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

FORM 10-Q

(MARK ONE)

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

_______________

Commission file number 0-28977

_______________

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

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

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

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

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

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

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

As of August 13, 2001, the registrant had 16,871,062 shares of common
stock outstanding.



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1



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VARSITY GROUP INC. AND SUBSIDIARIES

QUARTERLY REPORT ON FORM 10-Q
For the quarter ended June 30, 2001

INDEX

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

2



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PART I.
FINANCIAL INFORMATION

Item 1:Financial Statements

VARSITY GROUP INC.

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

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

3



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VARSITY GROUP INC.

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

ASSETS

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

See accompanying notes to condensed consolidated financial statements.

4



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VARSITY GROUP INC.

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

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

See accompanying notes to consolidated financial statements

5



---



VARSITY GROUP INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

Note 1: Description of Operations

Varsity Group Inc., a leading online retailer of
new textbooks and a provider of marketing services for businesses interested in
reaching the college and private middle and high school markets, was
incorporated on December 16, 1997 and launched its Website in
August 1998, at which time the Company began generating revenues. In
August 1999, the Company established two wholly owned subsidiaries,
CollegeImpact.com, Inc. and VarsityBooks.com, LLC (formerly CollegeOps.com
LLC), to assist in the overall management of its marketing and retailing
activities, respectively.

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

Note 2: Basis of Presentation

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

Certain information and footnote disclosure
normally included in the financial statements prepared in accordance with
generally accepted accounting principles have been condensed or omitted. The
interim financial statements should be read in conjunction with the
consolidated financial statements and notes thereto included in the Companys
Annual Report on Form 10-K for the fiscal year ended December 31, 2000.
Operating results for the interim periods are not necessarily indicative of
results for an entire year.

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

Note 3: Fixed Assets

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

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

Forward Looking Statements

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

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

Readers are also urged to carefully review and
consider the various disclosures made by us that attempt to advise interested
parties of the factors which affect our business, including without limitation
the disclosures made under the caption Managements Discussion and Analysis of
Financial Condition and Results of Operations included herein and under the

6



---



captions Managements Discussion and Analysis of Financial Condition and
Results of Operations and Risk Factors included in the Companys Annual
Report on Form 10-K for the year ended December 31, 2000 and other
reports and filings made with the Securities and Exchange Commission.

Overview

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

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



| |  |  | developing our business model;                                                              
| | - |  | --------------------------------------------------------------------------------------------
|
| |  |  | establishing, negotiating and consummating a relationship with our supplier, Baker & Taylor;
|
| |  |  | initial planning and development of our Web site;                                           
|
| |  |  | developing our information systems infrastructure;                                          
|
| |  |  | developing our marketing plans; and                                                         
|
| |  |  | establishing finance and administrative functions.                                          

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

We also generate revenue from online marketing agreements, as well as offline
marketing service agreements for which we use College Impact, our student
representative network. During the fourth quarter of fiscal 1999, we began
generating revenues from marketing programs. We have signed marketing services
agreements with a number of public and private companies, including AT&T
Wireless Services, Inc., Palm, Inc., Papa Johns International, Inc. and Ben &
Jerrys Homemade, Inc. We continue to develop marketing services agreements
with businesses that are seeking to reach the college and private middle and
high school markets.

In addition, we have continued to successfully lower the overall expenses of
our retail book business through various means, including the imposition of
increased retail pricing. We base our current and future expense levels on our
operating plans and estimates of future revenues. In view of the rapidly
evolving nature of our business and our limited operating history, we have
little experience forecasting our revenues. Therefore, we believe that
period-to-period comparisons of our financial results might not necessarily be
meaningful and you should not rely on them as indication of future performance.
If we cannot achieve and sustain profitability or positive cash flow from
operations, we may be unable to meet our working capital requirements or to
obtain additional financing, which would adversely affect our business and may
cause us to discontinue operations.

We have incurred losses from operations in every fiscal period since our
inception. For the year ended December 31, 1998, we incurred a loss from
operations of approximately $2.7 million and negative cash flows from
operations of $1.2 million. For the year ended December 31, 1999, we incurred a
loss from operations of approximately $31.9 million and negative cash flows
from operations of $29.4 million. For the year ended December 31, 2000, we
incurred a loss from operations of approximately $34.6 million and negative
cash flows from operations of $27.5 million. As of December 31, 1998, 1999 and
2000 we had accumulated deficits of approximately $2.7 million, $34.2 million
and $68.2 million, respectively. Net loss for the quarter ended June 30, 2001
was $1.0 million compared to a net loss of $7.1 million for the quarter ended
June 30, 2000. Net loss for the six months ended June 30, 2001 was $2.3 million
compared to a net loss of $26.0 million for the six months ended June 30, 2000.
As part of the increased emphasis on eduPartners, we anticipate that costs and
expenses related to brand development, marketing and other promotional
activities associated with our traditional retail book business will continue
to decrease from historical levels. Although, in the short-term, this has and
may continue to result in decreased revenues from the sales of new textbooks,
we believe, in the aggregate, that this has and will continue to reduce the
losses and negative cash flows from our sales of new textbooks.

Results of Operations

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

7



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Percentage of Total Net Sales

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

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

Net Sales

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

Operating Expenses

Cost of Books Related Party (Baker & Taylor).Cost of books related
party consists of the cost of books sold to customers. Cost of books-related
party decreased to approximately $0.3 million for the three months ended June
30, 2001 from $1.8 million for the three months ended June 30, 2000. This
decrease was primarily attributable to our decreased sales volume.

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

Cost of Marketing Services. Cost of marketing services includes personnel
costs associated with the implementation of our on campus marketing programs
and other directly identifiable costs associated with our online advertising
and on campus promotions. Cost of marketing services totaled $14,000 for the
three months ended June 30, 2001. There were no costs of marketing services
for the three months ended June 30, 2000.

8



---



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

Product Development.Product development expense consists of payroll and
related expenses such as the amortization of deferred compensation for
development and systems personnel and consultants. Product development expense
decreased to approximately $79,000 for the three months ended June 30, 2001
from $1.3 million for the three months ended June 30, 2000. This decrease was
primarily attributable to decreased web development, consulting and personnel
costs between periods.

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

Other income (expense), net.

Other income (expense), net consists primarily of interest income on our
cash and cash equivalents and investments and gains or losses associated with
the disposal of fixed assets. Other income was $0.2 million for the three
months ended June 30, 2001 compared to $0.3 million for the three months ended
June 30, 2000. Interest income decreased due largely to lower average cash,
cash equivalent and short-term investment balances and lower rates of return
compared to the previous period.

Income Taxes.

As of June 30, 2001, we had net operating loss carryforwards for federal
income tax purposes of approximately $56 million, which expire beginning in
2018. We have provided a full valuation allowance on the resulting deferred tax
asset because of uncertainty regarding its realizability.

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

Net Sales

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

Operating Expenses

Cost of Books Related Party (Baker & Taylor).Cost of books related
party consists of the cost of books sold to customers. Cost of books-related
party decreased to approximately $1.3 million for the six months ended June 30,
2001 from $12.2 million for the six months ended June 30, 2000. This decrease
was primarily attributable to our decreased sales volume.

Cost of Shipping Related Party (Baker & Taylor).Cost of shipping 
related party consists of outbound shipping. Cost of shipping decreased to
approximately $0.1 million for the six months ended June 30, 2001 from
approximately $1.4 million for the six months ended June 30, 2000. This
decrease was primarily attributable to our decreased sales volume. Also for the

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

Cost of Marketing Services. Cost of marketing services includes personnel
costs associated with the implementation of our on campus marketing programs
and other directly identifiable costs associated with our online advertising
and on campus promotions. Cost of marketing services totaled $39,000 for the
six months ended June 30, 2001. There were no costs of marketing services for
the six months ended June 30, 2000.

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

Product Development. Product development expense consists of payroll and
related expenses such as the amortization of deferred compensation for
development and systems personnel and consultants. Product development expense
decreased to approximately $0.2 million for the six months ended June 30, 2001
from $3.3 million for the six months ended June 30, 2000. This decrease was
primarily attributable to decreased web development, consulting and personnel
costs between periods.

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

Other income (expense), net.

Other income (expense), net consists primarily of interest income on our
cash and cash equivalents and investments and gains or losses associated with
the disposal of fixed assets. Other income was $0.4 million for the six months
ended June 30, 2001 compared to $0.5 million for the six months ended June 30,
2000. Interest income decreased due largely to lower average cash, cash
equivalent and short-term investment balances and lower rates of return
compared to the previous period.

Income Taxes.

As of June 30, 2001, we had net operating loss carryforwards for federal
income tax purposes of approximately $56 million, which expire beginning in
2018. We have provided a full valuation allowance on the resulting deferred tax
asset because of uncertainty regarding its realizability.

Liquidity and Capital Resources

As of June 30, 2001, we had $15.9 million of cash and cash equivalents. As of
that date, our principal commitments consisted of obligations outstanding,
accounts payable and accrued liabilities. Although we have no material
commitments for capital expenditures, we may experience increases in our
capital expenditures and lease commitments consistent with anticipated growth
in operations, infrastructure and personnel.

Net cash used in operating activities was $0.6 million for the six months ended
June 30, 2001, and $20.2 million for the six months ended June 30, 2000,
consisting primarily of net losses adjusted for changes in accounts receivable,
accounts payable and accrued expenses.

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

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

As part of the increased emphasis on eduPartners, we anticipate that costs and
expenses related to brand development, marketing and other promotional
activities associated with our traditional retail book business will continue
to decrease from recent levels. Although this may result in decreased revenues
from the sales of new textbooks than would be the case if we continued to spend
at or above our historical levels, we believe, in the aggregate, that this will
reduce the losses and negative cash flows historically associated with our
sales of new textbooks. We intend to increase spending on the development of
eduPartners and relationships with other businesses. We believe that we can
capture additional revenues, on which we expect to recognize higher gross
margins, by increasing the number of businesses for whom we provide marketing
services. Our failure to generate sufficient revenues, raise additional capital
or, if necessary, reduce discretionary spending could harm our results of
operations and financial condition.

We currently anticipate that our available funds will be sufficient to meet our
anticipated needs for working capital and capital expenditures until such time
as we achieve operating profitability. We may need to raise additional funds
prior to the expiration of such period if, for example, we pursue new business,
technology or intellectual property acquisitions or experience net losses that
exceed our current expectations. Any required additional financing may be
unavailable on terms favorable to us, or at all.

Item 3.   Quantitative and Qualitative Disclosures About Market
Risk

The Company is subject to interest rate risk on
its cash and cash equivalents, short-term investments and credit facility. If
market rates were to increase immediately and uniformly by 10% from the level
at June 30, 2001, the change to the Companys interest sensitive assets and
liabilities would have an immaterial effect on the Companys financial
position, results of operations and cash flows over the next fiscal year.

PART II.

OTHER INFORMATION

Item 1:Legal Proceedings

Not Applicable

Item 2:Changes in Securities

Not Applicable

Item 3:Defaults Upon Senior Securities

Not Applicable

Item 4:Submission of Matters to a Vote of Security Holders

The Annual Meeting of Stockholders was held on May 24, 2001. All of the
proposals presented for the stockholders consideration at the Annual Meeting
were approved. The following is a tabulation of the voting on each
proposal presented at the Annual Meeting:

Proposal 1  Election if Director



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

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Other directors whose terms continued after the Annual Meeting include Mr.
Eric J. Kuhn, Mr. Andrew J. Oleszczuk and Mr. James S. Ulsamer.

Proposal 2  Ratification of the appointment of PriceWaterhouseCoopers LLP
as the independent auditors of the Company for the fiscal year ending December
31, 2001.

|           |  |               |       |                |  |                  |  |                  |  |  |        |  |  |  |   | 
|---------- |  | ------------- | ----- | -------------- |  | ---------------- |  | ---------------- |  |  | ------ |  |  |  | - | 
|Votes For  |  | Votes Against |       | Votes Withheld |  | Votes Abstaining |  | Broker Non Votes
|           |  |               |       |                |  |                  |  |                 
|12,394,364 |  |               | 7,930 |                |  |                  |  |                  |  |  | 10,650 |  |  |  |  | 

Item 5:Other Information

Not Applicable

Item 6:Exhibits and Reports on Form 8-K

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

SIGNATURES

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

Date: August 14, 2001

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

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