower of cost or market value. Our
inventory balance as of June 30, 2005 consists mainly of used textbooks that we purchased during our first and second quarters of fiscal 2005, new and used textbooks located at our two on-campus bookstores and nine Campus Outfitters retail
locations, new textbooks that we are able to procure at better terms than B&T and apparel related with the acquisition of Campus Outfitters in May 2005. Historically, approximately 90% of the unsold new textbook inventory held by B&T in
support of our eduPartners program has been returned for full credit with publishers, which substantially reduces our risk of inventory obsolescence. We take title to the remaining unsold inventory and write down this balance, as well as any
remaining used book inventory, for estimated excess and obsolete or unmarketable inventory equal to the difference between the cost of inventory and the estimated market value based upon assumptions about future demand and market conditions on a
quarterly basis.



In connection with our acquisition of Campus Outfitters, we
acquired approximately $2.6 million in apparel inventory. In accordance with Statement of Financial Accounting Standards No. 141 Business Combinations (SFAS 141), we valued the acquired inventory based on estimated selling
prices less the sum of a reasonable profit allowance for our selling effort and costs of disposal.



Valuation and Impairment Review of Long-Lived Assets



We accounted for our purchase of Campus Outfitters in accordance SFAS 141 and accounted for the related acquired intangible assets in accordance with Statement of Financial Accounting Standards No. 142 Goodwill
and Other Intangible Assets (SFAS 142). In accordance with SFAS 141, we allocated the cost of Campus Outfitters to the identifiable tangible and intangible assets and liabilities assumed, with the remaining amount being classified
as goodwill. As required by SFAS 142, in lieu of amortizing goodwill, we will test goodwill for impairment periodically and record any necessary impairment in accordance with SFAS 142.



We have made preliminary estimates of the fair value of the acquired identifiable intangible assets based on our expectations of cash flows
from those assets discounted for the risk commensurate with the acquisition. We plan to have an independent valuation of the Campus Outfitters acquisition in our third or fourth quarter of fiscal 2005. Accordingly, our current estimates may change.



We assess the impairment of long-lived assets, including software developed
for internal use, in accordance with Statement of Financial Accounting Standards No. 144 (SFAS 144) Accounting for the Impairment of Long-Lived Assets, whenever events or changes in circumstances indicate that the carrying
value may not be fully recoverable. When we determine that the carrying value of such assets may not be recoverable, we generally measure any impairment based on a projected discounted cash flow method using a discount rate determined by management
to be commensurate with the risk inherent in our current business model. In addition, at each reporting date, we compare the net realizable value of capitalized software development costs to the unamortized capitalized costs. To the extent the
unamortized capitalized costs exceed the net realizable value, the excess amount is written off. In accordance with SFAS 144, we recorded a write-off of approximately $15,000 during the three months ended June 30, 2005 related to the discontinued
use of our buyback program software, which has been replaced with another tool.



Evaluating long-lived assets for impairment involves judgments as to when an asset may potentially be impaired. We consider there to be a risk of impairment if there is a significant decrease in the market value of an asset or if there is a
significant change in the extent or intended use of an asset.



Results of
Operations:



The following table includes the condensed consolidated
statements of operations data for the three and six months ended June 30, 2005 and June 30, 2004, expressed as a percentage of total net sales:



|                            |  |                             |    |  |                           |    |  |       |    |  |       |   
|--------------------------- |  | --------------------------- | -- |  | ------------------------- | -- |  | ----- | -- |  | ----- | --
|                            |  | Three Months Ended June 30, |    |  | Six Months Ended June 30, |   
|                            |  | 2005                        |    |  | 2004                      |    |  | 2005  |    |  | 2004  |   
|Net sales:                  |  |                             |    |  |                           |    |  |       |    |  |       |   
|Textbooks                   |  | 63.7                        | %  |  | 94.2                      | %  |  | 79.8  | %  |  | 92.1  | % 
|Uniforms                    |  | 31.7                        | %  |  |                          |    |  | 13.4  | %  |  |      |   
|Shipping                    |  | 4.6                         | %  |  | 5.8                       | %  |  | 6.8   | %  |  | 7.9   | % 
|                            |  |                             |    |  |                           |    |  |       |    |  |       |   
|Total net sales             |  | 100.0                       | %  |  | 100.0                     | %  |  | 100.0 | %  |  | 100.0 | % 
|                            |  |                             |    |  |                           |    |  |       |    |  |       |   
|Operating Expenses:         |  |                             |    |  |                           |    |  |       |    |  |       |   
|Cost of textbooks           |  | 39.4                        | %  |  | 57.7                      | %  |  | 52.0  | %  |  | 62.6  | % 
|Cost of uniforms            |  | 12.7                        | %  |  |                          |    |  | 5.4   | %  |  |      |   
|Cost of shipping            |  | 3.6                         | %  |  | 4.4                       | %  |  | 5.5   | %  |  | 6.4   | % 
|Sales and marketing         |  | 71.9                        | %  |  | 63.6                      | %  |  | 51.4  | %  |  | 42.8  | % 
|Product development         |  | 5.6                         | %  |  | 3.2                       | %  |  | 5.5   | %  |  | 2.0   | % 
|General and administrative  |  | 48.5                        | %  |  | 45.7                      | %  |  | 38.5  | %  |  | 35.0  | % 
|Amortization expense        |  | 0.7                         | %  |  |                          |    |  | 0.3   | %  |  |      |   
|Non-cash stock compensation |  |                            |    |  | 0.8                       | %  |  |      |    |  | 1.1   | % 
|                            |  |                             |    |  |                           |    |  |       |    |  |       |   
|Total operating expenses    |  | 182.3                       | %  |  | 175.4                     | %  |  | 158.5 | %  |  | 149.9 | % 
|                            |  |                             |    |  |                           |    |  |       |    |  |       |   
|Loss from operations        |  | (82.3                       | )% |  | (75.4                     | )% |  | (58.5 | )% |  | (49.9 | )%
|Other income, net           |  | 6.2                         | %  |  | 4.2                       | %  |  | 6.4   | %  |  | 3.6   | % 
|                            |  |                             |    |  |                           |    |  |       |    |  |       |   
|Loss before income taxes    |  | (76.1                       | )% |  | (71.2                     | )% |  | (52.2 | )% |  | (46.3 | )%
|Income tax benefit          |  | 28.9                        | %  |  | 118.7                     | %  |  | 19.8  | %  |  | 52.1  | % 
|                            |  |                             |    |  |                           |    |  |       |    |  |       |   
|Net (loss) income           |  | (47.2                       | )% |  | 47.5                      | %  |  | (32.3 | )% |  | 5.8   | % 
|                            |  |                             |    |  |                           |    |  |       |    |  |       |   



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Seasonality:



We experience significant seasonality in our results of operations. Consistent with our focus on the expansion of eduPartners and its current concentration of private
middle and high school institutions, since the year ended December 31, 2000, our peak selling period is the July/August/September back-to-school season. During fiscal 2004 and 2003, approximately 85% of our revenues were recognized in this period.
We expect this trend to continue as we expand our eduPartners program in the private middle and high school market. While many private middle and high school institutions have an active book buying season in December/January, the volume of purchases
are typically significantly lower than the initial back-to-school season. Part of our strategy is to extend eduPartners more deeply into the college and distance learning markets. This would result in more balanced selling seasons between fall and
winter. However, based upon our current eduPartners school mix, we will continue to experience significant fluctuations in quarterly operating results. Historically, Campus Outfitters has experienced similar seasonality in its results of operations
prior to our acquisition on May 26, 2005. Consistent with its current concentration of private elementary, middle and high schools, Campus Outfitters peak selling season has been July/August/September back-to-school season. Please see
Forward-Looking Statements.



Net Sales:



Net sales increased 57.4%, or $0.6 million, to $1.7 million, and
increased 39.2%, or $1.1 million, to $4.1 million for the three and six-month periods ended June 30, 2005, respectively, compared to the same periods in 2004. The acquisition of Campus Outfitters in May 2005 contributed to approximately $0.5 million
of this increase for the three and six month periods in 2005. The remainder of the increase was attributable to the growth of our eduPartners program.



Operating Expenses:



Cost of Textbooks.Cost of textbooks consists of the cost of textbooks and related products sold to customers. Cost of textbooks increased 7.5%, or approximately $48,000, to approximately $0.7 million, and
increased 15.6%, or approximately $0.3 million, to approximately $2.1 million, for the three and six months ended June 30, 2005, respectively, compared to the same periods in 2004. This increase was attributable to our increased sales volume.
Expressed as a percentage of related revenue, cost of textbooks was 61.8% and 61.3%, for the three months ended June 30, 2005 and 2004, respectively, and 65.2% and 68.0% for the six months ended June 30, 2005 and 2004, respectively. Cost of
textbooks varies with textbook revenue and we expect these costs to increase in absolute dollars as our customer base and number of eduPartners served expands. Please see Forward-Looking Statements.



Cost of Uniforms.Cost of uniforms consists of the cost of uniforms and apparel sold
to customers. Cost of uniforms was approximately $0.2 million for the three and six months ended June 30, 2005, respectively. This cost was attributable to acquisition of Campus Outfitters in May 2005. Expressed as a percentage of related revenue,
cost of uniforms was 40.0% for the three and six months ended June 30, 2005, respectively. Cost of uniforms varies with uniform revenue and we expect these costs to increase in absolute dollars as our customer base expands. Please see
Forward-Looking Statements.



Cost of Shipping. Cost
of shipping consists of outbound shipping to our customers. Cost of shipping increased 25.3%, or approximately $13,000, to approximately $62,000, and increased 19.9%, or approximately $37,000, to approximately $0.2 million, for the three and six
months ended June 30, 2005, respectively, compared to the same periods in 2004. This increase was



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attributable to our increased sales volume. Expressed as a percentage of related revenue, cost of shipping was 77.9% and 76.7% for the three months ended
June 30, 2005 and 2004, respectively, and 80.3% and 80.2% for the six months ended June 30, 2005 and 2004, respectively.



Sales and Marketing.Sales and marketing expense consists primarily of promotional expenditures, credit card processing fees, travel expense, expenses associated
with contracting with our eduPartners schools, expenses associated with our Campus Outfitters retail locations and road shows, seasonal overhead associated with performing inventory purchases at eduPartner schools, and payroll and related expenses
for personnel engaged in sales and marketing, account management, eduPartners operations and Campus Outfitters operations. Sales and marketing expense increased 77.9%, or approximately $0.5 million, to approximately $1.2 million and increased 67.3%,
or approximately $0.8 million, to approximately $2.1 million, for the three and six months ended June 30, 2005, respectively, compared to the same periods in 2004. Approximately $0.2 million of this increase in the three and six month periods ended
June 30, 2005 as compared to the prior year periods was attributable to the acquisition of Campus Outfitters in May 2005. The remainder of the increases for the three and six month periods were attributable to an increase of approximately $0.2
million in the uncapitalizable seasonal costs associated with performing used book buyback purchases at more of our eduPartner schools during our second quarter of fiscal 2005 compared to 2004 and increases in payroll and related expenses and other
costs resulting from an increase in the number of sales and marketing employees compared to the prior year period.



We expect certain aspects of sales and marketing expense, including credit card expenses, certain expenses associated with contracting with our eduPartners and Campus
Outfitters, schools, and sales expenses associated with our agreement with B&T, will continue to increase at levels consistent with revenue growth. We anticipate that staffing and related expenses will continue to increase in absolute dollars as
we expand operations to support expected short and longer-term revenue growth. Please see Forward-Looking Statements.



Product Development  Product development expense includes payroll and related expenses for our development and systems personnel, costs associated with the
upgrade and maintenance of our website and outside consultant expense, and are reported net of costs capitalized for software developed for internal use. The following table sets forth product development costs for the three and six months ended
June 30, 2005 and 2004 (in thousands):



|                                          |  |                             |      |   |                           |   |      |      |  |   |      |   |  |   |      |  
|----------------------------------------- |  | --------------------------- | ---- | - | ------------------------- | - | ---- | ---- |  | - | ---- | - |  | - | ---- | -
|                                          |  | Three Months Ended June 30, |      |   | Six Months Ended June 30, |  
|                                          |  | 2005                        |      |   | 2004                      |   |      | 2005 |  |   | 2004 |  
|Gross product development cost            |  | $                           | 383  |   |                           | $ | 411  |      |  | $ | 625  |   |  | $ | 540  |  
|Percent of total revenue                  |  |                             | 22.1 | % |                           |   | 37.5 | %    |  |   | 15.3 | % |  |   | 18.5 | %
|Less: Software developed for internal use |  |                             | 287  |   |                           |   | 376  |      |  |   | 400  |   |  |   | 480  |  
|Percent of total revenue                  |  |                             | 16.6 | % |                           |   | 34.3 | %    |  |   | 9.82 | % |  |   | 16.4 | %
|                                          |  |                             |      |   |                           |   |      |      |  |   |      |   |  |   |      |  
|Product development costs, as reported    |  | $                           | 96   |   |                           | $ | 35   |      |  | $ | 225  |   |  | $ | 60   |  
|Percentage of total revenue               |  |                             | 5.6  | % |                           |   | 3.2  | %    |  |   | 5.5  | % |  |   | 2.1  | %



Product development costs, as
reported, increased 175.6%, or approximately $61,000, and increased 276.8%, or approximately $0.2 million, for the three and six months ended June 30, 2005, respectively, from the prior year periods. The increase compared to the prior year period
was due to an increase in maintenance costs associated with the costs we capitalized for software developed for internal use in fiscal 2004 and our first two quarters of fiscal 2005. We are currently upgrading our website, which includes
substantially all aspects of transaction processing, including order management, cash and credit card processing, purchasing, inventory management and shipping in order to accommodate the large increase in the volume of traffic we have recently
experienced on our website.



We are capitalizing certain of these costs in
accordance with American Institute of Certified Public Accountants (AICPA) Statement of Position No. 98-1 (SOP 98-1), Accounting for the Costs of Computer Software Developed or Obtained for Internal Use. We began
to amortize the capitalized costs on our balance sheet as of June 30, 2004 on a straight-line basis over a period of five years beginning in our third quarter of fiscal 2004 when the website was placed into service, and we will continue to
capitalize the costs of new functionality related to the website upgrade during fiscal 2005 in accordance with SOP 98-1. We expect amortization of software developed for internal use to increase beginning in our third quarter of 2005 as enhancements
made during our first two fiscal quarters of 2005 were placed into service on July 1, 2005. We expect system upgrade efforts to continue in our remaining quarters of fiscal 2005 and, therefore, expect capitalization and maintenance costs associated
with this effort to increase. Please see Forward-Looking Statements.



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We assess the impairment of long-lived assets, including software developed for internal use, in accordance with
Statement of Financial Accounting Standards No. 144 (SFAS 144) Accounting for the Impairment of Long-Lived Assets, whenever events or changes in circumstances indicate that the carrying value may not be fully recoverable. In
accordance with SFAS 144, we recorded a write-off of approximately $15,000 during the three months ended June 30, 2005 related to the discontinued use of our buyback program software, which has been replaced with another tool.



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 increased 67.4%, or approximately $0.3
million, to approximately $0.8 million and increased 53.0%, or approximately $0.5 million, to approximately $1.6 million, during the three and six months ended June 30, 2005, respectively compared to the prior year periods. Approximately $0.1
million of this increase was attributable to the acquisition of Campus Outfitters in May 2005; the remainder of the increase was due to an increase in personnel and infrastructure expenditures needed to support the growth of our business.



At June 30, 2005, we reassessed our filing status to determine whether or not
we were eligible for a one-year extension to comply with Section 404 of the Sarbanes Oxley Act. Since the aggregate market value of our non-affiliated common stock was less than $75 million on this date, we qualified for an additional one-year
extension to comply. However, we do anticipate increases in internal overhead costs as we take the necessary steps to comply with the numerous reporting and control requirements imposed by Section 404. Please see Forward-Looking
Statements.



Non-Cash Stock Compensation  Non-cash
compensation expense consists of expenses related to previous grants of employee options based on the intrinsic value of the stock option and was fully amortized as of September 30, 2004. Non-cash compensation was approximately $9,000 and $31,000
for the three and six months ended June 30, 2004, respectively.



Other
income (expense), net



Other income (expense), net consists primarily
of interest income on our cash and cash equivalents and investments. Other income was $108,000 and $259,000 for the three and six months ended June 30, 2005, respectively, compared to $46,000 and $105,000 for the three and six months ended June 30,
2004, respectively. The increase was due to higher average cash invested in long-term investments and higher average interest rates during the three and six months ended June 30, 2005 as compared to the prior year period



Income Taxes



Income tax benefit for the three and six months ended June 30, 2005 was approximately $0.5 million and $0.8 million, respectively. We record
a deferred tax benefit during the interim periods based on our expectations of income for the annual period. We account for income taxes in accordance with SFAS 109. Under SFAS No. 109, deferred tax assets and liabilities are determined based on
differences between the financial reporting and tax basis of assets and liabilities and are measured using the enacted tax rates and laws that will be in effect when the differences are expected to reverse. A valuation allowance is established when
necessary to reduce deferred tax assets to the amount expected to be realized. In determining the need for a valuation allowance, management reviews both positive and negative evidence pursuant to the requirements of SFAS No. 109, including current
and historical results of operations, the annual limitation on utilization of net operating loss carry forwards pursuant to Internal Revenue Code section 382, future income projections and the overall prospects of our business. During fiscal 2004,
management reassessed the potential realization of its remaining valuation allowance based on its financial projections, estimates of future profitability and the overall prospects of the Companys business and concluded that it was more likely
than not that a portion of the recorded deferred tax benefits would be realized. Consequently, we released $1.0 million of the valuation allowance in the three and six months ended June 30, 2004. During the first two quarters of fiscal 2005,
management has not made any adjustments to its previous estimates of recoverability for the remaining deferred tax assets.



We will continue to monitor all available evidence and reassess the potential realization of our deferred tax assets and expect our next review to be at the end of our
quarter ending September 30, 2005. If we continue to meet our financial projections and improve upon our results of operations, it is reasonably possible that we may release all, or a portion, of the remaining valuation allowance in the future. Any
such release would result in recording a tax benefit that would increase net income in the period the allowance is released. Please see Forward-Looking Statements.



Liquidity and Capital Resources



As of June 30, 2005, we had $5.3 million of cash, cash equivalents and short-term investments and net working capital of $9.5 million, compared to approximately $11.9
million of cash, cash equivalents and short-term investments and net working capital of $14.1 million at December 31, 2004. As of June 30, 2005, our principal commitments consisted of obligations outstanding under capital and operating leases,
accounts payable and accrued liabilities. The decrease in cash, cash equivalents and short-term investments during 2005 was primarily attributable to cash payments to acquire used textbooks during our fiscal 2005 buyback campaign and cash payments
for the Campus Outfitters acquisition and related liabilities. During 2004 and in the six months ended June 30, 2005, we began an initiative to upgrade our internally developed system for our website. In the



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remainder of 2005, we expect to experience additional expenditures related to the website upgrade. We also may experience additional increases in our capital
expenditures and lease commitments consistent with anticipated growth in operations, infrastructure and personnel.



Net cash used in operating activities was approximately $3.5 million for the six months ended June 30, 2005 compared to approximately $2.2 million net cash used in
operations for the six months ended June 30, 2004. This increase was primarily the result of an increase in inventory associated with our used book buyback purchases at our eduPartner schools and purchases of new textbooks in anticipation of our
fall back to school season during the three months ended June 30, 2005 and wholesale purchases of used textbooks during the six months ended June 30, 2005. The increase in cash used by operating activities were partially offset by an increase in
accounts payable in the six months ended June 30, 2005 compared to the prior year period.



Net cash used in investing activities was approximately $1.8 million for the six months ended June 30, 2005 compared to net cash used in investing activities of approximately $2.9 million for the six months ended June
30, 2004. Investing activities consist acquisitions of businesses, capitalization of software developed for internal use, purchases of property, plant and equipment, purchases of software, and purchases and sales of short-term and long-term
investments. During the six months ended June 30, 2005, we used approximately $3.1 million cash for the acquisition of Campus Outfitters and had total purchases of property, equipment and software, including capitalization of software, of
approximately $0.6 million during the six months ended June 30, 2005, primarily due to our initiative to upgrade our internal software system for our website. During the six months ended June 30, 2005, we sold approximately $7.0 million of
short-term investments and purchased approximately $1.5 million of long-term investments compared to sales of $13.5 million of short-term investments and purchases of $10.0 million of long-term investments in the prior year period.



Net cash provided by financing activities was approximately $0.2 million for the six months
ended June 30, 2005 and approximately $0.1 million for the six months ended June 30, 2004. Net cash provided by financing activities during both periods consisted of net proceeds from the exercise of warrants and employee stock options.



Lease Arrangements.



With our acquisition of Campus Outfitters in May 2005, we assumed capital and operating
leases for certain equipment and vehicles used in the normal course of business and lease obligations for eleven retail stores. Operating lease arrangements are sometimes referred to as a form of off-balance sheet financing. We do not use
off-balance sheet arrangements with unconsolidated entities; accordingly, our liquidity and capital resources are not subject to off-balance sheet risks from unconsolidated entities. We do have an off-balance sheet arrangement with a related party
for our College Park, MD retail and warehouse lease. (See footnote 10.)



The
following table provides an overview or our aggregate contractual obligations and the effect these obligations are expected to have on our liquidity and cash flows in future periods are as follows (in thousands):



|                            |  |                                 |     |      |   |      |  |      |     |      |   |            |  |       |     |  |   |       |  |   |      
|--------------------------- |  | ------------------------------- | --- | ---- | - | ---- |  | ---- | --- | ---- | - | ---------- |  | ----- | --- |  | - | ----- |  | - | -----
|Contractual Obligations     |  | Six Months Ending Dec. 31, 2005 |     | 2006 |   | 2007 |  | 2008 |     | 2009 |   | Thereafter |  | Total
|Capital Lease Obligations   |  | $                               | 6   |      | $ | 9    |  | $    | 9   |      | $ | 1          |  | $     |    |  | $ |      |  | $ | 25   
|Operating Lease Obligations |  | $                               | 457 |      | $ | 586  |  | $    | 471 |      | $ | 353        |  | $     | 312 |  | $ | 1,153 |  | $ | 3,332
|                            |  |                                 |     |      |   |      |  |      |     |      |   |            |  |       |     |  |   |       |  |   |      
|Total                       |  | $                               | 463 |      | $ | 595  |  | $    | 480 |      | $ | 354        |  | $     | 312 |  | $ | 1,153 |  | $ | 3,357



As of the date of this filing, we
currently lease approximately 60,000 square feet pursuant to thirteen leases that are month-to-month or are scheduled to expire between September 2005 and May 2015.



Based upon our current and expected cost structure and recent growth levels within the eduPartners program and our acquisition of Campus
Outfitters, we believe that we are positioned to improve upon the financial performance of 2004. However, we intend to increase spending on the development of eduPartners and related infrastructure and we anticipate incurring increases in general
and administrative expenses in fiscal 2005 and fiscal 2006 as we take the necessary steps to comply with the numerous reporting and control requirements imposed by the Sarbanes-Oxley Act, including Section 404. Failure to generate sufficient
revenues or, if necessary, reduce discretionary spending could harm our results of operations and financial condition. Please see Forward-Looking Statements.



We are currently considering and may in the future, pursue additional acquisitions of complementary businesses. In addition, we may make
strategic investments in businesses and enter into joint ventures that complement our existing business strategy. Any future acquisition or investment may result in a dilution to existing shareholders to the extent we issue shares of our common
stock as consideration or reduced liquidity and capital resources to the extent we use cash as consideration



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We believe that our existing liquidity and expected cash flows from operations will satisfy the capital requirements of
our current business for the foreseeable future. We believe that the combination of cash, cash equivalents, short-term and long-term investments and anticipated cash flows from operations will be sufficient to fund expected capital expenditures,
capital lease obligations and working capital needs for at least the next twelve months. See Forward Looking Statements.



|Item 3. | Quantitative and Qualitative Disclosures About Market Risk
|------- | ----------------------------------------------------------



We are exposed to market risk for the effect of interest rate changes and changes in the market values of our investments.



Interest Rate Risk. Our cash equivalents and long-term investments are subject to
interest rate risk. We manage this risk by maintaining a diversified investment portfolio of instruments with high credit quality and varying maturity dates. These instruments are designated as available-for-sale and, accordingly, are presented at
fair value on our balance sheets and include, but are not limited to, commercial paper, money-market instruments, bank time deposits and variable rate and fixed rate obligations of corporations and national, state and local governments and agencies.
These instruments are denominated in U.S. dollars. The fair market value of cash equivalents and long-term investments held was $11.8 million and $18.9 million at June 30, 2005 and December 31, 2004, respectively. We also hold cash balances in
accounts with commercial banks in the United States. These cash balances represent operating balances only and are invested in short-term deposits of the local bank.



The weighted average yield on interest-bearing investments held as of June 30, 2005 was approximately 3.5 % per annum. Based on our
investment holdings at June 30, 2005, a 100 basis point decline in the average yield would have reduced our annual interest income by $0.1 million.



|Item 4. | Controls and Procedures
|------- | -----------------------



We maintain disclosure controls and procedures that are designed to ensure that information required to be disclosed in our Exchange Act reports is recorded, processed,
summarized and reported within the time periods specified in the Securities and Exchange Commissions rules and forms and that such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief
Financial Officer, as appropriate, to allow for timely decisions regarding required disclosure. In designing and evaluating the disclosure controls and procedures, management recognizes that any controls and procedures, no matter how well designed
and operated, can provide only reasonable assurance of achieving the desired control objectives, and management is required to apply its judgment in evaluating the cost-benefit relationship of possible controls and procedures.



As required by SEC Rule 13a-15(b), we carried out an evaluation, under the supervision and
with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures as of the end of the period covered by this
report. Based on the foregoing, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective at the reasonable assurance level. There has been no change in our internal controls over
financial reporting during our most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, our internal controls over financial reporting.



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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
|------- | ---------------------------------------------------



On June 24, 2005, we held our 2004 Annual Meeting of Stockholders. At the meeting, our stockholders voted on the following:



| |  |  | The election of one director, Eric Kuhn (with 13,401,220 affirmative votes, 0 votes against and 193,493 votes withheld), with terms expiring in 2008; and
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | The approval of the ratification of the appointment of PricewaterhouseCoopers LLP as independent auditors for the fiscal year ending 2005 (with 13,580,643 affirmative votes, 3,100
votes against and 10,970 votes abstaining).
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|Item 5: | Other Information
|------- | -----------------



Not Applicable



|Item 6: | Exhibits and Reports on Form 8-K
|------- | --------------------------------



| | A) | Exhibits
| | -- | --------



|     |  |                                                                                                                                                  
|---- |  | -------------------------------------------------------------------------------------------------------------------------------------------------
|10.2 |  | 2004/2005 Fulfillment Letter Agreement by and between Baker & Taylor, Inc. and Varsity Group Inc. dated as of February 17, 2004.                 
|     | 
|10.3 |  | Amended and Restated 2004/2005 Fulfillment Letter Agreement by and between Baker & Taylor, Inc. and Varsity Group Inc. dated as of July 15, 2005.
|     | 
|10.4 |  | 2007/2008 Fulfillment Letter Agreement by and between Baker & Taylor, Inc. and Varsity Group Inc. dated as of July 15, 2005.                     
|     | 
|31.1 |  | Certification of the Companys Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.                                
|     | 
|31.2 |  | Certification of the Companys Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.                                
|     | 
|32.1 |  | Certification of the Companys Chief Executive Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.                                
|     | 
|32.2 |  | Certification of the Companys Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.                                



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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 15, 2005



Varsity Group Inc.By:

/s/ JACK M BENSONJack M BensonChief Financial Officer




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