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UNITED STATES SECURITIES AND EXCHANGE COMMISSION


Washington, D.C. 20549




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FORM 10-K

|           |  |                                                                                              
|---------- |  | ---------------------------------------------------------------------------------------------
|(MARK ONE) |  |                                                                                              
|          
|x          |  | ANNUAL REPORT PURSUANT TO SECTION 13 OR
    15(d)
     OF THE SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended January 26, 2003

OR

|  |  |                                                                                                 
|- |  | ------------------------------------------------------------------------------------------------
|o |  | 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 1-13740



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BORDERS GROUP, INC.

(Exact name of registrant as specified in its
charter)


|                                                                   |  |                                         
|------------------------------------------------------------------ |  | ----------------------------------------
|Michigan                                                           |  | 38-3294588                              
|(State or other jurisdiction of
    incorporation or organization) |  | (I.R.S. Employer
    Identification No.)
|                                                                  
|100 Phoenix Drive, Ann Arbor,
    Michigan                         |  | 48108                                   
|(Address of principal executive
    offices)                       |  | (zip code)                              

(734) 477-1100

(Registrants telephone number, including
area code)


Securities registered pursuant to section
12(g) of the act:

|               |  |                                     
|-------------- |  | ------------------------------------
|Title of Class |  | Name of Exchange on which registered
|               |  |                                     
|Common Stock   |  | New York Stock Exchange             

Securities registered pursuant to
Section 12(b) of the act:

None

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 o

Indicate by check mark if disclosure of
delinquent filers pursuant to Item 405 of
Regulation S-K is not contained herein, and will not be
contained, to the best of registrants knowledge, in
definitive proxy or information statements incorporated by
reference in Part III of this Form 10-K or any
amendment to this
Form 10-K. x

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

The aggregate market value of the voting stock
held by non-affiliates of the registrant was approximately
$1,163,800,918 based upon the closing market price of
$14.83 per share of Common Stock on the New York Stock
Exchange as of March 27, 2003.

Number of shares of Common Stock outstanding
as of March 27, 2003: 78,476,124

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the
Registrants Proxy Statement for the May 22,
2003 Annual Meeting of Stockholders are incorporated by
reference into Part III.



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TABLE OF CONTENTS



|                                                                                              |  |  |  |  |  |  |  | 
|--------------------------------------------------------------------------------------------- |  |  |  |  |  |  |  | 
|PART I                                                                                       
|Item 1. Business                                                                             
|Item 2. Properties                                                                           
|Item 3. Legal Proceedings                                                                    
|Item 4. Submission of Matters to a Vote of Security Holders                                  
|PART II                                                                                      
|Item 5. Market for Registrants Common Equity and Related Stockholder Matters                
|Item 6. Selected Financial Data                                                              
|Item 7. Managements Discussion and Analysis of Financial Condition and Results of Operations
|Item 7A. Quantitative and Qualitative Disclosures About Market Risk                          
|Item 8. Financial Statements and Supplementary Data                                          
|CONSOLIDATED STATEMENTS OF OPERATIONS                                                        
|CONSOLIDATED BALANCE SHEETS                                                                  
|CONSOLIDATED STATEMENTS OF CASH FLOWS                                                        
|Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure 
|PART III                                                                                     
|Item 10. Directors and Executive Officers of the Registrant                                  
|Item 11. Executive Compensation                                                              
|Item 12. Security Ownership of Certain Beneficial Owners and Management                      
|Item 13. Certain Relationships and Related Party Transactions                                
|Item 14. Controls and Procedures                                                             
|PART IV                                                                                      
|Item 16. Principle Accountant Fees and Services                                              
|Code of Ethics                                                                               
|Subsidiaries of Registrant                                                                   
|Consent of Ernst Et Young LLP                                                                
|Cautionary Statement                                                                         
|906 Certification of Chief Executive Officer                                                 
|906 Certification of Chief Financial Officer                                                 



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BORDERS GROUP, INC.

INDEX

|         |  |                                                                                           |  |      |    | 
|-------- |  | ----------------------------------------------------------------------------------------- |  | ---- | -- | 
|         |  |                                                                                           |  | Page |   
|         |  |                                                                                           |  |      |   
|PART I   |  |                                                                                           |  |      |    | 
|Item 1.  |  | Business                                                                                  |  |      | 2  | 
|Item 2.  |  | Properties                                                                                |  |      | 11 | 
|Item 3.  |  | Legal Proceedings                                                                         |  |      | 12 | 
|Item 4.  |  | Submission of Matters to a Vote of Security
    Holders                                   |  |      | 13 | 
|PART II  |  |                                                                                           |  |      |    | 
|Item 5.  |  | Market for Registrants Common Equity and
    Related Stockholder Matters                 |  |      | 14 | 
|Item 6.  |  | Selected Financial Data                                                                   |  |      | 15 | 
|Item 7.  |  | Managements Discussion and Analysis of
    Financial Condition and Results of Operations |  |      | 16 | 
|Item 7A. |  | Quantitative and Qualitative Disclosures About
    Market Risk                            |  |      | 36 | 
|Item 8.  |  | Financial Statements and Supplementary Data                                               |  |      | 37 | 
|Item 9.  |  | Changes in and Disagreements with Accountants on
    Accounting and Financial Disclosure  |  |      | 64 | 
|PART III |  |                                                                                           |  |      |    | 
|Item 10. |  | Directors and Executive Officers of the Registrant                                        |  |      | 64 | 
|Item 11. |  | Executive Compensation                                                                    |  |      | 64 | 
|Item 12. |  | Security Ownership of Certain Beneficial Owners
    and Management                        |  |      | 64 | 
|Item 13. |  | Certain Relationships and Related Party
    Transactions                                  |  |      | 64 | 
|PART IV  |  |                                                                                           |  |      |    | 
|Item 14. |  | Controls and Procedures                                                                   |  |      | 64 | 
|Item 15. |  | Exhibits, Financial Statement Schedules, and
    Reports on Form 8-K                      |  |      | 65 | 
|Item 16. |  | Principle Accountant Fees and Services                                                    |  |      | 68 | 

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PART I







Item 1. Business


Forward-Looking Statements

This Annual Report on Form 10-K contains
forward-looking statements as defined by the Private Securities
Litigation Reform Act of 1995. Forward-looking statements
reflect managements current expectations and are
inherently uncertain. The Companys actual results may
differ significantly from managements expectations.
Exhibit 99.1, Cautionary Statement Under the Private
Securities Litigation Reform Act of 1995, filed with this
Annual Report on Form 10-K identifies the forward-looking
statements and describes some, but not all, of the factors that
could cause these differences.

General

Borders Group, Inc., through its subsidiaries,
Borders, Inc. (Borders), Walden Book Company, Inc.
(Waldenbooks), Borders U.K. Limited, Borders Australia Pty
Limited and others (individually and collectively, the
Company), is the second largest operator of book, music
and movie superstores and the largest operator of mall-based
bookstores in the world based upon both sales and number of
stores. At January 26, 2003, the Company operated 434
superstores under the Borders name, including 17 in the United
Kingdom, nine in Australia, two in Puerto Rico, and one each in
Singapore and New Zealand. The Company also operated 778
mall-based and other bookstores primarily under the Waldenbooks
name in the United States and 37 bookstores under the Books etc.
name in the United Kingdom.

Segment Information

The Company is organized based upon the following
operating segments: domestic Borders stores, Waldenbooks stores,
international Borders and Books etc. stores, and other.

Borders

Borders is a premier operator of book, music and
movie superstores in the United States, offering customers
selection and service that the Company believes to be superior
to other such superstore operators. A key element of the
Companys strategy is to continue its growth and increase
its profitability through the ongoing expansion and refinement
of its Borders superstore operations. In 2002, the Company
opened 41 new Borders superstores, and achieved average sales
per square foot of $237 and average sales per superstore of
$6.0 million. Borders superstores also achieved compound
annual net sales growth of 8.0%, 13.6% and 18.5% for the three
years ended January 26, 2003, January 27, 2002 and
January 28, 2001, respectively.

Each Borders superstore offers customers a vast
assortment of books, superior customer service, value pricing
and an inviting and comfortable environment designed to
encourage browsing. Borders superstores carry an average of
110,000 book titles, ranging from 62,000 titles to 209,000
titles, across numerous categories, including many hard-to-find
titles. As of January 26, 2003, 390 of the 404 domestic Borders
superstores were in a book, music and movie format, which also
feature an extensive selection of pre-recorded music, with an
emphasis on hard-to-find recordings and categories such as jazz,
classical and world music, and a broad assortment of DVDs,
focusing on new release and catalog movies. A typical Borders
superstore carries approximately 29,000 titles of music and over
6,500 titles of movies.

Borders superstores average 25,700 square feet in
size, including approximately 4,500 square feet devoted to
music, approximately 600 square feet devoted to movies and
approximately 1,400 square feet devoted to a café.
Stores opened in 2002 averaged 21,500 square feet. Each
store is distinctive in appearance and architecture and is
designed to complement its local surroundings, although Borders
utilizes certain standardized specifications to increase the
speed and lower the cost of new store openings.

In 2002, Borders entered into an agreement with
Amazon.com, Inc. (Amazon) to allow customers
ordering certain book, music and movie products through certain
of Amazons web sites to purchase and pick up the
merchandise at Borders stores in the United States
(Express In-Store Pick Up). Under this agreement,
the Company is the merchant of record for all sales made through
this service, and determines all prices and other terms and

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conditions applicable to such sales. The Company
fulfills all products sold through Express In-Store Pick Up. In
addition, the Company assumes all risk, cost and responsibility
related to the sale and fulfillment of all products sold. The
Company recognizes revenue upon customers pick up of the
merchandise at the store. The Company also pays referral fees to
Amazon pursuant to this agreement. This service was offered to
customers beginning November 27, 2002.


The number of Borders domestic stores located in
each state and the District of Columbia as of January 26,
2003 are listed below:

|                     |  |           |     | 
|-------------------- |  | --------- | --- | 
|                     |  | Number of |    
|State                |  | Stores    |    
|                     |  |           |    
|Alaska               |  |           | 1   | 
|Arizona              |  |           | 8   | 
|California           |  |           | 65  | 
|Colorado             |  |           | 12  | 
|Connecticut          |  |           | 6   | 
|District of Columbia |  |           | 3   | 
|Delaware             |  |           | 2   | 
|Florida              |  |           | 23  | 
|Georgia              |  |           | 15  | 
|Hawaii               |  |           | 6   | 
|Iowa                 |  |           | 2   | 
|Idaho                |  |           | 1   | 
|Illinois             |  |           | 28  | 
|Indiana              |  |           | 11  | 
|Kansas               |  |           | 6   | 
|Louisiana            |  |           | 1   | 
|Massachusetts        |  |           | 11  | 
|Maryland             |  |           | 10  | 
|Maine                |  |           | 2   | 
|Michigan             |  |           | 16  | 
|Minnesota            |  |           | 7   | 
|Missouri             |  |           | 7   | 
|Mississippi          |  |           | 1   | 
|North Carolina       |  |           | 8   | 
|Nebraska             |  |           | 2   | 
|New Hampshire        |  |           | 3   | 
|New Jersey           |  |           | 14  | 
|New Mexico           |  |           | 3   | 
|Nevada               |  |           | 5   | 
|New York             |  |           | 20  | 
|Ohio                 |  |           | 16  | 
|Oklahoma             |  |           | 4   | 
|Oregon               |  |           | 7   | 
|Pennsylvania         |  |           | 20  | 
|Rhode Island         |  |           | 2   | 
|South Dakota         |  |           | 1   | 
|Tennessee            |  |           | 6   | 
|Texas                |  |           | 17  | 
|Utah                 |  |           | 4   | 
|Virginia             |  |           | 11  | 
|Vermont              |  |           | 1   | 
|Washington           |  |           | 9   | 
|Wisconsin            |  |           | 6   | 
|West Virginia        |  |           | 1   | 
|                     |  |           |    
|Total                |  |           | 404 | 
|                     |  |           |    

Waldenbooks

Waldenbooks is the nations leading operator
of mall-based bookstores in terms of sales and number of stores,
offering customers a convenient source for new releases,
hardcover and paperback bestsellers, periodicals, and a standard
selection of other titles. Waldenbooks generates cash flow that
the Company uses to finance the Companys growth
initiatives. Waldenbooks achieved average sales per square foot
of $263 and average sales per store of $1.1 million for
2002. Waldenbooks stores average approximately 4,100 square feet
in size, and carry an average of 18,000 titles, ranging from
5,000 in an airport store to 30,000 in a large format store.
Waldenbooks also operates one of the longest-running customer
loyalty programs in the nation, the Preferred Reader Program.

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The number of Waldenbooks stores located in each
state and the District of Columbia as of January 26, 2003
are listed below:

|                     |  |           |     | 
|-------------------- |  | --------- | --- | 
|                     |  | Number of |    
|State                |  | Stores    |    
|                     |  |           |    
|Alaska               |  |           | 5   | 
|Alabama              |  |           | 5   | 
|Arkansas             |  |           | 7   | 
|Arizona              |  |           | 8   | 
|California           |  |           | 57  | 
|Colorado             |  |           | 11  | 
|Connecticut          |  |           | 14  | 
|District of Columbia |  |           | 2   | 
|Delaware             |  |           | 3   | 
|Florida              |  |           | 49  | 
|Georgia              |  |           | 22  | 
|Hawaii               |  |           | 11  | 
|Iowa                 |  |           | 12  | 
|Idaho                |  |           | 4   | 
|Illinois             |  |           | 38  | 
|Indiana              |  |           | 17  | 
|Kansas               |  |           | 7   | 
|Kentucky             |  |           | 12  | 
|Louisiana            |  |           | 7   | 
|Massachusetts        |  |           | 23  | 
|Maryland             |  |           | 19  | 
|Maine                |  |           | 2   | 
|Michigan             |  |           | 27  | 
|Minnesota            |  |           | 7   | 
|Missouri             |  |           | 16  | 
|Mississippi          |  |           | 6   | 
|Montana              |  |           | 4   | 
|North Carolina       |  |           | 26  | 
|North Dakota         |  |           | 3   | 
|Nebraska             |  |           | 5   | 
|New Hampshire        |  |           | 5   | 
|New Jersey           |  |           | 23  | 
|New Mexico           |  |           | 4   | 
|Nevada               |  |           | 3   | 
|New York             |  |           | 42  | 
|Ohio                 |  |           | 40  | 
|Oklahoma             |  |           | 11  | 
|Oregon               |  |           | 9   | 
|Pennsylvania         |  |           | 53  | 
|Rhode Island         |  |           | 5   | 
|South Carolina       |  |           | 13  | 
|South Dakota         |  |           | 2   | 
|Tennessee            |  |           | 14  | 
|Texas                |  |           | 50  | 
|Utah                 |  |           | 3   | 
|Virginia             |  |           | 28  | 
|Vermont              |  |           | 4   | 
|Washington           |  |           | 15  | 
|Wisconsin            |  |           | 14  | 
|West Virginia        |  |           | 9   | 
|Wyoming              |  |           | 2   | 
|                     |  |           |    
|Total                |  |           | 778 | 
|                     |  |           |    

International

The Companys international operations began
in 1997 with the acquisition of Books etc. in the United Kingdom
and the opening of a superstore in Singapore. Since then, the
Company has expanded its international operations to establish a
presence on four continents. The Company opened eight
international superstores in 2002.

International superstores as of January 26,
2003 are listed below:

|               |  |           |    | 
|-------------- |  | --------- | -- | 
|               |  | Number of |   
|Country        |  | Stores    |   
|               |  |           |   
|Australia      |  |           | 9  | 
|New Zealand    |  |           | 1  | 
|Puerto Rico    |  |           | 2  | 
|Singapore      |  |           | 1  | 
|United Kingdom |  |           | 17 | 
|Total          |  |           | 30 | 

International superstores, which operate under
the Borders name, achieved average sales per square foot of $361
and average sales per store of $8.6 million for 2002.
International superstores range between 14,000 and 42,000 square
feet in size, and tend to be multi-level facilities located in
older buildings in urban locations. All international
superstores offer book, music and movie products. Furthermore,
the Company believes it has a

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competitive advantage due to its depth of
system-driven assortment and level of service. In addition, all
international superstores offer cafés. Those cafés
located in the United Kingdom are licensed to (and operated by)
Starbucks Coffee Company (U.K.) Limited. Currently, four of the
ten highest-volume Borders superstores are international stores.


The Company also operated 37 stores under the
Books etc. name in the United Kingdom as of January 26,
2003, which are small-format stores located primarily in central
London or in various airports in the United Kingdom. These
stores primarily offer books and range from 2,000 to 5,000
square feet in size, with the largest being 8,000 square feet,
and the smallest being 650 square feet.

Borders.com and Waldenbooks.com

From May 1998 to August 2001, the
Company operated an Internet commerce site, Borders.com. In
2001, the Company entered into an agreement with an affiliate of
Amazon for Amazon to develop and operate a web site utilizing
the Borders.com URL (the Mirror Site). Operation of
the Mirror Site began August 1, 2001. As of that date, the
Company stopped selling merchandise via its Company-owned and
-operated Borders.com web site (and the Internet). In 2002, the
Company entered into an additional agreement with Amazon for
Amazon to develop and operate a web site utilizing the
Waldenbooks.com URL (the Second Mirror Site).
Operation of the Second Mirror Site began November 11, 2002.

Under these agreements, Amazon is the merchant of
record for all sales made through the Mirror Sites, and
determines all prices and other terms and conditions applicable
to such sales. Amazon is responsible for the fulfillment of all
products sold through the Mirror Sites and retains all payments
from customers. The Company receives referral fees for products
purchased through the Mirror Sites. The agreements contain
mutual indemnification provisions, including provisions that
essentially allocate between the parties responsibilities with
respect to any liabilities for sales, use and similar taxes,
including penalties and interest, associated with products sold
on the Mirror Sites. Currently, taxes are not collected with
respect to products sold on the Mirror Sites except in certain
states.

Discontinued Operations

In January 2001, the Company adopted a plan
to discontinue operations of All Wound Up, a seasonal retailer
of interactive toys and novelty merchandise the Company had
acquired in March 1999. Accordingly, the operating results
of All Wound Up have been segregated from continuing operations.

Distribution

The Company believes that its centralized
distribution system, consisting of 13 distribution facilities
worldwide, combined with Borders use of its proprietary
expert system to manage inventory, significantly
enhances its ability to manage inventory on a store-by-store
basis. Inventory is shipped from vendors primarily to the
Companys distribution centers. Approximately 91% and 70%
of the books carried by Borders and Waldenbooks, respectively,
are processed through the Companys distribution
facilities. Approximately 85% of the inventory that arrives from
publishers is processed within 48 hours for shipment to the
stores. New-release titles and rush orders are processed within
24 hours. Borders purchases substantially all of its music and
movie merchandise directly from manufacturers and utilizes the
Companys own distribution center to ship approximately 96%
of its music and movie inventory to its stores.

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As of January 26, 2003, the Company utilized
distribution centers in the following localities:

|                            |  |        |    | 
|--------------------------- |  | ------ | -- | 
|Locality, Country           |  | Number |   
|                            |  |        |   
|Auckland, New Zealand       |  |        | 1  | 
|California, United States   |  |        | 1  | 
|Indiana, United States      |  |        | 1  | 
|Ohio, United States         |  |        | 1  | 
|Pennsylvania, United States |  |        | 1  | 
|Singapore                   |  |        | 1  | 
|St. Columb, United Kingdom  |  |        | 1  | 
|Tennessee, United States    |  |        | 5  | 
|Victoria, Australia         |  |        | 1  | 
|Total                       |  |        | 13 | 

The Company has a 200,000 square-foot fulfillment
center in La Vergne, Tennessee that supported Borders.com prior
to August 2001. Pursuant to the Mirror Site agreement with
Amazon as discussed above, Amazon assumed the fulfillment of
online orders upon the transition to a co-branded site in
August 2001. This fulfillment center also distributed the
Companys special order merchandise to Borders and
Waldenbooks stores. Pursuant to a March 15, 2001 agreement,
Ingram Book Group (Ingram) became the primary
provider of book fulfillment services for the Companys
special order sales. The transaction included the sale to Ingram
of a large percentage of the book inventory housed in this
fulfillment center. The Company has since converted the La
Vergne facility to support other products and retail store
growth.

In general, books can be returned to their
publishers at cost. Borders and Waldenbooks stores return books
to the Companys centralized returns center in Nashville,
Tennessee to be processed for return to the publishers. In
general, Borders can return music and movie merchandise to its
vendors at cost plus an additional fee to cover handling and
processing costs.

Employees

As of January 26, 2003, the Company had a
total of approximately 15,500 full-time employees and
approximately 17,200 part-time employees. When hiring new
employees, the Company considers a number of factors, including
education and experience, personality and orientation toward
customer service. All new store employees participate in a
training program that provides up to two weeks of in-store
training in all aspects of customer service and selling,
including title searches for in-stock and in-print merchandise,
merchandising, sorting, operation of point of sale terminals and
store policies and procedures. The Company believes that its
relations with employees are generally excellent. The majority
of the Companys employees are not represented by unions,
with the exception of the employees of two Borders stores, which
elected in 2002 to be represented by the United Food and
Commercial Workers International Union (UFCW). Agreements have
not been reached between the Company and the UFCW with respect
to these stores.

Trademarks and Service Marks

Borders®, Borders Book Shop®, and
Borders Books & Music®, among other marks, are all
registered trademarks and service marks used by Borders.
Brentanos®, Coopersmiths®,
Waldenbooks®, Waldenbooks Preferred Reader® and
Waldenkids®, among other marks, are all registered
trademarks and service marks used by Waldenbooks. Books
etc® is a registered trademark and service mark used by
Borders U.K. Limited. Borders.com® is a registered
trademark and service mark used by Borders Online, Inc. The
Borders, Waldenbooks, Books etc., Borders.com and
Waldenbooks.com service marks are used as trade names in
connection with their business operations.

Relationship with Kmart

General.Prior to
its initial public offering in May 1995, the Company was a
subsidiary of Kmart Corporation (Kmart); Kmart currently owns no
shares of common stock of the Company. In January 2002,
Kmart filed for

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reorganization under Chapter 11 of the U.S.
Bankruptcy Code. Such filing has not affected the operations of
the Company.


Kmart and the Company continue to have the
following contractual relationships.

Tax Allocation and Indemnification Agreement.Prior to the completion of its initial
public offering (IPO), the Company was included in the
consolidated federal income tax returns of Kmart and filed on a
combined basis with Kmart in certain states. Pursuant to a tax
allocation and indemnification agreement between the Company and
Kmart (Tax Allocation Agreement) the Company will remain
obligated to pay to Kmart any income taxes the Company would
have had to pay if it had filed separate tax returns for the tax
period beginning on January 26, 1995, and ending on
June 1, 1995, the date of the consummation of the IPO (to
the extent that it has not previously paid such amounts to
Kmart). In addition, if the tax liability attributable to the
Company for any previous tax period during which the Company was
included in a consolidated federal income tax return filed by
Kmart or a combined state return is adjusted as a result of an
action of a taxing authority or a court, then the Company will
pay to Kmart the amount of any increase in such liability and
Kmart has agreed to pay to the Company the amount of any
decrease in such liability (in either case together with
interest and penalties). The Companys tax liability for
previous years will not be affected by any increase or decrease
in Kmarts tax liability if such increase or decrease is
not directly attributable to the Company. After completion of
the IPO, the Company continued to be subject under existing
federal regulations to several liability for the consolidated
federal income taxes for any tax year in which it was a member
of any consolidated group of which Kmart was the common parent.
Pursuant to the Tax Allocation Agreement, however, Kmart agreed
to indemnify the Company for any federal income tax liability of
Kmart or any of its subsidiaries (other than that which is
attributable to the Company) that the Company could be required
to pay and the Company agreed to indemnify Kmart for any of the
Companys separate company taxes.

Lease Guaranty Agreement.Borders leases for 13 of its
retail stores and its distribution center in Harrisburg,
Pennsylvania have been guaranteed by Kmart. Under the terms of a
lease guaranty, indemnification and reimbursement agreement
entered into upon completion of the IPO, as amended, (Lease
Guaranty Agreement), the underlying leases will be transferable
by Borders, subject to a right of first refusal in favor of
Kmart with respect to sites within a three-mile radius of a
Kmart store and, with respect to all other sites, a right of
first offer in favor of Kmart. The Company and Borders are
required to indemnify Kmart with respect to (i) any
liabilities Kmart may incur under the lease guarantees, except
those liabilities arising from the gross negligence or willful
misconduct of Kmart, and (ii) any losses incurred by Kmart
after taking possession of any particular premises, except to
the extent such losses arise solely from the acts or omissions
of Kmart. Under the terms of the Lease Guaranty Agreement, in
the event of the Companys or Borders
(i) failure to provide any required indemnity,
(ii) knowing and material violation of the limitations on
transfers of guaranteed leases set forth in the agreement, or
(iii) certain events of bankruptcy, Kmart will have the
right to assume any or all of the guaranteed leases and to take
possession of all of the premises underlying such guaranteed
leases; provided, that in the event of a failure or failures to
provide required indemnities, the remedy of taking possession of
all of the premises underlying the guaranteed leases may be
exercised only if such failures relate to aggregate liability of
$10.0 million or more and only if Kmart has provided
100 days prior written notice. In the event of a
failure to provide required indemnities resulting in losses of
more than the equivalent of two months rent under a particular
lease but less than $10.0 million, Kmart may exercise such
remedy of possession as to the premises underlying the
guaranteed lease or leases to which the failure to provide the
indemnity relates and one additional premise for each such
premises to which the failure relates, up to a maximum, in any
event, of five additional premises, and thereafter, with respect
to such additional premises, Kmart remedies and indemnification
rights shall terminate. In the event of a failure to provide
required indemnities resulting in liabilities of less than the
equivalent of two months rent under a particular lease, Kmart
may exercise such remedy of possession only as to the premises
underlying the guaranteed lease or leases to which the failure
to provide the indemnity relates. The Lease Guaranty Agreement
will remain in effect until the expiration of all lease
guarantees, which the Company believes will be in
January 2020.

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Executive Officers of the Company

Set forth below is certain information regarding
the executive officers of the Company:

|                      |  |     |    |  |          |                                                  
|--------------------- |  | --- | -- |  | -------- | -------------------------------------------------
|Name                  |  | Age |    |  | Position
|                      |  |     |    |  |         
|Gregory P. Josefowicz |  |     | 50 |  |          | Chairman, President and Chief Executive Officer  
|Vincent E. Altruda    |  |     | 53 |  |          | President, International                         
|Thomas D. Carney      |  |     | 56 |  |          | Vice President, General Counsel                  
|Tamara L. Heim        |  |     | 45 |  |          | President, Borders                               
|Daniel T. Smith       |  |     | 38 |  |          | Vice President, Human Resources                  
|Michael G. Spinozzi   |  |     | 43 |  |          | Executive Vice President, Chief Marketing Officer
|Cedric J. Vanzura     |  |     | 39 |  |          | President, Waldenbooks                           
|Edward W. Wilhelm     |  |     | 44 |  |          | Senior Vice President, Chief Financial Officer   
|Mark A. Winterhalter  |  |     | 48 |  |          | Vice President, Information Technology           

Gregory P. Josefowicz has served as
President, Chief Executive Officer and as a director of the
Company since November 1999, and as Chairman of the Board
since January 2002. For more than five years prior to
joining the Company, he served in a variety of executive
positions with Jewel-Osco, a food and drug retailer that is
currently a division of Albertsons, Inc., most recently as
President. Mr. Josefowicz also serves as a director of
Ryerson Tull, Inc., a distributor and processor of metals, and
Spartan Stores, Inc., a food retailer.

Vincent E. Altruda has served as President
of the Companys international operations since
December 1997. From February 1997 through
December 1997, Mr. Altruda served as Senior Vice
President of Borders Store Development. From February 1995
through February 1997, Mr. Altruda served as Senior
Vice President of Borders Store Operations. From
December 1992 through February 1995, Mr. Altruda
served as Vice President of Borders Store Operations.

Thomas D. Carney has been Vice President,
General Counsel and Secretary of the Company since
December 1994. For more than five years prior to joining
the Company, Mr. Carney was a Partner at the law firm of
Dickinson, Wright, Moon, Van Dusen & Freeman in
Detroit, Michigan.

Tamara L. Heim has served as President of
Borders since January 2000. From February 1999 to
January 2000, Ms. Heim served as Senior Vice President
of Sales and Marketing for Borders. Ms. Heim served as a
Territorial Vice President of Borders from December 1996 to
February 1999. From 1980 to 1996, Ms. Heim held
several key positions of increasing responsibility for Federated
Department Stores, and served as Regional Vice President and
Director of Stores for Richs Lazarus Goldsmith, a division
of Federated Department Stores, prior to joining the Company.

Daniel T. Smith has served as Vice President
of Human Resources of the Company since March 2000. From
April 1998 to March 2000, Mr. Smith served as
Vice President of Human Resources of Waldenbooks. Mr. Smith
served as Director of Human Resources for Waldenbooks from
April 1996 to April 1998. He also served as Director
of Compensation and Benefits of the Company from July 1995
to April 1996.

Michael G. Spinozzi has served as Executive
Vice President and Chief Marketing Officer of the Company since
January 2002. He also served as Sr. Vice President of
Sales and Marketing of Borders Stores from March 2001 to
January 2002. Prior to joining the Company, he spent
19 years with Jewel-Osco stores, a food and drug retailer
that is currently a division of Albertsons, Inc., and was
most recently Senior Vice President of Marketing and
Merchandising.

Cedric J. Vanzura has served as President of
Waldenbooks since March 2003. Prior to rejoining the
Company, Mr. Vanzura served as Chief Strategy Officer,
Information Systems and Services for General Motors Corporation
from 2000 to 2003. He was President and Chief Operating Officer
for Lifemasters, a national disease management provider, from
1999 to 2000. From 1994 to 1999, Mr. Vanzura served in a
variety of management positions with the Company, most recently
as President of Borders Online.

Edward W. Wilhelm has served as Senior Vice
President and Chief Financial Officer of the Company since
August 2000. From 1997 through August 2000,
Mr. Wilhelm served as Vice President of Planning, Reporting
and Treasury for the Company. From 1994 through 1997,
Mr. Wilhelm served as Vice President of Finance.

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Mark A. Winterhalter has served as Vice
President of Information Technology of the Company since
October 1999. He also served as Vice President of
Applications Development from May 1998 to
October 1999. Prior to joining the Company,
Mr. Winterhalter served as Vice President and Chief
Information Officer for Arbor Drugs, Inc., a drug retailer, from
October 1989 until May 1998.

Risk Factors

The following risk factors and other information
included in this Annual Report on Form 10-K should be
carefully considered. The risks and uncertainties described
below are not the only ones the Company faces. Additional risks
and uncertainties not presently known to the Company or that the
Company currently deems immaterial also may impair the
Companys business operations. If any of the following
risks occur, the Companys business, financial condition,
operating results and cash flows could be materially adversely
affected.

Expansion
Strategy

The Companys growth strategy is dependent
principally on its ability to open new superstores and operate
them profitably. The Company is engaged in an aggressive
expansion program, pursuant to which it has opened 41 domestic
superstores in 2002 and expects to open 35 to 40 domestic
superstores in 2003. The Company has also opened eight
international superstores in 2002, and expects to open six to
eight international superstores in 2003. The rate of the
Companys expansion will depend, among other things, on
general economic and business conditions affecting consumer
confidence and spending, the availability of qualified
management personnel and the Companys ability to manage
the operational aspects of its growth. The rate of the
Companys expansion will also depend upon the availability
of adequate capital, which in turn will depend in a large part
upon cash flow generated by Waldenbooks.

The Companys expansion into international
markets has additional risks. It is costly to establish
international facilities and operations, and to promote the
Companys brands internationally. Sales from the
Companys international segment may not offset the expense
of establishing and maintaining the related operations and,
therefore, these operations may not be profitable on a sustained
basis. The Company is also subject to a number of risks inherent
in selling abroad, including, but not limited to, risks with
respect to foreign exchange rate fluctuations, local economic
and political conditions, restrictive governmental policies and
laws (such as trade protection measures, limitations on the
repatriation of funds, nationalization and consumer protection
laws and restrictions on pricing or discounts), difficulty in
developing and simultaneously managing a larger number of unique
foreign operations as a result of distance, language and
cultural differences, tax and other laws and policies of the
U.S. and other jurisdictions and geopolitical events, including
war and terrorism. In addition, local companies may have a
substantial competitive advantage because of their greater
understanding of, and focus on, the local customer, as well as
their more established local brand name recognition. Also, the
Company may not be able to hire, train, retain, motivate and
manage required personnel, which may limit the Companys
growth internationally.

The Companys future results will depend,
among other things, on its success in implementing its expansion
strategy. If stores are opened more slowly than expected, sales
at new stores reach targeted levels more slowly than expected
(or fail to reach targeted levels) or related overhead costs
increase in excess of expected levels, the Companys
ability to successfully implement its expansion strategy would
be adversely affected. In addition, the Company expects to open
new superstores in certain markets in which it is already
operating superstores, which could adversely affect sales at
those existing stores.

There can be no assurance that the Company will
sustain its accelerated rate of superstore growth or that it
will achieve and sustain acceptable levels of profitability,
particularly as other leading national and regional book, music
and movie store chains develop and open superstores.

Waldenbooks

Waldenbooks results are highly dependent
upon conditions in the mall retailing industry, including
overall mall traffic. Mall traffic has been sluggish over the
past several years and the Company expects it to remain sluggish
for the foreseeable future. In addition, increased competition
from superstores has adversely affected Waldenbooks sales.
As a result, Waldenbooks comparable store sales results
have been negatively affected. There can be no

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assurance that mall traffic will not decline
further or that superstore competition, or other factors, will
not further adversely affect Waldenbooks sales.


Seasonality

The Companys business is highly seasonal,
with sales generally highest in the fourth quarter. During 2002,
35.0% of the Companys sales and 91.0% of the
Companys operating income were generated in the fourth
quarter. The Companys results of operations depend
significantly upon the holiday selling season in the fourth
quarter; less than satisfactory net sales for such period could
have a material adverse effect on the Companys financial
condition or results of operations for the year and may not be
sufficient to cover any losses which may be incurred in the
first three quarters of the year. The Companys expansion
program generally is weighted with store openings in the second
half of the fiscal year. In the future, changes in the number
and timing of store openings, or other factors, may result in
different seasonality trends.

Competition

The retail book business is highly competitive.
Competition within the retail book industry is fragmented, with
Borders facing direct competition from other superstore
operators, such as Barnes & Noble, Inc., as well as
regional chains and superstores. In addition, Borders and
Waldenbooks compete with each other, as well as other specialty
retail stores that offer books in a particular area of
specialty, independent single store operators, discount stores,
drug stores, warehouse clubs, mail order clubs and mass
merchandisers. In the future, Borders and Waldenbooks may face
additional competition from other categories of retailers
entering the retail book market.

The music and movie businesses are also highly
competitive and Borders faces competition from large established
music chains, such as Tower Records and the Musicland and Media
Play divisions of Best Buy Co., Inc. (which also sell movies),
established movie chains, such as Blockbuster and Suncoast
Motion Picture Company (a division of Best Buy Co., Inc.), as
well as specialty retail stores, movie rental stores, discount
stores, warehouse clubs and mass merchandisers. In addition,
consumers receive television and mail order offers and have
access to mail order clubs. The largest mail order clubs are
affiliated with major manufacturers of pre-recorded music and
may have advantageous marketing relationships with their
affiliates.

The Internet has emerged as a significant channel
for retailing in all media categories that the Company carries.
In particular, the retailing of books and music over the
Internet is highly competitive. Competitors on the Internet
include Amazon.com, barnesandnoble.com and others. In addition,
the Company faces competition from companies engaged in the
business of selling books, music and movies via electronic
means, including the downloading of music content.

Consumer
Spending Patterns

Sales of books, music and movies have
historically been dependent upon discretionary consumer
spending, which may be affected by general economic conditions,
consumer confidence and other factors beyond the control of the
Company. In addition, sales are dependent on a hit-driven
merchandising strategy. A decline in consumer spending on books,
music and movies, or in best-seller book, music and movie buying
could have a material adverse effect on the Companys
financial condition and results of operations and its ability to
fund its superstore growth strategy.

Foreign
Exchange Risk

The results of operations of the international
segment are exposed to foreign exchange rate fluctuations as the
financial results of the applicable subsidiaries are translated
from the local currency into U.S. dollars upon consolidation. As
exchange rates vary, sales and other operating results, when
translated, may differ materially from expectations. In
addition, the Company is subject to gains and losses on foreign
currency transactions, which could vary based on fluctuations in
exchange rates and the timing of the transactions and their
settlement.

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Potential
for Uninsured Losses

The Company is subject to the possibility of
uninsured losses from risks such as terrorism, earthquakes, or
floods, for which no, or limited, insurance coverage is
maintained. The Company has elected not to maintain insurance
coverage for losses resulting from terrorism (except for its
operations in the United Kingdom), based upon its assessment of
the insurance cost and the likelihood (and range) of loss.

Reliance
on Key Personnel

Management believes that the Companys
continued success will depend to a significant extent upon the
efforts and abilities of Mr. Gregory P. Josefowicz,
Chairman, President and Chief Executive Officer, as well as
certain other key officers of the Company and each of its
subsidiaries. The loss of the services of Mr. Josefowicz or
of such other key officers could have a material adverse effect
on the Company. The Company does not maintain key
man life insurance on any of its key officers.

Availability of Information

The Companys web site is located at
www.bordersgroupinc.com. The Company makes available on
this web site under Investors, free of charge,
annual reports on Form 10-K, quarterly reports on
Form 10-Q, current reports on Form 8-K and amendments
to those reports as soon as reasonably practicable after having
electronically filed or furnished such materials to the
U.S. Securities and Exchange Commission.






Item 2. Properties


Borders leases all of its stores. Borders
store leases have an average initial term of 15 to 20 years
with multiple three- to five-year renewal options. At
January 26, 2003, the average unexpired term under
Borders existing store leases in the United States was
12.9 years prior to the exercise of any options. The
expiration of Borders leases for stores open at January
26, 2003 are as follows:

|                                       |  |           |     | 
|-------------------------------------- |  | --------- | --- | 
|Lease Terms to Expire During 12 Months |  | Number of |    
|Ending on or about January 31          |  | Stores    |    
|                                       |  |           |    
|2003                                   |  |           | 4   | 
|2004                                   |  |           | 17  | 
|2005                                   |  |           | 7   | 
|2006                                   |  |           | 4   | 
|2007                                   |  |           | 9   | 
|2008 and later                         |  |           | 363 | 
|                                       |  |           |    
|Total                                  |  |           | 404 | 
|                                       |  |           |    

Waldenbooks leases all of its stores.
Waldenbooks store leases generally have an initial term of
ten years. At present, the average unexpired term under
Waldenbooks existing store leases is approximately
3.0 years. The expiration of Waldenbooks leases for
stores open at January 26, 2003 are as follows:

|                                       |  |           |     | 
|-------------------------------------- |  | --------- | --- | 
|Lease Terms to Expire During 12 Months |  | Number of |    
|Ending on or about January 31          |  | Stores    |    
|                                       |  |           |    
|2003                                   |  |           | 294 | 
|2004                                   |  |           | 121 | 
|2005                                   |  |           | 82  | 
|2006                                   |  |           | 63  | 
|2007                                   |  |           | 42  | 
|2008 and later                         |  |           | 176 | 
|                                       |  |           |    
|Total                                  |  |           | 778 | 
|                                       |  |           |    

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The Company leases all of its international
superstores. International store leases generally have an
initial term of 15 to 25 years. At present, the average
unexpired term under existing international store leases is
approximately 14.7 years. The expiration of international
superstore leases for stores open at January 26, 2003 are
as follows:

|                                       |  |           |    | 
|-------------------------------------- |  | --------- | -- | 
|Lease Terms to Expire During 12 Months |  | Number of |   
|Ending on or about January 31          |  | Stores    |   
|                                       |  |           |   
|2003                                   |  |           |   | 
|2004                                   |  |           |   | 
|2005                                   |  |           |   | 
|2006                                   |  |           |   | 
|2007                                   |  |           | 1  | 
|2008 and later                         |  |           | 29 | 
|Total                                  |  |           | 30 | 

Books etc. operated 37 stores in the United
Kingdom as of January 26, 2003. Books etc. generally leases
its stores under operating leases with terms ranging from 5 to
25 years. The average remaining lease term for Books etc.
stores is 11.7 years.

The Company leases a portion of its corporate
headquarters in Ann Arbor, Michigan and owns the remaining
building and improvements. The Company leases all distribution
centers.






Item 3. Legal Proceedings


In August 1998, The Intimate Bookshop, Inc.
(Intimate) and its owner, Wallace Kuralt, filed a lawsuit in the
United States District Court for the Southern District of
New York against the Company, Barnes & Noble, Inc., and
others alleging violation of the Robinson-Patman Act and other
federal laws, New York statutes governing trade practices
and common law. In response to Defendants Motion to
Dismiss the Complaint, plaintiff Kuralt withdrew his claims and
plaintiff Intimate voluntarily dismissed all but its
Robinson-Patman claims. Intimate has filed a Second Amended
Complaint limited to allegations of violations of the
Robinson-Patman Act. The Second Amended Complaint alleges that
Intimate has suffered $11.3 million or more in damages and
requests treble damages, injunctive and declaratory relief,
interest, costs, attorneys fees and other unspecified
relief. The Company intends to vigorously defend the action.

Two former employees, individually and on behalf
of a purported class consisting of all current and former
employees who worked as assistant managers in Borders stores in
the state of California at any time between April 10, 1996,
and the present, have filed an action against the Company in the
Superior Court of California for the County of San Francisco.
The action alleges that the individual plaintiffs and the
purported class members worked hours for which they were
entitled to receive, but did not receive, overtime compensation
under California law, and that they were classified as exempt
store management employees but were forced to work more than 50%
of their time in non-exempt tasks. The Amended Complaint, which
names two additional plaintiffs, alleges violations of the
California Labor Code and the California Business and
Professions Code. The relief sought includes compensatory and
punitive damages, penalties, preliminary and permanent
injunctions requiring Borders to pay overtime compensation as
required under California and Federal law, prejudgment interest,
costs, and attorneys fees and such other relief as the
court deems proper. On July 29, 2002, the Superior Court of
California granted the plaintiffs motion for class
certification in the action. The class certified consists of all
individuals who worked as Assistant Managers in a Borders
superstore in California at any time between April 10, 1996
and March 18, 2001. The class was further certified by the
Court into the following subclasses: Assistant
Manager-Merchandising; Assistant Manager-Inventory; Assistant
Manager-Human Resources; Assistant Manager-Music; Assistant
Manager-Training; Assistant Manager-Cafe. The Companys
request for an immediate appeal of the class certification
ruling has been denied, and the Company has agreed to engage in
non-binding mediation of the matter. Unless mediation is
successful, the Company will continue to vigorously defend the
action.

On October 29, 2002, Gary Gerlinger,
individually and on behalf of all other similarly situated
consumers in the United States who, during the period from
August 1, 2001 to the present, purchased books online from
either Amazon or the Company, instituted an action against the
Company and Amazon in the United States District Court

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for the Northern District of California. The
Complaint alleges that the agreement pursuant to which an
affiliate of Amazon operates Borders.com as a co-branded site
violates federal anti-trust laws, California statutory law and
the common law of unjust enrichment. The Complaint seeks
injunctive relief, damages, including treble damages or
statutory damages where applicable, attorneys fees, costs and
disbursements, disgorgement of all sums obtained by allegedly
wrongful acts, interest and declaratory relief. The Company has
filed an answer denying any liability and intends to vigorously
defend the action.


The Company has not included any liability in its
consolidated financial statements in connection with the
lawsuits described above and has expensed as incurred all legal
costs to date. Although an adverse resolution of these lawsuits
could have a material adverse effect on the result of the
operations of the Company for the applicable period or periods,
the Company does not believe that any such litigation will have
a material effect on its liquidity or financial position.

Certain states and private litigants have sought
to impose sales or other tax collection efforts on
out-of-jurisdiction companies that engage in e-commerce. The
Company currently is disputing a claim by the state of
California relating to sales taxes that the state alleges should
have been collected on certain Borders.com sales in California
prior to implementation of the Companys Mirror Site
Agreement with Amazon. Also, the Company and Amazon have been
named as defendants in an action filed by a private litigant on
behalf of the State of Tennessee under the Tennessee False
Claims Act relating to the failure to collect use taxes on
Internet sales in Tennessee for periods both before and after
the implementation of the Mirror Site Agreement. The Complaint
seeks a judgment, jointly and severally, against the defendants
for, among other things, injunctive relief, treble the amount of
damages suffered by the State of Tennessee as a result of the
alleged violations of the defendants, penalties, costs and
expenses, including legal fees. Contrary to the claims in the
Complaint, the Company did collect taxes on Internet sales in
Tennessee (as well as Michigan) prior to the implementation of
the Mirror Site Agreement.

The Company does not believe that it should be
liable under existing laws and regulations for any failure by it
or Amazon to collect sales or other taxes relating Internet
sales. Although any liability relating to the failure to collect
sales or other taxes on online sales could have a material
effect on the results of the operations of the Company for the
applicable period or periods, the Company does not believe that
any such liability would have a material adverse effect on its
liquidity or financial position.

In addition to the matters described above, the
Company is, from time to time, involved in or affected by other
litigation incidental to the conduct of its businesses.






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


Not applicable.

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PART II







Item 5. Market for Registrants
Common Equity and Related Stockholder Matters


The following table sets forth, for the fiscal
quarters indicated, the high and low closing market prices for
the Common Stock on the New York Stock Exchange.

|                    |                |      |   |       |     |  |   |       | 
|------------------- | -------------- | ---- | - | ----- | --- |  | - | ----- | 
|                    |                | High |   |       | Low | 
|                    |                |      |   |       |     | 
|Fiscal Quarter 2001 |                |      |   |       |     |  |   |      
|                    | First Quarter  |      | $ | 18.00 |     |  | $ | 12.50 | 
|                    | Second Quarter |      | $ | 23.50 |     |  | $ | 17.40 | 
|                    | Third Quarter  |      | $ | 24.43 |     |  | $ | 16.74 | 
|                    | Fourth Quarter |      | $ | 24.14 |     |  | $ | 14.64 | 
|Fiscal Quarter 2002 |                |      |   |       |     |  |   |      
|                    | First Quarter  |      | $ | 24.40 |     |  | $ | 21.38 | 
|                    | Second Quarter |      | $ | 24.20 |     |  | $ | 14.90 | 
|                    | Third Quarter  |      | $ | 19.44 |     |  | $ | 15.48 | 
|                    | Fourth Quarter |      | $ | 19.79 |     |  | $ | 15.36 | 

The Common Stock is traded on the New York Stock
Exchange.

As of March 27, 2003, 3,720 holders of
record held the Companys Common Stock.

The Company has not declared any cash dividends;
however, it intends to periodically assess cash dividends as a
possible strategy to increase shareholder value. The declaration
and payment of dividends, if any, is subject to the discretion
of the Board and to certain limitations under the Michigan
Business Corporation Act. In addition, the Companys
ability to pay dividends is restricted by certain agreements to
which the Company is a party. See Managements
Discussion and Analysis of Financial Condition and Results of
Operations  Liquidity and Capital Resources.

The Company has the following equity compensation
plans in effect at January 26, 2003 (number of shares in
thousands):

|                                    |                                 |             |        |        |                |   |       |                  |  |  |       |       | 
|----------------------------------- | ------------------------------- | ----------- | ------ | ------ | -------------- | - | ----- | ---------------- |  |  | ----- | ----- | 
|                                    |                                 | Number of   |        |        | Weighted-      |   |       | Number of        | 
|                                    |                                 | Shares      |        |        | Average        |   |       | Shares Available | 
|Plan Category                       |                                 | Outstanding |        |        | Exercise Price |   |       | for Issuance     | 
|                                    |                                 |             |        |        |                |   |       |                  | 
|Plans approved by shareholders:     |                                 |             |        |        |                |   |       |                  |  |  |       |      
|                                    | 1995 Stock Option Plan          |             |        | 11,260 |                |   | $     | 18.90            |  |  |       | 587   | 
|                                    | Director Plan                   |             |        | 158    |                |   |       | 17.56            |  |  |       | 8     | 
|                                    | Management Stock Purchase Plan  |             |        |       |                |   |       |                 |  |  |       | 3,454 | 
|Plans not approved by shareholders: |                                 |             |        |        |                |   |       |                  |  |  |       |      
|                                    | 1998 Stock Option Plan          |             |        | 2,947  |                |   |       | 17.98            |  |  |       | 238   | 
|                                    | International Stock Option Plan |             |        | 704    |                |   |       | 20.15            |  |  |       | 39    | 
|                                    |                                 |             |        |        |                |   |       |                  | 
|Total plans                         |                                 |             | 15,069 |        |                | $ | 18.76 |                  |  |  | 4,326 |      
|                                    |                                 |             |        |        |                |   |       |                  | 

The 1998 Stock Option Plan and the Stock Option
Plan for International Employees provide for the grant of stock
options to a broad base of employees of the Company. Executive
officers of the Company are not eligible to participate in
either of these Plans. The exercise price of options granted
under the Plans is fair market value as of the date of grant,
and options have terms of up to 10 years. The number of
options granted to individual employees under the Plans varies
according to the level of the employees position with the
Company. The Plans are consistent with the Companys
philosophy of providing equity incentives to employees at all
levels of the Company.

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Item 6. Selected Financial
Data


SELECTED CONSOLIDATED FINANCIAL AND OPERATING
DATA

The information set forth below should be read in
conjunction with Managements Discussion and Analysis
of Financial Condition and Results of Operations and the
Companys consolidated financial statements and the notes
thereto.

|                                                                                 |                                      |                                             |         |   |          |   |         |          |  |   |          |      |  |          |         |     |  |   |         |   | 
|-------------------------------------------------------------------------------- | ------------------------------------ | ------------------------------------------- | ------- | - | -------- | - | ------- | -------- |  | - | -------- | ---- |  | -------- | ------- | --- |  | - | ------- | - | 
|                                                                                 |                                      |                                            
|                                                                                 |                                      | Fiscal Year Ended                           |        
|                                                                                 |                                      | Jan. 26,                                    |         |   | Jan. 27, |   |         | Jan. 28, |  |   | Jan. 23, |      |  | Jan. 24, |        
|                                                                                 |                                      | 2003                                        |         |   | 2002     |   |         | 2001(1)  |  |   | 2000     |      |  | 1999     |        
|                                                                                 |                                      |                                             |         |   |          |   |         |          |  |   |          |      |  |          |        
|                                                                                 |                                      |                                            
|                                                                                 |                                      | (dollars in millions except per share data) |        
|Statement of Operations Data                                                     |                                      |                                             |         |   |          |   |         |          |  |   |          |      |  |          |         |     |  |   |         |  
|Borders sales                                                                    |                                      | $                                           | 2,319.0 |   |          | $ | 2,234.1 |          |  | $ | 2,107.7  |      |  | $        | 1,841.1 |     |  | $ | 1,525.6 |  
|Waldenbooks sales                                                                |                                      |                                             | 852.2   |   |          |   | 902.1   |          |  |   | 944.3    |      |  |          | 959.1   |     |  |   | 948.7   |  
|International sales                                                              |                                      |                                             | 314.9   |   |          |   | 251.7   |          |  |   | 219.2    |      |  |          | 168.2   |     |  |   | 120.7   |  
|                                                                                 |                                      |                                             |         |   |          |   |         |          |  |   |          |      |  |          |        
|Total sales                                                                      |                                      | $                                           | 3,486.1 |   |          | $ | 3,387.9 |          |  | $ | 3,271.2  |      |  | $        | 2,968.4 |     |  | $ | 2,595.0 |  
|                                                                                 |                                      |                                             |         |   |          |   |         |          |  |   |          |      |  |          |        
|Operating income                                                                 |                                      | $                                           | 193.9   |   |          | $ | 157.0   |          |  | $ | 135.1    |      |  | $        | 171.0   |     |  | $ | 167.3   |  
|Income from continuing operations                                                |                                      | $                                           | 111.7   |   |          | $ | 87.4    |          |  | $ | 73.8     |      |  | $        | 94.0    |     |  | $ | 92.1    |  
|Discontinued operations, net of tax                                              |                                      |                                             |         |   |          |   |         |          |  |   |          |      |  |          |         |     |  |   |         |  
|                                                                                 | Loss from operations of All Wound Up |                                             |         |  |          |   |         |         |  |   |          | 10.8 |  |          |         | 3.7 |  |   |         |  | 
|                                                                                 | Loss on disposition of All Wound Up  |                                             |         |  |          |   |         |         |  |   |          | 19.4 |  |          |         |    |  |   |         |  | 
|                                                                                 |                                      |                                             |         |   |          |   |         |          |  |   |          |      |  |          |        
|Net income                                                                       |                                      | $                                           | 111.7   |   |          | $ | 87.4    |          |  | $ | 43.6     |      |  | $        | 90.3    |     |  | $ | 92.1    |  
|                                                                                 |                                      |                                             |         |   |          |   |         |          |  |   |          |      |  |          |        
|Diluted earnings per common share from continuing
    operations                 |                                      | $                                           | 1.36    |   |          | $ | 1.06    |          |  | $ | 0.92     |      |  | $        | 1.17    |     |  | $ | 1.12    |  
|Diluted earnings per common share                                                |                                      | $                                           | 1.36    |   |          | $ | 1.06    |          |  | $ | 0.54     |      |  | $        | 1.13    |     |  | $ | 1.12    |  
|Balance Sheet Data                                                               |                                      |                                             |         |   |          |   |         |          |  |   |          |      |  |          |         |     |  |   |         |  
|Working capital                                                                  |                                      | $                                           | 453.7   |   |          | $ | 335.4   |          |  | $ | 217.2    |      |  | $        | 170.3   |     |  | $ | 144.5   |  
|Total assets                                                                     |                                      | $                                           | 2,268.2 |   |          | $ | 2,179.3 |          |  | $ | 2,047.1  |      |  | $        | 1,914.8 |     |  | $ | 1,766.6 |  
|Short-term borrowings                                                            |                                      | $                                           | 112.1   |   |          | $ | 81.6    |          |  | $ | 143.5    |      |  | $        | 133.4   |     |  | $ | 131.9   |  
|Long-term capital lease and financing
    obligations, including current portion |                                      | $                                           | 19.6    |   |          | $ | 51.4    |          |  | $ | 15.8     |      |  | $        | 18.8    |     |  | $ | 8.5     |  
|Stockholders equity                                                             |                                      | $                                           | 1,030.6 |   |          | $ | 949.9   |          |  | $ | 846.5    |      |  | $        | 802.6   |     |  | $ | 715.1   |  




|    |                                                          
|--- | ---------------------------------------------------------
|(1) | The Companys 2000 fiscal year consisted of
    53 weeks.

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|        |                                                                                          
|------- | -----------------------------------------------------------------------------------------
|Item 7. | Managements Discussion and Analysis of
    Financial Condition and Results of Operations

General

Borders Group, Inc., through its subsidiaries,
Borders, Inc. (Borders), Walden Book Company, Inc.
(Waldenbooks), Borders U.K. Limited, Borders Australia Pty
Limited and others (individually and collectively, the
Company), is the second largest operator of book, music
and movie superstores and the largest operator of mall-based
bookstores in the world based upon both sales and number of
stores. At January 26, 2003, the Company operated
434 superstores under the Borders name, including 17 in the
United Kingdom, nine in Australia, two in Puerto Rico, and one
each in Singapore and New Zealand. The Company also
operated 778 mall-based and other bookstores primarily
under the Waldenbooks name in the United States and
37 bookstores under the Books etc. name in the United
Kingdom.

The Companys business strategy is to
continue its growth and increase its profitability through
(i) expanding and refining its core domestic superstore
business, (ii) driving international growth by expanding
established markets and leveraging infrastructure investments,
(iii) leveraging strategic alliances and in-store web-based
commerce technologies which enhance the customer experience, and
(iv) maximizing cash flow at Waldenbooks by containing
costs. Specifically, the Company expects to open 35 to
40 domestic Borders stores in 2003 and a reduced number in
2004. International store growth over the next several years
will focus on existing markets, primarily in the United Kingdom
and Australia, with approximately six to eight international
store openings annually. Full year profitability is expected to
be achieved by the International segment in 2004. The
Waldenbooks segment has experienced decreased comparable sales
percentages for the past several years primarily due to the
overall decrease in mall traffic and the impact of superstore
openings. As a result, the Company is continuing to implement
its plan for the optimization of the Waldenbooks store
base in order to improve sales, net income and free cash flow.
This plan could result in further store closing costs or asset
impairments over the next few years. The Companys
objectives with respect to these initiatives are to continue to
grow consolidated sales and earnings in 2003.

From May 1998 to August 2001, the Company
operated an Internet commerce site, Borders.com. In 2001, the
Company entered into an agreement with an affiliate of
Amazon.com, Inc. (Amazon) for Amazon to develop and
operate a web site utilizing the Borders.com URL (the
Mirror Site). Operation of the Mirror Site began
August 1, 2001. As of that date, the Company stopped
selling merchandise via its Company-owned and -operated
Borders.com web site (and the Internet). In 2002, the Company
entered into an additional agreement with Amazon for Amazon to
develop and operate a web site utilizing the Waldenbooks.com URL
(the Second Mirror Site). Operation of the Second
Mirror Site began November 11, 2002.

Under these agreements, Amazon is the merchant of
record for all sales made through the Mirror Sites, and
determines all prices and other terms and conditions applicable
to such sales. Amazon is responsible for the fulfillment of all
products sold through the Mirror Sites and retains all payments
from customers. The Company receives referral fees for products
purchased through the Mirror Sites. The agreements contain
mutual indemnification provisions, including provisions that
essentially allocate between the parties responsibilities with
respect to any liabilities for sales, use and similar taxes,
including penalties and interest, associated with products sold
on the Mirror Sites. Currently, taxes are not collected with
respect to products sold on the Mirror Sites except in certain
states.

Amounts relating to the Company-owned and
-operated Borders.com web site prior to August 2001, other than
intercompany interest expense (net of related taxes), have been
classified in the Borders segment for all periods presented.
Intercompany interest charges (net of related taxes) relating to
Borders.com have been included in the other segment.

Also in 2002, Borders entered into an agreement
with Amazon to allow customers ordering certain book, music and
movie products through certain of Amazons web sites to
purchase and pick up their merchandise at Borders stores in the
United States (Express In-Store Pick Up). Under this
agreement, the Company is the merchant of record for all sales
made through this service, and determines all prices and other
terms and conditions applicable to such sales. The Company
fulfills all products sold through Express In-Store Pick Up. In
addition, the Company assumes all risk, cost and responsibility
related to the sale and fulfillment of all products sold. The
Company recognizes revenue upon customers pick up of the
merchandise at the store, and classifies this revenue as a

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component of Sales in the
Companys consolidated statements of operations. The
Company also pays referral fees to Amazon pursuant to this
agreement. This service was offered to customers beginning
November 27, 2002.


The Companys fiscal year ends on the Sunday
immediately preceding the last Wednesday in January.
Fiscal 2002 consisted of 52 weeks and ended
January 26, 2003. Fiscal 2001 consisted of
52 weeks and ended January 27, 2002. Fiscal 2000
consisted of 53 weeks and ended January 28, 2001.
References herein to years are to the Companys fiscal
years.

Results of Operations

The following table presents the Companys
consolidated statements of operations data, as a percentage of
sales, for the three most recent fiscal years.

|                                                  |                                      |          |       |       |          |  |       |          |  |  |       |       | 
|------------------------------------------------- | ------------------------------------ | -------- | ----- | ----- | -------- |  | ----- | -------- |  |  | ----- | ----- | 
|                                                  |                                      | Jan. 26, |       |       | Jan. 27, |  |       | Jan. 28, | 
|                                                  |                                      | 2003     |       |       | 2002     |  |       | 2001     | 
|                                                  |                                      |          |       |       |          |  |       |          | 
|Sales                                             |                                      |          | 100.0 | %     |          |  | 100.0 | %        |  |  | 100.0 | %    
|Other revenue                                     |                                      |          | 0.8   |       |          |  | 0.7   |          |  |  | 0.8   |      
|                                                  |                                      |          |       |       |          |  |       |          | 
|                                                  | Total revenue                        |          |       | 100.8 |          |  |       | 100.7    |  |  |       | 100.8 | 
|Cost of merchandise sold (includes occupancy)     |                                      |          | 73.1  |       |          |  | 72.7  |          |  |  | 72.8  |      
|Fulfillment center and other inventory writedowns |                                      |          | 0.1   |       |          |  | 0.3   |          |  |  |      |      
|                                                  |                                      |          |       |       |          |  |       |          | 
|                                                  | Gross margin                         |          |       | 27.6  |          |  |       | 27.7     |  |  |       | 28.0  | 
|Selling, general and administrative expenses      |                                      |          | 21.4  |       |          |  | 22.0  |          |  |  | 22.5  |      
|Legal settlement expense                          |                                      |          |      |       |          |  | 0.1   |          |  |  |      |      
|Pre-opening expense                               |                                      |          | 0.2   |       |          |  | 0.2   |          |  |  | 0.2   |      
|Asset impairments and other writedowns            |                                      |          | 0.4   |       |          |  | 0.7   |          |  |  | 1.1   |      
|Goodwill amortization                             |                                      |          |      |       |          |  | 0.1   |          |  |  | 0.1   |      
|                                                  |                                      |          |       |       |          |  |       |          | 
|                                                  | Operating income                     |          |       | 5.6   |          |  |       | 4.6      |  |  |       | 4.1   | 
|Interest expense                                  |                                      |          | 0.4   |       |          |  | 0.4   |          |  |  | 0.4   |      
|                                                  |                                      |          |       |       |          |  |       |          | 
|                                                  | Income before income tax             |          |       | 5.2   |          |  |       | 4.2      |  |  |       | 3.7   | 
|Income tax                                        |                                      |          | 2.0   |       |          |  | 1.6   |          |  |  | 1.4   |      
|                                                  |                                      |          |       |       |          |  |       |          | 
|                                                  | Income from continuing operations    |          |       | 3.2   |          |  |       | 2.6      |  |  |       | 2.3   | 
|Discontinued operations, net of tax:              |                                      |          |       |       |          |  |       |          |  |  |       |      
|                                                  | Loss from operations of All Wound Up |          |       |      |          |  |       |         |  |  |       | 0.4   | 
|                                                  | Loss on disposition of All Wound Up  |          |       |      |          |  |       |         |  |  |       | 0.6   | 
|                                                  |                                      |          |       |       |          |  |       |          | 
|Net income                                        |                                      |          | 3.2   | %     |          |  | 2.6   | %        |  |  | 1.3   | %    
|                                                  |                                      |          |       |       |          |  |       |          | 

Consolidated Results  Comparison
of 2002 to 2001

Sales

Consolidated sales increased $98.2 million,
or 2.9%, to $3,486.1 million in 2002 from
$3,387.9 million in 2001. This resulted primarily from
increased sales in the Borders and international segments due to
the opening of new superstores, partially offset by a decrease
in Borders comparable store sales. A decrease in sales of
the Waldenbooks segment also partially offset the increase in
consolidated sales, due primarily to store closures and a
decrease in comparable store sales. See Segment
Results for a detailed discussion of the change in sales.

Other revenue

Other revenue consists primarily of membership
income from Waldenbooks Preferred Reader Program.

Waldenbooks sells memberships in its Preferred
Reader Program, which offers members discounts on purchases and
other benefits. The Company recognizes membership income on a
straight-line basis over the 12-month term of the membership,
and categorizes the income as Other revenue in the
Companys consolidated statements of

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operations. Discounts on purchases are netted
against Sales in the Companys consolidated
statements of operations.


The Company had previously categorized membership
income as an offset to Cost of merchandise sold in
the Companys consolidated statements of operations, but
has determined that categorization as Other revenue
is more appropriate. Accordingly, membership income has been
reclassified for all periods presented.

Gross margin

Consolidated gross margin increased
$22.3 million, or 2.4%, to $960.9 million in 2002 from
$938.6 million in 2001. As a percentage of sales,
consolidated gross margin decreased by 0.1%, to 27.6% in 2002
from 27.7% in 2001. Gross margin in 2001 was negatively impacted
by an $8.7 million charge taken by the Borders segment for
the writedown of inventory affected by the Companys
agreement with Ingram Book Company (Ingram). On
March 15, 2001, the Company announced an agreement with
Ingram, a wholesaler of books, spoken audio and magazines,
pursuant to which Ingram provides fulfillment services for the
Companys special order book sales. The agreement included
the sale to Ingram of a large percentage of the book inventory
housed in the Companys fulfillment center in LaVergne,
Tennessee, which handled the function assumed by Ingram.
Excluding this charge, 2002 gross margin as a percentage of
sales decreased approximately 0.3% as compared to 2001,
primarily resulting from decreased gross margin percentages in
the Borders, Waldenbooks, and international segments. This was
primarily due to all segments incurring higher occupancy costs
as a percentage of sales. In the Borders and Waldenbooks
segments, this was primarily due to occupancy costs for stores
open more than one year remaining essentially flat while
comparable store sales declined.

The Company classifies the following items as
Cost of merchandise sold on its consolidated
statements of operations: product costs and related discounts,
markdowns, freight, shrinkage, capitalized inventory costs,
distribution center costs (including payroll, rent, supplies,
depreciation, and other operating expenses), and store occupancy
costs (including rent, common area maintenance, depreciation,
repairs and maintenance, taxes, insurance, and others). The
Companys gross margin may not be comparable to that of
other retailers, since some retailers exclude items such as
their distribution and occupancy costs from cost of sales and
include them in other financial statement lines.

Selling, general and administrative
expenses

Consolidated selling, general and administrative
expenses (SG&A) increased $0.4 million, or 0.1%, to
$745.2 million in 2002 from $744.8 million in 2001. As
a percentage of sales, however, it decreased 0.6% to 21.4% in
2002 from 22.0% in 2001. This decrease primarily resulted from a
decrease in SG&A expenses as a percentage of sales for the
Borders segment (and to a lesser extent the international
segment), while the Waldenbooks percentage remained flat. The
improvement at Borders was primarily the result of a reduction
in Borders.com operating expenses in 2002 in conjunction with
the Mirror Site agreement with Amazon, coupled with a decrease
in store operating expenses as a percentage of sales due to
disciplined cost controls at the store level. The improvement in
the international segment was primarily the result of store and
administrative payroll costs, along with the store operating
expenses, increasing at rates less than the sales growth.

The Company classifies the following items as
Selling, general and administrative expenses on its
consolidated statements of operations: store and administrative
payroll, utilities, supplies and equipment costs, credit card
and bank processing fees, bad debt, legal and consulting fees,
advertising, referral fee income and other.

Legal settlement expense

In March 1998, the American Booksellers
Association and 26 independent bookstores filed a lawsuit in the
United States District Court for the Northern District of
California against the Company and Barnes & Noble, Inc.
alleging violations of the Robinson-Patman Act, the California
Unfair Trade Practice Act, and the California Unfair Competition
Act. On April 19, 2001, the Company announced that a
settlement had been reached in this action. The Company paid
$2.4 million under the agreement in 2001.

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Goodwill amortization

In the first quarter of 2002, the Company adopted
Statement of Financial Accounting Standards No. 142,
Goodwill and Other Intangible Assets (FAS 142).
Adoption had the impact of eliminating the Companys
goodwill amortization and increasing net income by approximately
$2.8 million in 2002. In 2001, the Company recorded
$2.7 million of goodwill amortization. Upon initial
application of FAS 142, and at the annual testing date for
2002, the Company determined no goodwill impairment existed.

Asset impairments and other
writedowns

In 2002, the Company recorded a
$14.0 million fourth quarter charge related to the
impairment of certain long-lived assets (primarily leasehold
improvements, furniture, and fixtures), of certain Borders,
Waldenbooks and Books etc. stores. In addition, the Company
adopted a plan to close certain underperforming Waldenbooks
stores and a Books etc. store and recorded a fourth quarter
$0.9 million charge for the closing costs of those stores.

In 2001, the Company recorded a
$25.4 million charge for asset impairments and other
writedowns. The aforementioned agreement with Ingram in
March 2001 resulted in a first quarter 2001 charge of
approximately $16.0 million, primarily related to the
writedown of assets used by the Company-owned facility to
fulfill special order sales, including warehouse equipment,
hardware and software. The Company also took a fourth quarter
2001 charge of $6.9 million primarily related to the
impairment of the leasehold improvements and furniture and
fixtures of underperforming Waldenbooks stores. In addition, the
Company adopted a plan to close certain underperforming
Waldenbooks stores and recorded a fourth quarter 2001
$2.5 million charge for the closing costs of those stores.

Interest expense

Consolidated interest expense decreased
$1.8 million, or 12.5%, to $12.6 million in 2002 from
$14.4 million in 2001. This was primarily due to lower
average debt levels in the first half of 2002 as compared to the
first half of 2001, which primarily resulted from increased cash
flow generated by the Borders segment.

Taxes

The effective tax rate for the years presented
differed from the federal statutory rate primarily as a result
of state income taxes. The Companys effective tax rate
used was 38.4% in 2002 compared to 38.7% in 2001. The decrease
is primarily due to the elimination of goodwill amortization
which is not deductible for tax purposes.

Net income

Due to the factors mentioned above, net income as
a percentage of sales increased to 3.2% in 2002 from 2.6% in
2001, and net income dollars increased to $111.7 million in
2002 from $87.4 million in 2001.

Consolidated Results  Comparison
of 2001 to 2000

Sales

Consolidated sales increased $116.7 million,
or 3.6%, to $3,387.9 million in 2001 from
$3,271.2 million in 2000. This resulted primarily from
increased sales in the Borders and international segments due to
the opening of new superstores and an increase in comparable
store sales. A decrease in sales of the Waldenbooks segment
partially offset the increase in consolidated sales, due
primarily to store closures and a decrease in comparable store
sales. See Segment Results for a detailed discussion
of the change in sales.

Other revenue

Other revenue consists primarily of membership
income from Waldenbooks Preferred Reader Program.

Gross margin

Consolidated gross margin increased
$21.9 million, or 2.4%, to $938.6 million in 2001 from
$916.7 million in 2000. As a percentage of sales, however,
it decreased to 27.7% in 2001 from 28.0% in 2000. This decrease
primarily

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resulted from an $8.7 million charge taken
in 2001 for the writedown of inventory affected by the
Companys agreement with Ingram, as previously discussed.
Excluding this charge, gross margin as a percentage of sales
remained essentially flat in 2001 with 2000. This was the result
of an increase in gross margin as a percentage of sales at the
Waldenbooks segment offsetting a slight decrease at the Borders
segment.


Selling, general and administrative
expenses

Consolidated SG&A increased
$8.6 million, or 1.2%, to $744.8 million in 2001 from
$736.2 million in 2000. As a percentage of sales, however,
it decreased to 22.0% in 2001 from 22.5% in 2000. This decrease
primarily resulted from a decrease in SG&A expenses as a
percentage of sales for the Borders segment (and to a lesser
extent, the international segment), partially offset by an
increase at the Waldenbooks segment. The improvement at Borders
was primarily the result of decreased store payroll costs as a
percentage of sales due to the restructuring of Borders store
personnel, coupled with a reduction in Borders.com operating
expenses in conjunction with the Mirror Site agreement with
Amazon. Waldenbooks experienced higher store payroll and
operating costs as a percentage of sales as these costs
decreased at rates less than Waldenbooks negative
comparable store sales rate.

Goodwill amortization

In 2001 and 2000, the Company used the
straight-line method for amortizing goodwill, and recorded
$2.7 million and $2.8 million of amortization in 2001
and 2000, respectively.

Asset impairments and other
writedowns

In 2001, the Company recorded a
$25.4 million charge for asset impairments and other
writedowns. The aforementioned agreement with Ingram in
March 2001 resulted in a first quarter 2001 charge of
approximately $16.0 million, primarily related to the
writedown of assets used by the Company-owned facility to
fulfill special order sales, including warehouse equipment,
hardware, and software. The Company also took a fourth quarter
2001 charge of $6.9 million primarily related to the
impairment of the leasehold improvements and furniture and
fixtures of underperforming Waldenbooks stores. In addition, the
Company adopted a plan to close certain underperforming
Waldenbooks stores and recorded a fourth quarter 2001
$2.5 million charge for the closing costs of those stores.

In 2000, the Company took a charge of
$36.2 million related to the impairment of certain
long-lived assets and other writedowns. The charge taken in 2000
primarily consisted of $17.7 million for computer hardware
and software of Borders.com and $12.5 million for leasehold
improvements and furniture and fixtures primarily related to
underperforming Waldenbooks stores. The remainder of the charge
related to employee severance, the costs of certain lease
obligations for redundant headquarter buildings, and the
writeoff of certain equity investments.

Interest expense

Consolidated interest expense increased
$1.3 million, or 9.9%, to $14.4 million in 2001 from
$13.1 million in 2000.

Taxes

The effective tax rate for the years presented
differed from the federal statutory rate primarily as a result
of state income taxes. The Companys effective tax rate was
38.7% in 2001 compared to 39.4% in 2000. The decrease is
primarily due to changes in the mix of income subject to tax in
the various taxing jurisdictions.

Discontinued operations

In January 2001, the Company adopted a plan
to discontinue operations of All Wound Up, a seasonal retailer
of interactive toys and novelty merchandise the Company had
acquired in March 1999. The discontinuance and closure of
All Wound Up resulted in an after-tax charge of
$19.4 million in the fourth quarter of 2000 and is
reflected in the consolidated statements of operations as a
discontinued operation. The charge was substantially non-cash
and related primarily to the writeoff of goodwill, inventory and
fixed assets. Operations of All Wound Up were substantially
discontinued in February 2001. A small percentage of All
Wound Ups stores (representing six of a total

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of 162 stores) remained open beyond
February 2001, and closed at various dates thereafter until
all were closed by the end of May 2001. The six stores that
continued operating experienced only de minimus sales activity
between February 2001 and May 2001.


Net income

Due to the factors mentioned above, net income as
a percentage of sales increased to 2.6% in 2001 from 1.3% in
2000, and net income dollars increased to $87.4 million in
2001 from $43.6 million in 2000.

Segment Results

The Company is organized based upon the following
operating segments: domestic Borders stores, Waldenbooks stores,
international Borders and Books etc. stores, and other
(consisting of interest expense, certain corporate governance
costs, and corporate incentive costs). Amounts relating to the
Company-owned and -operated Borders.com web site, other than
intercompany interest expense (net of related taxes), have been
classified in the Borders segment for all periods presented.
Intercompany interest charges (net of related taxes) relating to
Borders.com have been included in the other segment. See
Note 16  Segment Information in the
notes to consolidated financial statements for further
information relating to these segments.

Segment data includes charges allocating all
corporate headquarters costs to each segment. Interest income
and expense are allocated to segments based upon the funding
required to meet the operational needs of those segments. The
Company utilizes fixed interest rates, approximating the
Companys medium-term borrowing and investing rates, in
calculating segment interest income and expense.

|                                      |  |      |         |   |      |   |         |      |  |   |         |  
|------------------------------------- |  | ---- | ------- | - | ---- | - | ------- | ---- |  | - | ------- | -
|Borders                               |  | 2002 |         |   | 2001 |   |         | 2000 | 
|                                      |  |      |         |   |      |   |         |      | 
|(dollar amounts in millions)          |  |      |         |   |      |   |         |      |  |   |         |  
|Sales                                 |  | $    | 2,319.0 |   |      | $ | 2,234.1 |      |  | $ | 2,107.7 |  
|Net income                            |  | $    | 102.5   |   |      | $ | 72.1    |      |  | $ | 56.5    |  
|Net income as % of sales              |  |      | 4.4     | % |      |   | 3.2     | %    |  |   | 2.7     | %
|Depreciation and amortization expense |  | $    | 66.7    |   |      | $ | 65.4    |      |  | $ | 60.7    |  
|Interest expense                      |  | $    | 2.5     |   |      | $ | 9.1     |      |  | $ | 12.8    |  
|Store openings                        |  |      | 41      |   |      |   | 29      |      |  |   | 44      |  
|Store closings                        |  |      |        |   |      |   | 1       |      |  |   |        |  
|Store count                           |  |      | 404     |   |      |   | 363     |      |  |   | 335     |  

Comparison of 2002 to 2001

Sales

Borders sales increased $84.9 million,
or 3.8%, to $2,319.0 million in 2002 from
$2,234.1 million in 2001. This increase was comprised of
non-comparable sales primarily associated with 2002 and 2001
store openings of $129.5 million, comparable store sales
decreases of $35.7 million, and decreased Borders.com sales
of $8.9 million (due to the Mirror Site agreement with
Amazon).

Comparable store sales decreased 1.2% in 2002.
Borders comparable store sales measures, which are based
upon a 52-week year, include all stores open more than one year
except those not offering music (of which there are 14,
representing approximately 3% of total sales). New stores are
included in the calculation of comparable store sales measures
upon the 13th month of operation. The comparable store
sales decrease for 2002 was due primarily to the music category,
which experienced negative comparable store sales. Among other
factors, this was primarily the result of fewer high-impact new
releases in the current year as compared to the prior year. Also
impacting the overall decrease was a comparable sales decrease
in the book category, which also suffered from fewer significant
new releases in 2002 as compared to 2001. Partially offsetting
the weakness in the music and book categories, however, were
increased comparable store sales in the movie and gifts and
stationery categories. Sales of the movie category improved on a
comparable store basis primarily as the result of increased
sales of DVDs. This increase resulted from the increasing
popularity of the DVD format. Sales of the gifts and stationery
category also increased, principally the result of category
management initiatives resulting in product enhancements,
improved placements,

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and a slight increase in space allocation.
However, the overall mix of book, music, movie, cafe, and gifts
and stationery merchandise sold by Borders stores did not change
significantly in 2002 as compared to 2001. The impact of price
changes on comparable store sales was not significant.


Gross margin

Gross margin as a percentage of sales decreased
approximately 0.1% in 2002 compared to 2001. Gross margin in
2001 was negatively impacted by an $8.7 million charge
taken for the writedown of inventory affected by the
Companys agreement with Ingram. Excluding this charge,
2002 gross margin as a percentage of sales decreased
approximately 0.3%, primarily due to higher store occupancy
costs as a percentage of sales. Store occupancy costs as a
percentage of sales increased 0.5% in 2002 compared to 2001
primarily as a result of the stores rent expense
representing a higher percentage of sales. This was primarily
due to rent expense for stores open more than one year remaining
essentially flat while comparable store sales declined. In
addition, new stores rent costs represented a higher
percentage of sales due to the permanent refinancing in 2002 of
certain stores previously financed through the Original Lease
Facility, as discussed below. Partially offsetting the increase
in store occupancy costs were decreases in product costs of 0.1%
and distribution costs of 0.1%.

Gross margin dollars increased approximately 2.3%
in 2002 primarily due to new store openings and the
$8.7 million charge taken in 2001 for the writedown of
inventory affected by the Companys agreement with Ingram.
Partially offsetting these factors were increased store
occupancy costs associated with new store openings.

Selling general and administrative

SG&A as a percentage of sales improved 0.8%
in 2002 compared to 2001. Of this, 0.4% was primarily due to a
reduction in Borders.com operating expenses in 2002 in
conjunction with the Mirror Site agreement with Amazon. The
remaining improvement was primarily due to a decrease of 0.3% in
store operating expenses as a percentage of sales due to
disciplined cost controls at the store level and a 0.1% increase
in advertising income as a percentage of sales.

SG&A dollars remained flat from 2002 to 2001
despite increased store payroll expenses resulting from new
store openings, primarily due to disciplined store operating
expense controls and the reduction in Borders.com operating
expenses in 2002 in conjunction with the Mirror Site agreement
with Amazon.

Asset impairments and other
writedowns

In 2002, the Company recorded a $2.9 million
writedown related to the impairment of assets at certain
underperforming Borders stores.

In addition to the writedown of inventory in 2001
discussed above, the Companys agreement with Ingram in
March 2001 resulted in a $16.0 million charge in 2001
primarily related to the writedown of assets used by the
Company-owned facility to fulfill special order sales, including
computer hardware and software, leasehold improvements and
warehouse equipment.

Depreciation and amortization

Depreciation and amortization expense increased
$1.3 million, or 2.0%, to $66.7 million in 2002 from
$65.4 million in 2001. This was primarily the result of
increased depreciation expense recognized on new stores
capital expenditures, partially offset by the cessation of
goodwill amortization pursuant to the Companys adoption of
FAS 142 in 2002.

Interest expense

Interest expense decreased $6.6 million, or
72.5%, to $2.5 million in 2002 from $9.1 million in
2001. This was due to the generation of increased cash flow,
which reduced average borrowing levels at fixed internal
interest rates.

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Net income

Due to the factors mentioned above, net income as
a percentage of sales increased to 4.4% in 2002 from 3.2% in
2001, and net income dollars increased to $102.5 million in
2002 from $72.1 million in 2001.

Effect of terrorist attacks on
September 11, 2001

As a result of the terrorist attacks on
September 11, 2001, a Borders store that operated in the
World Trade Center in New York City was destroyed. The loss of
that stores sales and net income was not material to the
consolidated 2002 or 2001 results as a whole. The Company was
insured for the replacement value of the assets destroyed at the
store and up to 24 months of lost income from business
interruption coverage and has recognized a total recovery of
$15.9 million to date.

During 2002, the Company recognized a
$2.9 million gain from insurance proceeds related to the
terrorist attacks on September 11, 2001. Of this,
$1.2 million represented business interruption proceeds for
2002. This was categorized as Cost of merchandise
sold in the consolidated statements of operations, because
the stores lost income would primarily have been
categorized as Gross margin in the consolidated
statements of operations. The remaining $1.7 million gain
was categorized as an offset to Selling, general and
administrative expenses. This amount primarily represented
the excess of lost assets replacement value over their net
book value. It is the Companys policy to record gains and
losses on asset disposals as part of Selling, general and
administrative expenses.

During 2001, net asset values of
$8.0 million (net of straight-line rent reserves of
$2.0 million) were written off against the allocated
property insurance proceeds of $11.0 million. Gains were
categorized in the consolidated statements of operations as
follows: $1.0 million in Selling, general and
administrative and $2.0 million in Cost of
merchandise sold. In addition, $2.0 million of
business interruption proceeds were recorded in Cost of
merchandise sold to offset otherwise lost profits from the
store.

The Company expects to recover additional
insurance amounts, up to a maximum of approximately
$4.0 million, based upon, among other things, capital
expenditures in replacement stores and the performance of such
stores, which will be recognized when collection of such
additional recoveries is assured.

Comparison of 2001 to 2000

Sales

Borders sales increased
$126.4 million, or 6.0%, to $2,234.1 million in 2001
from $2,107.7 million in 2000. This increase was comprised
of non-comparable sales associated with 2001 and 2000 store
openings of $145.7 million, comparable store sales
increases of $29.6 million, decreased Borders.com sales of
$18.5 million (primarily due to the Mirror Site agreement
with Amazon), and decreased 2001 sales resulting from one less
week in fiscal 2001 than 2000 of $30.4 million.

Comparable store sales increased 2.0% in 2001.
The comparable store sales increase for 2001 was due primarily
to strength in the movie and gifts and stationary categories.
Sales of the movie category improved on a comparable basis
primarily as the result of increased sales of DVDs. This
increase, which was slightly offset by a decrease in videotape
sales, resulted from the increasing popularity of the DVD
format. Sales of the gifts and stationary category also
increased, principally the result of category management
initiatives resulting in product enhancements, improved
placements, and a slight increase in space allocation. Book
sales, on a comparable store basis, increased slightly. The
overall mix of book, music, movie, café, and gifts and
stationary merchandise sold by Borders stores did not change
significantly in 2001 as compared to 2000, but the movie
category experienced an increase in the percentage of DVDs sold
relative to videotapes as discussed above. The impact of price
changes on comparable store sales was not significant.

Gross margin

Gross margin as a percentage of sales decreased
approximately 0.5% in 2001 compared to 2000. As discussed
previously, this was primarily the result of an
$8.7 million charge taken in 2001 for the writedown of
inventory

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affected by the Companys agreement with
Ingram. Excluding this charge, 2001 gross margin as a percentage
of sales decreased 0.1%, primarily the result of higher store
occupancy costs as a percentage of sales and the change in the
sales mix to DVDs. Store occupancy costs as a percentage of
sales increased in 2001 compared to 2000 primarily as a result
of the stores rent expense representing a higher
percentage of sales. This was due to new stores rent costs
representing a higher percentage of sales and the increased
lease costs related to the permanent refinancing of certain
stores previously financed through the Original Lease Facility.
Because of lower gross margins on DVDs as compared to those on
videotapes, the increased sales of DVDs also negatively impacted
overall gross margin, although to a lesser extent than store
occupancy costs.


Gross margin dollars increased approximately 4.0%
in 2001 primarily due to new store openings, partially offset by
the $8.7 million charge taken for the writedown of
inventory affected by the Companys agreement with Ingram.

Selling, general and administrative
expenses

SG&A as a percentage of sales decreased
approximately 1.0% in 2001 compared to 2000. Approximately half
of this decrease was the result of lower store payroll expenses
as a percentage of sales, which was achieved by a restructuring
of store personnel. The remaining improvement in SG&A
expenses as a percentage of sales was primarily due to a
reduction in Borders.com operating expenses in conjunction with
the Mirror Site agreement with Amazon.

SG&A dollars increased approximately 1.3% in
2001 primarily due to new store openings and the increased store
payroll and operating expenses required.

Asset impairments and other
writedowns

In 2001, the Company incurred approximately
$16.0 million of asset writedowns resulting from the March
2001 agreement with Ingram, as previously discussed. In 2000,
the Company recorded a $17.7 million asset impairment
charge related to the computer hardware and software of
Borders.com.

Depreciation and amortization

Depreciation and amortization expense increased
$4.7 million, or 7.7%, to $65.4 million in 2001 from
$60.7 million in 2000. This was the result of depreciation
expense recognized on new stores capital expenditures.

Interest expense

Interest expense decreased $3.7 million, or
28.9%, to $9.1 million in 2001 from $12.8 million in
2000. This was due to lower average borrowing levels at fixed
internal interest rates.

Net income

Due to the factors mentioned above, net income as
a percentage of sales increased to 3.2% in 2001 from 2.7% in
2000, and net income dollars increased $15.6 million, or
27.6%, to $72.1 million in 2001 from $56.5 million in
2000.

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|                             |  |      |       |   |      |   |       |      |  |   |       |  
|---------------------------- |  | ---- | ----- | - | ---- | - | ----- | ---- |  | - | ----- | -
|Waldenbooks                  |  | 2002 |       |   | 2001 |   |       | 2000 | 
|                             |  |      |       |   |      |   |       |      | 
|(dollar amounts in millions) |  |      |       |   |      |   |       |      |  |   |       |  
|Sales                        |  | $    | 852.2 |   |      | $ | 902.1 |      |  | $ | 944.3 |  
|Other revenue                |  | $    | 25.0  |   |      | $ | 25.3  |      |  | $ | 25.9  |  
|Net income                   |  | $    | 41.4  |   |      | $ | 39.5  |      |  | $ | 40.2  |  
|Net income as % of sales     |  |      | 4.9   | % |      |   | 4.4   | %    |  |   | 4.3   | %
|Depreciation expense         |  | $    | 20.7  |   |      | $ | 21.4  |      |  | $ | 25.8  |  
|Interest income              |  | $    | 33.5  |   |      | $ | 28.3  |      |  | $ | 26.2  |  
|Store openings               |  |      | 4     |   |      |   | 11    |      |  |   | 11    |  
|Store closings               |  |      | 53    |   |      |   | 53    |      |  |   | 46    |  
|Store count                  |  |      | 778   |   |      |   | 827   |      |  |   | 869   |  

Comparison of 2002 to 2001

Sales

Waldenbooks sales decreased
$49.9 million, or 5.5%, to $852.2 million in 2002 from
$902.1 million in 2001. This decrease was comprised of
decreased comparable store sales of $20.7 million and
decreased non-comparable sales associated with 2002 and 2001
store closings of $29.2 million.

Comparable store sales decreased 3.2% in 2002.
Waldenbooks comparable store sales measures, which are
based upon a 52-week year, include all stores open more than
one year. New stores are included in the calculation of
comparable store sales measures upon the 13th month of
operation. The Companys seasonal mall-based kiosks are
also included in Waldenbooks comparable store sales
measures. The comparable store sales decrease for 2002 was due
primarily to decreased mall traffic and the impact of superstore
openings. These factors were partially offset by seasonal kiosk
sales, which increased 14.1% over the prior year, primarily due
to an increased number of kiosks and to improved execution of
the Companys kiosk strategy. This also slightly increased
the calendar categorys percentage of Waldenbooks
overall merchandise mix relative to the book and sideline
categories. Overall, however, the merchandise mix did not change
significantly in 2002 as compared to 2001, nor was the impact of
price changes on comparable store sales significant.

Other revenue

Waldenbooks other revenue, which consists
of membership income from the Preferred Reader Program, remained
essentially flat in 2002 at $25.0 million as compared to
$25.3 million in 2001.

Gross margin

Gross margin as a percentage of sales decreased
approximately 0.2% in 2002 as compared to 2001. Contributing to
this decrease was a 0.7% increase in store occupancy expenses as
a percentage of sales, due primarily to rent expense for stores
remaining open more than one year remaining essentially flat
while comparable stores sales declined. This was partially
offset by lower product costs of 0.2%, resulting primarily from
the increased sales of calendars, which offered higher gross
margin percentages than other categories. In addition,
distribution and other costs as a percentage of sales improved
0.3%.

Gross margin dollars decreased approximately 6.2%
in 2002, primarily due to store closings, the decrease in
comparable store sales, and the decrease in gross margin
percentage.

Selling, general and administrative
expenses

SG&A as a percentage of sales remained flat
in 2002 compared to 2001. This was primarily due to increased
store payroll costs of 0.6% and increased store operating
expenses of 0.1% as a percentage of sales, offset by decreased
corporate non-payroll costs of 0.6% and increased vendor
advertising income of 0.1% as a percentage of sales.

SG&A dollars decreased approximately 6.8% in
2002 primarily due to store closings.

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Asset impairments and other
writedowns

In 2002, the Company incurred approximately
$8.2 million of asset impairment charges related to
underperforming Waldenbooks stores. In addition, the Company
adopted a plan in 2002 to close certain Waldenbooks stores and
recorded a $0.8 million charge in 2002 for the related
closing costs.

In 2001, the Company incurred approximately
$6.9 million of asset impairment charges related to
underperforming Waldenbooks stores. In addition, the Company
adopted a plan in 2001 to close certain Waldenbooks stores and
recorded a $2.5 million charge for the related closing
costs.

Depreciation

Depreciation expense decreased $0.7 million,
or 3.3%, to $20.7 million in 2002 from $21.4 million
in 2001. This was primarily due to a lower fixed asset base
resulting from asset impairments and store closings.

Interest income

Interest income increased $5.2 million, or
18.4% to $33.5 million in 2002 from $28.3 million in
2001. This was the result of Waldenbooks continued
positive cash flow at fixed internal interest rates.

Net income

Due to the factors mentioned above, net income as
a percentage of sales increased to 4.9% in 2002 from 4.4% in
2001, while net income dollars increased $1.9 million, or
4.8%, to $41.4 million in 2002 from $39.5 million in
2001.

Comparison of 2001 to 2000

Sales

Waldenbooks sales decreased
$42.2 million, or 4.5%, to $902.1 million in 2001 from
$944.3 million in 2000. This decrease was comprised of
comparable store sales decreases of $14.3 million,
decreased non-comparable sales associated with 2001 and 2000
store closings of $13.7 million, and decreased 2001 sales
resulting from one less week in fiscal 2001 than 2000 of
$14.2 million.

Comparable store sales decreased 1.6% in 2001.
The comparable store sales decrease for 2001 was due primarily
to decreased mall traffic and the impact of superstore openings.
These factors were partially offset by Waldenbooks
seasonal calendar kiosk sales, which increased 15.0% over the
prior year, primarily due to an increased number of kiosks and
to improved execution of the Companys kiosk strategy. This
also slightly increased the calendar categorys percentage
of Waldenbooks overall merchandise mix relative to the
book and sideline categories. Overall, however, the merchandise
mix did not change significantly in 2001 as compared to 2000,
nor was the impact of price changes on comparable store sales
significant.

Other revenue

Waldenbooks other revenue, which consists
of membership income from the Preferred Reader Program, remained
relatively flat in 2001 at $25.3 million as compared to
$25.9 million in 2000.

Gross margin

Gross margin as a percentage of sales increased
approximately 0.3% in 2001 as compared to 2000. This increase
was due primarily to increased sales of calendars, which offered
higher gross margin percentages than those of the other
categories Waldenbooks carries. This, along with several other
less significant factors, represented approximately 0.5% of the
gross margin improvement as a percentage of sales.
Waldenbooks gross margin percentage was also positively
impacted by a decrease in distribution costs as a percentage of
sales due to Borders increased usage of Waldenbooks
distribution facilities (coupled with a corresponding decrease
in Waldenbooks usage). This represented an additional 0.4%
gross margin percentage improvement. These factors were
partially offset by higher store occupancy costs as a percentage
of sales, primarily the result of the stores straight-line
rent

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expenses having remained essentially flat while
comparable stores sales declined. This negatively impacted the
gross margin percentage by approximately 0.6%.


Gross margin dollars decreased approximately 3.5%
in 2001, primarily due to store closings and the decrease in
comparable store sales.

Selling, general and administrative
expenses

SG&A as a percentage of sales increased
approximately 0.7% in 2001 compared to 2000. This was the result
of store payroll costs and other store operating expenses
decreasing at rates less than Waldenbooks negative
comparable store sales rate.

SG&A dollars decreased approximately 1.1% in
2001 primarily due to store closings.

Asset impairments and other
writedowns

In 2001, the Company incurred approximately
$6.9 million of asset impairment charges related to
underperforming Waldenbooks stores. In addition, the Company
adopted a plan in 2001 to close certain Waldenbooks stores and
recorded a $2.5 million charge for the related closing
costs.

In 2000, the Company recorded a
$12.5 million asset impairment charge related to
underperforming stores.

Depreciation

Depreciation expense decreased $4.4 million,
or 17.1%, to $21.4 million in 2001 from $25.8 million
in 2000. This was primarily due to a lower fixed asset base
resulting from asset impairments and store closings.

Interest income

Interest income increased $2.1 million, or
8.0%, to $28.3 million in 2001 from $26.2 million in
2000. This was a result of Waldenbooks continued positive
cash flow at fixed internal interest rates.

Net income

Due to the factors mentioned above, net income as
a percentage of sales increased to 4.4% in 2001 from 4.3% in
2000, while net income dollars decreased $0.7 million, or
1.7%, to $39.5 million in 2001 from $40.2 million in
2000.

|                                      |  |      |       |   |      |   |       |      |  |   |       |  
|------------------------------------- |  | ---- | ----- | - | ---- | - | ----- | ---- |  | - | ----- | -
|International                         |  | 2002 |       |   | 2001 |   |       | 2000 | 
|                                      |  |      |       |   |      |   |       |      | 
|(dollar amounts in millions)          |  |      |       |   |      |   |       |      |  |   |       |  
|Sales                                 |  | $    | 314.9 |   |      | $ | 251.7 |      |  | $ | 219.2 |  
|Net loss                              |  | $    | 12.3  |   |      | $ | 7.5   |      |  | $ | 10.2  |  
|Net loss as % of sales                |  |      | 3.9   | % |      |   | 3.0   | %    |  |   | 4.7   | %
|Depreciation and amortization expense |  | $    | 9.7   |   |      | $ | 9.4   |      |  | $ | 8.8   |  
|Interest expense                      |  | $    | 17.2  |   |      | $ | 14.3  |      |  | $ | 12.4  |  
|Superstore store openings             |  |      | 8     |   |      |   | 8     |      |  |   | 5     |  
|Superstore store count                |  |      | 30    |   |      |   | 22    |      |  |   | 14    |  
|Books etc. store openings             |  |      | 1     |   |      |   | 5     |      |  |   | 6     |  
|Books etc. store closings             |  |      |      |   |      |   |      |      |  |   | 2     |  
|Books etc. store count                |  |      | 37    |   |      |   | 36    |      |  |   | 31    |  

Comparison of 2002 to 2001

Sales

International sales increased $63.2 million,
or 25.1%, to $314.9 million in 2002 from
$251.7 million in 2001. This is primarily the result of new
superstore openings. In 2002, the Company opened five
international stores in the United Kingdom and three stores in
Australia. Also contributing to the increase in sales was a
comparable store sales

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increase in 2002. International comparable store
sales measures, which are based upon a 52-week year, include all
stores open more than one year. New stores are included in the
calculation of comparable store sales measures upon the 13th
month of operation.


The overall mix of book, music, movie, cafe, and
sideline merchandise sold by international superstores, and the
mix of books and sidelines offered by Books etc. stores, did not
change significantly in 2002 as compared to 2001. The impact of
price changes on comparable store sales was also not significant.

Gross margin

Gross margin as a percentage of sales decreased
0.8% in 2002 as compared to 2001, primarily the result of a 0.6%
increase in occupancy costs as a percentage of sales. Also
impacting the decrease was a 0.3% increase in merchandise costs
as a percentage of sales. The increase in merchandise costs as a
percentage of sales is primarily due to the Companys
growth of its U.K. operations, which have typically experienced
higher product costs than the international segments other
countries. The Companys U.K. operations represented a
larger percentage of the international segments total
operations in 2002 than in 2001. Occupancy costs increased as a
percentage of sales due to new store openings and
landlord-imposed rent adjustments. Partially offsetting these
factors were improvements of 0.1% in distribution costs as a
percentage of sales.

Gross margin dollars increased approximately
20.6% in 2002 primarily due to new store openings.

Selling, general and administrative
expenses

SG&A as a percentage of sales decreased
approximately 0.5% in 2002 compared to 2001. This improvement
was primarily the result of general and administrative payroll
costs, store payroll costs and store operating expenses
increasing at rates less than sales growth. Although general and
administrative payroll, store payroll and operating expenses
increased in dollars, the increase in sales reduced these
expenses as a percentage of sales.

SG&A dollars increased approximately 22.2% in
2002 primarily due to store openings and the increased store
payroll and operating expenses required.

Asset impairments and other
writedowns

In 2002, the Company incurred approximately
$2.9 million of asset impairment charges related to
underperforming Books etc. stores. In addition, the Company
adopted a plan in 2002 to close a Books etc. store and recorded
a $0.1 million charge for the related closing costs.

Depreciation and amortization

Depreciation and amortization expense increased
$0.3 million, or 3.2%, to $9.7 million in 2002 from
$9.4 million in 2001. This was primarily due to
depreciation expense recognized on new stores capital
expenditures, partially offset by the cessation of goodwill
amortization in 2002.

Interest expense

Interest expense increased $2.9 million, or
20.3%, to $17.2 million in 2002 from $14.3 million in
2001. This was a result of higher average borrowing levels at
fixed internal interest rates.

Net loss

Due to the factors mentioned above, net loss as a
percentage of sales increased to 3.9% in 2002 as compared to
3.0% in 2001, and net loss dollars increased $4.8 million
to $12.3 million in 2002 from $7.5 million in 2001.

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Comparison of 2001 to 2000

Sales

International sales increased $32.5 million,
or 14.8%, to $251.7 million in 2001 from
$219.2 million in 2000. This is primarily the result of new
superstore openings, and to a lesser extent, comparable store
sales increases. In 2001, the Company opened eight international
stores: three stores in the United Kingdom, four stores in
Australia, and the Companys second store in Puerto Rico.

The overall mix of book, music, movie, café,
and sideline merchandise sold by International superstores, and
the mix of books and sidelines offered by Books etc. stores, did
not change significantly in 2001 as compared to 2000. The impact
of price changes on comparable store sales was also not
significant.

Gross margin

Gross margin as a percentage of sales in 2001
remained essentially flat with 2000. A decrease of approximately
0.6% in occupancy costs as a percentage of sales was offset by a
similar increase in merchandise costs as a percentage of sales.
The improvement in occupancy costs as a percentage of sales
resulted primarily from the stores straight-line rent
expenses having remained essentially flat while comparable
stores sales increased. This was offset by increased merchandise
costs as a percentage of sales, primarily the result of the
Company obtaining merchandise from a wholesaler to address
internal distribution capacity limits in the United Kingdom.

Gross margin dollars increased approximately
14.0% in 2001 primarily due to new store openings.

Selling, general and administrative
expenses

SG&A as a percentage of sales decreased
approximately 2.3% in 2001 compared to 2000. Approximately 1.8%
of this improvement was primarily the result of store payroll
costs and store operating expenses increasing at rates less than
sales growth and a decrease in corporate overhead costs.
Although store payroll and operating expenses increased in
dollars, the increase in comparable store sales reduced their
percentage of sales. Corporate overhead expenses also decreased
as a percentage of sales because of the stores sales
growth and decreased spending levels. The remaining 0.5%
improvement in SG&A expenses as a percentage of sales is
primarily related to foreign currency transaction gains of
$0.3 million recognized in 2001, which compared to losses
of $0.8 million in 2000.

SG&A dollars increased approximately 3.6% in
2001 primarily due to store openings and the increased store
payroll and operating expenses required.

Depreciation and amortization

Depreciation and amortization expense increased
$0.6 million, or 6.8%, to $9.4 million in 2001 from
$8.8 million in 2000. This was primarily due to
depreciation expense recognized on new stores capital
expenditures.

Interest expense

Interest expense increased $1.9 million, or
15.3%, to $14.3 million in 2001 from $12.4 million in
2000. This was a result of higher average borrowing levels at
fixed internal interest rates.

Net loss

Due to the factors mentioned above, net loss as a
percentage of sales decreased to 3.0% in 2001 from 4.7% in 2000,
and net loss dollars decreased $2.7 million, or 26.5%, to
$7.5 million in 2001 from $10.2 million in 2000.

|                             |  |      |      |  |      |   |      |      |  |   |      | 
|---------------------------- |  | ---- | ---- |  | ---- | - | ---- | ---- |  | - | ---- | 
|Other                        |  | 2002 |      |  | 2001 |   |      | 2000 | 
|                             |  |      |      |  |      |   |      |      | 
|(dollar amounts in millions) |  |      |      |  |      |   |      |      |  |   |      | 
|Interest expense             |  | $    | 26.4 |  |      | $ | 19.3 |      |  | $ | 14.1 | 
|Net loss                     |  | $    | 19.9 |  |      | $ | 16.7 |      |  | $ | 12.7 | 

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The Other segment includes unallocated interest
expense, various corporate governance costs and corporate
incentive costs.

Comparison of 2002 to 2001

Net loss dollars increased $3.2 million, or
19.2%, to $19.9 million in 2002 from $16.7 million in
2001. This was primarily due to increased interest expense for
this segment primarily resulting from increased corporate stock
repurchases in 2002, partially offset by a reduction in
corporate incentive costs and a reduction in various governance
costs as compared to the prior year. Interest expense represents
corporate-level interest costs not charged to the Companys
other segments.

Comparison of 2001 to 2000

Net loss dollars increased $4.0 million, or
31.5%, to $16.7 million in 2001 from $12.7 million in
2000. This was primarily the result of an increase in the amount
of corporate incentive costs and interest expense. Interest
expense represents corporate-level interest costs not charged to
the Companys other segments.

Liquidity and Capital Resources

The Companys principal capital requirements
are to fund the opening of new stores, the refurbishment and
expansion of existing stores, continued expansion of in-store
web-based commerce technologies, and corporate information
technology streamlining.

Net cash provided by continuing operations was
$189.2 million, $265.0 million, and $152.8 million in
2002, 2001, and 2000, respectively. The current year operating
cash inflows primarily reflect operating results net of non-cash
charges for depreciation and asset impairments and other
writedowns, as well as increases in other long-term assets and
liabilities, taxes payable and deferred income taxes. Operating
cash outflows for the period resulted from increases in accounts
receivable and prepaid expenses, and decreases in accounts
payable and accrued payroll and other liabilities. The most
significant of these was the decrease in accounts payable, which
resulted from reduced purchases of inventory and elevated
returns to vendors in order to better manage inventory levels
within stores. However, inventory net of accounts payable
decreased over the prior year primarily due to supply chain
improvements and strong inventory management.

Net cash used by discontinued operations
represents the cash needed for the operations of All Wound Up in
fiscal 2001 and 2000.

Net cash used for investing in 2002 was
$121.5 million, which primarily funded capital expenditures
for new stores and the refurbishment of existing stores. Capital
expenditures in 2002 reflect the opening of 49 new superstores
and four new Waldenbooks stores. In fiscal 2001 capital
expenditures were $90.7 million, which primarily funded new
stores and the refurbishment of existing stores. Capital
expenditures in 2001 reflect the opening of 37 new superstores
and 11 new Waldenbooks stores. Capital expenditures of
$141.1 million in 2000 primarily reflect the opening of 49
new superstores and 11 new Waldenbooks stores. Additional
capital spending in 2002, 2001 and 2000 reflected the
development and installation of in-store web-based technology
and spending on corporate information technology streamlining.

Net cash provided by financing in 2002 was
$8.4 million, resulting primarily from the issuance of
$50.0 million senior guaranteed notes and the issuance of
common stock under the Companys employee benefit plans,
partially offset by the repurchase of shares. Net cash used for
financing in 2001 was $41.1 million, resulting primarily from
the paydown of the Companys Credit Agreement of
$58.2 million and the repurchase of common stock of
$17.7 million, partially offset by $34.9 million
received from the issuance of common stock under the
Companys employee benefit plans. Net cash provided by
financing in 2000 was $19.5 million, resulting primarily
from net borrowings under the Credit Agreement and the issuance
of common stock under the Companys employee benefit plans.

The Company expects capital expenditures to be
approximately $110.0 million to $120.0 million in
2003, resulting primarily from new domestic superstore openings.
In addition, capital expenditures will result from international
store openings, refurbishment of a number of existing stores,
and investment in information technology streamlining. The

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Company currently plans to open approximately 35
to 40 domestic Borders superstores and six to eight
international stores in 2003. Average cash requirements for the
opening of a prototype Borders Books and Music superstore are
$2.4 million, representing capital expenditures of
$1.1 million, inventory requirements (net of related
accounts payable) of $1.1 million, and $0.2 million of
pre-opening costs. Average cash requirements to open a new or
expanded Waldenbooks store range from $0.4 million to
$0.7 million, depending on the size and format of the
store. The Company plans to lease new store locations
predominantly under operating leases.


The Company plans to execute its expansion plans
for Borders superstores and other strategic initiatives
principally with funds generated from operations and financing
through the Lease Financing Facilities and Credit Agreement. The
Company believes funds generated from operations, borrowings
under the Credit Agreement and financing through the Lease
Financing Facilities will be sufficient to fund its anticipated
capital requirements for the next several years.

The Company currently has a share repurchase
program in place with remaining authorization to repurchase
approximately $22.6 million. During 2002, 2001, and 2000,
$74.8 million, $17.7 million, and $9.2 million of
common stock was repurchased, respectively. The Company plans to
continue the repurchase of its common stock throughout fiscal
2003, subject to the Companys share price and capital
needs.

The Company has a Multicurrency Revolving Credit
Agreement (the Credit Agreement), which will expire
in June 2005. The Credit Agreement provides for borrowings
of up to $400.0 million. Borrowings under the Credit
Agreement bear interest at a variable base rate plus an
increment or LIBOR plus an increment at the Companys
option. The Credit Agreement contains covenants which limit,
among other things, the Companys ability to incur
indebtedness, grant liens, make investments, consolidate or
merge, declare dividends, dispose of assets, repurchase its
common stock in excess of $100.0 million over the term of
the Agreement or $50.0 million in any fiscal year (plus any
proceeds and tax benefits resulting from stock option exercises
and tax benefits resulting from restricted shares purchased by
employees from the Company), and requires the Company to meet
certain financial measures regarding fixed coverage, leverage,
tangible net worth and capital expenditures. As of
January 26, 2003 the Company was in compliance with all
covenants contained within this agreement.

On July 30, 2002, the Company issued
$50.0 million of senior guaranteed notes (the
Notes) due July 30, 2006 and bearing interest
at 6.31% (payable semi-annually). The proceeds of the sale of
the Notes are being used to refinance existing indebtedness of
the Company and its subsidiaries and for general corporate
purposes. The note purchase agreement relating to the Notes
contains covenants which limit, among other things, the
Companys ability to incur indebtedness, grant liens, make
investments, engage in any merger or consolidation, dispose of
assets or change the nature of its business, and requires the
Company to meet certain financial measures regarding net worth,
total debt coverage and fixed charge coverage. As of
January 26, 2003 the Company was in compliance with all
covenants contained within this agreement.

The Company has two lease financing facilities
(collectively, the Lease Financing Facilities) to
finance new stores and other property owned by unaffiliated
entities and leased to the Company or its subsidiaries. The
original facility (the Original Lease Facility) will
expire in June 2004 (2005 if certain conditions are
satisfied). In June 2002, the Company established a new
facility (the New Lease Facility), which will expire
in 2007. The aggregate amount available under the Lease
Financing Facilities is $75.0 million. Properties to be
financed after the effective date of the New Lease Facility will
be financed under that Facility, and no additional properties
will be financed under the Original Lease Facility. The Lease
Financing Facilities provide financing to lessors of properties
leased to the Company or its subsidiaries through loans from
lenders for up to 95% of a projects cost. Additionally,
under the New Lease Facility, the unaffiliated lessor will make
equity contributions approximating 5% of the cost of each
project. The lessors under the Original Lease Facility have made
similar contributions. Independent of the Companys
obligations relating to the leases, the Company and certain of
its subsidiaries guarantee payment when due of all amounts
required to be paid to the third-party lenders. The principal
amount guaranteed is limited to approximately 89% of the
original cost of a project so long as the Company is not in
default under the lease relating to such project. The agreements
relating to both of the Lease Financing Facilities contain
covenants and events of default that are similar to those
contained in the Credit Agreement described above. The Company
is in compliance with these covenants. Security interests in the
properties underlying the leases and in the Companys
interests in the leases have been given to the lenders. The
Lease Financing Facilities contain cross default provisions with
respect to

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the obligations of the company under the Credit
Agreement and certain other agreements to which the Company is a
party. There also are cross default provisions with respect to
the obligations relating to the Lease Financing Facilities of
Wilmington Trust Company, as owner-trustee of a grantor trust
formed for the Lease Financing Facilities, and the unaffiliated
beneficial owner of the grantor trust.


To date, the Company has not been required to
perform under the guarantees described above. In the event that
the Company should be required to perform, borrowings under the
Credit Agreement would be sufficient to meet its obligations.

Substantially all of the Companys capital
lease assets are related to properties financed under the
Original Lease Facility. The Company pays lessors who have
financed properties under the Original Lease Facility regular
rental amounts for use of the properties. These payments are
equal to the carrying cost of the lessors borrowings for
construction of the properties, and do not include amortization
of the principal amounts of the lessors indebtedness
relating to the properties. The rental payments are categorized
as occupancy expense, and as such are included as a component of
Cost of merchandise sold in the Companys
consolidated statements of operations. These rental payments are
also included in the disclosure of future minimum lease payments
of operating leases.

There were 7 and 31 properties financed
through the Original Lease Facility at January 26, 2003 and
January 27, 2002, respectively, with financed values of
$36.3 million and $121.8 million. The Company has
recorded approximately $19.0 million in 2002 and
$49.7 million in 2001 of the amounts outstanding under the
Original Lease Facility as capitalized leases under Other
assets (for the capital lease assets) and Long-term
capital lease and financing obligations (for the capital
lease liabilities) on the consolidated balance sheets. These
amounts have been treated as non-cash items on the consolidated
statements of cash flows. There were no borrowings under the New
Lease Facility as of January 26, 2003. In 2002, the Company
permanently financed, through long-term leases,
24 properties that had been financed through the Original
Lease Facility with a total value of approximately
$85.5 million, 14 of which had been capitalized.

Management believes that the rental payments for
properties financed through the Lease Financing Facilities may
be lower than those which the Company could obtain elsewhere due
to, among other factors, (i) the lower borrowing rates
available to the Companys landlords under the facility and
(ii) the fact that rental payments for properties financed
through the facility do not include amortization of the
principal amounts of the landlords indebtedness related to
the properties. Rental payments relating to such properties will
be adjusted when permanent financing is obtained to reflect the
interest rates available at the time of the refinancing and the
amortization of principal.

During 1994, the Company entered into agreements
in which leases with respect to four Borders locations served as
collateral for certain mortgage pass-through certificates. These
mortgage pass-through certificates included a provision
requiring the Company to repurchase the underlying mortgage
notes in certain events. In the fourth quarter of fiscal 2001,
the Company was obligated to purchase the notes for
$33.5 million and cash payment to retain these notes was
made in the first quarter of 2002. As a result, the Company has
categorized this prepaid rent amount as part of Other
assets in the consolidated balance sheets, and is
amortizing the balance over each propertys remaining lease
term.

The following table summarizes the Companys
significant financing and lease obligations:

|                             |  |             |       |  |           |   |       |           |  |   |                     |  |  |       |         |  |  |   |         | 
|---------------------------- |  | ----------- | ----- |  | --------- | - | ----- | --------- |  | - | ------------------- |  |  | ----- | ------- |  |  | - | ------- | 
|                             |  |            
|                             |  | Fiscal Year |      
|                             |  | 2003        |       |  | 2004-2005 |   |       | 2006-2007 |  |   | 2008 and thereafter |  |  | Total |        
|(dollars in millions)        |  |             |       |  |           |   |       |           |  |   |                     |  |  |       |        
|Credit Agreement borrowings  |  | $           | 112.1 |  |           | $ |      |           |  | $ |                    |  |  | $     |        |  |  | $ | 112.1   | 
|Capital lease obligations    |  |             | 0.6   |  |           |   | 19.0  |           |  |   |                    |  |  |       |        |  |  |   | 19.6    | 
|Operating lease obligations  |  |             | 307.5 |  |           |   | 562.2 |           |  |   | 525.9               |  |  |       | 2,177.4 |  |  |   | 3,573.0 | 
|Senior guaranteed notes      |  |             |      |  |           |   |      |           |  |   | 50.0                |  |  |       |        |  |  |   | 50.0    | 
|                             |  |             |       |  |           |   |       |           |  |   |                     |  |  |       |        
|Total                        |  | $           | 420.2 |  |           | $ | 581.2 |           |  | $ | 575.9               |  |  | $     | 2,177.4 |  |  | $ | 3,754.7 | 
|                             |  |             |       |  |           |   |       |           |  |   |                     |  |  |       |        
|Lease Facility guarantees(1) |  | $           | 36.3  |  |           | $ |      |           |  | $ |                    |  |  | $     |        |  |  | $ | 36.3    | 




|    |                                                                 
|--- | ----------------------------------------------------------------
|(1) | Includes $19.0 million treated as capital
    lease obligations.

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The Company is subject to risk resulting from
interest rate fluctuations since interest on the Companys
borrowings is principally based on variable rates. The
Companys objective in managing its exposure to interest
rate fluctuations is to limit the impact of interest rate
changes on earnings and cash flows and to lower its overall
borrowing costs. The Company primarily utilizes interest rate
swaps to achieve this objective, effectively converting a
portion of its variable rate exposures to fixed interest rates.

LIBOR is the rate upon which the Companys
variable rate debt and its payments under the Lease Financing
Facilities are principally based. If LIBOR were to increase 1%
for the full year in 2003 as compared to the end of 2002, the
Companys after-tax earnings, after considering the effects
of its existing interest rate swap agreements, would decrease
approximately $0.8 million based on the Companys
expected average outstanding debt, including its indirect
borrowings under the Original Lease Facility, as of
January 26, 2003.

A portion of the Companys operations takes
place in foreign jurisdictions, primarily the United Kingdom,
Australia, New Zealand and Singapore. As a result, the
Companys financial results could be affected by factors
such as changes in foreign currency exchange rates or weak
economic conditions in the foreign markets where the Company
operates. The Company has generally not used derivative
instruments to manage this risk.

Seasonality

The Companys business is highly seasonal,
with sales significantly higher and substantially all operating
income realized during the fourth quarter, which includes the
holiday selling season.

|                      |                  |                           |       |      |      |   |       |         |   |   |         |      |   |   |         |      |  
|--------------------- | ---------------- | ------------------------- | ----- | ---- | ---- | - | ----- | ------- | - | - | ------- | ---- | - | - | ------- | ---- | -
|                      |                  |                          
|                      |                  | Fiscal 2002 Quarter Ended |      
|                      |                  | April                     |       |      | July |   |       | October |   |   | January |     
|(dollars in millions) |                  |                           |       |      |      |   |       |         |   |   |         |     
|Sales                 |                  | $                         | 751.7 |      |      | $ | 763.6 |         |   | $ | 749.8   |      |   | $ | 1,221.0 |     
|Operating income      |                  |                           | 8.7   |      |      |   | 8.0   |         |   |   | 0.8     |      |   |   | 176.4   |     
|% of full year:       |                  |                           |       |      |      |   |       |         |   |   |         |      |   |   |         |     
|                      | Sales            |                           |       | 21.6 | %    |   |       | 21.9    | % |   |         | 21.5 | % |   |         | 35.0 | %
|                      | Operating income |                           |       | 4.5  |      |   |       | 4.1     |   |   |         | 0.4  |   |   |         | 91.0 |  

|                        |                         |                           |       |       |      |   |       |         |   |   |         |      |   |   |         |       |  
|----------------------- | ----------------------- | ------------------------- | ----- | ----- | ---- | - | ----- | ------- | - | - | ------- | ---- | - | - | ------- | ----- | -
|                        |                         |                          
|                        |                         | Fiscal 2001 Quarter Ended |      
|                        |                         | April                     |       |       | July |   |       | October |   |   | January |     
|(dollars in millions)   |                         |                           |       |       |      |   |       |         |   |   |         |     
|Sales                   |                         | $                         | 729.9 |       |      | $ | 739.8 |         |   | $ | 713.7   |      |   | $ | 1,204.5 |      
|Operating income (loss) |                         |                           | (26.0 | )     |      |   | 4.1   |         |   |   | (1.4    | )    |   |   | 180.3   |      
|% of full year:         |                         |                           |       |       |      |   |       |         |   |   |         |      |   |   |         |      
|                        | Sales                   |                           |       | 21.5  | %    |   |       | 21.8    | % |   |         | 21.1 | % |   |         | 35.6  | %
|                        | Operating income (loss) |                           |       | (16.5 | )    |   |       | 2.6     |   |   |         | (0.9 | ) |   |         | 114.8 |  

|                        |                         |                           |       |      |      |   |       |         |   |   |         |      |   |   |         |      |  
|----------------------- | ----------------------- | ------------------------- | ----- | ---- | ---- | - | ----- | ------- | - | - | ------- | ---- | - | - | ------- | ---- | -
|                        |                         |                          
|                        |                         | Fiscal 2000 Quarter Ended |      
|                        |                         | April                     |       |      | July |   |       | October |   |   | January |     
|(dollars in millions)   |                         |                           |       |      |      |   |       |         |   |   |         |     
|Sales                   |                         | $                         | 679.7 |      |      | $ | 698.4 |         |   | $ | 701.0   |      |   | $ | 1,192.1 |     
|Operating income (loss) |                         |                           | 3.5   |      |      |   | 3.4   |         |   |   | (0.1    | )    |   |   | 128.3   |     
|% of full year:         |                         |                           |       |      |      |   |       |         |   |   |         |      |   |   |         |     
|                        | Sales                   |                           |       | 20.8 | %    |   |       | 21.4    | % |   |         | 21.4 | % |   |         | 36.4 | %
|                        | Operating income (loss) |                           |       | 2.6  |      |   |       | 2.5     |   |   |         | (0.1 | ) |   |         | 95.0 |  

Critical Accounting Policies and
Estimates

In the ordinary course of business, the Company
has made a number of estimates and assumptions relating to the
reporting of results of operations and financial condition in
the preparation of its financial statements in conformity with
accounting principles generally accepted in the United States.
Actual results could differ from those estimates under different
assumptions and conditions. The Company believes that the
following discussion addresses

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the Companys most critical accounting
policies and estimates. There have been no significant changes
in these methodologies in 2002 as compared to the prior year.


Asset Impairments

The carrying value of long-lived assets is
evaluated whenever changes in circumstances indicate the
carrying amount of such assets may not be recoverable. In
performing such reviews for recoverability, the Company compares
the expected cash flows to the carrying value of long-lived
assets for the applicable stores. If the expected future cash
flows are less than the carrying amount of such assets, the
Company recognizes an impairment loss for the difference between
the carrying amount and the estimated fair value. Expected
future cash flows, which are estimated over each stores
remaining lease term, contain estimates of sales and the impact
those future sales will have upon cash flows. Future sales are
estimated based upon a projection of each stores sales
trend of the past several years. Additionally, each stores
future cash contribution is based upon the most recent
years actual cash contribution, but is adjusted based upon
projected sales trends. Fair value is estimated using expected
discounted future cash flows, with the discount rate
approximating the Companys borrowing rate. Significant
deterioration in the performance of the Companys stores
compared to projections could result in significant additional
asset impairments.

Goodwill Impairment

Upon adoption of FAS 142 on January 28,
2002, the Companys goodwill was tested for impairment, and
no impairment existed. The carrying amounts of the net assets of
the applicable reporting units (including goodwill) were
compared to the estimated fair values of those reporting units.
Fair value was estimated using a discounted cash flow model
which depended on, among other factors, estimates of future
sales and expense trends, liquidity, and capitalization. The
discount rate used approximated the weighted average cost of
capital of a hypothetical third party buyer. Changes in any of
the assumptions underlying these estimates may result in the
future impairment of goodwill. The Companys annual tests
of goodwill impairment are based upon the methodology described
above and are subject to the same risks and uncertainties.

Inventory

The carrying value of the Companys
inventory is affected by reserves for shrinkage and
non-returnable inventory. Projections of shrinkage are based
upon the results of regular, periodic physical counts of the
Companys inventory. The Companys shrinkage reserve
is adjusted as warranted based upon the trends yielded by the
physical counts. Reserves for non-returnable inventory are based
upon the Companys history of liquidating non-returnable
inventory. The markdown percentages utilized in developing the
reserve are evaluated against actual, ongoing markdowns of
non-returnable inventory to ensure that they remain consistent.
Significant differences between future experience and that which
was projected (for either the shrinkage or non-returnable
inventory reserves) could affect the recorded amounts of
inventory and cost of sales.

The Company includes certain distribution and
other expenses in its inventory costs, particularly freight,
distribution payroll, and certain occupancy expenses. In
addition, certain selling, general and administrative expenses
are included in inventory costs. These amounts totaled
approximately $81.0 million and $85.1 million as of
January 26, 2003 and January 27, 2002, respectively.
The extent to which these costs are included in inventory is
based on certain estimates of space and labor allocation.

Leases

All leases, including those for properties
financed through the Lease Financing Facilities, are reviewed
for capital or operating classification at their inception under
the guidance of Statement of Financial Accounting Standards
No. 13, Accounting for Leases (FAS 13), as
amended. The leases of certain properties financed through the
Original Lease Facility were capitalized based upon this and
other guidance.

Furthermore, properties financed through the
Lease Financing Facilities are evaluated under various
accounting literature including EITF 92-1, Allocation
of Residual Value or First-Loss Guarantee to Minimum Lease
Payments in Leases Involving Land and Buildings,
EITF 97-1, Implementation Issues in Accounting for
Lease Transactions Including those Involving Special Purpose
Entities, EITF 97-10, The Effect of Lessee
Involvement in Asset Construction, among others. Based on
the results of analysis performed by the Company, lessors of
certain properties

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financed through the Original Lease Facility are
consolidated in the consolidated financial statements of the
Company.


Advertising and Vendor Incentive
Programs

The Company receives payments and credits from
vendors pursuant to co-operative advertising programs, shared
markdown programs, purchase volume incentive programs and
magazine slotting programs. These programs continue to be
beneficial for both the Company and vendors, and the Company
expects continued participation in these types of programs.
Changes in vendor participation levels, as well as changes in
the volume of merchandise purchased, among other factors, could
adversely impact the Companys results of operations and
liquidity.

Pursuant to co-operative advertising programs
offered by vendors, the Company contracts with vendors to
promote merchandise for specified time periods. Pursuant to the
provisions of Emerging Issues Task Force Issue No. 02-16,
Accounting by a Customer (Including a Reseller) for
Certain Consideration Received from a Vendor
(EITF 02-16), which the Company adopted effective
January 1, 2003, vendor consideration which represents a
reimbursement of specific, incremental, identifiable costs is
included in the Selling, general and administrative
line on the consolidated statements of operations, along with
the related costs, in the period the promotion takes place.
Consideration which exceeds such costs is classified as a
reduction of the Cost of merchandise sold line on
the consolidated statements of operations. Prior to the adoption
of EITF 02-16, all consideration and costs pursuant to
co-operative advertising programs were included in the
Selling, general and administrative expenses line of
the consolidated statements of operations.

The Company also receives credits from vendors
pursuant to shared markdown programs, purchase volume programs,
and magazine slotting programs. Credits received pursuant to
these programs are classified in the Cost of merchandise
sold line on the consolidated statements of operations,
and are recognized upon certain product volume thresholds being
met or product placements occurring.

See further discussion of EITF 02-16 under New
Accounting Guidance.

New Accounting Guidance

In June 2002, the Financial Accounting
Standards Board (FASB) issued Statement of Financial
Accounting Standards No. 146, Accounting for Costs
Associated with Exit or Disposal Activities
(FAS 146). This pronouncement requires that a liability for
a cost associated with an exit or disposal activity be
recognized and measured initially at fair value only when the
liability is incurred. Prior to the adoption of this Standard, a
liability for an exit cost, as defined by Emerging Issues Task
Force Issue No. 94-3, Liability Recognition for
Certain Employee Termination Benefits and Other Costs to Exit an
Activity (including Certain Costs Incurred in a
Restructuring) (EITF 94-3), was recognized at the
date of an entitys commitment to an exit plan. FAS 146 was
effective for the Company for exit plans or disposal activities
committed to after December 31, 2002. Adoption did not have
a material impact on the Companys financial position or
results of operations in fiscal 2002, but will impact the timing
of recognition of store closing costs in future periods.

In November 2002, the FASB issued
Interpretation No. 45, Guarantors Accounting
and Disclosure Requirements for Guarantees, Including Indirect
Guarantees of Indebtedness of Others. This interpretation
elaborates on the disclosure requirements in the financial
statements concerning obligations under certain guarantees. It
also clarifies the requirements related to the recognition of
liabilities by a guarantor at the inception of certain
guarantees. The Company adopted the disclosure requirements of
this interpretation on January 1, 2003. The recognition
provisions of the interpretation are applicable only to
guarantees issued or modified after December 31, 2002.
Adoption of these recognition provisions did not have a material
impact on the Companys financial position or results of
operations in fiscal 2002.

In November 2002, the Emerging Issues Task
Force issued Consensus No. 02-16, Accounting by a
Customer (Including a Reseller) for Certain Consideration
Received from a Vendor (EITF 02-16), which is
effective prospectively for all vendor arrangements entered into
after December 31, 2002. The Consensus requires that
consideration received from a vendor be considered a reduction
of the prices of vendors products and shown as a reduction
of cost of sales in the income statement of the customer. If the
consideration represents a reimbursement of specific incremental
identifiable costs incurred, these amounts should be offset
against the related costs with any excess

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consideration recorded in cost of sales. Adoption
of the Consensus did not have a material impact on the
Companys financial position or results of operations in
fiscal 2002. The Company is evaluating the impact of the
Consensus on its financial position and results of operations in
fiscal 2003.


In December 2002, the FASB issued Statement of
Financial Accounting Standards No. 148, Accounting
for Stock-Based Compensation  Transition and
Disclosure (FAS 148). This statement amends Statement
of Financial Accounting Standards No. 123, Accounting
for Stock-Based Compensation (FAS 123) to provide
alternative methods of transition for a voluntary change to the
fair value based method of accounting for stock-based employee
compensation. In addition, FAS 148 amends the disclosure
provisions of FAS 123 to require disclosure in the summary
of significant accounting policies of the effects of an
entitys accounting policy with respect to stock-based
employee compensation on reported net income and earnings per
share in annual and interim financial statements. The Company
adopted the disclosure requirements of FAS 148 on
January 26, 2003.

In January 2003, the FASB issued Interpretation
No. 46, Consolidation of Variable Interest
Entities. This interpretation addresses the requirements
for business enterprises to consolidate related entities in
which they are the determined to be the primary beneficiary as a
result of their variable economic interests. The interpretation
is intended to provide guidance in judging multiple economic
interests in an entity and in determining the primary
beneficiary. The interpretation outlines disclosure requirements
for variable interest entities in existence prior to
January 31, 2003 and requires consolidation of variable
interest entities created after January 31, 2003. In
addition, the interpretation requires consolidation of variable
interest entities created prior to January 31, 2003 for
fiscal periods beginning after June 15, 2003. The Company
is evaluating the impact of the interpretation.

Related Party Transactions

The Company has not engaged in any related party
transactions which would have had a material effect on the
Companys financial position, cash flows, or results of
operations.






Item 7A. Quantitative and
Qualitative Disclosures About Market Risk


See Managements Discussion and
Analysis of Financial Condition and Results of
Operations  Liquidity and Capital Resources.

36



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##### Table of Contents








Item 8. Financial Statements and
Supplementary Data


INDEX TO FINANCIAL STATEMENTS

|                                                                                                                                           |  |      |    | 
|------------------------------------------------------------------------------------------------------------------------------------------ |  | ---- | -- | 
|                                                                                                                                           |  | Page |   
|                                                                                                                                           |  |      |   
|Consolidated Statements of Operations for the
    fiscal years ended January 26, 2003, January 27, 2002
    and January 28, 2001           |  |      | 38 | 
|Consolidated Balance Sheets as of
    January 26, 2003 and January 27, 2002                                                                |  |      | 39 | 
|Consolidated Statements of Cash Flows for the
    fiscal years ended January 26, 2003, January 27, 2002
    and January 28, 2001           |  |      | 40 | 
|Consolidated Statements of Stockholders
    Equity for the fiscal years ended January 26, 2003,
    January 27, 2002 and January 28, 2001 |  |      | 41 | 
|Notes to Consolidated Financial Statements                                                                                                 |  |      | 42 | 
|Report of Independent Auditors                                                                                                             |  |      | 63 | 

37



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CONSOLIDATED STATEMENTS OF
OPERATIONS


(dollars in millions except per share
data)


|                                                   |                                                                                    |                                       |         |         |          |   |         |          |      |   |         |         |       |  
|-------------------------------------------------- | ---------------------------------------------------------------------------------- | ------------------------------------- | ------- | ------- | -------- | - | ------- | -------- | ---- | - | ------- | ------- | ----- | -
|                                                   |                                                                                    |                                      
|                                                   |                                                                                    | Fiscal Year Ended                     |        
|                                                   |                                                                                    | Jan. 26,                              |         |         | Jan. 27, |   |         | Jan. 28, |     
|                                                   |                                                                                    | 2003                                  |         |         | 2002     |   |         | 2001     |     
|                                                   |                                                                                    |                                       |         |         |          |   |         |          |     
|Sales                                              |                                                                                    | $                                     | 3,486.1 |         |          | $ | 3,387.9 |          |      | $ | 3,271.2 |        
|Other revenue                                      |                                                                                    |                                       | 26.9    |         |          |   | 25.3    |          |      |   | 25.9    |        
|                                                   |                                                                                    |                                       |         |         |          |   |         |          |     
|                                                   | Total revenue                                                                      |                                       | $       | 3,513.0 |          |   | $       | 3,413.2  |      |   | $       | 3,297.1 |      
|Cost of merchandise sold (includes occupancy)      |                                                                                    |                                       | 2,550.3 |         |          |   | 2,464.5 |          |      |   | 2,380.4 |        
|Fulfillment center and other inventory writedowns  |                                                                                    |                                       | 1.8     |         |          |   | 10.1    |          |      |   |        |        
|                                                   |                                                                                    |                                       |         |         |          |   |         |          |     
|                                                   | Gross margin                                                                       |                                       |         | 960.9   |          |   |         | 938.6    |      |   |         | 916.7   |      
|Selling, general and administrative expenses       |                                                                                    |                                       | 745.2   |         |          |   | 744.8   |          |      |   | 736.2   |        
|Legal settlement expense                           |                                                                                    |                                       |        |         |          |   | 2.4     |          |      |   |        |        
|Pre-opening expense                                |                                                                                    |                                       | 6.9     |         |          |   | 6.3     |          |      |   | 6.4     |        
|Asset impairments and other writedowns             |                                                                                    |                                       | 14.9    |         |          |   | 25.4    |          |      |   | 36.2    |        
|Goodwill amortization                              |                                                                                    |                                       |        |         |          |   | 2.7     |          |      |   | 2.8     |        
|                                                   |                                                                                    |                                       |         |         |          |   |         |          |     
|                                                   | Operating income                                                                   |                                       |         | 193.9   |          |   |         | 157.0    |      |   |         | 135.1   |      
|Interest expense                                   |                                                                                    |                                       | 12.6    |         |          |   | 14.4    |          |      |   | 13.1    |        
|                                                   |                                                                                    |                                       |         |         |          |   |         |          |     
|                                                   | Income from continuing operations before income
    tax                            |                                       |         | 181.3   |          |   |         | 142.6    |      |   |         | 122.0   |      
|Income tax provision                               |                                                                                    |                                       | 69.6    |         |          |   | 55.2    |          |      |   | 48.2    |        
|                                                   |                                                                                    |                                       |         |         |          |   |         |          |     
|                                                   | Income from continuing operations                                                  |                                       | $       | 111.7   |          |   | $       | 87.4     |      |   | $       | 73.8    |      
|Discontinued operations (Note 3)                   |                                                                                    |                                       |         |         |          |   |         |          |      |   |         |        
|                                                   | Loss from operations of All Wound Up, net of
    income tax credit of $7.0         |                                       |         |        |          |   |         |         |      |   |         | 10.8    |      
|                                                   | Loss on disposition of All Wound Up, net of
    deferred income tax credit of $8.9 |                                       |         |        |          |   |         |         |      |   |         | 19.4    |      
|                                                   |                                                                                    |                                       |         |         |          |   |         |          |     
|Net income                                         |                                                                                    | $                                     | 111.7   |         |          | $ | 87.4    |          |      | $ | 43.6    |        
|                                                   |                                                                                    |                                       |         |         |          |   |         |          |     
|Earnings (loss) per common share data
    (Note 2) |                                                                                    |                                       |         |         |          |   |         |          |      |   |         |        
|                                                   | Diluted earnings (loss) per common share                                           |                                       |         |         |          |   |         |          |      |   |         |         |      
|                                                   |                                                                                    | Continuing operations                 |         | $       | 1.36     |   |         | $        | 1.06 |   |         | $       | 0.92  |  
|                                                   |                                                                                    | Discontinued operations               |         |         |         |   |         |          |     |   |         |         | (0.38 | )
|                                                   |                                                                                    |                                       |         |         |          |   |         |          |     
|                                                   |                                                                                    | Net diluted earnings per common share |         | $       | 1.36     |   |         | $        | 1.06 |   |         | $       | 0.54  |  
|                                                   |                                                                                    |                                       |         |         |          |   |         |          |     
|                                                   | Basic earnings (loss) per common share                                             |                                       |         |         |          |   |         |          |      |   |         |         |      
|                                                   |                                                                                    | Continuing operations                 |         | $       | 1.39     |   |         | $        | 1.08 |   |         | $       | 0.94  |  
|                                                   |                                                                                    | Discontinued operations               |         |         |         |   |         |          |     |   |         |         | (0.38 | )
|                                                   |                                                                                    |                                       |         |         |          |   |         |          |     
|                                                   |                                                                                    | Net basic earnings per common share   |         | $       | 1.39     |   |         | $        | 1.08 |   |         | $       | 0.56  |  
|                                                   |                                                                                    |                                       |         |         |          |   |         |          |     

See accompanying notes to consolidated financial
statements.

38



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CONSOLIDATED BALANCE SHEETS


(dollars in millions except share
amounts)


|                                                  |                                                                                                                                                                         |                           |                            |         |          |         |         |         |         |       | 
|------------------------------------------------- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------- | ------------------------- | -------------------------- | ------- | -------- | ------- | ------- | ------- | ------- | ----- | 
|                                                  |                                                                                                                                                                         |                          
|                                                  |                                                                                                                                                                         | Fiscal Year Ended         |                           
|                                                  |                                                                                                                                                                         | Jan. 26,                  |                            |         | Jan. 27, |        
|                                                  |                                                                                                                                                                         | 2003                      |                            |         | 2002     |        
|                                                  |                                                                                                                                                                         |                           |                            |         |          |        
|Assets                                            |                                                                                                                                                                         |                           |                            |         |          |         |         |        
|Current assets:                                   |                                                                                                                                                                         |                           |                            |         |          |         |         |        
|                                                  | Cash and cash equivalents                                                                                                                                               |                           | $                          | 269.1   |          |         | $       | 190.2   |        
|                                                  | Merchandise inventories                                                                                                                                                 |                           |                            | 1,183.3 |          |         |         | 1,178.8 |        
|                                                  | Accounts receivable and other current assets                                                                                                                            |                           |                            | 88.9    |          |         |         | 73.1    |        
|                                                  |                                                                                                                                                                         |                           |                            |         |          |        
|                                                  |                                                                                                                                                                         | Total current assets      |                            |         | 1,541.3  |         |         |         | 1,442.1 |      
|Property and equipment, net                       |                                                                                                                                                                         |                           | 553.8                      |         |          |         | 529.4   |        
|Other assets                                      |                                                                                                                                                                         |                           | 74.5                       |         |          |         | 105.8   |        
|Deferred income taxes                             |                                                                                                                                                                         |                           | 2.1                        |         |          |         | 13.3    |        
|Goodwill                                          |                                                                                                                                                                         |                           | 96.5                       |         |          |         | 88.7    |        
|                                                  |                                                                                                                                                                         |                           |                            |         |          |        
|                                                  |                                                                                                                                                                         | Total assets              |                            | $       | 2,268.2  |         |         | $       | 2,179.3 |      
|                                                  |                                                                                                                                                                         |                           |                            |         |          |        
|Liabilities and Stockholders Equity              |                                                                                                                                                                         |                           |                            |         |          |         |         |        
|Current liabilities:                              |                                                                                                                                                                         |                           |                            |         |          |         |         |        
|                                                  | Short-term borrowings and current portion of
    long-term debt                                                                                                         |                           | $                          | 112.7   |          |         | $       | 83.3    |        
|                                                  | Trade accounts payable                                                                                                                                                  |                           |                            | 565.4   |          |         |         | 638.2   |        
|                                                  | Accrued payroll and other liabilities                                                                                                                                   |                           |                            | 280.1   |          |         |         | 288.9   |        
|                                                  | Taxes, including income taxes                                                                                                                                           |                           |                            | 120.7   |          |         |         | 93.0    |        
|                                                  | Deferred income taxes                                                                                                                                                   |                           |                            | 8.7     |          |         |         | 3.3     |        
|                                                  |                                                                                                                                                                         |                           |                            |         |          |        
|                                                  |                                                                                                                                                                         | Total current liabilities |                            |         | 1,087.6  |         |         |         | 1,106.7 |      
|Long-term debt                                    |                                                                                                                                                                         |                           | 50.0                       |         |          |         |        |        
|Long-term capital lease and financing obligations |                                                                                                                                                                         |                           | 19.0                       |         |          |         | 49.7    |        
|Other long-term liabilities                       |                                                                                                                                                                         |                           | 81.0                       |         |          |         | 73.0    |        
|Commitments and contingencies (Note 10)           |                                                                                                                                                                         |                           |                           |         |          |         |        |        
|                                                  |                                                                                                                                                                         |                           |                            |         |          |        
|                                                  |                                                                                                                                                                         | Total liabilities         |                            |         | 1,237.6  |         |         |         | 1,229.4 |      
|                                                  |                                                                                                                                                                         |                           |                            |         |          |        
|Stockholders equity:                             |                                                                                                                                                                         |                           |                            |         |          |         |         |        
|                                                  | Common stock, 200,000,000 shares authorized;
    78,731,922 and 81,202,967 shares issued and
    outstanding at January 26, 2003 and January 27, 2002,
    respectively |                           |                            | 657.0   |          |         |         | 707.9   |        
|                                                  | Deferred compensation and officer receivables                                                                                                                           |                           |                            | (0.2    | )        |         |         | (0.2    | )      
|                                                  | Accumulated other comprehensive gain (loss)                                                                                                                             |                           |                            | 4.4     |          |         |         | (15.5   | )      
|                                                  | Retained earnings                                                                                                                                                       |                           |                            | 369.4   |          |         |         | 257.7   |        
|                                                  |                                                                                                                                                                         |                           |                            |         |          |        
|                                                  |                                                                                                                                                                         |                           | Total stockholders equity |         |          | 1,030.6 |         |         |         | 949.9 | 
|                                                  |                                                                                                                                                                         |                           |                            |         |          |        
|                                                  |                                                                                                                                                                         | $                         | 2,268.2                    |         |          | $       | 2,179.3 |        
|                                                  |                                                                                                                                                                         |                           |                            |         |          |        

See accompanying notes to consolidated financial
statements.

39



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CONSOLIDATED STATEMENTS OF CASH
FLOWS


(dollars in millions)


|                                                 |                                                                         |                                                                  |                                 |        |          |       |       |          |       |       |      |        |        |       | 
|------------------------------------------------ | ----------------------------------------------------------------------- | ---------------------------------------------------------------- | ------------------------------- | ------ | -------- | ----- | ----- | -------- | ----- | ----- | ---- | ------ | ------ | ----- | 
|                                                 |                                                                         |                                                                 
|                                                 |                                                                         | Fiscal Year Ended                                                |                                
|                                                 |                                                                         | Jan. 26,                                                         |                                 |        | Jan. 27, |       |       | Jan. 28, |      
|                                                 |                                                                         | 2003                                                             |                                 |        | 2002     |       |       | 2001     |      
|                                                 |                                                                         |                                                                  |                                 |        |          |       |       |          |      
|Cash provided by (used for):                     |                                                                         |                                                                  |                                 |        |          |       |       |          |       |       |      |       
|Operations                                       |                                                                         |                                                                  |                                 |        |          |       |       |          |       |       |      |       
|                                                 | Income from continuing operations                                       |                                                                  | $                               | 111.7  |          |       | $     | 87.4     |       |       | $    | 73.8   |       
|                                                 | Adjustments to reconcile net income to operating
    cash flows:        |                                                                  |                                 |        |          |       |       |          |       |       |      |        |       
|                                                 |                                                                         | Depreciation and amortization                                    |                                 |        | 97.1     |       |       |          | 96.2  |       |      |        | 95.3   |      
|                                                 |                                                                         | (Increase) decrease in deferred income taxes                     |                                 |        | 14.0     |       |       |          | 6.3   |       |      |        | (4.6   | )    
|                                                 |                                                                         | Increase in other long-term assets and liabilities               |                                 |        | 14.7     |       |       |          | 6.0   |       |      |        | 6.0    |      
|                                                 |                                                                         | Asset impairments and other writedowns                           |                                 |        | 13.4     |       |       |          | 16.7  |       |      |        | 23.0   |      
|                                                 | Cash provided by (used for) current assets and
    current liabilities: |                                                                  |                                 |        |          |       |       |          |       |       |      |        |       
|                                                 |                                                                         | (Increase) decrease in inventories                               |                                 |        | 6.2      |       |       |          | 20.4  |       |      |        | (136.5 | )    
|                                                 |                                                                         | (Increase) decrease in accounts receivable                       |                                 |        | (9.3     | )     |       |          | 10.1  |       |      |        | (9.5   | )    
|                                                 |                                                                         | (Increase) decrease in prepaid expenses                          |                                 |        | (4.6     | )     |       |          | (4.9  | )     |      |        | 4.0    |      
|                                                 |                                                                         | Increase (decrease) in accounts payable                          |                                 |        | (77.3    | )     |       |          | 18.2  |       |      |        | 45.0   |      
|                                                 |                                                                         | Increase in taxes payable                                        |                                 |        | 30.5     |       |       |          | 15.3  |       |      |        | 35.2   |      
|                                                 |                                                                         | Increase (decrease) in accrued payroll and
    other liabilities |                                 |        | (7.2     | )     |       |          | (6.7  | )     |      |        | 21.1   |      
|                                                 |                                                                         |                                                                  |                                 |        |          |       |       |          |      
|                                                 |                                                                         | Net cash provided by continuing operations                       |                                 |        | 189.2    |       |       |          | 265.0 |       |      |        | 152.8  |      
|                                                 |                                                                         | Net cash used for discontinued operations                        |                                 |        |         |       |       |          | (0.8  | )     |      |        | (14.2  | )    
|                                                 |                                                                         |                                                                  |                                 |        |          |       |       |          |      
|                                                 |                                                                         |                                                                  | Net cash provided by operations |        |          | 189.2 |       |          |       | 264.2 |      |        |        | 138.6 | 
|                                                 |                                                                         |                                                                  |                                 |        |          |       |       |          |      
|Investing                                        |                                                                         |                                                                  |                                 |        |          |       |       |          |       |       |      |       
|                                                 | Capital expenditures                                                    |                                                                  |                                 | (121.5 | )        |       |       | (90.7    | )     |       |      | (138.7 | )     
|                                                 | Net investing activities of discontinued
    operations                 |                                                                  |                                 |       |          |       |       |         |       |       |      | (2.4   | )     
|                                                 |                                                                         |                                                                  |                                 |        |          |       |       |          |      
|                                                 |                                                                         | Net cash used for investing                                      |                                 |        | (121.5   | )     |       |          | (90.7 | )     |      |        | (141.1 | )    
|                                                 |                                                                         |                                                                  |                                 |        |          |       |       |          |      
|Financing                                        |                                                                         |                                                                  |                                 |        |          |       |       |          |       |       |      |       
|                                                 | Net funding from long-term debt                                         |                                                                  |                                 | 50.0   |          |       |       |         |       |       |      |       |       
|                                                 | Repayment of long-term capital lease obligations                        |                                                                  |                                 | (1.0   | )        |       |       | (0.1     | )     |       |      | (4.2   | )     
|                                                 | Net funding from (repayment of) credit facility                         |                                                                  |                                 | 15.4   |          |       |       | (58.2    | )     |       |      | 21.4   |       
|                                                 | Issuance of common stock                                                |                                                                  |                                 | 18.8   |          |       |       | 34.9     |       |       |      | 11.5   |       
|                                                 | Repurchase of common stock                                              |                                                                  |                                 | (74.8  | )        |       |       | (17.7    | )     |       |      | (9.2   | )     
|                                                 |                                                                         |                                                                  |                                 |        |          |       |       |          |      
|                                                 |                                                                         | Net cash provided by (used for) financing                        |                                 |        | 8.4      |       |       |          | (41.1 | )     |      |        | 19.5   |      
|                                                 |                                                                         |                                                                  |                                 |        |          |       |       |          |      
|Effect of exchange rates on cash and equivalents |                                                                         |                                                                  | 2.8                             |        |          |       | (1.3  | )        |       |       | 0.5  |       
|                                                 |                                                                         |                                                                  |                                 |        |          |       |       |          |      
|Net increase in cash and equivalents             |                                                                         |                                                                  | 78.9                            |        |          |       | 131.1 |          |       |       | 17.5 |       
|Cash and equivalents at beginning of year        |                                                                         |                                                                  | 190.2                           |        |          |       | 59.1  |          |       |       | 41.6 |       
|                                                 |                                                                         |                                                                  |                                 |        |          |       |       |          |      
|Cash and equivalents at end of year              |                                                                         | $                                                                | 269.1                           |        |          | $     | 190.2 |          |       | $     | 59.1 |       
|                                                 |                                                                         |                                                                  |                                 |        |          |       |       |          |      
|Supplemental cash flow disclosures:              |                                                                         |                                                                  |                                 |        |          |       |       |          |       |       |      |       
|                                                 | Interest paid                                                           |                                                                  | $                               | 11.0   |          |       | $     | 14.6     |       |       | $    | 15.8   |       
|                                                 | Income taxes paid                                                       |                                                                  | $                               | 26.9   |          |       | $     | 33.9     |       |       | $    | 38.6   |       

See accompanying notes to consolidated financial
statements.

40



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##### Table of Contents



CONSOLIDATED STATEMENTS OF STOCKHOLDERS
EQUITY

(dollars in millions except share
amounts)


|                                                                                    |  |              |            |              |             |          |       |               |             |   |               |   |  |          |       |   |       |   |       |  |  |   |         |  
|----------------------------------------------------------------------------------- |  | ------------ | ---------- | ------------ | ----------- | -------- | ----- | ------------- | ----------- | - | ------------- | - |  | -------- | ----- | - | ----- | - | ----- |  |  | - | ------- | -
|                                                                                    |  |              |            |              |             | Deferred |       |               | Accumulated |   |               |   |  |         
|                                                                                    |  |              |            | Compensation |             |          | Other |               |             |   |               |  
|                                                                                    |  | Common Stock |            |              | and Officer |          |       | Comprehensive |             |   | Retained      |   |  |         
|                                                                                    |  | Shares       |            |              | Amount      |          |       | Receivables   |             |   | Income (Loss) |   |  | Earnings |       |   | Total |  
|                                                                                    |  |              |            |              |             |          |       |               |             |   |               |   |  |          |       |   |       |  
|Balance at January 23, 2000                                                         |  |              | 77,687,829 |              |             | $        | 679.6 |               |             | $ | (3.9          | ) |  | $        | 0.2   |   |       | $ | 126.7 |  |  | $ | 802.6   |  
|                                                                                    |  |              |            |              |             |          |       |               |             |   |               |   |  |          |       |   |       |  
|                                                                                   
|Net income                                                                          |  |              |           |              |             |          |      |               |             |   |              |   |  |          |      |   |       |   | 43.6  |  |  |   | 43.6    |  
|Foreign currency translation adjustments                                            |  |              |           |              |             |          |      |               |             |   |              |   |  |          | (8.2  | ) |       |   |      |  |  |   | (8.2    | )
|                                                                                    |  |              |            |              |             |          |       |               |             |   |               |   |  |          |       |   |       |  
|Comprehensive income                                                                |  |              |            |              |             |          |       |               |             |   |               |   |  |          |       |   |       |   |       |  |  |   | 35.4    |  
|Issuance of common stock                                                            |  |              | 1,596,475  |              |             |          | 11.5  |               |             |   |              |   |  |          |      |   |       |   |      |  |  |   | 11.5    |  
|Repurchase and retirement of common stock                                           |  |              | (634,803   | )            |             |          | (9.2  | )             |             |   |              |   |  |          |      |   |       |   |      |  |  |   | (9.2    | )
|Tax benefit of equity compensation                                                  |  |              |           |              |             |          | 3.3   |               |             |   |              |   |  |          |      |   |       |   |      |  |  |   | 3.3     |  
|Change in receivables and deferred compensation                                     |  |              |           |              |             |          |      |               |             |   | 2.9           |   |  |          |      |   |       |   |      |  |  |   | 2.9     |  
|                                                                                    |  |              |            |              |             |          |       |               |             |   |               |   |  |          |       |   |       |  
|Balance at January 28, 2001                                                         |  |              | 78,649,501 |              |             | $        | 685.2 |               |             | $ | (1.0          | ) |  | $        | (8.0  | ) |       | $ | 170.3 |  |  | $ | 846.5   |  
|                                                                                    |  |              |            |              |             |          |       |               |             |   |               |   |  |          |       |   |       |  
|                                                                                   
|Net income                                                                          |  |              |           |              |             |          |      |               |             |   |              |   |  |          |      |   |       |   | 87.4  |  |  |   | 87.4    |  
|Foreign currency translation adjustments                                            |  |              |           |              |             |          |      |               |             |   |              |   |  |          | (4.4  | ) |       |   |      |  |  |   | (4.4    | )
|Cumulative effect of change in accounting
    principle, net of tax benefit of $1.0 |  |              |           |              |             |          |      |               |             |   |              |   |  |          | (1.6  | ) |       |   |      |  |  |   | (1.6    | )
|Change in fair value of derivatives, net of tax
    benefit of $0.9                 |  |              |           |              |             |          |      |               |             |   |              |   |  |          | (1.5  | ) |       |   |      |  |  |   | (1.5    | )
|                                                                                    |  |              |            |              |             |          |       |               |             |   |               |   |  |          |       |   |       |  
|Comprehensive income                                                                |  |              |            |              |             |          |       |               |             |   |               |   |  |          |       |   |       |   |       |  |  |   | 79.9    |  
|Issuance of common stock                                                            |  |              | 3,729,906  |              |             |          | 34.9  |               |             |   |              |   |  |          |      |   |       |   |      |  |  |   | 34.9    |  
|Repurchase and retirement of common stock                                           |  |              | (1,176,440 | )            |             |          | (17.7 | )             |             |   |              |   |  |          |      |   |       |   |      |  |  |   | (17.7   | )
|Tax benefit of equity compensation                                                  |  |              |           |              |             |          | 5.5   |               |             |   |              |   |  |          |      |   |       |   |      |  |  |   | 5.5     |  
|Change in receivables and
    deferred compensation                                 |  |              |           |              |             |          |      |               |             |   | 0.8           |   |  |          |      |   |       |   |      |  |  |   | 0.8     |  
|                                                                                    |  |              |            |              |             |          |       |               |             |   |               |   |  |          |       |   |       |  
|Balance at January 27, 2002                                                         |  |              | 81,202,967 |              |             | $        | 707.9 |               |             | $ | (0.2          | ) |  | $        | (15.5 | ) |       | $ | 257.7 |  |  | $ | 949.9   |  
|                                                                                    |  |              |            |              |             |          |       |               |             |   |               |   |  |          |       |   |       |  
|                                                                                   
|Net income                                                                          |  |              |           |              |             |          |      |               |             |   |              |   |  |          |      |   |       |   | 111.7 |  |  |   | 111.7   |  
|Foreign currency translation adjustments                                            |  |              |           |              |             |          |      |               |             |   |              |   |  |          | 17.7  |   |       |   |      |  |  |   | 17.7    |  
|Change in fair value of derivatives, net of tax
    provision of $1.4               |  |              |           |              |             |          |      |               |             |   |              |   |  |          | 2.2   |   |       |   |      |  |  |   | 2.2     |  
|                                                                                    |  |              |            |              |             |          |       |               |             |   |               |   |  |          |       |   |       |  
|Comprehensive income                                                                |  |              |            |              |             |          |       |               |             |   |               |   |  |          |       |   |       |   |       |  |  |   | 131.6   |  
|Issuance of common stock                                                            |  |              | 1,515,955  |              |             |          | 18.8  |               |             |   |              |   |  |          |      |   |       |   |      |  |  |   | 18.8    |  
|Repurchase and retirement of common stock                                           |  |              | (3,987,000 | )            |             |          | (74.8 | )             |             |   |              |   |  |          |      |   |       |   |      |  |  |   | (74.8   | )
|Tax benefit of equity compensation                                                  |  |              |           |              |             |          | 5.1   |               |             |   |              |   |  |          |      |   |       |   |      |  |  |   | 5.1     |  
|                                                                                    |  |              |            |              |             |          |       |               |             |   |               |   |  |          |       |   |       |  
|Balance at January 26, 2003                                                         |  |              | 78,731,922 |              |             | $        | 657.0 |               |             | $ | (0.2          | ) |  | $        | 4.4   |   |       | $ | 369.4 |  |  | $ | 1,030.6 |  
|                                                                                    |  |              |            |              |             |          |       |               |             |   |               |   |  |          |       |   |       |  

See accompanying notes to consolidated financial
statements.

41



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##### Table of Contents



NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS

(dollars in millions except per share
data)


NOTE 1  SUMMARY OF SIGNIFICANT
ACCOUNTING POLICIES

Nature of Business:Borders Group, Inc. (the Company),
through its subsidiaries, operates book, music and movie
superstores, mall-based bookstores and other bookstores in the
United States, United Kingdom, Australia, Singapore,
New Zealand, and Puerto Rico.

From May 1998 to August 2001, the Company
operated an Internet commerce site, Borders.com. In 2001, the
Company entered into an agreement with an affiliate of
Amazon.com (Amazon) for Amazon to develop and
operate a web site utilizing the Borders.com URL (the
Mirror Site). Operation of the Mirror Site began
August 1, 2001. As of that date, the Company stopped
selling merchandise via its Company-owned and -operated
Borders.com web site (and the Internet). In 2002, the Company
entered into an additional agreement with Amazon for Amazon to
develop and operate a web site utilizing the Waldenbooks.com URL
(the Second Mirror Site). Operation of the Second
Mirror Site began November 11, 2002.

Under these agreements, Amazon is the merchant of
record for all sales made through the Mirror Sites, and
determines all prices and other terms and conditions applicable
to such sales. Amazon is responsible for the fulfillment of all
products sold through the Mirror Sites and retains all payments
from customers. The Company receives referral fees for products
purchased through the Mirror Sites, and includes this income as
a component of Selling, general and administrative
expenses in the Companys consolidated statements of
operations. The agreements contain mutual indemnification
provisions, including provisions that essentially allocate
between the parties responsibilities with respect to any
liabilities for sales, use and similar taxes, including
penalties and interest, associated with products sold on the
Mirror Sites. Currently, taxes are not collected with respect to
products sold on the Mirror Sites except in certain states.

Principles of Consolidation:The consolidated financial statements
include the accounts of the Company and all majority-owned
subsidiaries. All significant intercompany transactions and
balances have been eliminated.

Use of Estimates:The preparation of financial
statements in conformity with accounting principles generally
accepted in the United States requires management to make
estimates and assumptions that affect the reported amounts of
assets and liabilities and disclosure of contingent assets and
liabilities at the date of the financial statements and the
reported amounts of revenues and expenses during the reporting
period. Actual results could differ from those estimates.

Fiscal Year:The
Companys fiscal year ends on the Sunday immediately
preceding the last Wednesday in January. Fiscal 2002
consisted of 52 weeks and ended January 26, 2003.
Fiscal 2001 consisted of 52 weeks and ended
January 27, 2002. Fiscal 2000 consisted of
53 weeks and ended January 28, 2001. References herein
to years are to the Companys fiscal years.

Foreign Currency and Translation of Foreign
Subsidiaries:The functional
currencies of the Companys foreign operations are the
respective local currencies. All assets and liabilities of the
Companys foreign operations are translated into
U.S. dollars at fiscal period-end exchange rates. Income
and expense items are translated at average exchange rates
prevailing during the year. The resulting translation
adjustments are recorded as a component of stockholders
equity and other comprehensive income. Foreign currency
transaction gains/(losses) were $0.1, $0.3, and $(0.8) in 2002,
2001, and 2000, respectively.

Cash and Equivalents:Cash and equivalents include
short-term investments with original maturities of 90 days
or less.

Inventories:Merchandise inventories are valued on
a first-in, first-out (FIFO) basis at the lower of cost or
market using the retail inventory method. The Company includes
certain distribution and other expenses in its inventory costs,
totaling $81.0 and $85.1 as of January 26, 2003, and
January 27, 2002, respectively.

Property and Equipment:Property and equipment are recorded at
cost, including capitalized interest, and depreciated over their
estimated useful lives on a straight-line basis for financial
statement purposes and on accelerated methods for income tax
purposes. Most store properties are leased and improvements are
amortized

42



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##### Table of Contents



NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS


(dollars in millions except per share data)
(Continued)


over the term of the lease, generally over 3 to
20 years. Other annual rates used in computing depreciation
for financial statement purposes are 2% to 3% for buildings and
10% to 33% for other fixtures and equipment. Amortization of
assets under capital leases is included in depreciation expense.

The carrying values of long-lived assets are
evaluated whenever changes in circumstances indicate the
carrying amounts of such assets may not be recoverable, in
accordance with Statement of Financial Accounting Standards
No. 144, Accounting for the Impairment or Disposal of
Long-Lived Assets (FAS 144). In performing such
reviews for recoverability, the Company compares the expected
cash flows to the carrying values of long-lived assets. If the
expected future cash flows are less than the carrying amounts of
such assets, the Company recognizes an impairment loss for the
difference between the carrying amount and its estimated fair
value. Fair value is estimated using expected discounted future
cash flows.

Goodwill:Pursuant
to the provisions of Statement of Financial Accounting Standards
No. 142, Goodwill and Other Intangible Assets
(FAS 142), which the Company adopted effective
January 28, 2002, goodwill is not amortized but is subject
to annual impairment tests in accordance with FAS 142.
Adoption of the provisions of FAS 142 had the impact of
eliminating the Companys goodwill amortization in 2002 and
increasing net income by approximately $2.8.

Prior to the adoption of FAS 142, goodwill
was amortized over 20 to 40 years on a straight-line basis.
The Company evaluated the recoverability of goodwill using a
fair value methodology whenever events or changes in
circumstances indicated that the carrying amount of goodwill may
not have been recoverable.

Financial Instruments:The recorded values of the
Companys financial instruments, which include accounts
receivable, accounts payable and indebtedness, approximate their
fair values.

Pursuant to the provisions of Statement of
Financial Accounting Standards No. 133, Accounting
For Derivative Instruments and Hedging Activities
(FAS 133), as amended, which the Company adopted effective
January 29, 2001, the Company recognizes the fair value of
its derivatives on the consolidated balance sheets. Changes in
derivative fair values are either recognized in earnings as
offsets to the changes in fair value of related hedged assets,
liabilities and firm commitments, or, for forecasted
transactions, deferred and recorded as a component of other
stockholders equity until the hedged transactions occur
and are recognized in earnings. The ineffective portion of a
hedging derivatives change in fair value is immediately
recognized in earnings.

Prior to the adoption of FAS 133, the net
cash amounts paid or received by the Company resulting from
interest rate swap agreements were recognized as adjustments to
interest expense in the period to which they related. The
Company was not required to recognize the fair value of the
derivatives on the consolidated balance sheets.

Revenue:Revenue is
recognized, net of estimated returns, at the point of sale for
all of the Companys segments.

The Company allows customers ordering certain
book, music, and movie products through certain of Amazons
web sites to purchase and pick up the merchandise at Borders
stores in the United States. Under this agreement, the Company
is the merchant of record for all sales made through this
service, and determines all prices and other terms and
conditions applicable to such sales. The Company fulfills all
products sold through this arrangement. In addition, the Company
assumes all risk, cost and responsibility related to the sale
and fulfillment of all products sold. The Company recognizes
revenue upon customers pick up of the merchandise at the
store, and classifies this revenue as a component of
Sales in the Companys consolidated statements
of operations.

Pre-Opening Costs:The Company expenses pre-opening costs
as incurred in accordance with SOP 98-5, Reporting on
the Costs of Start-Up Activities.

Closing Costs:Pursuant to the provisions of
Statement of Financial Accounting Standards No. 146,
Accounting for Costs Associated with Exit or Disposal
Activities (FAS 146), which the Company adopted
effective January 1, 2003, the Company expenses when
incurred all amounts related to discontinuance of operations of
stores identified for closure subsequent to December 31,
2002.

43



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NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS


(dollars in millions except per share data)
(Continued)


Prior to the adoption of FAS 146, the
Company applied the provisions of Emerging Issues Task Force
Issue No. 94-3, Liability Recognition for Certain
Employee Termination Benefits and Other Costs to Exit an
Activity (including Certain Costs Incurred in a
Restructuring) (EITF 94-3) for all stores it had
identified for closure as of December 31, 2002, and
provided for expenses directly related to discontinuance of
operations of the stores identified.

Preferred Reader Program:Waldenbooks sells memberships in its
Preferred Reader Program, which offers members discounts on
purchases and other benefits. The Company recognizes membership
income on a straight-line basis over the 12-month term of the
membership, and categorizes the income as Other
revenue in the Companys consolidated statements of
operations. Discounts on purchases are netted against
Sales in the Companys consolidated statements
of operations.

The Company had previously categorized membership
income as an offset to Cost of merchandise sold in
the Companys consolidated statements of operations, but
has determined that categorization as Other revenue
is more appropriate. Accordingly, membership income has been
reclassified for all periods presented.

Advertising Costs:The Company expenses advertising costs
as incurred, and recorded approximately $36.1, $38.5 and $39.0
of gross advertising expenses in 2002, 2001 and 2000,
respectively.

The Company receives payments and credits from
vendors pursuant to co-operative advertising programs, shared
markdown programs, purchase volume incentive programs and
magazine slotting programs.

Pursuant to co-operative advertising programs
offered by vendors, the Company contracts with vendors to
promote merchandise for specified time periods. Pursuant to the
provisions of Emerging Issues Task Force Issue No. 02-16,
Accounting by a Customer (Including a Reseller) for
Certain Consideration Received from a Vendor
(EITF 02-16), which the Company adopted effective
January 1, 2003, vendor consideration which represents a
reimbursement of specific, incremental, identifiable costs is
included in the Selling, general and administrative
line on the consolidated statements of operations, along with
the related costs, in the period the promotion takes place.
Consideration which exceeds such costs, is classified as a
reduction of the Cost of merchandise sold line on
the consolidated statements of operations. Prior to the adoption
of EITF 02-16, all consideration and costs pursuant to
co-operative advertising programs were included in the
Selling, general and administrative line of the
consolidated statements of operations.

The Company also receives credits from vendors
pursuant to shared markdown programs, purchase volume programs,
and magazine slotting programs. Credits received pursuant to
these programs are classified in the Cost of merchandise
sold line on the consolidated statements of operations,
and are recognized upon certain product volume thresholds being
met or product placements occurring.

Advertising costs and income not part of the
programs listed above are included in the Selling, general
and administrative line of the consolidated statements of
operations.

44



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##### Table of Contents



NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS


(dollars in millions except per share data)
(Continued)


Equity-Based Compensation:The Company accounts for equity-based
compensation under the guidance of APB No. 25. As
permitted, the Company has adopted the disclosure-only option of
Statement of Financial Accounting Standards No. 123,
Accounting for Stock Based Compensation
(FAS 123). The following table illustrates the effect on
net income and earnings per share if the Company had applied the
fair value recognition provisions of FAS 123 to stock-based
employee compensation:

|                                                                                                                              |                       |      |       |      |      |   |      |      |  |   |      |      | 
|----------------------------------------------------------------------------------------------------------------------------- | --------------------- | ---- | ----- | ---- | ---- | - | ---- | ---- |  | - | ---- | ---- | 
|                                                                                                                              |                       | 2002 |       |      | 2001 |   |      | 2000 | 
|                                                                                                                              |                       |      |       |      |      |   |      |      | 
|Net income, as reported                                                                                                       |                       | $    | 111.7 |      |      | $ | 87.4 |      |  | $ | 43.6 |     
|Add: Stock-based employee expense included in
    reported net income, net of related tax effects                             |                       |      | 0.1   |      |      |   | 0.1  |      |  |   | 0.1  |     
|Deduct: Total stock-based employee compensation
    expense determined under fair value method for all awards, net
    of tax |                       |      | 4.9   |      |      |   | 6.6  |      |  |   | 12.1 |     
|                                                                                                                              |                       |      |       |      |      |   |      |      | 
|Pro forma net income                                                                                                          |                       | $    | 106.9 |      |      | $ | 80.9 |      |  | $ | 31.6 |     
|                                                                                                                              |                       |      |       |      |      |   |      |      | 
|Earnings per share:                                                                                                           |                       |      |       |      |      |   |      |      |  |   |      |     
|                                                                                                                              | Basic  as reported   |      | $     | 1.39 |      |   | $    | 1.08 |  |   | $    | 0.56 | 
|                                                                                                                              | Basic  pro forma     |      | $     | 1.33 |      |   | $    | 1.00 |  |   | $    | 0.40 | 
|                                                                                                                              | Diluted  as reported |      | $     | 1.36 |      |   | $    | 1.06 |  |   | $    | 0.54 | 
|                                                                                                                              | Diluted  pro forma   |      | $     | 1.30 |      |   | $    | 0.98 |  |   | $    | 0.39 | 

See Note 14  Stock-Based
Benefit Plans for further discussion of the Companys
equity-based compensation plans.

New Accounting Guidance:In June 2002, the Financial
Accounting Standards Board (FASB) issued Statement of
Financial Accounting Standards No. 146, Accounting
for Costs Associated with Exit or Disposal Activities
(FAS 146). This pronouncement requires that a liability for
a cost associated with an exit or disposal activity be
recognized and measured initially at fair value only when the
liability is incurred. Prior to the adoption of this Standard, a
liability for an exit cost, as defined by Emerging Issues Task
Force Issue No. 94-3, Liability Recognition for Certain
Employee Termination Benefits and Other Costs to Exit an
Activity (including Certain Costs Incurred in a
Restructuring) (EITF 94-3), was recognized at the date of
an entitys commitment to an exit plan. FAS 146 was
effective for the Company for exit plans or disposal activities
committed to after December 31, 2002. Adoption did not have
a material impact on the Companys financial position or
results of operations in fiscal 2002, but will impact timing of
recognition of store closing costs in future periods.

In November 2002, the FASB issued
Interpretation No. 45, Guarantors Accounting
and Disclosure Requirements for Guarantees, Including Indirect
Guarantees of Indebtedness of Others. This interpretation
elaborates on the disclosure requirements in the financial
statements concerning obligations under certain guarantees. It
also clarifies the requirements related to the recognition of
liabilities by a guarantor at the inception of certain
guarantees. The Company adopted the disclosure requirements of
this interpretation on January 1, 2003. The recognition
provisions of the interpretation are applicable only to
guarantees issued or modified after December 31, 2002.
Adoption of these recognition provisions did not have a material
impact on the Companys financial position or results of
operations in fiscal 2002.

In November 2002, the Emerging Issues Task
Force issued Consensus No. 02-16, Accounting by a
Customer (Including a Reseller) for Certain Consideration
Received from a Vendor (EITF 02-16), which is effective
prospectively for all vendor arrangements entered into after
December 31, 2002. The Consensus requires that
consideration received from a vendor be considered a reduction
of the prices of vendors products and shown as a reduction
of cost of sales in the income statement of the customer. If the
consideration represents a reimbursement of specific incremental
identifiable costs incurred, these amounts should be offset
against the related costs with any excess consideration recorded
in cost of sales. Adoption of the Consensus did not have a
material impact on the Companys financial position or
results of operations in fiscal 2002. The Company is evaluating
the impact of the Consensus on its financial position and
results of operations in fiscal 2003.

45



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##### Table of Contents



NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS


(dollars in millions except per share data)
(Continued)


In December 2002, the FASB issued Statement
of Financial Accounting Standards No. 148, Accounting
for Stock-Based Compensation  Transition and
Disclosure (FAS 148). This statement amends Statement
of Financial Accounting Standards No. 123, Accounting
for Stock-Based Compensation (FAS 123) to provide
alternative methods of transition for a voluntary change to the
fair value based method of accounting for stock-based employee
compensation. In addition, FAS 148 amends the disclosure
provisions of FAS 123 to require disclosure in the summary
of significant accounting policies of the effects of an
entitys accounting policy with respect to stock-based
employee compensation on reported net income and earnings per
share in annual and interim financial statements. The Company
adopted the disclosure requirements of FAS 148 on
January 26, 2003.

In January 2003, the FASB issued
Interpretation No. 46, Consolidation of Variable
Interest Entities. This interpretation addresses the
requirements for business enterprises to consolidate related
entities in which they are determined to be the primary
beneficiary as a result of their variable economic interests.
The interpretation is intended to provide guidance in judging
multiple economic interests in an entity and in determining the
primary beneficiary. The interpretation outlines disclosure
requirements for variable interest entities in existence prior
to January 31, 2003 and requires consolidation of variable
interest entities created after January 31, 2003. In
addition, the interpretation requires consolidation of variable
interest entities created prior to January 31, 2003 for
fiscal periods beginning after June 15, 2003. The Company
is evaluating the impact of the interpretation.

Reclassifications:Certain prior year amounts have been
reclassified to conform to 2002 presentation.

NOTE 2  WEIGHTED-AVERAGE SHARES
OUTSTANDING

Weighted-average shares outstanding are
calculated as follows (thousands):

|                                                         |  |      |        |  |      |  |        |      |  |  |        | 
|-------------------------------------------------------- |  | ---- | ------ |  | ---- |  | ------ | ---- |  |  | ------ | 
|                                                         |  | 2002 |        |  | 2001 |  |        | 2000 | 
|                                                         |  |      |        |  |      |  |        |      | 
|Weighted-average common shares
    outstanding  basic   |  |      | 80,280 |  |      |  | 80,559 |      |  |  | 78,374 | 
|Dilutive effect of employee stock options                |  |      | 1,753  |  |      |  | 2,165  |      |  |  | 1,914  | 
|                                                         |  |      |        |  |      |  |        |      | 
|Weighted-average common shares
    outstanding  diluted |  |      | 82,033 |  |      |  | 82,724 |      |  |  | 80,288 | 
|                                                         |  |      |        |  |      |  |        |      | 

Unexercised employee stock options to purchase
7.5 million, 4.6 million, and 14.3 million common
shares as of January 26, 2003, January 27, 2002, and
January 28, 2001, respectively, were not included in the
weighted-average shares outstanding calculation because to do so
would have been antidilutive.

NOTE 3  DISCONTINUED
OPERATIONS

In March 1999, the Company purchased All
Wound Up, a seasonal retailer of interactive toys and novelty
merchandise for a purchase price of $19.7 (excluding debt
repayment of $2.2), allocated primarily to fixed assets,
inventory, and goodwill. The acquisition was accounted for as a
purchase.

In January 2001, the Company adopted a plan
to discontinue operations of All Wound Up. Accordingly, the
operating results of All Wound Up, including a writeoff of
leasehold improvements, equipment, and deferred charges of
approximately $19.4, were segregated from continuing operations
and reported as a separate line item on the consolidated
statements of operations. The Company restated its prior
consolidated financial statements to present the operating
results of All Wound Up as a discontinued operation. Operations
of All Wound Up were substantially discontinued in
February 2001. A small percentage of All Wound Ups
stores (representing 6 of a total of 162 stores) remained open
beyond February 2001, and closed at various dates
thereafter until all were closed by the end of May 2001.
The 6 stores which continued operating experienced only de
minimus sales activity between February 2001 and
May 2001.

46



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##### Table of Contents



NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS


(dollars in millions except per share data)
(Continued)


Operating results (exclusive of the
aforementioned provisions) from discontinued operations are as
follows:

|                         |                                              |      |       |      | 
|------------------------ | -------------------------------------------- | ---- | ----- | ---- | 
|                         |                                              | 2000 |      
|                         |                                              |      |      
|Net sales                |                                              | $    | 23.2  |     
|Costs and expenses       |                                              |      |       |     
|                         | Cost of sales                                |      |       | 25.4 | 
|                         | Selling, general and administrative expenses |      |       | 12.0 | 
|                         | Goodwill amortization                        |      |       | 0.9  | 
|                         |                                              |      |      
|Operating loss           |                                              |      | (15.1 | )   
|Other deductions         |                                              |      | 2.7   |     
|                         |                                              |      |      
|Loss before income tax   |                                              |      | (17.8 | )   
|Income tax credit        |                                              |      | (7.0  | )   
|                         |                                              |      |      
|Net loss from operations |                                              | $    | (10.8 | )   
|                         |                                              |      |      

NOTE 4  ASSET IMPAIRMENTS AND OTHER
WRITEDOWNS

Store Impairments.In accordance with the provisions of
FAS 144, Accounting for the Impairment or Disposal of
Long-Lived Assets, the Company evaluates the carrying
values of long-lived assets whenever changes in circumstances
indicate the carrying amounts of such assets may not be
recoverable. In the fourth quarter of 2002, the Company took a
charge of $14.0 related to the impairment of certain long-lived
assets (primarily leasehold improvements, furniture, and
fixtures), consisting of the following: $2.9 related to
underperforming domestic Borders superstores, $8.2 related to
underperforming Waldenbooks stores and $2.9 related to
underperforming Books etc. stores.

In the fourth quarter of 2001, the Company took a
charge of $6.9 primarily related to the impairment of certain
long-lived assets related to leasehold improvements and
furniture and fixtures of underperforming Waldenbooks stores.

In the fourth quarter of 2000, the Company took a
charge of $36.2 related to the impairment of certain long-lived
assets, consisting primarily of the following: $12.5 for
leasehold improvements and furniture and fixtures of
underperforming Waldenbooks stores and $17.7 for computer
hardware and software of Borders.com. The remainder of the
charge related to employee severance, the costs of certain lease
obligations for redundant headquarter buildings, and the
writeoff of certain equity investments.

The charges taken for these impairments are
categorized as Asset impairments and other
writedowns on the consolidated statements of operations.

Store Closings.In
accordance with the provisions of EITF 94-3, Liability
Recognition for Certain Employee Termination Benefits and Other
Costs to Exit an Activity (including Certain Costs Incurred in a
Restructuring), for stores identified for closure on or
before December 31, 2002, the Company has provided for
expenses directly related to the closures. These expenses
typically pertain to inventory markdowns, asset impairments, and
store payroll and other costs which will be incurred subsequent
to the stores scheduled closure. When the Company adopts a
plan to close any of its stores, the inventory of the stores
included in the closure plan is either returned to vendors or
marked down and sold. Stores leasehold improvements,
furniture, fixtures and equipment are generally discarded or
sold for nominal amounts.

Waldenbooks stores average between five and seven
employees per store, who have been or will be displaced by the
closures, with the majority being transferred to other
Waldenbooks or Borders store locations. Those employees not
transferred are eligible for involuntary termination benefits,
but the total amount of these benefits for the stores affected
by the closing plans is not significant.

47



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##### Table of Contents



NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS


(dollars in millions except per share data)
(Continued)


During the fourth quarter of 2002, the Company
adopted a plan to close 65 underperforming Waldenbooks stores.
As a result of this plan, the Company recorded a $2.2 charge for
the closing costs of the stores (net of a $0.6 adjustment of the
prior year reserve resulting from actual costs differing from
estimates). The charge includes $0.5 of asset impairments, and
$0.3 of store payroll and other costs which will be incurred
subsequent to the stores scheduled closure in 2002. These
costs are categorized as Asset impairments and other
writedowns on the consolidated statements of operations.
Also included in the $2.2 charge is a $1.4 charge for inventory
markdowns of the stores to be closed, categorized as
Fulfillment center and other inventory writedowns on
the consolidated statements of operations.

During the fourth quarter of 2001, the Company
recorded a $3.9 charge for the closing costs relating to the
closure of 67 underperforming Waldenbooks stores. This charge
included $0.8 of lease termination costs, $0.6 of asset
impairments, and $1.1 of store payroll and other costs,
categorized as Asset impairments and other
writedowns on the consolidated statements of operations.
Also included in the $3.9 charge is a $1.4 charge for inventory
markdowns of the stores to be closed, categorized as
Fulfillment center and other inventory writedowns on
the consolidated statements of operations.

Pursuant to Waldenbooks store closing
plans, 53 stores were closed during 2002, 53 stores were
closed during 2001, and 40 are scheduled to close in 2003.

The following table summarizes Waldenbooks
store closing reserve:

|                                    |                         |   |     |      |  
|----------------------------------- | ----------------------- | - | --- | ---- | -
|                                    | 2001 Charge             |   | $   | 3.9  |  
|                                    | 2001 Cash payments      |   |     | (0.5 | )
|                                    |                         |   |    
|Reserve balance at January 27, 2002 |                         |   | 3.4 |     
|                                    |                         |   |    
|                                    | 2002 Charge             |   |     | 2.8  |  
|                                    | 2002 Reserve adjustment |   |     | (0.6 | )
|                                    | 2002 Cash payments      |   |     | (3.0 | )
|                                    |                         |   |    
|Reserve balance at January 26, 2003 |                         | $ | 2.6 |     
|                                    |                         |   |    

The following table summarizes the sales and
operating income (loss) for the stores included in the
closure plans:

|                        |  |      |      |   |      |   |      |      |  |   |      | 
|----------------------- |  | ---- | ---- | - | ---- | - | ---- | ---- |  | - | ---- | 
|                        |  | 2002 |      |   | 2001 |   |      | 2000 | 
|                        |  |      |      |   |      |   |      |      | 
|Sales                   |  | $    | 48.1 |   |      | $ | 81.4 |      |  | $ | 90.0 | 
|Operating income (loss) |  |      | (1.2 | ) |      |   | 0.6  |      |  |   | 2.1  | 

During the fourth quarter of 2002, the Company
adopted a plan to close one underperforming Books etc. store. As
a result of this plan, the Company recorded a $0.1 charge
for the closing costs of the store, categorized as Asset
impairments and other writedowns on the consolidated
statements of operations. The Company also recorded a
$0.4 charge for the estimated future lease obligations of
the store, categorized as Fulfillment center and other
inventory writedowns on the consolidated statements of
operations.

The Company applies provisions of FAS 146,
Accounting for Costs Associated with Exit or Disposal
Activities, for exit plans or disposal activities
committed to after December 31, 2002.

Fulfillment Center.On March 15, 2001, the Company
announced an agreement with Ingram Book Group (Ingram), a
wholesaler of books, spoken audio and magazines, pursuant to
which Ingram provides fulfillment services for the
Companys special order book sales. This agreement with
Ingram resulted in a first quarter 2001 charge of approximately
$16.0 primarily related to the writedown of assets used by the
Company-owned facility to fulfill special order sales, including
warehouse equipment, hardware, and software, and is included in
Asset impairments and other writedowns on the
consolidated statements of operations. This agreement also
resulted in a first quarter 2001 charge of $12.7 for the
writedown of fulfillment center inventory. In the fourth quarter
of 2001, the Company

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NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS


(dollars in millions except per share data)
(Continued)


reversed approximately $4.0 of this charge as a
result of favorable experience in the disposition of the
inventory. The net charge of $8.7 is categorized as
Fulfillment center and other inventory writedowns on
the consolidated statements of operations.

NOTE 5  GOODWILL

Effective January 28, 2002, the Company
adopted FAS 142, Goodwill and Other Intangible
Assets. As required by FAS 142, the Company is no
longer amortizing goodwill, but will be reviewing annually (or
more frequently if impairment indicators arise) for impairment.
Upon adoption and at the annual testing date of January 26,
2003, the Company determined that there was no impairment of
goodwill for any of its reporting units. The following earnings
and earnings per share data have been presented on a
pro forma basis to eliminate goodwill amortization, as
required by FAS 142.

|                            |                       |                     |   |       |       |  |   |      |      |  |   |      |      | 
|--------------------------- | --------------------- | ------------------- | - | ----- | ----- |  | - | ---- | ---- |  | - | ---- | ---- | 
|                            |                       | 2002                |   |       | 2001  |  |   | 2000 |     
|                            |                       |                     |   |       |       |  |   |      |     
|Adjusted net income:        |                       |                     |   |       |       |  |   |      |      |  |   |     
|                            | Net income            |                     | $ | 111.7 |       |  | $ | 87.4 |      |  | $ | 43.6 |     
|                            | Goodwill amortization |                     |   |      |       |  |   | 2.7  |      |  |   | 2.8  |     
|                            |                       |                     |   |       |       |  |   |      |     
|                            |                       | Adjusted net income |   | $     | 111.7 |  |   | $    | 90.1 |  |   | $    | 46.4 | 
|                            |                       |                     |   |       |       |  |   |      |     
|Diluted earnings per share: |                       |                     |   |       |       |  |   |      |      |  |   |     
|                            | Net income            |                     | $ | 1.36  |       |  | $ | 1.06 |      |  | $ | 0.54 |     
|                            | Goodwill amortization |                     |   |      |       |  |   | 0.03 |      |  |   | 0.03 |     
|                            |                       |                     |   |       |       |  |   |      |     
|                            |                       | Adjusted net income |   | $     | 1.36  |  |   | $    | 1.09 |  |   | $    | 0.57 | 
|                            |                       |                     |   |       |       |  |   |      |     
|Basic earnings per share:   |                       |                     |   |       |       |  |   |      |      |  |   |     
|                            | Net income            |                     | $ | 1.39  |       |  | $ | 1.08 |      |  | $ | 0.56 |     
|                            | Goodwill amortization |                     |   |      |       |  |   | 0.04 |      |  |   | 0.03 |     
|                            |                       |                     |   |       |       |  |   |      |     
|                            |                       | Adjusted net income |   | $     | 1.39  |  |   | $    | 1.12 |  |   | $    | 0.59 | 
|                            |                       |                     |   |       |       |  |   |      |     

NOTE 6  EFFECT OF TERRORIST
ATTACKS ON SEPTEMBER 11, 2001

As a result of the terrorist attacks on
September 11, 2001, a Borders store that operated in the
World Trade Center in New York City was destroyed. The loss of
that stores sales and net income was not material to the
consolidated 2002 or 2001 results as a whole. The Company was
insured for the replacement value of the assets destroyed at the
store and up to 24 months of lost income from business
interruption coverage and has recognized a total recovery of
$15.9 to date.

During 2002, the Company recognized a $2.9 gain
from insurance proceeds related to the terrorist attacks on
September 11, 2001. Of this, $1.2 represented business
interruption proceeds for 2002. This was categorized as
Cost of merchandise sold in the consolidated
statements of operations, because the stores lost income
would primarily have been categorized as Gross
margin in the consolidated statements of operations. The
remaining $1.7 gain was categorized as an offset to
Selling, general and administrative expenses. This
amount primarily represented the excess of lost assets
replacement value over their net book value. It is the
Companys policy to record gains and losses on asset
disposals as part of Selling, general and administrative
expenses.

During 2001, net asset values of $8.0 (net of
straight-line rent reserves of $2.0) were written off against
the allocated property insurance proceeds of $11.0. Gains were
categorized in the consolidated statements of operations as
follows: $1.0 in Selling, general and administrative
and $2.0 in Cost of merchandise sold. In addition,
$2.0 of business interruption proceeds were recorded in
Cost of merchandise sold to offset otherwise lost
profits from the store.

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NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS


(dollars in millions except per share data)
(Continued)


The Company expects to recover additional
insurance amounts, up to a maximum of approximately $4.0, based
upon, among other things, capital expenditures in replacement
stores and the performance of such stores, which will be
recognized when collection of such additional recoveries is
assured.

NOTE 7  LEGAL
SETTLEMENT

In March 1998, the American Booksellers
Association and 26 independent bookstores filed a lawsuit in the
United States District Court for the Northern District of
California against the Company and Barnes & Noble, Inc.
alleging violations of the Robinson-Patman Act, the California
Unfair Trade Practice Act, and the California Unfair Competition
Act. On April 19, 2001, the Company announced that a
settlement had been reached in this action. The Company paid
$2.4 under the agreement and categorized this charge as
Legal settlement expense in the consolidated
statements of operations during 2001.

NOTE 8  PROPERTY AND
EQUIPMENT

Property and equipment consists of the following:

|                                                     |                          |      |         |       |      |   |         |       | 
|---------------------------------------------------- | ------------------------ | ---- | ------- | ----- | ---- | - | ------- | ----- | 
|                                                     |                          | 2002 |         |       | 2001 |  
|                                                     |                          |      |         |       |      |  
|Property and equipment                               |                          |      |         |       |      |   |         |      
|                                                     | Land                     |      | $       | 10.2  |      |   | $       | 10.2  | 
|                                                     | Buildings                |      |         | 5.2   |      |   |         | 3.1   | 
|                                                     | Leasehold improvements   |      |         | 384.3 |      |   |         | 351.0 | 
|                                                     | Furniture and fixtures   |      |         | 790.5 |      |   |         | 745.7 | 
|                                                     | Construction in progress |      |         | 31.0  |      |   |         | 15.6  | 
|                                                     |                          |      |         |       |      |  
|                                                     |                          |      | 1,221.2 |       |      |   | 1,125.6 |      
|Less  accumulated depreciation
    and amortization |                          |      | (667.4  | )     |      |   | (596.2  | )    
|                                                     |                          |      |         |       |      |  
|Property and equipment, net                          |                          | $    | 553.8   |       |      | $ | 529.4   |      
|                                                     |                          |      |         |       |      |  

NOTE 9  INCOME TAXES

The income tax provision from continuing
operations consists of the following:

|                           |                 |      |      |      |      |   |      |      |   |   |      |      |  
|-------------------------- | --------------- | ---- | ---- | ---- | ---- | - | ---- | ---- | - | - | ---- | ---- | -
|                           |                 | 2002 |      |      | 2001 |   |      | 2000 |  
|                           |                 |      |      |      |      |   |      |      |  
|Current                    |                 |      |      |      |      |   |      |      |   |   |      |     
|                           | Federal         |      | $    | 45.1 |      |   | $    | 36.1 |   |   | $    | 46.0 |  
|                           | State and local |      |      | 8.0  |      |   |      | 5.5  |   |   |      | 5.3  |  
|                           | Foreign         |      |      |     |      |   |      | 0.2  |   |   |      | 0.3  |  
|Deferred                   |                 |      |      |      |      |   |      |      |   |   |      |     
|                           | Federal         |      |      | 16.8 |      |   |      | 14.4 |   |   |      | (0.6 | )
|                           | State and local |      |      | 0.1  |      |   |      | 0.4  |   |   |      | 1.0  |  
|                           | Foreign         |      |      | (0.4 | )    |   |      | (1.4 | ) |   |      | (3.8 | )
|                           |                 |      |      |      |      |   |      |      |  
|Total income tax provision |                 | $    | 69.6 |      |      | $ | 55.2 |      |   | $ | 48.2 |     
|                           |                 |      |      |      |      |   |      |      |  

A reconciliation of the federal statutory rate to
the Companys effective tax rate follows:

|                                                  |  |      |      |  |      |   |      |      |  |   |      | 
|------------------------------------------------- |  | ---- | ---- |  | ---- | - | ---- | ---- |  | - | ---- | 
|                                                  |  | 2002 |      |  | 2001 |   |      | 2000 | 
|                                                  |  |      |      |  |      |   |      |      | 
|Federal statutory rate                            |  | $    | 63.5 |  |      | $ | 49.9 |      |  | $ | 42.8 | 
|State and local taxes, net of federal tax benefit |  |      | 5.3  |  |      |   | 3.8  |      |  |   | 4.1  | 
|Other                                             |  |      | 0.8  |  |      |   | 1.5  |      |  |   | 1.3  | 
|                                                  |  |      |      |  |      |   |      |      | 
|Total income tax provision                        |  | $    | 69.6 |  |      | $ | 55.2 |      |  | $ | 48.2 | 
|                                                  |  |      |      |  |      |   |      |      | 

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NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS


(dollars in millions except per share data)
(Continued)


Deferred tax assets and liabilities resulted from
the following:

|                                      |                                        |      |      |      |      |   |      |      | 
|------------------------------------- | -------------------------------------- | ---- | ---- | ---- | ---- | - | ---- | ---- | 
|                                      |                                        | 2002 |      |      | 2001 |  
|                                      |                                        |      |      |      |      |  
|Deferred tax assets                   |                                        |      |      |      |      |   |      |     
|                                      | Accruals and other current liabilities |      | $    | 5.1  |      |   | $    | 6.9  | 
|                                      | Deferred revenue                       |      |      | 5.9  |      |   |      | 6.1  | 
|                                      | Other long-term liabilities            |      |      | 1.4  |      |   |      | 1.6  | 
|                                      | Deferred compensation                  |      |      | 0.9  |      |   |      | 1.7  | 
|                                      | Deferred rent                          |      |      | 24.8 |      |   |      | 22.8 | 
|                                      | Net operating losses                   |      |      | 11.4 |      |   |      | 9.3  | 
|                                      | Asset impairments and other writedowns |      |      | 12.7 |      |   |      | 27.2 | 
|                                      |                                        |      |      |      |      |  
|                                      | Total deferred tax assets              |      |      | 62.2 |      |   |      | 75.6 | 
|                                      |                                        |      |      |      |      |  
|Deferred tax liabilities              |                                        |      |      |      |      |   |      |     
|                                      | Inventory                              |      |      | 18.0 |      |   |      | 17.1 | 
|                                      | Property and equipment                 |      |      | 46.6 |      |   |      | 45.6 | 
|                                      | Net state deferred tax liability       |      |      | 1.9  |      |   |      | 0.9  | 
|                                      | Other                                  |      |      | 2.3  |      |   |      | 2.0  | 
|                                      |                                        |      |      |      |      |  
|                                      | Total deferred tax liabilities         |      |      | 68.8 |      |   |      | 65.6 | 
|                                      |                                        |      |      |      |      |  
|Net deferred tax assets (liabilities) |                                        | $    | (6.6 | )    |      | $ | 10.0 |     
|                                      |                                        |      |      |      |      |  

The Company has tax net operating loss
carryforwards in foreign jurisdictions totaling $35.3 as of
January 26, 2003, $33.1 as of January 27, 2002, and
$28.4 as of January 28, 2001. These losses have an
indefinite carryforward period.

For tax purposes, consolidated domestic
income/(loss) before taxes was $194.7 in 2002, $149.0 in 2001,
and $135.0 in 2000. The corresponding amounts for foreign
operations were $(13.4) in 2002, $(6.4) in 2001, and $(13.0) in
2000.

NOTE 10  COMMITMENTS AND
CONTINGENCIES

Litigation.In
August 1998, The Intimate Bookshop, Inc. (Intimate) and its
owner, Wallace Kuralt, filed a lawsuit in the United States
District Court for the Southern District of New York against the
Company, Barnes & Noble, Inc., and others alleging violation
of the Robinson-Patman Act and other federal laws, New York
statutes governing trade practices and common law. In response
to Defendants Motion to Dismiss the Complaint, plaintiff
Kuralt withdrew his claims and plaintiff Intimate voluntarily
dismissed all but its Robinson-Patman claims. Intimate has filed
a Second Amended Complaint limited to allegations of violations
of the Robinson-Patman Act. The Second Amended Complaint alleges
that Intimate has suffered $11.3 or more in damages and requests
treble damages, injunctive and declaratory relief, interest,
costs, attorneys fees and other unspecified relief. The
Company intends to vigorously defend the action.

Two former employees, individually and on behalf
of a purported class consisting of all current and former
employees who worked as assistant managers in Borders stores in
the state of California at any time between April 10, 1996,
and the present, have filed an action against the Company in the
Superior Court of California for the County of San Francisco.
The action alleges that the individual plaintiffs and the
purported class members worked hours for which they were
entitled to receive, but did not receive, overtime compensation
under California law, and that they were classified as exempt
store management employees but were forced to work more than 50%
of their time in non-exempt tasks. The Amended Complaint, which
names two additional plaintiffs, alleges violations of the
California Labor Code and the California Business and
Professions Code. The relief sought includes compensatory and
punitive damages, penalties, preliminary and permanent
injunctions requiring Borders to pay overtime compensation as
required under California and Federal law, prejudgment interest,
costs, and attorneys fees and such other relief as

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NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS


(dollars in millions except per share data)
(Continued)


the court deems proper. On July 29, 2002,
the Superior Court of California granted the plaintiffs
motion for class certification in the action. The class
certified consists of all individuals who worked as Assistant
Managers in a Borders superstore in California at any time
between April 10, 1996 and March 18, 2001. The class
was further certified by the Court into the following
subclasses: Assistant Manager-Merchandising; Assistant
Manager-Inventory; Assistant Manager-Human Resources; Assistant
Manager-Music; Assistant Manager-Training; Assistant
Manager-Cafe. The Companys request for an immediate appeal
of the class certification ruling has been denied, and the
Company has agreed to engage in non-binding mediation of the
matter. Unless mediation is successful, the Company will
continue to vigorously defend the action.

On October 29, 2002, Gary Gerlinger,
individually and on behalf of all other similarly situated
consumers in the United States who, during the period from
August 1, 2001 to the present, purchased books online from
either Amazon or the Company, instituted an action against the
Company and Amazon in the United States District Court for the
Northern District of California. The Complaint alleges that the
agreement pursuant to which an affiliate of Amazon operates
Borders.com as a co-branded site violates federal anti-trust
laws, California statutory law and the common law of unjust
enrichment. The Complaint seeks injunctive relief, damages,
including treble damages or statutory damages where applicable,
attorneys fees, costs and disbursements, disgorgement of all
sums obtained by allegedly wrongful acts, interest and
declaratory relief. The Company has filed an answer denying any
liability and intends to vigorously defend the action.

The Company has not included any liability in its
consolidated financial statements in connection with the
lawsuits described above and has expensed as incurred all legal
costs to date. Although an adverse resolution of these lawsuits
could have a material adverse effect on the result of the
operations of the Company for the applicable period or periods,
the Company does not believe that any such litigation will have
a material effect on its liquidity or financial position.

Certain states and private litigants have sought
to impose sales or other tax collection efforts on
out-of-jurisdiction companies that engage in e-commerce. The
Company currently is disputing a claim by the state of
California relating to sales taxes that the state alleges should
have been collected on certain Borders.com sales in California
prior to implementation of the Companys Mirror Site
Agreement with Amazon. Also, the Company and Amazon have been
named as defendants in an action filed by a private litigant on
behalf of the State of Tennessee under the Tennessee False
Claims Act relating to the failure to collect use taxes on
Internet sales in Tennessee for periods both before and after
the implementation of the Mirror Site Agreement. The Complaint
seeks a judgment, jointly and severally, against the defendants
for, among other things, injunctive relief, treble the amount of
damages suffered by the State of Tennessee as a result of the
alleged violations of the defendants, penalties, costs and
expenses, including legal fees. Contrary to the claims in the
Complaint, the Company did collect taxes on Internet sales in
Tennessee (as well as Michigan) prior to the implementation of
the Mirror Site Agreement.

The Company does not believe that it should be
liable under existing laws and regulations for any failure by it
or Amazon to collect sales or other taxes relating Internet
sales. Although any liability relating to the failure to collect
sales or other taxes on online sales could have a material
effect on the results of the operations of the Company for the
applicable period or periods, the Company does not believe that
any such liability would have a material adverse effect on its
liquidity or financial position.

In addition to the matters described above, the
Company is, from time to time, involved in or affected by other
litigation incidental to the conduct of its businesses.

Relationship with Kmart 
General.Prior to its initial public
offering in May 1995, the Company was a subsidiary of Kmart
Corporation (Kmart); Kmart currently owns no shares of common
stock of the Company. In January 2002, Kmart filed for
reorganization under Chapter 11 of the U.S. Bankruptcy
Code. Such filing has not affected the operations of the Company.

Kmart and the Company continue to have the
following contractual relationships.

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NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS


(dollars in millions except per share data)
(Continued)


Tax Allocation and Indemnification
Agreement.Prior to the completion of
its initial public offering (IPO), the Company was included in
the consolidated federal income tax returns of Kmart and filed
on a combined basis with Kmart in certain states. Pursuant to a
tax allocation and indemnification agreement between the Company
and Kmart (Tax Allocation Agreement) the Company will remain
obligated to pay to Kmart any income taxes the Company would
have had to pay if it had filed separate tax returns for the tax
period beginning on January 26, 1995, and ending on
June 1, 1995, the date of the consummation of the IPO (to
the extent that it has not previously paid such amounts to
Kmart). In addition, if the tax liability attributable to the
Company for any previous tax period during which the Company was
included in a consolidated federal income tax return filed by
Kmart or a combined state return is adjusted as a result of an
action of a taxing authority or a court, then the Company will
pay to Kmart the amount of any increase in such liability and
Kmart has agreed to pay to the Company the amount of any
decrease in such liability (in either case together with
interest and penalties). The Companys tax liability for
previous years will not be affected by any increase or decrease
in Kmarts tax liability if such increase or decrease is
not directly attributable to the Company. After completion of
the IPO, the Company continued to be subject under existing
federal regulations to several liability for the consolidated
federal income taxes for any tax year in which it was a member
of any consolidated group of which Kmart was the common parent.
Pursuant to the Tax Allocation Agreement, however, Kmart agreed
to indemnify the Company for any federal income tax liability of
Kmart or any of its subsidiaries (other than that which is
attributable to the Company) that the Company could be required
to pay and the Company agreed to indemnify Kmart for any of the
Companys separate company taxes.

Lease Guaranty
Agreement.Borders leases for 13
of its retail stores and its distribution center in Harrisburg,
Pennsylvania have been guaranteed by Kmart. Under the terms of a
lease guaranty, indemnification and reimbursement agreement
entered into upon completion of the IPO, as amended, (Lease
Guaranty Agreement), the underlying leases will be transferable
by Borders, subject to a right of first refusal in favor of
Kmart with respect to sites within a three-mile radius of a
Kmart store and, with respect to all other sites, a right of
first offer in favor of Kmart. The Company and Borders are
required to indemnify Kmart with respect to (i) any
liabilities Kmart may incur under the lease guarantees, except
those liabilities arising from the gross negligence or willful
misconduct of Kmart, and (ii) any losses incurred by Kmart
after taking possession of any particular premises, except to
the extent such losses arise solely from the acts or omissions
of Kmart. Under the terms of the Lease Guaranty Agreement, in
the event of (i) the Companys or Borders
failure to provide any required indemnity, (ii) a knowing
and material violation of the limitations on transfers of
guaranteed leases set forth in the agreement, or
(iii) certain events of bankruptcy, Kmart will have the
right to assume any or all of the guaranteed leases and to take
possession of all of the premises underlying such guaranteed
leases; provided, that in the event of a failure or failures to
provide required indemnities, the remedy of taking possession of
all of the premises underlying the guaranteed leases may be
exercised only if such failures relate to an aggregate liability
of $10.0 or more and only if Kmart has provided
100 days prior written notice. In the event of a
failure to provide required indemnities resulting in losses of
more than the equivalent of two months rent under a particular
lease but less than $10.0, Kmart may exercise such remedy of
possession as to the premises underlying the guaranteed lease or
leases to which the failure to provide the indemnity relates and
one additional premise for each such premises to which the
failure relates, up to a maximum, in any event, of five
additional premises, and thereafter, with respect to such
additional premises, Kmart remedies and indemnification rights
shall terminate. In the event of a failure to provide required
indemnities resulting in liabilities of less than the equivalent
of two months rent under a particular lease, Kmart may exercise
such remedy of possession only as to the premises underlying the
guaranteed lease or leases to which the failure to provide the
indemnity relates. The Lease Guaranty Agreement will remain in
effect until the expiration of all lease guarantees, which the
Company believes will be in January 2020.

NOTE 11  DEBT

Credit Agreement.The Company has a Multicurrency Revolving Credit Agreement (the
Credit Agreement), which will expire in June 2005.
The Credit Agreement provides for borrowings of up to $400.0.
Borrowings under the Credit Agreement bear interest at a
variable base rate plus an increment or LIBOR plus an increment
at the Companys option. The Credit Agreement contains
covenants which limit, among other things, the Companys
ability

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NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS


(dollars in millions except per share data)
(Continued)


to incur indebtedness, grant liens, make
investments, consolidate or merge, declare dividends, dispose of
assets, repurchase its common stock in excess of $100.0 over the
term of the Agreement or $50.0 in any fiscal year (plus any
proceeds and tax benefits resulting from stock option exercises
and tax benefits resulting from restricted shares purchased by
employees from the Company), and requires the Company to meet
certain financial measures regarding fixed coverage, leverage,
tangible net worth and capital expenditures. The Company had
borrowings outstanding under the Credit Agreement (or a prior
agreement) of $112.1 at January 26, 2003 and $81.6 at
January 27, 2002. The weighted average interest rate in
2002 and 2001 was approximately 4.5% and 4.1%, respectively.

Term Loan.On
July 30, 2002, the Company issued $50.0 of senior
guaranteed notes (the Notes) due July 30, 2006
and bearing interest at 6.31% (payable semi-annually). The
proceeds of the sale of the Notes were used to refinance
existing indebtedness of the Company and its subsidiaries and
for general corporate purposes. The note purchase agreement
relating to the Notes contains covenants which limit, among
other things, the Companys ability to incur indebtedness,
grant liens, make investments, engage in any merger or
consolidation, dispose of assets or change the nature of its
business, and requires the Company to meet certain financial
measures regarding net worth, total debt coverage and fixed
charge coverage.

As of January 26, 2003 the Company was in
compliance with its debt covenants.

NOTE 12  LEASES

Operating Leases:The Company conducts operations
primarily in leased facilities. Store leases are generally for
terms of 3 to 20 years. Borders leases generally
contain multiple three- to five-year renewal options which allow
Borders the option to extend the life of the leases up to
25 years beyond the initial noncancellable term.
Waldenbooks leases generally do not contain renewal
options. Certain leases provide for additional rental payments
based on a percentage of sales in excess of a specified base.
Also, certain leases provide for the payment by the Company of
executory costs (taxes, maintenance, and insurance).

Lease Commitments:Future minimum lease payments under
operating leases at January 26, 2003 total $307.5 in 2003,
$288.6 in 2004, $273.6 in 2005, $265.5 in 2006, $260.4 in 2007,
$2,177.4 in all later years, and in the aggregate, total
$3,573.0.

Rental Expenses:A
summary of operating lease minimum and percentage rental expense
follows:

|                   |       |      |       |       |      |   |       |       |  |   |       |       | 
|------------------ | ----- | ---- | ----- | ----- | ---- | - | ----- | ----- |  | - | ----- | ----- | 
|                   |       | 2002 |       |       | 2001 |   |       | 2000  | 
|                   |       |      |       |       |      |   |       |       | 
|Minimum rentals    |       | $    | 322.1 |       |      | $ | 303.1 |       |  | $ | 277.7 |      
|Percentage rentals |       |      | 1.6   |       |      |   | 1.8   |       |  |   | 2.0   |      
|                   |       |      |       |       |      |   |       |       | 
|                   | Total |      | $     | 323.7 |      |   | $     | 304.9 |  |   | $     | 279.7 | 
|                   |       |      |       |       |      |   |       |       | 

Capitalized Leases:The Company accounts for 4 stores
and certain computer equipment under capital leases. Scheduled
principal payments of capitalized lease obligations as of
January 26, 2003 total $0.6 in 2003, $0.0 in 2004, $19.0 in
2005, $0.0 in 2006, $0.0 in 2007, $0.0 in all later years, and
in the aggregate, total $19.6. Obligations related to properties
included in the Companys Original Lease Facility
(described below) have been classified as due in 2005.

Lease Financing
Facilities:The Company has two lease
financing facilities (collectively, the Lease Financing
Facilities) to finance new stores and other property owned
by unaffiliated entities and leased to the Company or its
subsidiaries. The original facility (the Original Lease
Facility) will expire in June 2004 (2005 if certain
conditions are satisfied). In June of 2002, the Company
established a new facility (the New Lease Facility),
which will expire in 2007. The aggregate amount available under
the Lease Financing Facilities is $75.0. Properties to be
financed after the effective date of the New Lease Facility will
be financed under that Facility, and no additional properties
will be financed under the Original Lease Facility. The Lease
Financing Facilities provide financing to lessors of

54



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NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS


(dollars in millions except per share data)
(Continued)


properties leased to the Company or its
subsidiaries through loans from lenders for up to 95% of a
projects cost. Additionally, under the New Lease Facility,
the unaffiliated lessor will make equity contributions
approximating 5% of the cost of each project. The lessors under
the Original Lease Facility have made similar contributions.
Independent of the Companys obligations relating to the
leases, the Company and certain of its subsidiaries guarantee
payment when due of all amounts required to be paid to the
third-party lenders. The principal amount guaranteed is limited
to approximately 89% of the original cost of a project so long
as the Company is not in default under the lease relating to
such project. The agreements relating to both of the Lease
Financing Facilities contain covenants and events of default
that are similar to those contained in the Credit Agreement
described above. The Company is in compliance with these
covenants. Security interests in the properties underlying the
leases and in the Companys interests in the leases have
been given to the lenders. The Lease Financing Facilities
contain cross default provisions with respect to the obligations
of the Company under the Credit Agreement and certain other
agreements to which the Company is a party. There also are cross
default provisions with respect to the obligations relating to
the Lease Financing Facilities of Wilmington Trust Company, as
owner trustee of a grantor trust formed for the Lease Financing
Facilities, and the unaffiliated beneficial owner of the grantor
trust.

Substantially all of the Companys capital
lease assets are related to properties financed under the
Original Lease Facility. The Company pays lessors who have
financed properties under the Original Lease Facility regular
rental amounts for use of the properties. These payments are
equal to the carrying cost of the lessors borrowings for
construction of the properties, and do not include amortization
of the principal amounts of the lessors indebtedness
relating to the properties. The rental payments are categorized
as occupancy expense, and as such are included as a component of
Cost of merchandise sold in the Companys
consolidated statements of operations. These rental payments are
also included in the disclosure of future minimum lease payments
under operating leases.

There was $36.3 and $121.8 outstanding under the
Original Lease Facility at January 26, 2003 and
January 27, 2002, respectively. The Company has recorded
approximately $19.0 at January 26, 2003 and $49.7 at
January 27, 2002 of the amounts outstanding under the
Original Lease Facility as capitalized leases under Other
assets (for the capital lease assets) and Long-term
capital lease and financing obligations (for the capital
lease liabilities) on the consolidated balance sheets. These
amounts have been treated as non-cash items on the consolidated
statements of cash flows. There were no borrowings under the New
Lease Facility as of January 26, 2003.

During 1994, the Company entered into agreements
in which leases with respect to four Borders locations served as
collateral for certain mortgage pass-through certificates. These
mortgage pass-through certificates included a provision
requiring the Company to repurchase the underlying mortgage
notes in certain events. In the fourth quarter of 2001, the
Company was obligated to purchase the notes for $33.5, due to
Kmart Corporations (the former guarantor of the leases)
failure to maintain investment grade credit ratings. As a
result, the Company has categorized this prepaid rent amount as
part of Other assets in the consolidated balance
sheets and is amortizing the balance over each propertys
remaining lease term. The remaining balance at January 26,
2003 was approximately $30.6.

NOTE 13  EMPLOYEE BENEFIT
PLANS

Employee Savings Plan:Employees of the Company who meet
certain requirements as to age and service are eligible to
participate in the Companys Savings Plan. The
Companys expense related to this plan was $4.2, $3.2, and
$3.2 for 2002, 2001, and 2000, respectively.

NOTE 14  STOCK-BASED BENEFIT
PLANS

Stock Option Plans:The Company has various stock option
plans pursuant to which the Company may grant options to
purchase its common stock. The exercise price of options granted
under these plans will generally not be less than the fair value
per share of the Companys common stock at the date of
grant with vesting periods up to six years from grant date
and maximum option terms up to ten years from grant date.
Options have been granted

55



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##### Table of Contents



NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS


(dollars in millions except per share data)
(Continued)


under the plans to all full-time employees of the
Company and its subsidiaries with 30 days or more of
service. At January 26, 2003, the Company has
34.8 million shares authorized for the grant of stock
options under these plans.

Stock Purchase Plans:The Company has a management stock
purchase plan (the Management Plan) and an employee stock
purchase plan (the Employee Plan). Under the Management Plan,
the Companys senior management personnel are required to
use 20%, and may use up to 100%, of their annual incentive
bonuses to purchase restricted shares of the Companys
common stock, at a 20% to 40% discount from the fair value of
the same number of unrestricted shares of common stock. In
addition, the Companys senior management personnel may
elect to make a one-time purchase of restricted shares.
Restricted shares of common stock purchased under the Management
Plan will generally be restricted from sale or transfer for two
to four years from date of purchase. The Employee Plan
allows the Companys associates not covered under the
Management Plan to purchase shares of the Companys common
stock at a 15% discount from their fair market value.

The Company recognizes compensation expense for
the discount on restricted shares of common stock purchased
under the Management Plan. Such discounts are recognized as
expense on a straight-line basis over the period during which
the shares are restricted from sale or transfer. The Company is
not required to record compensation expense with respect to
shares purchased under the Employee Plan.

A summary of the information relative to the
Companys stock option plans follows (number of shares in
thousands):

|                                |                  |           |        |           |                |   |       |       | 
|------------------------------- | ---------------- | --------- | ------ | --------- | -------------- | - | ----- | ----- | 
|                                |                  |           |        | Weighted- |               
|                                |                  | Number    |        |           | Average        |  
|All Plans                       |                  | of Shares |        |           | Exercise Price |  
|                                |                  |           |        |           |                |  
|Outstanding at January 23, 2000 |                  |           | 18,564 |           |                | $ | 18.89 |      
|                                | Granted          |           |        | 4,811     |                |   |       | 13.25 | 
|                                | Exercised        |           |        | 1,397     |                |   |       | 7.52  | 
|                                | Forfeited        |           |        | 4,324     |                |   |       | 20.80 | 
|Outstanding at January 28, 2001 |                  |           | 17,654 |           |                |   | 17.82 |      
|                                | Granted          |           |        | 3,326     |                |   |       | 16.51 | 
|                                | Exercised        |           |        | 2,659     |                |   |       | 12.25 | 
|                                | Forfeited        |           |        | 2,906     |                |   |       | 19.34 | 
|Outstanding at January 27, 2002 |                  |           | 15,415 |           |                |   | 18.11 |      
|                                | Granted          |           |        | 3,232     |                |   |       | 20.02 | 
|                                | Exercised        |           |        | 1,305     |                |   |       | 12.42 | 
|                                | Forfeited        |           |        | 2,273     |                |   |       | 20.52 | 
|Outstanding at January 26, 2003 |                  |           | 15,069 |           |                |   | 18.76 |      
|Balance exercisable at          |                  |           |        |           |                |   |       |      
|                                | January 28, 2001 |           |        | 6,803     |                |   |       | 16.80 | 
|                                | January 27, 2002 |           |        | 7,619     |                |   |       | 18.22 | 
|                                | January 26, 2003 |           |        | 8,832     |                |   |       | 18.59 | 

The weighted-average fair values of options at
their grant date where the exercise price equals the market
price on the grant date were $6.94, $6.09, and $5.17 in 2002,
2001, and 2000, respectively.

56



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##### Table of Contents



NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS


(dollars in millions except per share data)
(Continued)


The Company has the following equity compensation
plans in effect at January 26, 2003 (number of shares in
thousands):

|                                    |                                 |             |        |        |                |   |       |                  |  |  |       |       | 
|----------------------------------- | ------------------------------- | ----------- | ------ | ------ | -------------- | - | ----- | ---------------- |  |  | ----- | ----- | 
|                                    |                                 | Number of   |        |        | Weighted-      |   |       | Number of        | 
|                                    |                                 | Shares      |        |        | Average        |   |       | Shares Available | 
|Plan Category                       |                                 | Outstanding |        |        | Exercise Price |   |       | for Issuance     | 
|                                    |                                 |             |        |        |                |   |       |                  | 
|Plans approved by shareholders:     |                                 |             |        |        |                |   |       |                  |  |  |       |      
|                                    | 1995 Stock Option Plan          |             |        | 11,260 |                |   | $     | 18.90            |  |  |       | 587   | 
|                                    | Director Plan                   |             |        | 158    |                |   |       | 17.56            |  |  |       | 8     | 
|                                    | Management Stock Purchase Plan  |             |        |       |                |   |       |                 |  |  |       | 3,454 | 
|Plans not approved by shareholders: |                                 |             |        |        |                |   |       |                  |  |  |       |      
|                                    | 1998 Stock Option Plan          |             |        | 2,947  |                |   |       | 17.98            |  |  |       | 238   | 
|                                    | International Stock Option Plan |             |        | 704    |                |   |       | 20.15            |  |  |       | 39    | 
|                                    |                                 |             |        |        |                |   |       |                  | 
|Total plans                         |                                 |             | 15,069 |        |                | $ | 18.76 |                  |  |  | 4,326 |      
|                                    |                                 |             |        |        |                |   |       |                  | 

The Black-Scholes option valuation model was used
to calculate the fair market value of the options at the grant
date for the purpose of disclosures required by FAS 123. The
following assumptions were used in the calculation:

|                        |  |      |            |  |      |  |            |      |  |  |              | 
|----------------------- |  | ---- | ---------- |  | ---- |  | ---------- | ---- |  |  | ------------ | 
|                        |  | 2002 |            |  | 2001 |  |            | 2000 | 
|                        |  |      |            |  |      |  |            |      | 
|Risk-free interest rate |  |      | 2.2-5.3%   |  |      |  | 3.1-5.4%   |      |  |  | 4.8-6.8%     | 
|Expected life           |  |      | 3-10 years |  |      |  | 3-10 years |      |  |  | 2.5-10 years | 
|Expected volatility     |  |      | 46.3%      |  |      |  | 33.3-47.5% |      |  |  | 33.3-40.9%   | 
|Expected dividends      |  |      | 0%         |  |      |  | 0%         |      |  |  | 0%           | 

The following table summarizes the information
regarding stock options outstanding at January 26, 2003
(number of shares in thousands):

|                |              |             |           |  |             |                  |  |  |                  |  |  |           |       |  |                  |  |       |  |  |   |       | 
|--------------- | ------------ | ----------- | --------- |  | ----------- | ---------------- |  |  | ---------------- |  |  | --------- | ----- |  | ---------------- |  | ----- |  |  | - | ----- | 
|                |              |             |           | 
|                |              | Outstanding |           |  | Exercisable |                 
|                |              |             |           |  |             |                 
|Range of        |              |             | Number of |  |             | Weighted Average |  |  | Weighted Average |  |  | Number of |       |  | Weighted Average | 
|Exercise Prices |              |             | Shares    |  |             | Remaining Life   |  |  | Exercise Price   |  |  | Shares    |       |  | Exercise Price   | 
|                |              |             |           |  |             |                  |  |  |                  |  |  |           |       |  |                  | 
|$               | 6.81-$10.22  |             |           |  | 1,266       |                  |  |  | 2.4              |  |  | $         | 8.69  |  |                  |  | 1,266 |  |  | $ | 8.69  | 
|$               | 10.23-$13.63 |             |           |  | 2,655       |                  |  |  | 3.4              |  |  |           | 12.83 |  |                  |  | 2,212 |  |  |   | 12.84 | 
|$               | 13.64-$17.03 |             |           |  | 3,451       |                  |  |  | 4.5              |  |  |           | 14.72 |  |                  |  | 1,709 |  |  |   | 14.60 | 
|$               | 17.04-$20.44 |             |           |  | 2,712       |                  |  |  | 5.4              |  |  |           | 17.62 |  |                  |  | 577   |  |  |   | 18.05 | 
|$               | 20.45-$27.25 |             |           |  | 1,736       |                  |  |  | 4.3              |  |  |           | 23.62 |  |                  |  | 526   |  |  |   | 24.24 | 
|$               | 27.26-$30.66 |             |           |  | 2,542       |                  |  |  | 4.3              |  |  |           | 29.79 |  |                  |  | 2,018 |  |  |   | 29.79 | 
|$               | 30.67-$34.06 |             |           |  | 707         |                  |  |  | 4.7              |  |  |           | 31.60 |  |                  |  | 524   |  |  |   | 31.52 | 

57



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##### Table of Contents



NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS


(dollars in millions except per share data)
(Continued)


A summary of the information relative to the
Companys stock purchase plans follows (number of shares in
thousands):

|                                         |      |           |  |    |                  |  |   |                   |  |  |   |       | 
|---------------------------------------- | ---- | --------- |  | -- | ---------------- |  | - | ----------------- |  |  | - | ----- | 
|                                         |      | Number of |  |    | Weighted-Average |  |   | Weighted-Average  | 
|                                         |      | Shares    |  |    | Purchase Price   |  |   | at Grant Date FMV | 
|                                         |      |           |  |    |                  |  |   |                   | 
|Stock issued under stock purchase plans: |      |           |  |    |                  |  |   |                   |  |  |   |      
|Management plan                          |      |           |  |    |                  |  |   |                   |  |  |   |      
|                                         | 2000 |           |  | 13 |                  |  | $ | 10.56             |  |  | $ | 13.21 | 
|                                         | 2001 |           |  | 24 |                  |  |   | 13.26             |  |  |   | 16.57 | 
|                                         | 2002 |           |  | 28 |                  |  |   | 18.26             |  |  |   | 23.91 | 
|Employee plan                            |      |           |  |    |                  |  |   |                   |  |  |   |      
|                                         | 2000 |           |  | 65 |                  |  | $ | 12.38             |  |  | $ | 14.56 | 
|                                         | 2001 |           |  | 35 |                  |  |   | 16.52             |  |  |   | 19.43 | 
|                                         | 2002 |           |  | 35 |                  |  |   | 15.29             |  |  |   | 17.99 | 

NOTE 15  FINANCIAL
INSTRUMENTS

Effective January 29, 2001, the Company
adopted FAS 133, Accounting for Derivative Instruments and
Hedging Activities, as amended. FAS 133 requires the
transition adjustment resulting from adoption to be reported in
net income or other comprehensive income, as appropriate, as the
cumulative effect of a change in accounting principle.
Accordingly, the Company recorded a cumulative transition
adjustment to decrease other comprehensive income by $1.6 (net
of tax) to recognize the fair value of its derivative financial
instruments as of the date of adoption.

The Company is subject to risk resulting from
interest rate fluctuations, as interest on the Companys
borrowings is principally based on variable rates. The
Companys objective in managing its exposure to interest
rate fluctuations is to limit the impact of interest rate
changes on earnings and cash flows and to lower its overall
borrowing costs. The Company primarily utilizes interest rate
swaps to achieve this objective, effectively converting a
portion of its variable rate exposures to fixed interest rates.
In accordance with the provisions of FAS 133, the Company has
designated all of its interest rate swap agreements as cash flow
hedges.

The Company recognizes the fair value of its
derivatives on the consolidated balance sheets. Changes in the
fair value of a derivative that is designated as, and meets all
the required criteria for, a cash flow hedge are recorded in
accumulated other comprehensive income and reclassified into
earnings as the underlying hedged item affects earnings. Amounts
reclassified into earnings related to interest swap agreements
are included in interest expense. For the year ended
January 26, 2003, unrealized after-tax net gains of $2.2
related to interest rate swaps were recorded in other
comprehensive income. As of January 26, 2003, $0.9 of net
unrealized losses related to interest rate swaps were included
in accumulated other comprehensive income, all of which is
expected to be reclassified into earnings during the next
12 months. The hedge ineffectiveness for the year ending
January 26, 2003 was not material. See Note
18  Subsequent Events in the notes to
consolidated financial statements for further discussion.

58



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##### Table of Contents



NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS


(dollars in millions except per share data)
(Continued)


As of January 26, 2003, and January 27,
2002, the Company had the following interest rate swaps in
effect:

|                 |  |             |      |  |        |  |             |                   |  |   |       | 
|---------------- |  | ----------- | ---- |  | ------ |  | ----------- | ----------------- |  | - | ----- | 
|                
|January 26, 2003 | 
|Notional Amount  |  | Strike Rate |      |  | Period |  |             | Fair Market Value | 
|                 |  |             |      |  |        |  |             |                   | 
|$75.0            |  |             | 5.7% |  |        |  | 1/00-1/03   |                   |  | $ | (0.3) | 
|$33.0(a)         |  |             | 6.6% |  |        |  | 10/98-10/03 |                   |  | $ | (0.7) | 
|$33.0(a)         |  |             | 6.9% |  |        |  | 9/98-9/03   |                   |  | $ | (0.6) | 




|    |                                                                          
|--- | -------------------------------------------------------------------------
|(a) | Notional amount is the U.S. dollar equivalent of
    20.0 British pounds.

|                 |  |             |      |  |        |  |             |                   |  |   |       | 
|---------------- |  | ----------- | ---- |  | ------ |  | ----------- | ----------------- |  | - | ----- | 
|                
|January 27, 2002 | 
|Notional Amount  |  | Strike Rate |      |  | Period |  |             | Fair Market Value | 
|                 |  |             |      |  |        |  |             |                   | 
|$100.0           |  |             | 5.2% |  |        |  | 1/01-1/02   |                   |  | $ | (0.3) | 
|$ 75.0           |  |             | 5.7% |  |        |  | 1/00-1/03   |                   |  | $ | (2.7) | 
|$ 50.0           |  |             | 5.1% |  |        |  | 1/01-1/02   |                   |  | $ | (0.1) | 
|$ 33.0(a)        |  |             | 6.6% |  |        |  | 10/98-10/03 |                   |  | $ | (0.8) | 
|$ 33.0(a)        |  |             | 6.9% |  |        |  | 9/98-9/03   |                   |  | $ | (1.2) | 




|    |                                                                          
|--- | -------------------------------------------------------------------------
|(a) | Notional amount is the U.S. dollar equivalent of
    20.0 British pounds.

NOTE 16  SEGMENT
INFORMATION

The Company is organized based upon the following
operating segments: domestic Borders stores, Waldenbooks stores,
international Borders and Books etc. stores, and other
(consisting of interest expense, certain corporate governance
costs and corporate incentive costs).

The accounting policies of the segments are the
same as those described in the Summary of Significant
Accounting Policies. Segment data includes charges
allocating all corporate headquarters costs to each segment.
Transactions between segments, consisting principally of
inventory transfers, are recorded primarily at cost. The Company
evaluates the performance of its segments and allocates
resources to them based on anticipated future contribution.
Amounts relating to the Company-owned and -operated Borders.com
web site, other than intercompany interest expense (net of
related taxes), have been classified in the Borders segment for
all periods presented. Intercompany interest charges (net of
related taxes) relating to Borders.com have been included in the
other segment.

|                          |               |                        |   |         |         |  |   |         |         |  |   |         |         | 
|------------------------- | ------------- | ---------------------- | - | ------- | ------- |  | - | ------- | ------- |  | - | ------- | ------- | 
|                          |               | 2002                   |   |         | 2001    |  |   | 2000    |        
|                          |               |                        |   |         |         |  |   |         |        
|Sales                     |               |                        |   |         |         |  |   |         |         |  |   |        
|                          | Borders       |                        | $ | 2,319.0 |         |  | $ | 2,234.1 |         |  | $ | 2,107.7 |        
|                          | Waldenbooks   |                        |   | 852.2   |         |  |   | 902.1   |         |  |   | 944.3   |        
|                          | International |                        |   | 314.9   |         |  |   | 251.7   |         |  |   | 219.2   |        
|                          |               |                        |   |         |         |  |   |         |        
|                          |               | Total sales            |   | $       | 3,486.1 |  |   | $       | 3,387.9 |  |   | $       | 3,271.2 | 
|                          |               |                        |   |         |         |  |   |         |        
|Interest expense (income) |               |                        |   |         |         |  |   |         |         |  |   |        
|                          | Borders       |                        | $ | 2.5     |         |  | $ | 9.1     |         |  | $ | 12.8    |        
|                          | Waldenbooks   |                        |   | (33.5   | )       |  |   | (28.3   | )       |  |   | (26.2   | )      
|                          | International |                        |   | 17.2    |         |  |   | 14.3    |         |  |   | 12.4    |        
|                          | Other         |                        |   | 26.4    |         |  |   | 19.3    |         |  |   | 14.1    |        
|                          |               |                        |   |         |         |  |   |         |        
|                          |               | Total interest expense |   | $       | 12.6    |  |   | $       | 14.4    |  |   | $       | 13.1    | 
|                          |               |                        |   |         |         |  |   |         |        

59



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##### Table of Contents



NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS


(dollars in millions except per share data)
(Continued)


|                                      |               |                                             |                             |         |      |         |   |         |      |         |   |         |       |         | 
|------------------------------------- | ------------- | ------------------------------------------- | --------------------------- | ------- | ---- | ------- | - | ------- | ---- | ------- | - | ------- | ----- | ------- | 
|                                      |               | 2002                                        |                             |         | 2001 |         |   | 2000    |     
|                                      |               |                                             |                             |         |      |         |   |         |     
|Income tax expense (benefit)          |               |                                             |                             |         |      |         |   |         |      |         |   |        
|                                      | Borders       |                                             | $                           | 64.2    |      |         | $ | 48.8    |      |         | $ | 38.2    |      
|                                      | Waldenbooks   |                                             |                             | 24.5    |      |         |   | 23.7    |      |         |   | 24.2    |      
|                                      | International |                                             |                             | (6.1    | )    |         |   | (6.4    | )    |         |   | (6.8    | )    
|                                      | Other         |                                             |                             | (13.0   | )    |         |   | (10.9   | )    |         |   | (7.4    | )    
|                                      |               |                                             |                             |         |      |         |   |         |     
|                                      |               | Total income tax expense                    |                             | $       | 69.6 |         |   | $       | 55.2 |         |   | $       | 48.2  |        
|                                      |               |                                             |                             |         |      |         |   |         |     
|Depreciation and amortization expense |               |                                             |                             |         |      |         |   |         |      |         |   |        
|                                      | Borders       |                                             | $                           | 66.7    |      |         | $ | 65.4    |      |         | $ | 60.7    |      
|                                      | Waldenbooks   |                                             |                             | 20.7    |      |         |   | 21.4    |      |         |   | 25.8    |      
|                                      | International |                                             |                             | 9.7     |      |         |   | 9.4     |      |         |   | 8.8     |      
|                                      | Other         |                                             |                             |        |      |         |   |        |      |         |   |        |      
|                                      |               |                                             |                             |         |      |         |   |         |     
|                                      |               | Total depreciation and amortization expense |                             | $       | 97.1 |         |   | $       | 96.2 |         |   | $       | 95.3  |        
|                                      |               |                                             |                             |         |      |         |   |         |     
|Net income (loss)                     |               |                                             |                             |         |      |         |   |         |      |         |   |        
|                                      | Borders       |                                             | $                           | 102.5   |      |         | $ | 72.1    |      |         | $ | 56.5    |      
|                                      | Waldenbooks   |                                             |                             | 41.4    |      |         |   | 39.5    |      |         |   | 40.2    |      
|                                      | International |                                             |                             | (12.3   | )    |         |   | (7.5    | )    |         |   | (10.2   | )    
|                                      | Other         |                                             |                             | (19.9   | )    |         |   | (16.7   | )    |         |   | (12.7   | )    
|                                      |               |                                             |                             |         |      |         |   |         |     
|                                      |               |                                             | Total continuing operations |         |      | 111.7   |   |         |      | 87.4    |   |         |       | 73.8    | 
|                                      |               | Discontinued operations                     |                             |         |     |         |   |         |     |         |   |         | (30.2 | )      
|                                      |               |                                             |                             |         |      |         |   |         |     
|                                      |               |                                             | Total net income            |         | $    | 111.7   |   |         | $    | 87.4    |   |         | $     | 43.6    | 
|                                      |               |                                             |                             |         |      |         |   |         |     
|Total assets                          |               |                                             |                             |         |      |         |   |         |      |         |   |        
|                                      | Borders       |                                             | $                           | 1,310.0 |      |         | $ | 1,339.3 |      |         | $ | 1,309.0 |      
|                                      | Waldenbooks   |                                             |                             | 334.1   |      |         |   | 380.0   |      |         |   | 432.0   |      
|                                      | International |                                             |                             | 320.3   |      |         |   | 257.7   |      |         |   | 216.1   |      
|                                      | Other         |                                             |                             | 303.8   |      |         |   | 202.3   |      |         |   | 75.4    |      
|                                      |               |                                             |                             |         |      |         |   |         |     
|                                      |               |                                             | Total continuing operations |         |      | 2,268.2 |   |         |      | 2,179.3 |   |         |       | 2,032.5 | 
|                                      |               | Discontinued operations                     |                             |         |     |         |   |         |     |         |   |         | 14.6  |        
|                                      |               |                                             |                             |         |      |         |   |         |     
|                                      |               |                                             | Total assets                |         | $    | 2,268.2 |   |         | $    | 2,179.3 |   |         | $     | 2,047.1 | 
|                                      |               |                                             |                             |         |      |         |   |         |     
|Capital expenditures                  |               |                                             |                             |         |      |         |   |         |      |         |   |        
|                                      | Borders       |                                             | $                           | 66.0    |      |         | $ | 40.5    |      |         | $ | 87.6    |      
|                                      | Waldenbooks   |                                             |                             | 7.3     |      |         |   | 7.5     |      |         |   | 19.3    |      
|                                      | International |                                             |                             | 24.4    |      |         |   | 24.6    |      |         |   | 16.0    |      
|                                      | Other         |                                             |                             | 23.8    |      |         |   | 18.1    |      |         |   | 15.8    |      
|                                      |               |                                             |                             |         |      |         |   |         |     
|                                      |               |                                             | Total continuing operations |         |      | 121.5   |   |         |      | 90.7    |   |         |       | 138.7   | 
|                                      |               | Discontinued operations                     |                             |         |     |         |   |         |     |         |   |         | 2.4   |        
|                                      |               |                                             |                             |         |      |         |   |         |     
|                                      |               |                                             | Total capital expenditures  |         | $    | 121.5   |   |         | $    | 90.7    |   |         | $     | 141.1   | 
|                                      |               |                                             |                             |         |      |         |   |         |     

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NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS


(dollars in millions except per share data)
(Continued)


Total assets for the other operating segment
include certain corporate headquarters asset balances, which
have not been allocated to the other segments; however,
depreciation expense associated with such assets has been
allocated to the other segments as follows:

|              |       |      |      |      |      |   |     |      |  |   |     |      | 
|------------- | ----- | ---- | ---- | ---- | ---- | - | --- | ---- |  | - | --- | ---- | 
|              |       | 2002 |      |      | 2001 |   |     | 2000 | 
|              |       |      |      |      |      |   |     |      | 
|Borders       |       | $    | 10.0 |      |      | $ | 8.5 |      |  | $ | 5.0 |     
|Walden        |       |      | 5.3  |      |      |   | 3.9 |      |  |   | 5.4 |     
|International |       |      |     |      |      |   |    |      |  |   |    |     
|              |       |      |      |      |      |   |     |      | 
|              | Total |      | $    | 15.3 |      |   | $   | 12.4 |  |   | $   | 10.4 | 
|              |       |      |      |      |      |   |     |      | 

Long-lived assets by geographic area are as
follows:

|                   |               |                         |   |       |       |  |   |       |       |  |   |       |       | 
|------------------ | ------------- | ----------------------- | - | ----- | ----- |  | - | ----- | ----- |  | - | ----- | ----- | 
|                   |               | 2002                    |   |       | 2001  |  |   | 2000  |      
|                   |               |                         |   |       |       |  |   |       |      
|Long-lived assets: |               |                         |   |       |       |  |   |       |       |  |   |      
|                   | Domestic      |                         | $ | 532.9 |       |  | $ | 580.3 |       |  | $ | 566.8 |      
|                   | International |                         |   | 194.0 |       |  |   | 156.9 |       |  |   | 145.2 |      
|                   |               |                         |   |       |       |  |   |       |      
|                   |               | Total long-lived assets |   | $     | 726.9 |  |   | $     | 737.2 |  |   | $     | 712.0 | 
|                   |               |                         |   |       |       |  |   |       |      

NOTE 17  UNAUDITED QUARTERLY
FINANCIAL DATA

|                                              |  |                           |       |  |      |   |       |         |  |   |         |   |  |   |         | 
|--------------------------------------------- |  | ------------------------- | ----- |  | ---- | - | ----- | ------- |  | - | ------- | - |  | - | ------- | 
|                                              |  |                          
|                                              |  | Fiscal 2002 Quarter Ended |      
|                                              |  |                           |      
|                                              |  | April                     |       |  | July |   |       | October |  |   | January |  
|                                              |  |                           |       |  |      |   |       |         |  |   |         |  
|Sales                                         |  | $                         | 751.7 |  |      | $ | 763.6 |         |  | $ | 749.8   |   |  | $ | 1,221.0 | 
|Cost of merchandise sold (includes occupancy) |  |                           | 567.4 |  |      |   | 577.7 |         |  |   | 572.4   |   |  |   | 832.8   | 
|Operating income                              |  |                           | 8.7   |  |      |   | 8.0   |         |  |   | 0.8     |   |  |   | 176.4   | 
|Net income (loss)                             |  |                           | 3.9   |  |      |   | 3.4   |         |  |   | (1.8    | ) |  |   | 106.2   | 
|Diluted earnings (loss) per common share      |  |                           | 0.05  |  |      |   | 0.04  |         |  |   | (0.02   | ) |  |   | 1.32    | 
|Basic earnings (loss) per common share        |  |                           | 0.05  |  |      |   | 0.04  |         |  |   | (0.02   | ) |  |   | 1.34    | 

|                                              |  |                           |       |   |      |   |       |         |  |   |         |   |  |   |         | 
|--------------------------------------------- |  | ------------------------- | ----- | - | ---- | - | ----- | ------- |  | - | ------- | - |  | - | ------- | 
|                                              |  |                          
|                                              |  | Fiscal 2001 Quarter Ended |      
|                                              |  |                           |      
|                                              |  | April                     |       |   | July |   |       | October |  |   | January |  
|                                              |  |                           |       |   |      |   |       |         |  |   |         |  
|Sales                                         |  | $                         | 729.9 |   |      | $ | 739.8 |         |  | $ | 713.7   |   |  | $ | 1,204.5 | 
|Cost of merchandise sold (includes occupancy) |  |                           | 551.4 |   |      |   | 560.0 |         |  |   | 540.3   |   |  |   | 812.8   | 
|Operating income (loss)                       |  |                           | (26.0 | ) |      |   | 4.1   |         |  |   | (1.4    | ) |  |   | 180.3   | 
|Net income (loss)                             |  |                           | (18.9 | ) |      |   | 0.1   |         |  |   | (3.1    | ) |  |   | 109.3   | 
|Diluted earnings (loss) per common share      |  |                           | (0.24 | ) |      |   | 0.00  |         |  |   | (0.04   | ) |  |   | 1.32    | 
|Basic earnings (loss) per common share        |  |                           | (0.24 | ) |      |   | 0.00  |         |  |   | (0.04   | ) |  |   | 1.35    | 

Earnings per share amounts for each quarter are
required to be computed independently and may not equal the
amount computed for the total year.

NOTE 18  SUBSEQUENT
EVENTS

On February 24, 2003 the Company entered
into an agreement to extend its $33.0 interest rate swap, with
an original strike rate of 6.9%. The original agreement, which
would have expired in September 2003, has been extended through
June 2005 with a new strike rate of 4.7%. On March 24,
2003, the Company entered into an agreement to extend its $33.0
interest rate swap, with an original strike rate of 6.6%. The
original agreement, which would have expired in October 2003,
has been extended through June 2005, with a new strike rate of
4.9%.

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NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS


(dollars in millions except per share data)
(Continued)


On January 27, 2003 certain of the
Companys interest rate swaps, with a total notional amount
of $75.0 and a strike rate of 5.7%, expired.

On January 31, 2003 the Company arranged for
the permanent financing of three properties previously financed
under the Original Lease Facility, totaling $13.7. None of these
properties were capitalized at January 26, 2003. As a part
of the refinancing agreement, the Company guarantees to the
lender the principal amount borrowed by the third-party owners
of two of the properties, totaling $6.0.

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REPORT OF INDEPENDENT AUDITORS

To The Board of Directors and Stockholders

of Borders Group, Inc.


We have audited the accompanying consolidated
balance sheets of Borders Group, Inc. as of January 26,
2003 and January 27, 2002, and the related consolidated
statements of operations, stockholders equity, and cash
flows for each of the three years in the period ended
January 26, 2003. These financial statements are the
responsibility of the Companys management. Our
responsibility is to express an opinion on these financial
statements based on our audits.

We conducted our audits in accordance with
auditing standards generally accepted in the United States.
Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes
examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits
provide a reasonable basis for our opinion.

In our opinion, the financial statements referred
to above present fairly, in all material respects, the
consolidated financial position of Borders Group, Inc. at
January 26, 2003 and January 27, 2002, and the
consolidated results of its operations and its cash flows for
each of the three years in the period ended January 26,
2003, in conformity with accounting principles generally
accepted in the United States.

As discussed in Note 5 to the consolidated
financial statements, effective January 28, 2002 the
Company adopted the provisions of Financial Accounting Standards
Board Statement No. 142, Goodwill and Other Intangible
Assets.



| |                      
| | ---------------------
| | /s/ ERNST & YOUNG LLP

Detroit, Michigan

March 11, 2003


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|        |                                                                                         
|------- | ----------------------------------------------------------------------------------------
|Item 9. | Changes in and Disagreements with Accountants
    on Accounting and Financial Disclosure

Not applicable.






PART III







Item 10. Directors and Executive
Officers of the Registrant


Information regarding the executive officers of
the Company required by this Item 10 is set forth in
Item 1 of Part I herein under the caption Executive
Officers of the Company. Information pertaining to
directors of the Company required by Item 10 is included in
the Companys Proxy Statement dated April 17, 2003 for
the Companys May 22, 2003 Annual Meeting of
Stockholders, and is incorporated herein by reference.
Information relating to compliance with Section 16(a) of
the Securities Exchange Act of 1934, as amended, is set forth in
the Proxy Statement and incorporated herein by reference.

Section 16(a) Beneficial Ownership
Reporting Compliance

The information required by this section is
incorporated herein by reference to the information under the
caption Section 16(a) Beneficial Ownership Reporting
Compliance in the Proxy Statement dated April 17,
2003 for the Companys May 22, 2003 Annual Meeting of
Stockholders.






Item 11. Executive
Compensation


The information required by this Item 11 is
incorporated herein by reference to the information under the
captions Executive Compensation and
Compensation of Directors in the Proxy Statement
dated April 17, 2003 for the Companys May 22,
2003 Annual Meeting of Stockholders.






|         |                                                                   
|-------- | ------------------------------------------------------------------
|Item 12. | Security Ownership of Certain Beneficial
    Owners and Management

The information required by this Item 12 is
incorporated herein by reference to the information under the
heading Beneficial Ownership of Common Stock in the
Proxy Statement dated April 17, 2003 for the Companys
May 22, 2003 Annual Meeting of Stockholders.






Item 13. Certain Relationships and
Related Party Transactions


Not applicable.






Item 14. Controls and
Procedures


Controls and Procedures.The Companys Chief Executive
Officer and Chief Financial Officer have evaluated the
effectiveness of the Companys disclosure controls and
procedures (as such term is defined in Rules 13a-14(c) and
15d-14(c) under the Securities Exchange Act of 1934, as amended
(the Exchange Act)) as of a date within 90 days
prior to the filing date of this annual report (the
Evaluation Date). Based on such evaluation, such
officers have concluded that, as of the Evaluation Date, the
Companys disclosure controls and procedures are effective
in alerting them on a timely basis to material information
relating to the Company (including its consolidated
subsidiaries) required to be included in the Companys
periodic filings under the Exchange Act.

Changes in Internal Controls.Since the Evaluation Date, there have
not been any significant changes in the Companys internal
controls or in other factors that could significantly affect
such controls.

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PART IV




|         |                                                                     
|-------- | --------------------------------------------------------------------
|Item 15. | Exhibits, Financial Statement Schedules, and
    Reports on Form 8-K

(a) 1. Our Consolidated Financial
Statements are included in Part II, Item 8:

|                                                                                                                                           |  |      |    | 
|------------------------------------------------------------------------------------------------------------------------------------------ |  | ---- | -- | 
|                                                                                                                                           |  | Page |   
|                                                                                                                                           |  |      |   
|Consolidated Statements of Operations for the
    fiscal years ended January 26, 2003, January 27, 2002
    and January 28, 2001           |  |      | 38 | 
|Consolidated Balance Sheets as of
    January 26, 2003 and January 27, 2002                                                                |  |      | 39 | 
|Consolidated Statements of Cash Flows for the
    fiscal years ended January 26, 2003, January 27, 2002
    and January 28, 2001           |  |      | 40 | 
|Consolidated Statements of Stockholders
    Equity for the fiscal years ended January 26, 2003,
    January 27, 2002 and January 28, 2001 |  |      | 41 | 
|Notes to Consolidated Financial Statements                                                                                                 |  |      | 42 | 
|Report of Independent Auditors                                                                                                             |  |      | 63 | 

2. Financial Schedules included in
Item 15 (d):

All schedules for which provision is made in the
applicable accounting regulation of the Securities and Exchange
Commission are not required under the related instructions or
are inapplicable and therefore have been omitted.

3. The following exhibits are filed herewith
unless otherwise indicated:

|        |           |  |             |                                                                                                                            
|------- | --------- |  | ----------- | ---------------------------------------------------------------------------------------------------------------------------
|Exhibit |           |  |            
|Number  |           |  | Description
|        |           |  |            
|        | 2.1(4)    |  |             | Agreement and plan of Merger dated as of
    April 8, 1997 between Michigan Borders Group, Inc. and
    Borders Group, Inc.
|        | 3.1(9)    |  |             | Restated Articles of Incorporation of Borders
    Group, Inc.                                                              
|        | 3.2(14)   |  |             | Restated bylaws of Borders Group, Inc.                                                                                     
|        | 10.1(14)  |  |             | Form of Severance Agreement                                                                                                
|        | 10.2(4)   |  |             | Borders Group, Inc. Stock Option Plan                                                                                      
|        | 10.3(14)  |  |             | Amendment to the Borders Group, Inc. Stock Option
    Plan                                                                 
|        | 10.4(2)   |  |             | Tax Allocation Agreement dated May 24, 1995
    between Borders Group, Inc. and Kmart Corporation                          
|        | 10.5(2)   |  |             | Lease Guaranty Agreement dated May 24, 1995
    between Borders Group, Inc. and Kmart Corporation                          
|        | 10.6(15)  |  |             | First Amendment to Lease Guaranty Agreement
    between Borders Group, Inc. and Kmart Corporation                          
|        | 10.7(1)   |  |             | Borders Group, Inc. Management Stock Purchase
    Plan.                                                                    
|        | 10.8(6)   |  |             | First Amendment to the Borders Group, Inc.
    Management Stock Purchase Plan                                              
|        | 10.9(7)   |  |             | Second Amendment to the Borders Group, Inc.
    Management Stock Purchase Plan                                             
|        | 10.10(9)  |  |             | Third Amendment to the Borders Group, Inc.
    Management Stock Purchase Plan                                              
|        | 10.11(14) |  |             | Fourth Amendment to the Borders Group, Inc.
    Management Stock Purchase Plan                                             
|        | 10.12(16) |  |             | Fifth Amendment to the Borders Group, Inc.
    Management Stock Purchase Plan                                              
|        | 10.13(16) |  |             | Sixth Amendment to the Borders Group, Inc.
    Management Stock Purchase Plan                                              
|        | 10.14(1)  |  |             | Borders Group, Inc. Employee Stock Purchase Plan                                                                           
|        | 10.15(3)  |  |             | First Amendment to the Borders Group, Inc.
    Employee Stock Purchase Plan                                                
|        | 10.16(9)  |  |             | Second Amendment to the Borders Group, Inc.
    Employee Stock Purchase Plan                                               
|        | 10.17(9)  |  |             | Third Amendment to the Borders Group, Inc.
    Employee Stock Purchase Plan                                                
|        | 10.18(13) |  |             | Borders Group, Inc. Annual Incentive Bonus Plan                                                                            
|        | 10.19(1)  |  |             | Borders Group, Inc. Director Stock Plan                                                                                    
|        | 10.20(7)  |  |             | First Amendment to the Borders Group, Inc.
    Director Stock Plan                                                         
|        | 10.21(7)  |  |             | Second Amendment to the Borders Group, Inc.
    Director Stock Plan                                                        
|        | 10.22(14) |  |             | Third Amendment to Borders Group, Inc. Director
    Stock Plan                                                             
|        | 10.23(14) |  |             | Fourth Amendment to Borders Group, Inc. Director
    Stock Plan                                                            

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|        |           |  |             |                                                                                                                                                                                                                                                                                                                 
|------- | --------- |  | ----------- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit |           |  |            
|Number  |           |  | Description
|        |           |  |            
|        | 10.24(5)  |  |             | Amended and Restated Multicurrency Credit
    Agreement among Borders Group, Inc., its subsidiaries and
    Parties thereto                                                                                                                                                                                     
|        | 10.25(5)  |  |             | Amended and Restated Participation Agreement
    among Borders Group, Inc., its subsidiaries and Parties thereto                                                                                                                                                                                                
|        | 10.26(5)  |  |             | Appendix A to Participation Agreement among
    Borders Group, Inc., its subsidiaries and Parties thereto                                                                                                                                                                                                       
|        | 10.27(5)  |  |             | Amended and Restated Credit Agreement among
    Borders Group, Inc., its subsidiaries and Parties thereto                                                                                                                                                                                                       
|        | 10.28(5)  |  |             | Amended and Restated Guarantee Credit Agreement
    among Borders Group, Inc., its subsidiaries and Parties thereto                                                                                                                                                                                             
|        | 10.29(10) |  |             | Omnibus Amendment No. 1 to Amended and
    Restated Guarantee Credit Agreement among Borders Group, Inc.,
    its subsidiaries and Parties thereto                                                                                                                                                              
|        | 10.30(8)  |  |             | Borders Group, Inc. Stock Option Plan for
    International Employees                                                                                                                                                                                                                                           
|        | 10.31(9)  |  |             | 1998 Borders Group, Inc. Stock Option Plan                                                                                                                                                                                                                                                                      
|        | 10.32(12) |  |             | Agreement dated November 15, 1999, between
    Borders Group, Inc. and Gregory P. Josefowicz                                                                                                                                                                                                                    
|        | 10.33(9)  |  |             | Participation Agreement dated as of
    December 1, 1998 by and among Borders Group, Inc., Borders,
    Inc. and Parties thereto                                                                                                                                                                                
|        | 10.34(10) |  |             | Multicurrency Revolving Credit Facility Credit
    Agreement dated July 9, 1999 among Borders Group, Inc., its
    subsidiaries, and Parties thereto                                                                                                                                                            
|        | 10.35(11) |  |             | Amendment No. 1 to 1998 Borders Group, Inc.
    Stock Option Plan                                                                                                                                                                                                                                               
|        | 10.36(12) |  |             | Amended Schedule 1.01(B) to the Amended and
    Restated Multicurrency Credit Agreement among Borders Group,
    Inc., its Subsidiaries and Parties thereto                                                                                                                                                     
|        | 10.37(12) |  |             | Amended Schedule II to the Amended and
    Restated Credit Agreement among Borders Group, Inc., its
    subsidiaries and Parties thereto                                                                                                                                                                        
|        | 10.38(14) |  |             | Participation Agreement dated as of
    January 22, 2001 by and among Borders Group, Inc., Borders,
    Inc. and Parties thereto                                                                                                                                                                                
|        | 10.39(14) |  |             | Form of Lease Guaranty Related to Lease Facility
    Agreement                                                                                                                                                                                                                                                  
|        | 10.40(14) |  |             | Form of Environmental Indemnity Related to Lease
    Facility Agreement                                                                                                                                                                                                                                         
|        | 10.41(17) |  |             | Multicurrency Revolving Credit Agreement dated as
    of June 21, 2002 among Borders Group, Inc., certain of its
    subsidiaries and other Parties thereto.                                                                                                                                                    
|        | 10.42(17) |  |             | Omnibus Amendment dated as of June 21, 2002
    relating to the Amended and Restated Participation Agreement,
    the Amended and Restated Credit Agreement, the Amended and
    Restated Guarantee Agreement, and certain other agreements among
    Borders Group, Inc., its subsidiaries and Parties thereto.
|        | 10.43(17) |  |             | Master Agreement dated as of June 21, 2002
    among Borders Group, Inc., certain of its subsidiaries and the
    other Parties thereto.                                                                                                                                                                        
|        | 10.44(17) |  |             | Loan Agreement dated as of June 21, 2002
    among Atlantic Financial Group, LTD, the Financial Institutions
    party thereto, and Suntrust Bank relating to the Borders Group,
    Inc. Lease Financing Facility.                                                                                             
|        | 10.45(17) |  |             | Guaranty Agreement dated as of June 21, 2002
    from Borders Group, Inc., and certain of its subsidiaries.                                                                                                                                                                                                     
|        | 10.46(17) |  |             | Construction Agency Agreement dated as of
    June 21, 2002 among Borders Inc. and Atlantic Financial
    Group, LTD.                                                                                                                                                                                           
|        | 10.47(17) |  |             | Master Lease Agreement dated as of June 21,
    2002 between Borders Inc., certain other subsidiaries of Borders
    Group, Inc. and Atlantic Financial Group, LTD.                                                                                                                                             
|        | 10.48(17) |  |             | Note Purchase Agreement dated as of July 30,
    2002 relating to the 6.31% Senior Guaranteed Notes of Borders
    Group, Inc.                                                                                                                                                                                  
|        | 10.49(18) |  |             | Amendment No. 2 to the Credit Agreement
    dated as of August 12, 2002 among Borders Group Inc.,
    certain of its subsidiaries and other Parties thereto.                                                                                                                                                    
|        | 10.50(18) |  |             | Amendment No. 1 to the Multicurrency
    Revolving Credit Agreement dated as of September 18, 2002
    among Borders Group Inc., certain of its subsidiaries and other
    Parties thereto.                                                                                                                     
|        | 14.1      |  |             | Code of Ethics                                                                                                                                                                                                                                                                                                  
|        | 18.1(3)   |  |             | Letter of PricewaterhouseCoopers LLP dated
    July 17, 1995                                                                                                                                                                                                                                                    
|        | 21.1      |  |             | Subsidiaries of Registrant                                                                                                                                                                                                                                                                                      
|        | 23.1      |  |             | Consent of Ernst & Young LLP                                                                                                                                                                                                                                                                                    

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|        |      |  |             |                                                                                                                                                                                 
|------- | ---- |  | ----------- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit |      |  |            
|Number  |      |  | Description
|        |      |  |            
|        | 99.1 |  |             | Cautionary Statement under the Private Securities
    Litigation Reform Act of 1995  Safe
    Harbor for Forward-Looking Statements                                          
|        | 99.6 |  |             | Statement of Gregory P. Josefowicz,
    Chairman, President and Chief Executive Officer of Borders
    Group, Inc. pursuant to Section 906 of the Sarbanes-Oxley
    Act of 2002
|        | 99.7 |  |             | Statement of Edward W. Wilhelm, Senior Vice
    President and Chief Financial Officer of Borders Group, Inc.
    pursuant to Section 906 of the Sarbanes-Oxley Act of 2002      




| |     |                                                                                                                                              
| | --- | ---------------------------------------------------------------------------------------------------------------------------------------------
| | (1) | Incorporated by reference from the Companys
    Registration Statement on Form S-1 (File
    No. 333-90918).                                
| | (2) | Incorporated by reference from the Companys
    Quarterly Report on Form 10-Q for the quarter ended
    April 23, 1995 (File No. 1-13740).  
| | (3) | Incorporated by reference from the Companys
    Registration Statement on Form S-1 (File
    No. 333-80643).                                
| | (4) | Incorporated by reference from the Companys
    Proxy Statement dated April 9, 1997 of Borders Group, Inc.
    (File No. 1-13740).          
| | (5) | Incorporated by reference from the Companys
    Quarterly Report on Form 10-Q for the quarter ended
    October 26, 1997 (File No. 1-13740).
| | (6) | Incorporated by reference from the Companys
    Quarterly Report on Form 10-Q for the quarter ended
    October 22, 1995 (File No. 1-13740).
| | (7) | Incorporated by reference from the Companys
    Annual Report on Form 10-K for the year ended
    January 25, 1998 (File No. 1-13740).      
| | (8) | Incorporated by reference from the Companys
    Quarterly Report on Form 10-Q for the quarter ended
    July 26, 1998 (File No. 1-13740).   
| | (9) | Incorporated by reference from the Companys
    Annual Report on Form 10-K for the year ended
    January 24, 1999 (File No. 1-13740).      

|     |                                                                                                                                               
|---- | ----------------------------------------------------------------------------------------------------------------------------------------------
|(10) | Incorporated by reference from the Companys
    Quarterly Report on Form 10-Q for the quarter ended
    July 25, 1999 (File No. 1-13740).    
|(11) | Incorporated by reference from the Companys
    Quarterly Report on Form 10-Q for the quarter ended
    October 24, 1999 (File No. 1-13740). 
|(12) | Incorporated by reference from the Companys
    Annual Report on Form 10-K for the year ended
    January 23, 2000 (File No. 1-13740).       
|(13) | Incorporated by reference from the Companys
    Proxy Statement dated May 24, 2000 (File No. 1-13740).                                       
|(14) | Incorporated by reference from the Companys
    Annual Report on Form 10-K for the year ended
    January 28, 2001 (File No. 1-13740).       
|(15) | Incorporated by reference from the Companys
    Quarterly Report on Form 10-Q for the quarter ended
    April 29, 2001 (File No. 1-13740).   
|(16) | Incorporated by reference from the Companys
    Annual Report on Form 10-K for the year ended
    January 27, 2002 (File No. 1-13740).       
|(17) | Incorporated by reference from the Companys
    Quarterly Report on Form 10-Q for the quarter ended
    July 28, 2002 (File No. 1-13740).    
|(18) | Incorporated by reference from the Companys
    Quarterly Report on Form 10-Q for the quarter ended
    October 27, 2002 (Filed No. 1-13740).

(b) Financial Statement Schedules:

All financial statement schedules are omitted as
they are not applicable or the required information is included
in the consolidated financial statements of the Registrant.

(c) Reports on Form 8-K:

During fiscal 2002, there were two reports filed
on Form 8-K. The report dated and filed on July 31,
2002 (File No. 1-13740) was filed under
Item 5.  Other Events and Regulation FD
Disclosure. The report dated and filed on September 11,
2002 (File No. 1-13740) was filed under
Item 9.  Regulation FD Disclosure.

67



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##### Table of Contents



(d) Financial Statement Schedules

All schedules for which provision is made in the
applicable accounting regulation of the Securities and Exchange
Commission are not required under the related instructions or
are inapplicable and therefore have been omitted.






Item 16. Principle Accountant Fees
and Services


The information required by this Item 16 is
incorporated herein by reference to the information under the
heading Fees Paid to Independent Auditors in the
Proxy Statement dated April 17, 2003 for the Companys
May 22, 2003 Annual Meeting of Stockholders.

68



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##### Table of Contents



SIGNATURES

Pursuant to the requirements of Section 13
or 15(d) 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.

BORDERS GROUP, INC.

(Registrant)




| |     |                          
| | --- | -------------------------
| | BY: | /s/ GREGORY P. JOSEFOWICZ

| |                                                
| | -----------------------------------------------
| |                                                
| | Gregory P. Josefowicz                          
| | Chairman, Chief Executive Officer and President

Pursuant to the requirements of the Securities
Exchange Act of 1934, this report has been signed below by the
following persons on behalf of the registrant and in the
capacities and on the dates indicated.

|                                                   |  |                                                                                                    |  |               
|-------------------------------------------------- |  | -------------------------------------------------------------------------------------------------- |  | --------------
|Name                                               |  | Title                                                                                              |  | Date          
|                                                   |  |                                                                                                    |  |               
|/s/ GREGORY P. JOSEFOWICZGregory P. Josefowicz     |  | Chairman, Chief Executive Officer, and President                                                   |  | April 10, 2003
|/s/ EDWARD W. WILHELMEdward W. Wilhelm             |  | Senior Vice President and Chief Financial Officer
    (Principal Financial and Accounting Officer) |  | April 10, 2003
|/s/ JOEL J. COHENJoel J. Cohen                     |  | Director                                                                                           |  | April 10, 2003
|/s/ ROBERT F. DIROMUALDORobert F. DiRomualdo       |  | Director                                                                                           |  | April 10, 2003
|/s/ PETER R. FORMANEKPeter R. Formanek             |  | Director                                                                                           |  | April 10, 2003
|/s/ AMY B. LANEAmy B. Lane                         |  | Director                                                                                           |  | April 10, 2003
|/s/ VICTOR L. LUNDVictor L. Lund                   |  | Director                                                                                           |  | April 10, 2003
|/s/ DR. EDNA GREENE MEDFORDDr. Edna Greene Medford |  | Director                                                                                           |  | April 10, 2003
|/s/ GEORGE R. MRKONICGeorge R. Mrkonic             |  | Director                                                                                           |  | April 10, 2003
|/s/ LAWRENCE I. POLLOCKLawrence I. Pollock         |  | Director                                                                                           |  | April 10, 2003
|/s/ BETH M. PRITCHARDBeth M. Pritchard             |  | Director                                                                                           |  | April 10, 2003

69



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##### Table of Contents



CERTIFICATIONS

I, Gregory P. Josefowicz, certify that:

1) I have reviewed this annual report on
Form 10-K of Borders Group, Inc.;

2) Based on my knowledge, this annual report
does not contain any untrue statement of a material fact or omit
to state a material fact necessary to make the statements made,
in light of the circumstances under which such statements were
made, not misleading with respect to the period covered by this
annual report;

3) Based on my knowledge, the financial
statements, and other financial information included in this
annual report, fairly present in all material respects the
financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this annual
report;

4) The registrants other certifying
officers and I are responsible for establishing and maintaining
disclosure controls and procedures (as defined in Exchange Act
Rules 13a-14 and 15d-14) for the registrant and have:



| |                                                                                                                                                                                                                                                                                                                
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | a) designed such disclosure controls and
    procedures to ensure that material information relating to the
    registrant, including its consolidated subsidiaries, is made
    known to us by others within those entities, particularly during
    the period in which this annual report is being prepared;
|
| | b) evaluated the effectiveness of the
    registrants disclosure controls and procedures as of a
    date within 90 days prior to the filing date of this annual
    report (the Evaluation Date); and                                                                                                      
|
| | c) presented in this annual report our
    conclusions about the effectiveness of the disclosure controls
    and procedures based on our evaluation as of the Evaluation Date;                                                                                                                                

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



| |                                                                                                                                                                                                                                                                                                                      
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | a) all significant deficiencies in the
    design or operation of internal controls which could adversely
    affect the registrants ability to record, process,
    summarize and report financial data and have identified for the
    registrants auditors any material weaknesses in internal
    controls; and
|
| | b) any fraud, whether or not material, that
    involves management or other employees who have a significant
    role in the registrants internal controls; and                                                                                                                                                    

6) The registrants other certifying
officers and I have indicated in this annual report whether or
not there were significant changes in internal controls or in
other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including
any corrective actions with regard to significant deficiencies
and material weaknesses.

Date: April 10, 2003



|                                                    | 
|--------------------------------------------------- | 
|/s/ GREGORY P. JOSEFOWICZ                           | 
|                                                    | 
|Gregory P. Josefowicz                               | 
|Chairman, President and Chief Executive
    Officer | 
|Borders Group, Inc.                                 | 

70



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##### Table of Contents



I, Edward W. Wilhelm, certify that:

1) I have reviewed this annual report on
Form 10-K of Borders Group, Inc.;

2) Based on my knowledge, this annual report
does not contain any untrue statement of a material fact or omit
to state a material fact necessary to make the statements made,
in light of the circumstances under which such statements were
made, not misleading with respect to the period covered by this
annual report;

3) Based on my knowledge, the financial
statements, and other financial information included in this
annual report, fairly present in all material respects the
financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this annual
report;

4) The registrants other certifying
officers and I are responsible for establishing and maintaining
disclosure controls and procedures (as defined in Exchange Act
Rules 13a-14 and 15d-14) for the registrant and have:



| |                                                                                                                                                                                                                                                                                                                
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | a) designed such disclosure controls and
    procedures to ensure that material information relating to the
    registrant, including its consolidated subsidiaries, is made
    known to us by others within those entities, particularly during
    the period in which this annual report is being prepared;
|
| | b) evaluated the effectiveness of the
    registrants disclosure controls and procedures as of a
    date within 90 days prior to the filing date of this annual
    report (the Evaluation Date); and                                                                                                      
|
| | c) presented in this annual report our
    conclusions about the effectiveness of the disclosure controls
    and procedures based on our evaluation as of the Evaluation Date;                                                                                                                                

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



| |                                                                                                                                                                                                                                                                                                                      
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | a) all significant deficiencies in the
    design or operation of internal controls which could adversely
    affect the registrants ability to record, process,
    summarize and report financial data and have identified for the
    registrants auditors any material weaknesses in internal
    controls; and
|
| | b) any fraud, whether or not material, that
    involves management or other employees who have a significant
    role in the registrants internal controls; and                                                                                                                                                    

6) The registrants other certifying
officers and I have indicated in this annual report whether or
not there were significant changes in internal controls or in
other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including
any corrective actions with regard to significant deficiencies
and material weaknesses.

Date: April 10, 2003



|                                                      | 
|----------------------------------------------------- | 
|/s/ EDWARD W. WILHELM                                 | 
|                                                      | 
|Edward W. Wilhelm                                     | 
|Senior Vice President and Chief Financial
    Officer | 
|Borders Group, Inc.                                   | 

71



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##### Table of Contents



EXHIBIT INDEX

|        |           |  |             |                                                                                                                                                            
|------- | --------- |  | ----------- | -----------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit |           |  |            
|Number  |           |  | Description
|        |           |  |            
|        | 2.1(4)    |  |             | Agreement and plan of Merger dated as of
    April 8, 1997 between Michigan Borders Group, Inc. and
    Borders Group, Inc.                                
|        | 3.1(9)    |  |             | Restated Articles of Incorporation of Borders
    Group, Inc.                                                                                              
|        | 3.2(14)   |  |             | Restated bylaws of Borders Group, Inc.                                                                                                                     
|        | 10.1(14)  |  |             | Form of Severance Agreement                                                                                                                                
|        | 10.2(4)   |  |             | Borders Group, Inc. Stock Option Plan                                                                                                                      
|        | 10.3(14)  |  |             | Amendment to the Borders Group, Inc. Stock Option
    Plan                                                                                                 
|        | 10.4(2)   |  |             | Tax Allocation Agreement dated May 24, 1995
    between Borders Group, Inc. and Kmart Corporation                                                          
|        | 10.5(2)   |  |             | Lease Guaranty Agreement dated May 24, 1995
    between Borders Group, Inc. and Kmart Corporation                                                          
|        | 10.6(15)  |  |             | First Amendment to Lease Guaranty Agreement
    between Borders Group, Inc. and Kmart Corporation                                                          
|        | 10.7(1)   |  |             | Borders Group, Inc. Management Stock Purchase
    Plan.                                                                                                    
|        | 10.8(6)   |  |             | First Amendment to the Borders Group, Inc.
    Management Stock Purchase Plan                                                                              
|        | 10.9(7)   |  |             | Second Amendment to the Borders Group, Inc.
    Management Stock Purchase Plan                                                                             
|        | 10.10(9)  |  |             | Third Amendment to the Borders Group, Inc.
    Management Stock Purchase Plan                                                                              
|        | 10.11(14) |  |             | Fourth Amendment to the Borders Group, Inc.
    Management Stock Purchase Plan                                                                             
|        | 10.12(16) |  |             | Fifth Amendment to the Borders Group, Inc.
    Management Stock Purchase Plan                                                                              
|        | 10.13(16) |  |             | Sixth Amendment to the Borders Group, Inc.
    Management Stock Purchase Plan                                                                              
|        | 10.14(1)  |  |             | Borders Group, Inc. Employee Stock Purchase Plan                                                                                                           
|        | 10.15(3)  |  |             | First Amendment to the Borders Group, Inc.
    Employee Stock Purchase Plan                                                                                
|        | 10.16(9)  |  |             | Second Amendment to the Borders Group, Inc.
    Employee Stock Purchase Plan                                                                               
|        | 10.17(9)  |  |             | Third Amendment to the Borders Group, Inc.
    Employee Stock Purchase Plan                                                                                
|        | 10.18(13) |  |             | Borders Group, Inc. Annual Incentive Bonus Plan                                                                                                            
|        | 10.19(1)  |  |             | Borders Group, Inc. Director Stock Plan                                                                                                                    
|        | 10.20(7)  |  |             | First Amendment to the Borders Group, Inc.
    Director Stock Plan                                                                                         
|        | 10.21(7)  |  |             | Second Amendment to the Borders Group, Inc.
    Director Stock Plan                                                                                        
|        | 10.22(14) |  |             | Third Amendment to Borders Group, Inc. Director
    Stock Plan                                                                                             
|        | 10.23(14) |  |             | Fourth Amendment to Borders Group, Inc. Director
    Stock Plan                                                                                            
|        | 10.24(5)  |  |             | Amended and Restated Multicurrency Credit
    Agreement among Borders Group, Inc., its subsidiaries and
    Parties thereto                                
|        | 10.25(5)  |  |             | Amended and Restated Participation Agreement
    among Borders Group, Inc., its subsidiaries and Parties thereto                                           
|        | 10.26(5)  |  |             | Appendix A to Participation Agreement among
    Borders Group, Inc., its subsidiaries and Parties thereto                                                  
|        | 10.27(5)  |  |             | Amended and Restated Credit Agreement among
    Borders Group, Inc., its subsidiaries and Parties thereto                                                  
|        | 10.28(5)  |  |             | Amended and Restated Guarantee Credit Agreement
    among Borders Group, Inc., its subsidiaries and Parties thereto                                        
|        | 10.29(10) |  |             | Omnibus Amendment No. 1 to Amended and
    Restated Guarantee Credit Agreement among Borders Group, Inc.,
    its subsidiaries and Parties thereto         
|        | 10.30(8)  |  |             | Borders Group, Inc. Stock Option Plan for
    International Employees                                                                                      
|        | 10.31(9)  |  |             | 1998 Borders Group, Inc. Stock Option Plan                                                                                                                 
|        | 10.32(12) |  |             | Agreement dated November 15, 1999, between
    Borders Group, Inc. and Gregory P. Josefowicz                                                               
|        | 10.33(9)  |  |             | Participation Agreement dated as of
    December 1, 1998 by and among Borders Group, Inc., Borders,
    Inc. and Parties thereto                           
|        | 10.34(10) |  |             | Multicurrency Revolving Credit Facility Credit
    Agreement dated July 9, 1999 among Borders Group, Inc., its
    subsidiaries, and Parties thereto       
|        | 10.35(11) |  |             | Amendment No. 1 to 1998 Borders Group, Inc.
    Stock Option Plan                                                                                          
|        | 10.36(12) |  |             | Amended Schedule 1.01(B) to the Amended and
    Restated Multicurrency Credit Agreement among Borders Group,
    Inc., its Subsidiaries and Parties thereto
|        | 10.37(12) |  |             | Amended Schedule II to the Amended and
    Restated Credit Agreement among Borders Group, Inc., its
    subsidiaries and Parties thereto                   



---



##### Table of Contents



|        |           |  |             |                                                                                                                                                                                                                                                                                                                 
|------- | --------- |  | ----------- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit |           |  |            
|Number  |           |  | Description
|        |           |  |            
|        | 10.38(14) |  |             | Participation Agreement dated as of
    January 22, 2001 by and among Borders Group, Inc., Borders,
    Inc. and Parties thereto                                                                                                                                                                                
|        | 10.39(14) |  |             | Form of Lease Guaranty Related to Lease Facility
    Agreement                                                                                                                                                                                                                                                  
|        | 10.40(14) |  |             | Form of Environmental Indemnity Related to Lease
    Facility Agreement                                                                                                                                                                                                                                         
|        | 10.41(17) |  |             | Multicurrency Revolving Credit Agreement dated as
    of June 21, 2002 among Borders Group, Inc., certain of its
    subsidiaries and other Parties thereto.                                                                                                                                                    
|        | 10.42(17) |  |             | Omnibus Amendment dated as of June 21, 2002
    relating to the Amended and Restated Participation Agreement,
    the Amended and Restated Credit Agreement, the Amended and
    Restated Guarantee Agreement, and certain other agreements among
    Borders Group, Inc., its subsidiaries and Parties thereto.
|        | 10.43(17) |  |             | Master Agreement dated as of June 21, 2002
    among Borders Group, Inc., certain of its subsidiaries and the
    other Parties thereto.                                                                                                                                                                        
|        | 10.44(17) |  |             | Loan Agreement dated as of June 21, 2002
    among Atlantic Financial Group, LTD, the Financial Institutions
    party thereto, and Suntrust Bank relating to the Borders Group,
    Inc. Lease Financing Facility.                                                                                             
|        | 10.45(17) |  |             | Guaranty Agreement dated as of June 21, 2002
    from Borders Group, Inc., and certain of its subsidiaries.                                                                                                                                                                                                     
|        | 10.46(17) |  |             | Construction Agency Agreement dated as of
    June 21, 2002 among Borders Inc. and Atlantic Financial
    Group, LTD.                                                                                                                                                                                           
|        | 10.47(17) |  |             | Master Lease Agreement dated as of June 21,
    2002 between Borders Inc., certain other subsidiaries of Borders
    Group, Inc. and Atlantic Financial Group, LTD.                                                                                                                                             
|        | 10.48(17) |  |             | Note Purchase Agreement dated as of July 30,
    2002 relating to the 6.31% Senior Guaranteed Notes of Borders
    Group, Inc.                                                                                                                                                                                  
|        | 10.49(18) |  |             | Amendment No. 2 to the Credit Agreement
    dated as of August 12, 2002 among Borders Group Inc.,
    certain of its subsidiaries and other Parties thereto.                                                                                                                                                    
|        | 10.50(18) |  |             | Amendment No. 1 to the Multicurrency
    Revolving Credit Agreement dated as of September 18, 2002
    among Borders Group Inc., certain of its subsidiaries and other
    Parties thereto.                                                                                                                     
|        | 14.1      |  |             | Code of Ethics                                                                                                                                                                                                                                                                                                  
|        | 18.1(3)   |  |             | Letter of PricewaterhouseCoopers LLP dated
    July 17, 1995                                                                                                                                                                                                                                                    
|        | 21.1      |  |             | Subsidiaries of Registrant                                                                                                                                                                                                                                                                                      
|        | 23.1      |  |             | Consent of Ernst & Young LLP                                                                                                                                                                                                                                                                                    
|        | 99.1      |  |             | Cautionary Statement under the Private Securities
    Litigation Reform Act of 1995  Safe
    Harbor for Forward-Looking Statements                                                                                                                                                                          
|        | 99.6      |  |             | Statement of Gregory P. Josefowicz,
    Chairman, President and Chief Executive Officer of Borders
    Group, Inc. pursuant to Section 906 of the Sarbanes-Oxley
    Act of 2002                                                                                                                                
|        | 99.7      |  |             | Statement of Edward W. Wilhelm, Senior Vice
    President and Chief Financial Officer of Borders Group, Inc.
    pursuant to Section 906 of the Sarbanes-Oxley Act of 2002                                                                                                                                      




| |     |                                                                                                                                              
| | --- | ---------------------------------------------------------------------------------------------------------------------------------------------
| | (1) | Incorporated by reference from the Companys
    Registration Statement on Form S-1 (File
    No. 333-90918).                                
| | (2) | Incorporated by reference from the Companys
    Quarterly Report on Form 10-Q for the quarter ended
    April 23, 1995 (File No. 1-13740).  
| | (3) | Incorporated by reference from the Companys
    Registration Statement on Form S-1 (File
    No. 333-80643).                                
| | (4) | Incorporated by reference from the Companys
    Proxy Statement dated April 9, 1997 of Borders Group, Inc.
    (File No. 1-13740).          
| | (5) | Incorporated by reference from the Companys
    Quarterly Report on Form 10-Q for the quarter ended
    October 26, 1997 (File No. 1-13740).
| | (6) | Incorporated by reference from the Companys
    Quarterly Report on Form 10-Q for the quarter ended
    October 22, 1995 (File No. 1-13740).
| | (7) | Incorporated by reference from the Companys
    Annual Report on Form 10-K for the year ended
    January 25, 1998 (File No. 1-13740).      
| | (8) | Incorporated by reference from the Companys
    Quarterly Report on Form 10-Q for the quarter ended
    July 26, 1998 (File No. 1-13740).   
| | (9) | Incorporated by reference from the Companys
    Annual Report on Form 10-K for the year ended
    January 24, 1999 (File No. 1-13740).      



---



##### Table of Contents



|     |                                                                                                                                               
|---- | ----------------------------------------------------------------------------------------------------------------------------------------------
|(10) | Incorporated by reference from the Companys
    Quarterly Report on Form 10-Q for the quarter ended
    July 25, 1999 (File No. 1-13740).    
|(11) | Incorporated by reference from the Companys
    Quarterly Report on Form 10-Q for the quarter ended
    October 24, 1999 (File No. 1-13740). 
|(12) | Incorporated by reference from the Companys
    Annual Report on Form 10-K for the year ended
    January 23, 2000 (File No. 1-13740).       
|(13) | Incorporated by reference from the Companys
    Proxy Statement dated May 24, 2000 (File No. 1-13740).                                       
|(14) | Incorporated by reference from the Companys
    Annual Report on Form 10-K for the year ended
    January 28, 2001 (File No. 1-13740).       
|(15) | Incorporated by reference from the Companys
    Quarterly Report on Form 10-Q for the quarter ended
    April 29, 2001 (File No. 1-13740).   
|(16) | Incorporated by reference from the Companys
    Annual Report on Form 10-K for the year ended
    January 27, 2002 (File No. 1-13740).       
|(17) | Incorporated by reference from the Companys
    Quarterly Report on Form 10-Q for the quarter ended
    July 28, 2002 (File No. 1-13740).    
|(18) | Incorporated by reference from the Companys
    Quarterly Report on Form 10-Q for the quarter ended
    October 27, 2002 (Filed No. 1-13740).