<PAGE>   1
 
================================================================================
                UNITED STATES SECURITIES AND EXCHANGE COMMISSION
                             WASHINGTON, D.C. 20549
                            ------------------------
 
                                   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 25, 1998
 
                                       OR
 
    [ ]        TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
                     OF THE SECURITIES EXCHANGE ACT OF 1934
 
    For the transition period from                   to                   .
 
                         Commission File Number 1-13740
                            ------------------------
 
                              BORDERS GROUP, INC.
             (Exact name of registrant as specified in its charter)
 
<TABLE>
<S>                                                      <C>
                   MICHIGAN                                      38-3196915
       (STATE OR OTHER JURISDICTION OF                        (I.R.S. EMPLOYER
        INCORPORATION OR ORGANIZATION)                      IDENTIFICATION NO.)
 
    500 EAST WASHINGTON STREET, ANN ARBOR,                         48104
                   MICHIGAN
   (ADDRESS OF PRINCIPAL EXECUTIVE OFFICES)                      (ZIP CODE)
</TABLE>
 
                                 (734) 913-1100
              (REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE)
 
          SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:
 
<TABLE>
<CAPTION>
               TITLE OF CLASS                      NAME OF EXCHANGE ON WHICH REGISTERED
               --------------                      ------------------------------------
<S>                                                <C>
                COMMON STOCK                              NEW YORK STOCK EXCHANGE
</TABLE>
 
          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 [ ]
 
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]
 
THE AGGREGATE MARKET VALUE OF THE VOTING STOCK HELD BY NON-AFFILIATES OF THE
REGISTRANT WAS APPROXIMATELY $2,401,841,398 BASED UPON THE CLOSING MARKET PRICE
OF $32.125 PER SHARE OF COMMON STOCK ON THE NEW YORK STOCK EXCHANGE AS OF APRIL
7, 1998.
 
NUMBER OF SHARES OF COMMON STOCK OUTSTANDING AS OF APRIL 7, 1998: 77,100,395
 
                      DOCUMENTS INCORPORATED BY REFERENCE
 
     PORTIONS OF THE REGISTRANT'S PROXY STATEMENT FOR THE MAY 14, 1998 ANNUAL
MEETING OF STOCKHOLDERS ARE INCORPORATED BY REFERENCE INTO PART III.
 
                THE EXHIBIT INDEX IS LOCATED ON PAGE 39 HEREOF.
 
================================================================================
<PAGE>   2
 
                              BORDERS GROUP, INC.
 
                                     INDEX
 
<TABLE>
<CAPTION>
                                                                        PAGE
                                                                        ----
<S>       <C>                                                           <C>
PART I
Item 1.   Business....................................................    2
Item 2.   Properties..................................................    7
Item 3.   Legal Proceedings...........................................    8
Item 4.   Submission of Matters to a Vote of Security Holders.........    8

PART II
Item 5.   Market for Registrant's Common Equity and Related
            Stockholder Matters.......................................    9
Item 6.   Selected Financial Data.....................................   10
Item 7.   Management's Discussion and Analysis of Financial Condition
            and Results of Operations.................................   11
Item 8.   Financial Statements and Supplementary Data.................   18
Item 9.   Changes in and Disagreements with Accountants on Accounting
            and Financial Disclosure..................................   34

PART III
Item 10.  Directors and Executive Officers of the Registrant..........   35
Item 11.  Executive Compensation......................................   38
Item 12.  Security Ownership of Certain Beneficial Owners and
            Management................................................   38
Item 13.  Certain Relationships and Related Transactions..............   38

PART IV
Item 14.  Exhibits, Financial Statement Schedules, and Reports on Form
            8-K.......................................................   39
</TABLE>
 
                                        1
<PAGE>   3
 
                                     PART I
 
ITEM 1. BUSINESS
 
GENERAL
 
     Borders Group, Inc. (the Company), through its subsidiaries, Borders, Inc.
(Borders), Walden Book Company, Inc. (Walden) and Books etc. is the second
largest operator of book superstores and the largest operator of mall-based
bookstores in the world based upon both sales and number of stores. At March 22,
1998, the Company operated 204 superstores under the Borders name, including one
in Singapore, 904 mall-based and other bookstores primarily under the
Waldenbooks name and in the United Kingdom, 23 bookstores under the Books etc.
name. The Company had consolidated net sales of approximately $2.3 billion in
1997 and $2.0 billion in 1996. References herein to years are to fiscal years of
the Company which currently end in January of the following calendar year.
 
     Borders is a premier operator of book and music superstores, offering
customers selection and service that the Company believes to be superior to
other book superstore operators. A key element of the Company's strategy is to
continue its growth and increase its profitability through the ongoing expansion
of its Borders book and music superstore operations. In 1997, the Company opened
46 new Borders book and music superstores. Borders superstore operations
achieved compound annual growth in net sales for the three years ended January
25, 1998 of 47.1% and attained comparable store sales growth in 1997 of 8.0%.
Borders superstores achieved average sales per square foot of $261 and average
sales per superstore of $7.2 million in 1997, each of which the Company believes
to be higher than the comparable figures of any publicly reporting book
superstore operator.
 
     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. A Borders superstore typically
carries the broadest selection of book titles in its market. Borders superstores
carry an average of 128,000 book SKUs, ranging from 85,000 SKUs to 170,000 SKUs,
across numerous categories, including many hard-to-find titles. As of March 22,
1998, 188 of the 204 Borders superstores were in a book and music format, which
also features an extensive selection of pre-recorded music, with an emphasis on
hard-to-find recordings and categories such as jazz, classical and foreign
music, and a broad assortment of pre-recorded videotapes, focusing primarily on
classic movies and hard-to-find titles. Each book and music superstore carries
approximately 50,000 SKUs of music and 6,500 SKUs of videotapes. As of March 22,
1998, 200 of the 204 Borders superstores featured an espresso bar.
 
     Over the past two decades, Borders has developed what it believes is the
most sophisticated inventory management system in the retail book industry. The
inventory management system includes a centrally controlled "expert" system that
uses artificial intelligence principles to forecast sales and recommend
inventory levels for each book in each store. Management believes that Borders'
inventory management system, which reflects both overall sales trends and local
buying patterns, results in higher in-stock positions, a broader selection of
book titles, and increased inventory turnover, sales per store and sales per
square foot, while effectively managing inventory investment to provide Borders
stores with a more productive inventory assortment. As a result, management
believes this proprietary system has been a principal reason for Borders'
superior performance. The Company is adapting certain aspects of the system for
use in its mall-based business where appropriate, and believes that over the
long term it will enable the Company to offer a more productive assortment of
inventory throughout its operations.
 
     Borders superstores average 27,200 square feet, including approximately
5,600 square feet devoted to music, approximately 700 square feet devoted to
videos and approximately 1,500 square feet devoted to the espresso bar. Stores
opened in fiscal 1997 averaged 26,000 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.
 
     Walden is the 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, selected children's books and a standard
selection of business, cooking, reference and general interest books. Walden has
a well
 
                                        2
<PAGE>   4
 
established name and reputation and generates cash flow that the Company plans
to use toward financing the Company's growth initiatives. Walden stores average
approximately 3,300 square feet and typically carry between 15,000 and 25,000
titles.
 
     In addition to its traditional mall format described above, Walden operates
alternative mall-based bookstores utilizing a large format. This addresses the
desires of some developers to include a larger format bookstore in malls,
including, in many cases, where developers plan to include only one bookstore in
a mall, and is designed to take advantage of what management believes is the
desire by mall customers in some markets for greater selection and service. The
larger format consists of approximately 5,000 to 8,000 square feet and carries
between 30,000 and 40,000 titles. As of March 22, 1998, 101 of the larger format
stores had been opened.
 
     In October 1997, the Company acquired Books etc., a London-based retailer
of books and related products. This acquisition, coupled with the opening of a
Borders store in Singapore, marked the Company's entrance into the international
market for books. The Company believes that international expansion will
reinforce its existing businesses and drive continued earnings growth. Books
etc. currently operates 23 stores in the U.K., all of which are small-format
stores located primarily in central London or in various U.K. airports. These
stores generally range from 2,000 to 5,000 square feet, with the largest being
13,000 square feet, and the smallest being 650 square feet. The Books etc.
philosophy is to offer customers the widest range of quality reading at the best
prices, coupled with knowledgeable guidance from experienced store associates.
 
     The Company, through its subsidiary, Borders Online, Inc., expects to
launch its Internet commerce site, Borders.com in 1998. This site will offer
customers a wide selection of books, music and videos available for purchase
on-line. Borders.com represents the Company's investment in the fast-growing
area of Internet retailing, and is designed to be a continuously-evolving site.
 
     The Company is currently working to resolve the potential impact of the
year 2000 on the processing of date-sensitive information by the Company's
computerized information systems. The year 2000 problem is the result of
computer programs being written using two digits (rather than four) to define
the applicable year. Any of the Company's programs that have time-sensitive
software may recognize a date using "00" as the year 1900 rather than the year
2000, which could result in miscalculations or system failures. Based on
preliminary information, costs of addressing potential problems are not
currently expected to have a material adverse impact on the Company's financial
position, results of operations or cash flows in future periods. However, if the
Company, its customers or vendors are unable to resolve such processing issues
in a timely manner, it could result in a material financial risk. Accordingly,
the Company plans to devote the necessary resources to resolve all significant
year 2000 issues in a timely manner; however, there can be no guarantees that
the systems of other companies on which the Company relies will be converted in
a timely manner.
 
DISTRIBUTION
 
     Borders. Borders believes that its centralized distribution system,
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 to one of Borders'
distribution centers, located in Harrisburg, Pennsylvania; Reno, Nevada; Ann
Arbor, Michigan; Columbus, OH and Indianapolis, Indiana. Walden's distribution
centers, discussed below, are also utilized by Borders. Beginning in 1998, the
Company will combine the Reno and Walden's Ontario operations into a single
full-service facility located in Mira Loma, California. Approximately 95% of the
books carried by Borders are processed through its distribution facilities. At
each distribution facility, employees process the merchandise from the
publishers and write out claims for short orders, damaged books, incorrect
shipments and incorrect billings. Employees also label books with proprietary
bar code stickers identifying the book title, price and subject area. During the
non-holiday selling season, approximately 85% to 90% of the trade inventory that
arrives from publishers is processed within 48 hours for shipment to the stores.
Newly released titles and rush orders are processed within 24 hours. Borders
purchases 85% of music directly from certain manufacturers and utilizes Borders'
own distribution centers to ship a majority of its music inventory to its
stores.
 
                                        3
<PAGE>   5
 
     In general, books can be returned to their publishers at cost. Borders
stores return books to the Company's centralized returns center in Nashville,
Tennessee to be processed for return to the publishers. Borders believes that
its returns to publishers are substantially lower than the industry average, due
to the sophistication of its inventory management system. As a result, Borders
is able to reduce its handling, carrying and freight expenses. In general,
Borders has limited rights to return music and videos to its distributor.
 
     Walden. Approximately 65% of the number of books carried by Walden's stores
are shipped to one of Walden's two distribution centers, located in Ontario,
California and Nashville, Tennessee. Walden also utilizes the Company's
Nashville, Tennessee returns center facility. Walden continues to use Ingram, a
major book wholesaler, to supplement its distribution centers and also receives
some product in stores directly from publishers.
 
     Books etc. Books etc. airport stores are served primarily by the Books etc.
distribution center in Cornwall, England. Stores located in central London
receive the majority of their merchandise directly from publishers and
wholesalers.
 
     Fulfillment Center. In 1998, the Company, through its subsidiary, Borders
Fulfillment, Inc., will open its new, state-of-the-art fulfillment center in
Nashville, Tennessee. This facility can stock in excess of 700,000 unique book,
music, and video titles and will give the Company a significant competitive
advantage in terms of delivery capabilities. In addition to supporting
Borders.com, the fulfillment center will also provide delivery services for
store-originated special orders, institutional orders, and call center orders.
 
COMPETITION
 
     The retail book business is highly competitive. Competition within the
retail book industry is fragmented with Borders facing direct competition from
other superstores, such as Barnes & Noble, Books-A-Million, Crown Books, Media
Play and mass merchandiser Best Buy. Approximately 83% of Borders superstores
currently face direct competition from other large format book superstores.
Walden faces direct competition from the B. Dalton division of Barnes & Noble,
Inc., as well as regional chains and superstores. In addition, Borders and
Walden compete with each other, as well as specialty retail stores that offer
books in a particular area of specialty, independent single store operators,
variety discounters, drug stores, warehouse clubs, mail order clubs and mass
merchandisers. In the future, Borders and Walden may face additional competition
from other categories of retailers entering the retail book market.
 
     The music and video 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 Musicland Stores Corporation (which
also sell videos), established video chains, such as Blockbuster and Suncoast
Motion Picture Company (a division of Musicland Stores Corporation), as well as
specialty retail stores, video rental stores, variety discounters, warehouse
clubs and mass merchandisers (such as Best Buy), some of which may have greater
financial or other resources than the Company. 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.
 
     Recently the Internet has emerged as an avenue for retailing in all media
categories that the Company carries. In particular, the retailing of books and
music over the Internet is developing rapidly. Competitors on the Internet
include Amazon, Barnes & Noble, N2K, CDnow and others. The Company does not
believe that sales to date on the Internet have materially affected the
Company's sales, but Internet sales are expected to become more significant over
time. As discussed above, the Company is developing its own vehicle for
retailing over the Internet which it expects to be in operation in 1998.
 
CREDIT FACILITY
 
     The Company has a revolving credit facility pursuant to the Amended and
Restated Multicurrency Credit Agreement, dated as of October 17, 1997 (the
"Credit Agreement"), by and among the Company and certain subsidiaries,
including Borders and Walden, as both joint borrowers and cross guarantors, the
lenders party thereto, PNC, as administrative agent and First Chicago, as
syndication agent.
 
                                        4
<PAGE>   6
 
     General. The Credit Agreement currently provides for borrowings in a
principal amount of up to $425.0 million at any one time, which includes
sub-limits for discretionary lines of credit and letters of credit. The Credit
Agreement expires on October 16, 2002. Borrowings under the Credit Agreement are
referred to herein as the "Loans".
 
     Interest. The Company may elect to have the Loans bear interest at the Base
Rate or Euro-Rate. The Base Rate is a fluctuating rate per annum equal to the
greater of (i) the interest rate per annum announced from time to time by the
administrative agent at its principal office as its then prime rate or (ii) the
Federal Funds Effective Rate (as defined in the Credit Agreement) plus 1/2% per
annum. The Euro-Rate is a rate per annum equal to (a) the interest rate
determined by dividing (i) the London Interbank Offered Rate by (ii) one minus
the Euro-Rate Reserve Percentage (which in general is equal to the maximum
percentage reserve requirements with respect to eurocurrency funding), plus (b)
the Euro-Rate Margin (as defined in the Credit Agreement).
 
     Repayment. Subject to the provisions of the Credit Agreement, the Company
may, from time to time, borrow, repay and reborrow under the Credit Agreement.
The entire unpaid balance may be prepaid at any time without penalty, and is
payable on October 16, 2002.
 
     Covenants. The Credit Agreement contains financial covenants relating to
the maintenance of a minimum fixed charge coverage ratio, a maximum leverage
ratio and a minimum tangible net worth. The Credit Agreement also contains
restrictive covenants pertaining to the management and operation of the Company.
These covenants include, among others, significant limitations on indebtedness
(with an exception for certain permitted indebtedness necessary to satisfy
note-put agreements relating to certain mortgage pass-through certificates for
which certain Borders' leases serve as collateral), liens, contingent
obligations, loans and investments, dividends and distributions, liquidations,
mergers, consolidations, disposition of assets or subsidiaries, transactions
with affiliates, fundamental corporate changes and capital expenditures and
repurchase of its common stock in excess of $100.0 million (plus any proceeds
and tax benefits resulting from stock option exercises).
 
     Events of Default. The Credit Agreement provides for events of default
customary in facilities of this type, including: (i) failure to make payments
when due; (ii) breach of any representations and warranties; (iii) breach of
covenants; (iv) default under any agreement relating to indebtedness for
borrowed money in excess of $5.0 million in the aggregate; (v) bankruptcy
defaults; (vi) judgments in excess of $5.0 million; (vii) ERISA defaults; (viii)
solvency defaults; (ix) change in control defaults; and (x) certain events that
individually or in the aggregate could reasonably be expected to have a material
adverse effect.
 
LEASE FACILITY
 
     The Company has a $250.0 million lease financing facility pursuant to the
Amended and Restated Participation Agreement, dated as of October 17, 1997 (the
"Lease Facility"), by and among the Company and certain subsidiaries, including
Borders and Walden, as both joint borrowers and cross guarantors, the lenders
party thereto, PNC, as administrative agent and First Chicago, as syndication
agent. The Lease Facility will provide financing to lessors through loans from a
third party lender for up to 95% of a project cost. It is expected that lessors
will make equity contributions approximating 5% of each project. Independent of
its obligations as lessee, the Company guarantees payment when due of all
amounts required to be paid to the third party lender. The principal amounts
guaranteed are 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. Events of default are similar in nature to the Credit Agreement. As of
March 22, 1998 43 of Borders store locations were financed through the Lease
Facility and $168.4 million was outstanding. Upon the refinancing of the amounts
outstanding under the Lease Facility, rental expense for locations leased
thereunder could be adversely affected.
 
ASSOCIATES
 
     As of March 22, 1998, the Company had a total of approximately 14,100
full-time associates and approximately 10,200 part-time associates. When hiring
new associates, the Company considers a number of
 
                                        5
<PAGE>   7
 
factors, including education and experience, personality and orientation towards
customer service. All new associates 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 POS terminals and store policies and
procedures. The Company believes that its relations with its associates are
generally good. The Company's associates are not represented by unions except
that the associates of four Borders stores have elected to be represented by the
United Food and Commercial Workers International Union (UFCW). To date,
agreements have been reached between the Company and the UFCW with respect to
three of the four stores.
 
TRADEMARKS AND SERVICE MARKS
 
     Borders(R), Borders Book Shop(R), and Borders Books & Music(R), among other
marks, are all registered trademarks and service marks used by Borders.
Brentano's(R), Coopersmith's(R), Longmeadow Press(R), Waldenbooks(R),
Waldenbooks Preferred Reader(R), Waldenkids(R) and Waldensoftware(R), among
other marks, are all registered trademarks and service marks used by Walden.
BOOKS etc(R) is a registered trademark and service mark used by Books etc. The
Borders, Walden and Books etc. service marks are used as trade names in
connection with their business operations.
 
SEASONALITY
 
     The Company's business is highly seasonal, with sales generally highest in
the fourth quarter and lowest in the first quarter. During 1997, 37.9% of the
Company's sales and 95.4% 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. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations -- Seasonality".
 
RELATIONSHIP WITH KMART
 
     General. The Company was formerly a subsidiary of Kmart; Kmart currently
owns no shares of Common Stock.
 
     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 ("the 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 (the "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
will 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
 
                                        6
<PAGE>   8
 
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. 39 of Borders' leases for its retail stores have
been guaranteed by Kmart, on either a full or limited basis. Limited guarantees
generally provide for the release of Kmart's guarantee upon satisfaction by
Borders of certain financial requirements specified in the guarantee. Under the
terms of a lease guaranty, indemnification and reimbursement agreement entered
into upon completion of the IPO (the "Lease Guaranty Agreement"), until
termination of all of the lease guarantees, except during such time as the
Company achieves and maintains the investment grade status specified in the
Lease Guaranty Agreement, the Company will be subject to certain covenants and
restrictive covenants under the Lease Guaranty Agreement including restrictions
on indebtedness, dividends, mergers and certain liens.
 
     Under the terms of the 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, (iii) a breach of any of the financial covenants
described above or (iv) 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 on or after November 2019.
 
ITEM 2. PROPERTIES
 
     Borders. Borders operated 204 stores in 37 states and the District of
Columbia at March 22, 1998. Borders leases all of its stores. Borders' store
leases have an average initial term of 10 to 20 years with several five-year
renewal options. At March 22, 1998, the average unexpired term under Borders'
existing store leases was 12.6 years prior to the exercise of any options.
 
     The Company has leased its corporate headquarters in Ann Arbor, Michigan
and all distribution centers located in Harrisburg, Pennsylvania; Indianapolis,
Indiana; Reno, Nevada; Columbus, Ohio and Ann Arbor, Michigan.
 
     Walden. Walden operates 904 stores in all 50 states as of March 22, 1998.
Walden leases all of its stores. Walden's store leases generally have an initial
term of 10 years. At present, the average unexpired term under
 
                                        7
<PAGE>   9
 
Walden's existing store leases is approximately 4.6 years. The terms of Walden's
mall-based bookstores leases for its leased bookstores open as of March 22, 1998
expire as follows:
 
<TABLE>
<CAPTION>
                LEASE TERMS TO EXPIRE DURING                     NUMBER OF
          12 MONTHS ENDING ON OR ABOUT JANUARY 31               MALL STORES
          ---------------------------------------               -----------
<S>                                                             <C>
1998........................................................        163
1999........................................................        132
2000........................................................         79
2001 and later..............................................        530
</TABLE>
 
     Walden leases both of its distribution facilities located in Ontario,
California and Nashville, Tennessee. The Company relocated its Walden
headquarters during 1995 to Ann Arbor, Michigan in order to better coordinate
its operations with Borders and allow for streamlining and combination of
certain management and administrative functions. On December 5, 1995, Walden
completed the sale of its previous corporate headquarters facility located in
Stamford, Connecticut.
 
     Books etc. Books etc. operates 23 stores in the United Kingdom as of March
22, 1998. 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 13.0 years.
 
ITEM 3. LEGAL PROCEEDINGS
 
     The Company is from time to time involved in or affected by litigation
incidental to the conduct of its respective businesses. The Company believes
that no currently pending litigation to which it is a party will have a material
adverse effect on its liquidity, financial position or results of operations.
 
     In March 1998, the American Booksellers Association ("ABA") and twenty-six
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 Law. The Complaint seeks
injunctive and declaratory relief; treble damages on behalf of each of the
bookstore plaintiffs, and, with respect to the California bookstore plaintiffs,
any other damages permitted by California law; disgorgement of money, property
and gains wrongfully obtained in connection with the purchase of books for
resale, or offered for resale, in California from March 18, 1994 until the
action is completed and pre-judgment interest on any amounts awarded in the
action, as well as attorney fees and costs. The Company intends to vigorously
defend the action.
 
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
 
     Not applicable.
 
                                        8
<PAGE>   10
 
                                    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 (after the effect of the 2-for-1 stock split, effective, March 1,
1997).
 
<TABLE>
<CAPTION>
                                                                 HIGH      LOW
                                                                 ----      ---
<S>                                                             <C>       <C>
FISCAL QUARTER 1996
  First Quarter.............................................    $16.69    $ 9.75
  Second Quarter............................................    $18.69    $14.32
  Third Quarter.............................................    $19.63    $15.38
  Fourth Quarter............................................    $19.25    $15.07

FISCAL QUARTER 1997
  First Quarter.............................................    $22.82    $18.32
  Second Quarter............................................    $26.94    $19.25
  Third Quarter.............................................    $29.00    $22.31
  Fourth Quarter............................................    $31.94    $24.50
</TABLE>
 
     The Common Stock is traded on the New York Stock Exchange.
 
     As of March 25, 1998, the Common Stock was held by 3,744 holders of record.
 
     The Company currently intends to retain its earnings to finance future
growth and therefore does not anticipate paying any cash dividends in the
foreseeable future. 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 Credit Facility and the Lease
Facility prohibit the Company from paying any dividends. The Lease Guaranty
Agreement between the Company, Borders and Kmart restricts the Company's ability
to pay dividends, unless no defaults exist under any indebtedness of the Company
and such payments do not exceed the sum of 50% of cumulative consolidated net
income since the Company's initial public offering of common stock, which was
completed on June 1, 1995, and certain proceeds received from the sale of
capital stock. See "Management's Discussion and Analysis of Financial Condition
and Results of Operations -- Liquidity and Capital Resources".
 
                                        9
<PAGE>   11
 
ITEM 6. SELECTED FINANCIAL DATA
 
                              BORDERS GROUP, INC.
 
               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.
 
<TABLE>
<CAPTION>
                                                                   FISCAL YEAR ENDED
                                          -------------------------------------------------------------------
                                          JANUARY 25,   JANUARY 26,   JANUARY 28,   JANUARY 22,   JANUARY 23,
                                             1998          1997         1996(1)        1995          1994
                                          -----------   -----------   -----------   -----------   -----------
                                                      (DOLLARS IN MILLIONS EXCEPT PER SHARE DATA)
<S>                                       <C>           <C>           <C>           <C>           <C>
STATEMENT OF OPERATIONS DATA
Superstore Sales........................   $1,264.1      $  958.1      $  683.5      $  404.0      $  224.8
Mall Bookstore Sales....................      968.2         979.7       1,031.5       1,085.5       1,145.8
Other Sales.............................       33.7          21.0          34.0          21.5            --
                                           --------      --------      --------      --------      --------
  Total Sales...........................   $2,266.0      $1,958.8      $1,749.0      $1,511.0      $1,370.6
Operating Income Before Restructuring
  Provision, Goodwill Writedowns and FAS
  121...................................   $  138.0      $  103.1      $   64.5      $   50.2      $   49.9
Restructuring Provision.................         --            --            --           6.4         142.8
Goodwill Writedowns.....................         --            --         201.8            --            --
FAS 121 Impairment......................         --            --          63.1            --            --
Operating Income (Loss).................   $  138.0      $  103.1      $ (200.4)     $   43.8      $  (92.9)
Net Income (Loss).......................   $   80.2      $   57.9      $ (211.1)     $   20.9      $  (61.2)
Diluted Earnings (Loss) Per Common
  Share.................................   $   0.98      $   0.70      $  (2.94)     $   0.35      $  (1.06)
Pro Forma Diluted Earnings Per Common
  Share Before Restructuring Provision,
  Goodwill Writedowns and FAS 121(2)....   $   0.98      $   0.70      $   0.43      $   0.32      $   0.28
END OF PERIOD BALANCE SHEET DATA
Working Capital.........................   $  137.0      $  225.1      $  204.3      $  258.0      $   72.4
Total Assets............................    1,534.9       1,211.0       1,052.3       1,355.9       1,006.3
Short Term Borrowings...................      122.5          30.0          60.0            --            --
Long-Term Debt and Capital Lease
  Obligations, Including Current
  Portion, and Redeemable Preferred
  Stock.................................       10.0           6.7           8.6          21.1          11.1
Shares Subject to Repurchase............         --          34.1            --            --            --
Stockholders' Equity....................      598.1         511.4         472.0         726.3         457.5
</TABLE>
 
-------------------------
(1) The Company's 1995 fiscal year consisted of 53 weeks.
 
(2) Earnings (loss) per common share as of January 28, 1996, January 22, 1995
    and January 23, 1994 are pro forma and are based on actual common shares
    outstanding after the Company's initial public offering. The pro forma data
    assume the formation of the Company and the initial public offering took
    place at the beginning of fiscal 1993.
 
                                       10
<PAGE>   12
 
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
 
          MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
                           AND RESULTS OF OPERATIONS
 
GENERAL
 
     The Company, through its subsidiaries, is the second largest operator of
book and music superstores and the largest operator of mall-based bookstores in
the world based upon both sales and number of stores. At January 25, 1998, the
Company operated 203 superstores primarily under the Borders name, including 1
in Singapore, 923 mall-based and other bookstores primarily under the
Waldenbooks name and 23 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) the continued expansion and refinement of its Borders
superstore operation in the United States and internationally, (ii) the
continued focus on cost reductions in its mall-based bookstore operations and
(iii) realization of synergies and economies of scale through a combination of
certain of its books and music operations. The Company's 1997 fiscal year
consisted of the 52 weeks ended January 25, 1998. The Company's 1996 fiscal year
consisted of 52 weeks ended January 26, 1997. The Company's 1995 fiscal year
consisted of the 53 weeks ended January 28, 1996. References herein to years are
to the Company's fiscal years which currently end on the Sunday immediately
preceding the last Wednesday in January of the following calendar year.
 
RESULTS OF OPERATIONS
 
     The following table presents the Company's statement of operations data, as
a percentage of sales, for the three most recent fiscal years.
 
<TABLE>
<CAPTION>
                                                                JANUARY 25,    JANUARY 26,    JANUARY 28,
                                                                   1998           1997           1996
                                                                -----------    -----------    -----------
<S>                                                             <C>            <C>            <C>
RESULTS OF OPERATIONS
Sales.......................................................       100.0%         100.0%         100.0%
Cost of merchandise sold (includes occupancy)...............        72.1           73.4           74.5
                                                                   -----          -----          -----
Gross margin................................................        27.9           26.6           25.5
Selling, general and administrative expenses................        21.4           20.9           21.4
Pre-opening expense.........................................         0.4            0.4            0.4
Goodwill amortization.......................................          --             --            0.2
Operating losses of stores identified for closure...........          --             --           (0.2)
                                                                   -----          -----          -----
Operating income before goodwill writedowns and FAS 121.....         6.1            5.3            3.7
Goodwill writedowns.........................................          --             --           11.5
FAS 121 impairment..........................................          --             --            3.6
                                                                   -----          -----          -----
Operating income (loss).....................................         6.1            5.3          (11.4)
Interest expense............................................         0.3            0.4            0.3
                                                                   -----          -----          -----
Income (loss) before income tax.............................         5.8            4.9          (11.7)
Income tax provision........................................         2.3            1.9            0.4
                                                                   -----          -----          -----
Net income (loss)...........................................         3.5%           3.0%         (12.1)%
                                                                   -----          -----          -----
Net income excluding goodwill writedowns, and FAS 121.......         3.5%           3.0%           2.0%
                                                                   -----          -----          -----
STORE ACTIVITY
Borders Superstores
  Beginning number of stores................................         157            116             75
  Openings..................................................          46             41             41
                                                                   -----          -----          -----
  Ending number of stores...................................         203            157            116
                                                                   -----          -----          -----
Walden Mall Bookstores
  Beginning number of stores................................         961            992          1,102
  Openings..................................................           8              9              5
  Closings..................................................         (46)           (40)          (115)
                                                                   -----          -----          -----
  Ending number of stores...................................         923            961            992
                                                                   =====          =====          =====
</TABLE>
 
                                       11
<PAGE>   13
 
FISCAL YEARS ENDED JANUARY 25, 1998 AND JANUARY 26, 1997
 
     Sales for the year ended January 25, 1998 were $2,266.0 million, reflecting
a 15.7% increase over the $1,958.8 million in sales achieved in 1996. Both the
higher number of Borders superstores and Borders' 8.0% comparable store sales
increase contributed to the growth, which was partially offset by store closings
at Waldenbooks. The Walden 0.0% comparable store sales reflects flat mall
traffic levels and the impact of increased superstore competition offset by the
benefit of new merchandising initiatives. Walden also experienced a benefit from
a larger number of seasonal calendar kiosks introduced in malls with existing
Walden stores.
 
     Gross margin as a percent of sales rose, from 26.6% in 1996 to 27.9% in
1997. The increase in gross margin percentage primarily reflects improved buying
and sales mix resulting in higher initial product margin and tighter control of
inventory shrinkage.
 
     As a percentage of sales, SG&A for 1997 was 21.4%, or 0.5% higher than the
20.9% of sales in the corresponding period of 1996. The increase is due largely
to expenditures on strategic initiatives offset in part by the leveraging of
corporate overhead over the Company's expanding sales base.
 
     Pre-opening expense in 1997 was $7.2 million consistent with 1996 expense
of $7.2 million. Pre-opening expense per store varies primarily as a result of
differing levels of grand opening advertising, depending on the presence of the
Company in the market, and differing levels of labor costs associated with
opening the store. The Company opened 46 Borders superstores and 8 Waldenbooks
mall-based stores in 1997 as compared to 41 Borders superstores and 9
Waldenbooks mall-based stores in 1996.
 
     Goodwill amortization was $1.6 million in 1997, as compared to $1.1 million
in 1996. The increase in goodwill amortization of $0.5 million is a result of
the higher goodwill balance due to the acquisition of Books etc. in October
1997.
 
     Operating income was $138.0 million or 6.1% of sales in 1997, as compared
to $103.1 million or 5.3% of sales in 1996.
 
     Interest expense was $7.2 million in 1997, as compared to $7.0 million in
1996. The increase represents interest on borrowings for the repurchase of
common stock, and the acquisition of Books, etc.
 
     Income tax expense in 1997 was $50.6 million as compared to $38.2 million
in 1996. The effective tax rate for both periods differed from the statutory
rate primarily as a result of non-deductible goodwill amortization. The
Company's effective tax rate was 38.7% in 1997 as compared to 39.8% in 1996. The
decrease in effective rate is due primarily to the realization of benefits
related to state tax planning strategies.
 
     As a result of the foregoing, net income for the year ended January 25,
1998 was $80.2 million as compared to $57.9 million for the year ended January
26, 1997.
 
FISCAL YEARS ENDED JANUARY 26, 1997 AND JANUARY 28, 1996
 
     Sales for the year ended January 26, 1997 were $1,958.8 million, reflecting
a 12% increase over the $1,749.0 million in sales achieved in 1995. Both the
higher number of Borders superstores and Borders' 9.9% comparable store sales
increase contributed to the growth, which was partially offset by store closings
at Waldenbooks. The Walden comparable store sales increase of 0.1% reflects flat
mall traffic levels and the impact of increased superstore competition offset by
the benefit of new merchandising initiatives. Walden also experienced a benefit
from a larger number of seasonal calendar kiosks introduced in malls with
existing Walden stores and stores expanded to a larger format.
 
     Gross margin as a percent of sales rose, from 25.5% in 1995 to 26.6% in
1996. The increase in gross margin percentage reflects the impact of
consolidated distribution operations and improved buying and sales mix resulting
in higher initial product margin, reduced depreciation as a result of the fourth
quarter 1995 FAS 121 write-off and tighter control of inventory shrinkage.
 
     As a percentage of sales, SG&A for 1996 was 20.9%, or 0.5% less than the
21.4% of sales in the corresponding period of 1995. The 0.5% decrease is due
largely to the leveraging of corporate overhead over
 
                                       12
<PAGE>   14
 
the Company's expanding sales base, as well as headcount reductions and related
wage savings resulting from the move of the Waldenbooks headquarters from
Stamford, Connecticut to Ann Arbor, Michigan.
 
     Pre-opening expense in 1996 was $7.2 million as compared to $7.3 million in
1995. Pre-opening expense per store varies primarily as a result of differing
levels of grand opening advertising, depending on the presence of the Company in
the market, and differing levels of labor costs associated with opening the
store. The Company opened 41 Borders superstores and 9 Waldenbooks mall-based
stores in 1996 as compared to 41 Borders superstores and 5 Waldenbooks
mall-based stores in 1995.
 
     Goodwill amortization was $1.1 million in 1996, as compared to $3.7 million
in 1995. The decrease in goodwill amortization of $2.6 million is a result of
the lower goodwill balance due to the noncash writedowns of goodwill in 1995.
(See "Goodwill Writedown.")
 
     Operating income before goodwill writedown and FAS 121 was $103.1 million
or 5.3% of sales in 1996, as compared to $64.5 million or 3.7% of sales in 1995.
 
     Interest expense was $7.0 million in 1996, as compared to $4.6 million in
1995. The Company incurred full-year, pre-tax interest expense of $4.5 million
in 1996 versus $2.3 million in 1995 as a result of the purchase of Kmart's
remaining interest in the Company in August 1995.
 
     Income tax expense in 1996 was $38.2 million as compared to $6.1 million in
1995. The effective tax rate for both periods differed from the statutory rate
primarily as a result of non-deductible goodwill amortization and writedown and
the FAS 121 charge. Excluding the non-recurring charges, goodwill amortization
and writedown and a portion of the FAS 121 charge, the Company's effective tax
rate was 39.8% in 1996 as compared to 38.6% in 1995. The increase in effective
rate is due primarily to a higher marginal rate applied to a greater level of
1996 pre-tax income versus 1995.
 
     As a result of the foregoing, net income for the year ended January 26,
1997 was $57.9 million as compared to $35.3 million for the year ended January
28, 1996, excluding non-recurring charges for the goodwill writedown and the
effect of the adoption of FAS 121.
 
LIQUIDITY AND CAPITAL RESOURCES
 
     The Company's principal capital requirements are to fund working capital
needs, the opening of new stores and the refurbishment and expansion of existing
stores.
 
     Net cash provided by operations in 1997 was $147.0 million, as compared to
$101.0 million in 1996. The current year activity primarily reflects income
before non-cash charges for depreciation and amortization and increases in taxes
payable as a result of timing of estimated payments offset by cash used for
inventories as a result of store expansion at Borders. Inventory net of accounts
payable increased primarily due to 46 new Borders stores.
 
     Net cash used for investing was primarily for capital expenditures for new
stores, acquisition of Books etc. and spending on strategic initiatives
including the opening of the Company's first international superstore in
Singapore. Capital expenditures in 1997 reflect the opening of 46 new
superstores and 8 new Waldenbooks stores and the addition of a new fulfillment
center in Nashville. Capital expenditures in 1996 and 1995 reflected the opening
of 41 new Borders superstores in each year and new Waldenbooks stores. Capital
expenditures in 1995 also included expenditures for the Company's combined
headquarters facilities.
 
     Net cash provided by financing in 1997 was $50.5 million, resulting
primarily from net borrowings under the credit facility, cash received for
construction funding, and the issuance of Company stock under the Company's
employee benefit plans, offset by the repurchase of common stock of $61.8
million. Net cash used for financing in 1996 was $2.0 million, which resulted
from net repayments of borrowings under the credit facility, offset by cash
received from construction funding, issuance of stock under employee benefit
plans and the sale of put options on the Company's common stock.
 
     The Company expects capital expenditures to be approximately $160.0 million
in 1998. The Company currently plans to open approximately 43 Borders
superstores including 3 international stores and 8 new
 
                                       13
<PAGE>   15
 
Waldenbooks mall stores in 1998. Average cash requirements for the opening of a
prototype Borders books and music superstore are $1.7 million, representing
capital expenditures of $1.0 million, inventory requirements, net of related
accounts payable, of $0.6 million and $0.1 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.
 
     On a consolidated basis, the Company expects its working capital
requirements to increase as a result of its expansion program for its Borders
books and music superstores and international expansion programs.
 
     The Company plans to execute its expansion plans for its Borders
superstores principally with funds generated from operations and financing
through the lease facility in 1998 and beyond. In the event that working capital
requirements are in excess of operating cash flows and lease financing, the
Company may fund such excess with borrowings under the credit facility. The
Company believes funds generated from operations, borrowings under the credit
facility and financing through the lease facility will be sufficient to fund its
anticipated capital requirements for at least the next two to three years.
 
     In 1997, the Company announced its intention to increase its repurchase of
its common stock from time to time from $50 million to $100 million. Funds for
such purchases would be from borrowings under the credit facility. During 1997
$61.8 million of common stock was repurchased.
 
     In October 1997, the Company entered into a multicurrency credit agreement
which provides a $425.0 million, five-year working capital facility. Borrowings
under the credit facility bear interest at a base rate or an increment over
LIBOR at the Company's option. The credit agreement contains operating covenants
which limit the Company's ability to incur indebtedness, make acquisitions,
dispose of assets and issue or repurchase its common stock in excess of $100
million (plus any proceeds and tax benefits resulting from stock option
exercises), pay dividends on its common stock, and require the Company to meet
certain financial measures regarding fixed charge coverage, leverage and
tangible net worth. This agreement replaced the Company's previous $300.0
million credit facility.
 
     In October 1997, the Company entered into a five-year, $250.0 million lease
financing facility to finance new stores and other property through loans from a
third party lender for up to 95% of a project cost. It is expected that lessors
will make equity contributions approximating 5% of each project. Independent of
its obligations as lessee, the Company will guarantee payment when due of all
amounts required to be paid to the third party lender. The principal amount
guaranteed will be 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. This agreement replaced the Company's previous $150.0 million
lease financing facility.
 
     There were 41 properties financed through the lease facility, with a
financed value of $157.9 million at January 25, 1998. Management believes that
the rental payments for properties financed through the lease facility 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 serve as collateral for certain mortgage
pass-thru certificates. These mortgage pass-thru certificates include a
provision requiring the Company to repurchase the underlying mortgage notes in
certain events, including the failure by the Company to make payments of rent
under the related leases, the failure by Kmart (the former parent of the
Company) to maintain required investment grade ratings or the termination of the
guarantee by Kmart of the Company's obligations under the related leases (which
would require mutual consent of Kmart and Borders). In the event the Company is
required to repurchase all of the underlying mortgage notes, the Company would
be obligated to pay approximately $36.6 million. The Company would expect to
fund this obligation through its line of credit. Since February 1995, Kmart has
failed to maintain
 
                                       14
<PAGE>   16
 
investment grade ratings and, therefore, these notes are now subject to put by
the holder. To date, the holder has not exercised its right to put the notes.
 
     In November 1997, the Company entered into two interest rate swaps with a
total notional amount of $66.9 million, which effectively converted variable
rate foreign currency-denominated borrowings to fixed rates of 7.2% and 7.1%.
These swap agreements expire within 3 and 5 years of the date the Company
entered into the agreements.
 
     In January 1998, the Company entered into a treasury rate lock with a total
notional amount of $50.0 million at a rate of 5.5%. This agreement expires
within seven months of the date the Company entered into the agreement.
 
1995 ACCOUNTING CHANGES
 
     Goodwill Writedown. Prior to completion of the IPO, the Company, as a
subsidiary of Kmart, followed the accounting policies established by Kmart for
its consolidated group and, accordingly, evaluated the overall recoverability of
goodwill using projected undiscounted cash flows. At April 23, 1995, such
goodwill aggregated $257.6 million, net of accumulated amortization of $38.6
million.
 
     The sale of common stock in the IPO generated net proceeds that were less
than the historical book value of the Company, resulting in Kmart taking a write
off of its investment in the Company in the amount of $185.0 million. As a
result, the Company re-evaluated its accounting policy regarding goodwill
impairment and adopted a new policy for recognition and measurement of goodwill
impairment based on a fair value approach. The Company believes fair value is a
preferable method to assess goodwill as it believes that the value at which the
individual businesses could be bought and sold in an arm's length transaction
between a willing buyer and seller is the most objective evidence and,
therefore, the most relevant measure of their value. This change in the method
of evaluating the recoverability of goodwill resulted in the recording of a
pre-tax charge to operations of $182.0 million in the second quarter of 1995.
During the fourth quarter of 1995, the Company took an additional charge of
$19.8 million. The charges aggregated $132.2 million for Borders, $16.2 million
for Planet Music and $53.4 million for Waldenbooks. As of January 28, 1996, all
goodwill relating to Waldenbooks and Planet Music had been written-off.
 
     This change resulted in a reduction of $5.9 million and $1.5 million of
goodwill amortization expense on an annual and quarterly basis, respectively.
Earnings per share in 1996 and prospectively were improved by approximately
$0.07 on an annual basis. In 1995, the partial-year effect of the accounting
change excluding the one-time charge was $3.9 million, or approximately $0.05
per share.
 
     The Company's fair value methodology is applied to each of its businesses
on a separate basis. When evaluating the need to record a goodwill impairment,
the Company will evaluate whether there have been any temporary or permanent
impairments, and will record appropriate charges (if any) to operations for
permanent impairments in fair value. The Company will evaluate Borders and
Books, etc. for impairment every quarter. Since all goodwill related to the
Walden and Planet businesses has been written-off, no further evaluations for
impairment will be necessary. There was no goodwill impairment required in 1997
or 1996.
 
     Accounting for Impairment of Long-Lived Assets and for Long-Lived Assets to
Be Disposed Of (FAS 121). The Company adopted FAS 121, effective as of the
fourth quarter of 1995. The carrying value of long-lived assets and certain
identifiable intangible assets are 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 and identifiable
intangibles. 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 their estimated fair value. Fair value is
estimated using expected future cash flows. If an asset being tested for
recoverability was acquired in a business combination accounted for using the
purchase method, the goodwill that arose in that transaction is allocated to the
assets being tested for recoverability. This change resulted in a pre-tax charge
of $63.1 million to operations in the fourth quarter of 1995. The charge
consisted of $42.1 million for leasehold improvements and furniture and fixtures
of Waldenbook stores, $14.5 million for goodwill relating to
 
                                       15
<PAGE>   17
 
such stores and $6.5 million for leasehold improvements and furniture and
fixtures of Planet Music. The impairment relating to Waldenbooks resulted
principally from declining mall traffic and increasing superstore competition.
Planet Music also faces intense competition from superstores, resulting in
declining gross margins. As a result of this charge, depreciation and
amortization expense was reduced by approximately $5.1 million after-tax or
$0.06 per share ($0.07 including the effects of the fourth quarter goodwill
writedown previously discussed) in 1996 and will be reduced on a declining basis
for the next several years. No writedowns of long-lived assets were required in
1997 or 1996.
 
INITIAL PUBLIC OFFERING AND PURCHASE OF COMMON STOCK FROM KMART
 
     The Company sold 25,062,322 shares of common stock in the IPO, which was
completed on June 1, 1995, the net proceeds of which were paid to Kmart. In
addition, as part of the IPO, Kmart sold 46,747,678 shares of common stock it
previously owned, thereby reducing its interest in the Company to 13%. The
Company did not receive any proceeds from the sale of common stock by Kmart. On
August 15, 1995, the Company completed a transaction to purchase and retire the
remaining 10,771,460 shares of common stock owned by Kmart at a price of $6.75
per share.
 
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 Christmas selling season.
 
<TABLE>
<CAPTION>
                                                                    FISCAL 1997 QUARTER ENDED
                                                              --------------------------------------
                                                              APRIL      JULY     OCTOBER    JANUARY
                                                              -----      ----     -------    -------
                                                                      (DOLLARS IN MILLIONS)
<S>                                                           <C>       <C>       <C>        <C>
SALES.......................................................  $463.6    $466.3    $477.3     $858.8
Operating income............................................     1.8       2.3       2.2      131.7
% of full year:
  Sales.....................................................    20.5%     20.6%     21.0%      37.9%
  Operating income..........................................     1.3       1.7       1.6       95.4

                                                                    FISCAL 1996 QUARTER ENDED
                                                              --------------------------------------
                                                              APRIL      JULY     OCTOBER    JANUARY
                                                              ------    ------    -------    -------
SALES.......................................................  $404.0    $414.3    $413.5     $727.0
Operating income (loss).....................................    (3.7)     (2.0)     (2.9)     111.7
% of full year:
  Sales.....................................................    20.6%     21.2%     21.1%      37.1%
  Operating income (loss)...................................    (3.6)     (1.9)     (2.8)     108.3

                                                                    FISCAL 1995 QUARTER ENDED
                                                              --------------------------------------
                                                              APRIL      JULY     OCTOBER    JANUARY
                                                              ------    ------    -------    -------
SALES.......................................................  $353.6    $363.8    $362.1     $669.5
Operating income (loss) (excluding goodwill writedowns and
  FAS 121)..................................................    (8.8)     (7.7)     (8.0)      89.0
% of full year:
  Sales.....................................................    20.2%     20.8%     20.7%      38.3%
  Operating income (loss) (excluding goodwill writedowns and
     FAS 121)...............................................   (13.6)    (11.9)    (12.4)     137.9
</TABLE>
 
EFFECTS OF INFLATION
 
     The Company's management does not believe inflation has had a material
impact on its operating results or financial position for the periods presented.
 
                                       16
<PAGE>   18
 
OTHER MATTERS
 
     The Company is currently working to resolve the potential impact of the
year 2000 on the processing of date-sensitive information by the Company's
computerized information systems. The year 2000 problem is the result of
computer programs being written using two digits (rather than four) to define
the applicable year. Any of the Company's programs that have time-sensitive
software may recognize a date using "00" as the year 1900 rather than the year
2000, which could result in miscalculations or system failures. Based on
preliminary information, costs of addressing potential problems are not
currently expected to have a material adverse impact on the Company's financial
position, results of operations or cash flows in future periods. However, if the
Company, its customers or vendors are unable to resolve such processing issues
in a timely manner, it could result in a material financial risk. Accordingly,
the Company plans to devote the necessary resources to resolve all significant
year 2000 issues in a timely manner; however, there can be no guarantees that
the systems of other companies on which the Company relies will be converted in
a timely manner.
 
                                       17
<PAGE>   19
 
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
 
                         INDEX TO FINANCIAL STATEMENTS
 
<TABLE>
<CAPTION>
                                                              PAGE
                                                              ----
<S>                                                           <C>
Consolidated Statements of Operations for the fiscal years
  ended January 25, 1998, January 26, 1997 and January 28,
  1996......................................................   19
Consolidated Balance Sheets as of January 25, 1998 and
  January 26, 1997..........................................   20
Consolidated Statements of Cash Flows for the fiscal years
  ended January 25, 1998, January 26, 1997 and January 28,
  1996......................................................   21
Consolidated Statements of Stockholders' Equity for the
  fiscal years ended January 25, 1998, January 26, 1997,
  January 28, 1996 and January 22, 1995.....................   22
Notes to Consolidated Financial Statements..................   23
Report of Independent Accountants...........................   33
</TABLE>
 
                                       18
<PAGE>   20
 
                              BORDERS GROUP, INC.
 
                     CONSOLIDATED STATEMENTS OF OPERATIONS
 
<TABLE>
<CAPTION>
                                                                            FISCAL YEAR ENDED
                                                                -----------------------------------------
                                                                JANUARY 25,    JANUARY 26,    JANUARY 28,
                                                                   1998           1997           1996
                                                                -----------    -----------    -----------
                                                                       (DOLLARS IN MILLIONS EXCEPT
                                                                         PER COMMON SHARE DATA)
<S>                                                             <C>            <C>            <C>
Sales.......................................................     $2,266.0       $1,958.8       $1,749.0
Cost of merchandise sold (includes occupancy)...............      1,634.3        1,437.8        1,302.3
                                                                 --------       --------       --------
Gross margin................................................        631.7          521.0          446.7
Selling, general and administrative expenses................        484.9          409.6          374.5
Pre-opening expense.........................................          7.2            7.2            7.3
Goodwill amortization and writedowns........................          1.6            1.1          205.5
FAS 121 impairment..........................................           --             --           63.1
Operating losses of stores identified for closure...........           --             --           (3.3)
                                                                 --------       --------       --------
Operating income (loss).....................................        138.0          103.1         (200.4)
Interest expense............................................          7.2            7.0            4.6
                                                                 --------       --------       --------
Income (loss) before income tax.............................        130.8           96.1         (205.0)
Income tax provision........................................         50.6           38.2            6.1
                                                                 --------       --------       --------
Net income (loss)...........................................     $   80.2       $   57.9       $ (211.1)
                                                                 ========       ========       ========
Earnings (loss) per common share data (Note 3) --
  Diluted earnings (loss) per common share..................        $ .98           $.70         $(2.94)
                                                                 ========       ========       ========
  Diluted weighted average common shares outstanding (in
     thousands).............................................       82,241         82,554         71,707
                                                                 ========       ========       ========
  Basic earnings (loss) per common share....................        $1.06           $.77         $(2.94)
                                                                 ========       ========       ========
  Basic weighted average common shares outstanding (in
     thousands).............................................       75,825         75,575         71,707
                                                                 ========       ========       ========
</TABLE>
 
          See accompanying Notes to Consolidated Financial Statements.
 
                                       19
<PAGE>   21
 
                              BORDERS GROUP, INC.
 
                          CONSOLIDATED BALANCE SHEETS
 
<TABLE>
<CAPTION>
                                                                    FISCAL YEAR ENDED
                                                                --------------------------
                                                                JANUARY 25,    JANUARY 26,
                                                                   1998           1997
                                                                -----------    -----------
                                                                   (DOLLARS IN MILLIONS
                                                                  EXCEPT SHARE AMOUNTS)
<S>                                                             <C>            <C>
ASSETS
Current Assets:
  Cash and cash equivalents.................................     $   65.1       $   42.6
  Merchandise inventories...................................        879.1          737.5
  Accounts receivable and other current assets..............         59.5           44.1
  Property held for resale..................................          1.3            8.1
  Deferred income taxes.....................................         13.4           14.1
                                                                 --------       --------
       Total Current Assets.................................      1,018.4          846.4
Property and equipment, net.................................        373.7          289.2
Other assets................................................         20.1           18.4
Deferred income taxes.......................................         13.2           18.5
Goodwill, net of accumulated amortization of $43.1 and
  $41.5, respectively.......................................        109.5           38.5
                                                                 --------       --------
                                                                 $1,534.9       $1,211.0
                                                                 ========       ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities:
  Short-term borrowings and current portion of long-term
     debt...................................................     $  127.3       $   30.5
  Trade accounts payable....................................        480.7          350.1
  Accrued payroll and other liabilities.....................        210.8          184.6
  Taxes, including income taxes.............................         62.6           56.1
                                                                 --------       --------
       Total Current Liabilities............................        881.4          621.3
Long-term debt and capital lease obligations................          5.2            6.2
Other long-term liabilities.................................         50.2           38.0
Commitments and contingencies (Note 9)......................           --             --
                                                                 --------       --------
       Total Liabilities....................................        936.8          665.5
                                                                 --------       --------
Shares subject to repurchase (Note 9).......................           --           34.1
                                                                 --------       --------
Stockholders' Equity:
Common stock, 200,000,000 shares authorized; 75,395,998 and
  75,858,016 shares issued and outstanding at January 25,
  1998 and January 26, 1997, respectively...................        661.0          648.1
Deferred compensation and officer receivables...............         (6.3)          (0.8)
Cumulative translation adjustment...........................         (0.9)            --
Accumulated deficit.........................................        (55.7)        (135.9)
                                                                 --------       --------
       Total Stockholders' Equity...........................        598.1          511.4
                                                                 --------       --------
                                                                 $1,534.9       $1,211.0
                                                                 ========       ========
</TABLE>
 
          See accompanying Notes to Consolidated Financial Statements.
 
                                       20
<PAGE>   22
 
                              BORDERS GROUP, INC.
 
                     CONSOLIDATED STATEMENTS OF CASH FLOWS
 
<TABLE>
<CAPTION>
                                                                         FISCAL YEAR ENDED
                                                              ---------------------------------------
                                                              JANUARY 25,   JANUARY 26,   JANUARY 28,
                                                                 1998          1997          1996
                                                              -----------   -----------   -----------
                                                                       (DOLLARS IN MILLIONS)
<S>                                                           <C>           <C>           <C>
Cash Provided by (used for):
Operations
  Net income (loss).........................................    $  80.2       $  57.9       $(211.1)
  Adjustments to reconcile net income (loss) to operating
     cash flows:
     Depreciation and amortization..........................       54.8          42.9          42.0
     Goodwill writedown.....................................         --            --         201.8
     FAS 121 impairment.....................................         --            --          63.1
     Loss on disposal of property and equipment.............         --            --           1.8
     Deferred income taxes..................................        3.9          (6.4)         (0.4)
     Increase (decrease) in other long-term assets and
       liabilities..........................................        2.3          (2.8)         (7.6)
     Other -- net...........................................         --            --           1.5
  Cash provided by (used for) current assets and current
     liabilities:
     Increase in inventories................................     (130.4)       (100.0)       (109.7)
     Decrease in property held for resale...................         --            --          (7.0)
     Decrease in restructuring reserve......................         --          (2.1)        (38.0)
     Increase in accounts payable...........................      121.9          45.3          33.6
     Increase in taxes payable..............................       12.0          44.2           7.6
     Other -- net...........................................        2.3          22.0          34.1
                                                                -------       -------       -------
     Net cash provided by operations........................      147.0         101.0          11.7
                                                                -------       -------       -------
Investing
  Capital expenditures......................................     (113.6)        (97.2)       (116.0)
  Proceeds from sale of property and equipment..............         --           4.7          34.2
  Acquisitions..............................................      (61.4)           --            --
  Other.....................................................         --          (0.4)           --
                                                                -------       -------       -------
     Net cash used for investing............................     (175.0)        (92.9)        (81.8)
                                                                -------       -------       -------
Financing
  Repayment of long-term debt and capital lease
     obligations............................................       (0.9)         (2.0)         (7.2)
  Proceeds from sale of put options.........................         --           4.5            --
  Repurchase of put option..................................       (0.8)           --            --
  Proceeds (advances) for construction funding..............        6.8          19.8          (9.6)
  Proceeds from initial public offering.....................         --            --         248.0
  Repayments to Kmart.......................................         --            --        (360.0)
  Net funding from credit facility..........................       85.8         (30.0)         60.0
  Issuance of common stock..................................       21.4           5.7          11.1
  Purchase of shares held by Kmart..........................         --            --         (72.7)
  Repurchase of common stock................................      (61.8)           --            --
                                                                -------       -------       -------
     Net cash provided by (used for) financing..............       50.5          (2.0)       (130.4)
                                                                -------       -------       -------
Net Increase (decrease) in Cash and Equivalents.............       22.5           6.1        (200.5)
Cash and equivalents at beginning of year...................       42.6          36.5         237.0
                                                                -------       -------       -------
Cash and Equivalents at End of Year.........................    $  65.1       $  42.6       $  36.5
                                                                =======       =======       =======
Supplemental Cash Flow Disclosures:
  Interest paid.............................................    $   9.8       $   9.8       $   3.9
  Income taxes paid.........................................    $  40.0       $   5.9       $  13.7
  Common stock issued for business acquisition..............    $   6.5            --            --
  Debt and liabilities assumed in business acquisition......    $  26.9            --            --
</TABLE>
 
          See accompanying Notes to Consolidated Financial Statements.
 
                                       21
<PAGE>   23
 
                              BORDERS GROUP, INC.
 
                CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
 
<TABLE>
<CAPTION>
                                                                DEFERRED                     RETAINED
                                           COMMON STOCK       COMPENSATION   CUMULATIVE      EARNINGS
                                       --------------------   AND OFFICER    TRANSLATION   (ACCUMULATED
                                         SHARES      AMOUNT   RECEIVABLES    ADJUSTMENT      DEFICIT)      TOTAL
                                         ------      ------   ------------   -----------   ------------    -----
                                                       (DOLLARS IN MILLIONS EXCEPT SHARE AMOUNTS)
<S>                                    <C>           <C>      <C>            <C>           <C>            <C>
Balance at January 22, 1995..........   57,519,138   $708.7      $  --          $  --        $  17.6      $ 726.3
                                       -----------   ------      -----          -----        -------      -------
Conversion of mandatorily redeemable
  Series A Preferred stock...........      846,660     5.6          --             --             --          5.6
Dividends accrued on mandatorily
  redeemable Series A Preferred
  Stock..............................           --      --          --             --           (0.3)        (0.3)
Net loss.............................           --      --          --             --         (211.1)      (211.1)
Purchase of stock held by Kmart......  (10,771,460)  (72.7)         --             --             --        (72.7)
Shares sold by the Company in the
  Offering (Note 2)..................   25,062,322      --          --             --             --           --
Issuance of Common Stock.............    2,661,324    14.5        (3.4)            --             --         11.1
Conversion of SAR's to options.......           --    13.1          --             --             --         13.1
                                       -----------   ------      -----          -----        -------      -------
Balance at January 28, 1996..........   75,317,984   $669.2      $(3.4)         $  --        $(193.8)     $ 472.0
                                       -----------   ------      -----          -----        -------      -------
Net income...........................           --      --          --             --           57.9         57.9
Issuance of common stock.............      540,032     5.8          --             --             --          5.8
Tax benefit of equity compensation...           --     2.7          --             --             --          2.7
Issuance of put options:
  Receipt of premium.................           --     4.5          --             --             --          4.5
  Shares subject to repurchase.......           --   (34.1)         --             --             --        (34.1)
Change in receivables and deferred
  compensation.......................           --      --         2.6             --             --          2.6
                                       -----------   ------      -----          -----        -------      -------
Balance at January 26, 1997..........   75,858,016   $648.1      $(0.8)         $  --        $(135.9)     $ 511.4
                                       -----------   ------      -----          -----        -------      -------
Net income...........................           --      --          --             --           80.2         80.2
Issuance of Common Stock.............    1,916,844    29.4        (5.5)            --             --         23.9
Repurchase and retirement of Common
  Stock..............................   (2,518,800)  (61.8)         --             --             --        (61.8)
Tax benefit of equity compensation...           --     5.5          --             --             --          5.5
Cancellation of put options:
  Payment of premium.................           --    (0.8)         --             --             --         (0.8)
  Shares subject to repurchase.......           --    34.1          --             --             --         34.1
Acquisition..........................      139,938     6.5          --             --             --          6.5
Currency translation adjustment......           --      --          --           (0.9)            --         (0.9)
                                       -----------   ------      -----          -----        -------      -------
Balance at January 25, 1998..........   75,395,998   $661.0      $(6.3)         $(0.9)       $ (55.7)     $ 598.1
                                       ===========   ======      =====          =====        =======      =======
</TABLE>
 
          See accompanying Notes to Consolidated Financial Statements.
 
                                       22
<PAGE>   24
 
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
               (DOLLARS IN MILLIONS EXCEPT PER COMMON SHARE DATA)
 
NOTE 1 -- SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
 
     Nature of Business: Borders Group, Inc. (the Company), through its
subsidiaries, operates book and music superstores, mall-based bookstores and
other bookstores in the United States, United Kingdom and Singapore. The Company
owns all of the outstanding stock of Borders, Inc. (Borders), Walden Book
Company, Inc. (Walden) and Books etc.
 
     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 generally accepted accounting principles 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 1997 and fiscal 1996 consisted
of 52 weeks and ended on January 25, 1998 and January 26, 1997, respectively.
Fiscal 1995 consisted of 53 weeks and ended on January 28, 1996.
 
     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.
 
     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 over the term of the lease, generally over 5 to
20 years. Other annual rates used in computing depreciation for financial
statement purposes are 2% to 3% for buildings and 10% to 20% for other fixtures
and equipment. Amortization of assets under capital lease is included in
depreciation expense.
 
     Expenditures for properties, primarily self-developed locations which the
Company intends to sell and lease back within one year, are included in property
held for resale.
 
     Goodwill: Goodwill is amortized over 40 years on a straight-line basis. The
Company evaluates the recoverability of goodwill using a fair value methodology
on a quarterly basis. See Note 5-Accounting for Goodwill.
 
     Financial Instruments: The recorded values of the Company's financial
instruments, which include accounts receivable and accounts payable, approximate
their fair values.
 
     Pre-Opening and Closing Costs: Costs associated with the opening of a new
store are expensed during the first full fiscal month of the store's operations.
When the decision to close a store is made, the Company provides for the future
net lease obligation, nonrecoverable investment in fixed assets and other
expenses directly related to discontinuance of operations.
 
     Preferred Reader Program: Walden sells memberships in its Preferred Reader
Program, which offers members discounts on purchases and other benefits.
Membership fees are deferred and recognized over the 12-month membership period.
 
     Equity-Based Compensation: The Company accounts for equity-based
compensation under the guidance of APB No. 25. See Note 13 for discussion of the
pro forma net income calculated under FAS No. 123.
 
                                       23
<PAGE>   25
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
         (DOLLARS IN MILLIONS EXCEPT PER COMMON SHARE DATA) (CONTINUED)
 
     Reclassifications: Certain prior year amounts have been reclassified to
conform to fiscal 1997 presentation.
 
NOTE 2 -- INITIAL PUBLIC OFFERING OF COMMON STOCK
 
     The Company was formed in August 1994 as a wholly-owned subsidiary of Kmart
Corporation. On June 1, 1995, the Company sold 25,062,322 shares of common stock
in an initial public offering of common stock (the Offering), the net proceeds
of which were paid to Kmart. In addition, as part of the Offering, Kmart sold
46,747,678 shares of common stock it previously owned, thereby reducing its
interest in the Company to 13%. The Company did not receive any proceeds from
the sale of common stock by Kmart. On August 15, 1995, the Company completed a
transaction to purchase and retire the remaining 10,771,460 shares of common
stock owned by Kmart at a price of $6.75 per share.
 
NOTE 3 -- WEIGHTED AVERAGE SHARES OUTSTANDING
 
     The Company has adopted the provisions of Statement of Financial Accounting
Standards No. 128, "Earnings Per Share." All prior-period earnings per share
data presented has been restated in accordance with SFAS 128. Weighted average
shares outstanding are calculated as follows (thousands):
 
<TABLE>
<CAPTION>
                                                         1997     1996     1995
                                                         ----     ----     ----
<S>                                                     <C>      <C>      <C>
Weighted-average common shares outstanding -- basic
  earnings per share..................................  75,825   75,575   71,707
Dilutive effect of employee stock options.............   6,416    6,979       --
                                                        ------   ------   ------
Weighted-average common shares outstanding -- diluted
  earnings per share..................................  82,241   82,554   71,707
                                                        ======   ======   ======
</TABLE>
 
     Due to the Company's loss from continuing operations for the year ended
January 28, 1996, a calculation of earnings (loss) per common share assuming
dilution is not required. Unexercised employee stock options to purchase 14.7
million common shares as of January 28, 1996 were not included in the weighted
average shares outstanding calculation because to do so would have been
antidilutive.
 
NOTE 4 -- ACQUISITION
 
     Effective October 20, 1997 the Company purchased 100% of the outstanding
stock of Books etc., a London-based retailer of books and associated products
for a purchase price of $71.1, allocated to primarily fixed assets, inventory
and goodwill of $64.1. Books etc. currently operates 23 stores in the United
Kingdom. The acquisition has been accounted for as a purchase. This transaction
did not have a material impact on earnings in 1997.
 
NOTE 5 -- ACCOUNTING FOR GOODWILL
 
     Prior to completion of the Offering, the Company, as a subsidiary of Kmart,
followed the accounting policies established by Kmart for its consolidated group
and, accordingly, evaluated the overall recoverability of goodwill using
projected undiscounted cash flows. At April 23, 1995, such goodwill aggregated
$257.6, net of accumulated amortization of $38.6.
 
     The sale of common stock in the Offering generated net proceeds that were
less than the historical book value of the Company, resulting in Kmart taking a
write-off of its investment in the Company in the amount of $185.0. Subsequent
trading activity in the Company's common stock immediately after the Offering
did not result in any meaningful appreciation in value. As a result, the Company
reevaluated its accounting policy regarding goodwill impairment and adopted a
new policy for recognition and measurement of goodwill impairment based on a
fair value approach. The Company believes fair value is a preferable method to
assess
 
                                       24
<PAGE>   26
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
         (DOLLARS IN MILLIONS EXCEPT PER COMMON SHARE DATA) (CONTINUED)
 
goodwill as it believes that the value at which the individual businesses could
be bought and sold in an arms length transaction between a willing buyer and
seller is the most objective evidence and, therefore, the most relevant measure
of their value. This change in the method of evaluating the recoverability of
goodwill resulted in the recording of a pre-tax charge to operations of $182.0
in the second quarter of 1995. During the fourth quarter of 1995, the Company
took an additional charge of $19.8 for Walden. The charges aggregated $132.2 for
Borders, $16.2 for Planet Music and $53.4 for Walden. The charges for Walden and
Planet Music represented all existing goodwill relating to those businesses.
 
     The Company's fair value methodology is applied to each of its businesses
on a separate basis. In determining the fair value for a high growth retail
business, the median price/earnings (P/E) multiple for similar growth retail
companies is calculated based upon actual quoted market prices per share and
analysts' consensus earnings estimates for these growth companies. This P/E
multiple is applied to management's best estimates of the respective earnings
for Borders and Books etc. to arrive at an overall fair value of the respective
companies. The Company will continue to utilize the same basket of high-growth
retailers in order to determine this multiple for Borders and Books etc.
provided that there are no significant changes in the underlying characteristics
of such companies. With respect to Walden, given its retail market maturity, a
median earnings before depreciation and amortization, interest and taxes
(EBITDA) multiple for mature companies was applied to management's best estimate
of EBITDA to arrive at an overall fair value. Further, the calculation used by
the Company is net of transaction costs, which are estimated at 5.5% and consist
of assumed underwriting and other costs. In addition, when evaluating the need
to record a goodwill impairment, the Company will evaluate whether there have
been any temporary or permanent impairments, and will record appropriate charges
(if any) to operations for permanent impairments in fair value. The Company will
evaluate Borders and Books etc. for impairment every quarter, based on the above
methodology. Since all goodwill related to the Walden and Planet Music
businesses has been written-off, no further evaluations for impairment will be
necessary. No write-downs of goodwill were required in 1997 or 1996.
 
NOTE 6 -- FAS NO. 121 -- ACCOUNTING FOR IMPAIRMENT OF LONG-LIVED ASSETS AND FOR
          LONG-LIVED ASSETS TO BE DISPOSED OF (FAS 121)
 
     The Company adopted FAS 121, effective as of the fourth quarter of 1995.
The carrying value of long-lived assets and certain identifiable intangible
assets are 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 and identifiable intangibles. 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
their estimated fair value. Fair value is estimated using expected discounted
future cash flows. If an asset being tested for recoverability was acquired in a
business combination accounted for using the purchase method, the goodwill that
arose in that transaction is allocated to the assets being tested for
recoverability. This change resulted in a pre-tax charge of $63.1 to operations
in the fourth quarter of 1995. The charge consisted of $42.1 for leasehold
improvements and furniture and fixtures of Walden stores, $14.5 for goodwill
relating to such stores and $6.5 for leasehold improvements and furniture and
fixtures of Planet Music. The impairment relating to Walden resulted principally
from declining mall traffic and increasing superstore competition. Planet Music
also faces intense competition from superstores resulting in declining gross
margins. No writedowns of long-lived assets were required in 1997 or 1996.
 
                                       25
<PAGE>   27
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
         (DOLLARS IN MILLIONS EXCEPT PER COMMON SHARE DATA) (CONTINUED)
 
NOTE 7 -- PROPERTY AND EQUIPMENT
 
     Property and equipment consists of the following:
 
<TABLE>
<CAPTION>
                                                              1997      1996
                                                              ----      ----
<S>                                                          <C>       <C>
Property and equipment:
  Land.....................................................  $  10.2   $    --
  Buildings................................................      5.7        --
  Leasehold improvements...................................    214.4     179.1
  Furniture and fixtures...................................    404.3     342.6
  Construction in progress.................................     20.6       2.6
                                                             -------   -------
                                                               655.2     524.3
Less -- accumulated depreciation and amortization..........   (281.5)   (235.1)
                                                             -------   -------
Property and equipment, net................................  $ 373.7   $(289.2)
                                                             =======   =======
</TABLE>
 
NOTE 8 -- INCOME TAXES
 
     The income tax provision consists of:
 
<TABLE>
<CAPTION>
                                                       1997        1996         1995
                                                       ----        ----         ----
<S>                                                    <C>         <C>         <C>
Current:
  Federal..........................................    $42.7       $39.5       $  7.5
  State and local..................................      4.3         4.9          0.3
  Foreign..........................................      0.4          --           --
Deferred:
  Restructuring reserve............................      0.6         2.1         17.6
  FAS 121 impairment...............................      2.7         4.4        (17.0)
  Deferred compensation............................     (2.5)       (1.0)        (0.5)
  Differences in book and tax depreciation.........      5.1         1.9          3.4
  Inventory valuation differences..................     (2.3)       (4.1)        (3.6)
  Other............................................     (0.4)       (9.5)        (1.6)
                                                       -----       -----       ------
  Total income tax provision.......................    $50.6       $38.2       $  6.1
                                                       =====       =====       ======
</TABLE>
 
     A reconciliation of the federal statutory rate to the Company's effective
tax rate follows:
 
<TABLE>
<CAPTION>
                                                       1997        1996         1995
                                                       ----        ----         ----
<S>                                                    <C>         <C>         <C>
Federal statutory rate.............................    $45.8       $33.3       $(71.8)
State and local taxes, net of federal tax
  benefit..........................................      3.5         3.0          0.5
Goodwill amortization..............................      0.4         0.4          1.3
Goodwill writedowns................................       --          --         75.6
Other..............................................      0.9         1.5          0.5
                                                       -----       -----       ------
Total income tax provision.........................    $50.6       $38.2       $  6.1
                                                       =====       =====       ======
</TABLE>
 
                                       26
<PAGE>   28
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
         (DOLLARS IN MILLIONS EXCEPT PER COMMON SHARE DATA) (CONTINUED)
 
     Deferred tax assets and liabilities resulted from the following:
 
<TABLE>
<CAPTION>
                                                                JANUARY 25,       JANUARY 26,
                                                                   1998              1997
                                                                -----------       -----------
<S>                                                             <C>               <C>
Deferred tax assets:
  Federal benefit for state deferred taxes..................       $ 2.0             $ 2.6
  Accruals and other current liabilities....................        13.9              16.4
  Restructuring reserve.....................................         1.1               1.7
  Deferred revenue..........................................         7.0               6.8
  Other long-term liabilities...............................         2.0               2.6
  Deferred compensation.....................................         8.9               6.4
  Deferred rent.............................................        14.2              10.7
  FAS 121 impairment........................................         9.9              12.6
                                                                   -----             -----
  Total deferred tax assets.................................        59.0              59.8
                                                                   -----             -----
Deferred tax liabilities:
  Inventory.................................................         9.2              11.5
  Property and equipment....................................        19.4              14.3
  Other.....................................................         3.8               1.4
                                                                   -----             -----
  Total deferred tax liabilities............................        32.4              27.2
                                                                   -----             -----
Net deferred tax assets.....................................       $26.6             $32.6
                                                                   =====             =====
</TABLE>
 
NOTE 9 -- COMMITMENTS AND CONTINGENCIES
 
     There are various claims, lawsuits and actions pending against the Company
and its subsidiaries that are incident to their operations. It is the opinion of
management that the ultimate resolution of these matters will not have a
material effect on the Company's liquidity, financial position or results of
operations.
 
     During 1994, the Company entered into agreements in which leases with
respect to four Borders' locations serve as collateral for certain mortgage
pass-thru certificates. These mortgage pass-thru certificates include a
provision requiring the Company to repurchase the underlying mortgage notes in
certain events, including the failure by the Company to make payments of rent
under the related leases, the failure by Kmart to maintain required investment
grade ratings or the termination of the guarantee by Kmart of the Company's
obligations under the related leases (which would require the mutual consent of
Kmart and Borders). In the event the Company is required to repurchase all of
the underlying mortgage notes, the Company would be obligated to pay
approximately $36.6. Since February 1995, Kmart has failed to maintain
investment grade ratings and, therefore, these notes are now subject to put by
the holder. To date, the holder has not exercised its rights to put the notes.
 
     During December 1996, the Company sold two million put options on the
Company's common stock which had exercise prices of $16.75-$17.25 per share and
expired on various dates between March 16, 1998 and April 15, 1998. The Company
received proceeds of $4.5 million upon sale of the puts. The put options gave
the holder the right to, at the Company's option, a net cash settlement or share
repurchase. The total cash settlement that would have been required if the
options were put would have been $34.1, resulting in an effective repurchase
price, net of put proceeds of $14.82 per share. The $34.1 was reclassified to
shares subject to repurchase on the consolidated balance sheet in 1996. During
1997, all two million put options were repurchased from the holders for $0.8.
 
     In November 1997, the Company entered into two interest rate swaps with a
total notional amount of $66.9, which effectively converted variable rate
foreign currency-denominated borrowings to fixed rates of 7.2% and 7.1%. These
swap agreements expire within 3 and 5 years of the date the Company entered into
the agreements.
 
                                       27
<PAGE>   29
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
         (DOLLARS IN MILLIONS EXCEPT PER COMMON SHARE DATA) (CONTINUED)
 
     In January 1998, the Company entered into a treasury rate lock with a total
notional amount of $50.0 at a rate of 5.5%. This agreement expires within seven
months of the date the Company entered into the agreement.
 
NOTE 10 -- DEBT
 
     In October 1997, the Company entered into a multicurrency credit agreement
which provides a $425.0, five-year working capital facility. Borrowings under
the credit facility bear interest at a base rate or an increment over LIBOR at
the Company's option. The credit agreement contains operating covenants which
limit the Company's ability to incur indebtedness, make acquisitions, dispose of
assets and issue or repurchase its common stock in excess of $100 million (plus
any proceeds and tax benefits resulting from stock option exercises), pay
dividends on its common stock, and require the Company to meet certain financial
measures regarding fixed charge coverage, leverage and tangible net worth. This
agreement replaced the Company's previous $300.0 credit facility. The Company
had borrowings outstanding under the credit facility of $122.5 at January 25,
1998 and $30.0 at January 26, 1997. The weighted average interest rate in 1997
and 1996 was approximately 6.3% and 6.0%, respectively.
 
     The Company's long-term debt obligations consist of capital lease
liabilities at January 25, 1998. Scheduled principal payments and capitalized
lease obligations as of January 25, 1998 are as follows: 1998 -- $4.8; 1999 --
$0.3; 2000 -- $0.3; 2001 -- $0.3; 2002 -- $0.3; 2003 and, thereafter, -- $4.0.
 
NOTE 11 -- LEASES
 
     Operating Leases: The Company conducts operations primarily in leased
facilities. Store leases are generally for terms of 5 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. Walden's 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 25, 1998 total $208.4 in 1998, $201.1 in 1999, $192.3 in 2000, $187.5 in
2001, $172.0 in 2002, $1,223.4 in all later years and, in the aggregate, total
$2,184.7.
 
     Rental Expenses: A summary of operating lease rental expense and short-term
rentals follows:
 
<TABLE>
<CAPTION>
                                                         1997     1996     1995
                                                         ----     ----     ----
<S>                                                     <C>      <C>      <C>
Rental Expenses:
  Minimum rentals.....................................  $190.3   $163.8   $138.7
  Percentage rentals..................................     2.7      3.3      5.1
                                                        ------   ------   ------
     Total............................................  $193.0   $167.1   $143.8
                                                        ======   ======   ======
</TABLE>
 
     Capitalized Leases: The Company accounts for one store and certain computer
equipment under capital leases. At January 25, 1998, the Company's commitments
under leases accounted for as capital leases aggregated $5.5.
 
     Lease Financing Facility: In October 1997, the Company entered into a
five-year, $250.0 lease financing facility to finance new stores and other
property through loans from a third party lender for up to 95% of a project
cost. It is expected that lessors will make equity contributions approximating
5% of each project. Independent of its obligations as lessee, the Company will
guarantee payment when due of all amounts required to be paid to the third party
lender. The principal amount guaranteed will be 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
 
                                       28
<PAGE>   30
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
         (DOLLARS IN MILLIONS EXCEPT PER COMMON SHARE DATA) (CONTINUED)
 
project. This agreement replaced the Company's previous $150.0 lease financing
facility. There was $157.9 and $102.6 outstanding under the lease facility at
January 25, 1998 and January 26, 1997, respectively.
 
NOTE 12 -- EMPLOYEE BENEFIT PLANS
 
     Employee Savings Plan: Employees of Borders 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 $2.5, $2.8 and $2.3 for 1997,
1996 and 1995, respectively.
 
NOTE 13 -- STOCK-BASED BENEFIT PLANS
 
     Stock Option Plan: In February 1995, the Company adopted the 1995 Stock
Option Plan (the 1995 Plan) pursuant to which the Company may grant options to
purchase its common stock. With the exception of certain option grants described
below, the exercise price of options granted under the 1995 Plan 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. At January 25, 1998, the Company
has 29.6 million shares authorized for the grant of stock options under the 1995
Plan.
 
     The Company has established a compensation philosophy that is designed to
foster a performance-oriented, entrepreneurially-led ownership culture. The 1995
Plan is an integral part of the Company's employee ownership culture and
compensation program. Options have been granted under the 1995 Plan to all
full-time employees of the Company and its subsidiaries with 30 days or more of
service, consisting of approximately 14,000 employees. The Company's executive
compensation is heavily oriented toward equity incentives that includes a
combination of stock and options which require at least some annual
out-of-pocket investment in the business on the part of management. Restrictions
on the equity incentives promote a long-term focus on the part of management and
maximize retention of personnel. Management believes the equity incentives have
been integral to its success in meeting operating objectives and reducing
employee turnover since the Offering.
 
     In February 1995, the Company granted to certain senior management
personnel options to purchase 4,866,867 restricted shares of common stock under
the 1995 Plan (the Restricted Options). The exercise price of these options was
generally $6.00 per share, representing a discount from fair value at date of
grant. Such options were exercisable only at the time of the Offering. Options
were exercised to purchase 1,974,000 shares of restricted stock in 1995.
Restricted shares of common stock purchased upon exercise of the Restricted
Options are restricted from sale or transfer for three years from the date the
options were exercised. The remaining options not exercised were forfeited.
 
     The Company is recognizing compensation expense for the difference between
the exercise price and the fair value per share at grant date of the Restricted
Options. Such expense will be recognized over the three-year vesting period.
 
     Stock Purchase Plans: In connection with the Offering, the Company adopted
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% discount from the fair value of the same number of
unrestricted shares of common stock. Restricted shares of common stock purchased
under the Management Plan will generally be restricted from sale or transfer for
three 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.
 
                                       29
<PAGE>   31
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
         (DOLLARS IN MILLIONS EXCEPT PER COMMON SHARE DATA) (CONTINUED)
 
     The Company will recognize compensation expense for the discount on
restricted shares of common stock purchased under the Management Plan. Such
discount will be recognized as expense on a straight-line basis over the
three-year period during which the shares are restricted from sale or transfer.
Compensation expense under the Management Plan aggregated $1.2 in 1997, $0.4 in
1996 and $0.2 in 1995. The Company is not required to record compensation
expense with respect to shares purchased under the Employee Plan.
 
     Stock Appreciation Rights: In connection with its acquisition by Kmart,
Borders established a stock appreciation rights (SARs) plan covering all
employees at that date. Under the SARs plan, employees were entitled to receive
a cash payment per share equal to the excess of the fair value of a Borders'
share over the base price defined in the plan. In connection with the Offering,
substantially all remaining SARs were converted to options on the Company's
common stock.
 
     A summary of the information relative to the Company's stock option plans
follows (number of shares in thousands):
 
<TABLE>
<CAPTION>
                                                                              WEIGHTED
                                                               NUMBER         AVERAGE
                                                              OF SHARES    EXERCISE PRICE
                                                              ---------    --------------
<S>                                                           <C>          <C>
STOCK OPTIONS
Outstanding at January 22, 1995.............................       --              --
  Granted...................................................   20,087          $ 6.92
  Exercised.................................................    1,985            5.91
  Forfeited.................................................    3,398            6.09
Outstanding at January 28, 1996.............................   14,704            7.25
  Granted...................................................    3,361           16.00
  Exercised.................................................      297            5.44
  Forfeited.................................................    1,581            9.19
Outstanding at January 26, 1997.............................   16,187            8.92
  Granted...................................................    8,304           27.99
  Exercised.................................................    1,800            3.43
  Forfeited.................................................    1,394           12.63
Outstanding at January 25, 1998.............................   21,297           16.58
  Exercisable at:
  January 28, 1996..........................................       --              --
  January 26, 1997..........................................    2,278            2.70
  January 25, 1998..........................................    2,791            9.51
</TABLE>
 
     Certain options granted by the Company upon conversions of existing SARs at
the time of the IPO were granted with exercise prices less than market value at
the date of the grant. The weighted average exercise price and weighted average
grant date fair value were $5.02 and $9.35, respectively for such grants. The
weighted average fair values of options at their grant date where the exercise
price equals the market price on the grant date were $12.27, $7.33 and $2.87 in
1997, 1996, and 1995 respectively.
 
     As permitted, the Company has adopted the disclosure-only option of
Financial Accounting Standards Board Statement No. 123, "Accounting for Stock
Based Compensation" (FAS 123). The pro forma net income (loss) had the Company
adopted the fair-value accounting provisions of FAS 123 would have been $69.0,
$50.8 and $(220.6) in 1997, 1996, and 1995 respectively. Pro forma diluted and
basic earnings per share would have been $0.84, $0.62 and $(3.08) and $0.91,
$.67, and $(3.08) in 1997, 1996 and 1995 respectively.
 
                                       30
<PAGE>   32
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
         (DOLLARS IN MILLIONS EXCEPT PER COMMON SHARE DATA) (CONTINUED)
 
     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:
 
<TABLE>
<CAPTION>
                                                             1997            1996            1995
                                                             ----            ----            ----
<S>                                                       <C>             <C>             <C>
Risk-Free Interest Rate.................................     5.5-6.8%        5.5-6.5%        5.0-7.4%
Expected Life...........................................  2-10 years      2-10 years      2-10 years
Expected Volatility.....................................   33.3-39.0%      33.3-40.0%      33.3-40.0%
Expected Dividends......................................           0%              0%              0%
</TABLE>
 
     The following table summarizes the information regarding stock options
outstanding at January 25, 1998 (number of shares in thousands):
 
<TABLE>
<CAPTION>
                                      OUTSTANDING                             EXERCISABLE
                    -----------------------------------------------   ----------------------------
     RANGE OF        NUMBER     WEIGHTED AVERAGE   WEIGHTED AVERAGE    NUMBER     WEIGHTED AVERAGE
  EXERCISE PRICES   OF SHARES    REMAINING LIFE     EXERCISE PRICE    OF SHARES    EXERCISE PRICE
  ---------------   ---------   ----------------   ----------------   ---------   ----------------
  <S>               <C>         <C>                <C>                <C>         <C>
   $ 3.06-$ 4.64        899           2.2               $ 3.98           899           $ 3.98
   $ 6.86-$11.57      9,935           5.6                 8.26           999             7.64
   $14.25-$17.81      2,433           5.9                16.67           893            17.16
   $18.63-$27.50      1,879           6.8                22.97            --               --
   $28.56-$31.31      6,151           9.4                29.87            --               --
</TABLE>
 
     A summary of the information relative to the Company's stock purchase plans
follows (number of shares in thousands):
 
<TABLE>
<CAPTION>
                                                       NUMBER      WEIGHTED AVERAGE    WEIGHTED AVERAGE
                                                      OF SHARES     PURCHASE PRICE     AT GRANT DATE FMV
                                                      ---------    ----------------    -----------------
<S>                                                   <C>          <C>                 <C>
STOCK ISSUED UNDER STOCK PURCHASE PLANS
Management Plan
  1995..............................................      93            $ 7.13              $ 8.91
  1996..............................................      48              9.33               11.67
  1997..............................................     923             18.09               22.62
Employee Plan
  1995..............................................     494              6.43                7.56
  1996..............................................     196             14.00               16.48
  1997..............................................     157             20.06               23.60
</TABLE>
 
NOTE 14 -- SUBSEQUENT EVENT (UNAUDITED)
 
     In March 1998, the American Booksellers Association ("ABA") and twenty-six
independent bookstores have 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 Law. The Complaint seeks
injunctive and declaratory relief; treble damages on behalf of each of the
bookstore plaintiffs, and, with respect to the California bookstore plaintiffs,
any other damages permitted by California law; disgorgement of money, property
and gains wrongfully obtained in connection with the purchase of books for
resale, or offered for resale, in California from March 18,1994 until the action
is completed and prejudgement interest on any amounts awarded in the action, as
well as attorney fees and costs. The Company intends to vigorously defend the
action.
 
                                       31
<PAGE>   33
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
         (DOLLARS IN MILLIONS EXCEPT PER COMMON SHARE DATA) (CONTINUED)
 
NOTE 15 -- UNAUDITED QUARTERLY FINANCIAL DATA
 
<TABLE>
<CAPTION>
                                                                      FISCAL 1997 QUARTER ENDED
                                                                --------------------------------------
                                                                APRIL      JULY     OCTOBER    JANUARY
                                                                -----      ----     -------    -------
                                                                     (DOLLARS IN MILLIONS EXCEPT
                                                                          PER SHARE AMOUNTS)
<S>                                                             <C>       <C>       <C>        <C>
SALES.......................................................    $463.6    $466.3    $477.3     $858.8
Cost of merchandise sold (includes occupancy)...............     350.8     351.1     355.1      577.3
Operating Income............................................       1.8       2.3       2.2      131.7
Net Income..................................................       0.4       0.5       0.4       78.9
Basic earnings per common share.............................      0.01      0.01      0.01       1.05
Diluted earnings per common share...........................      0.00      0.01      0.00       0.96
</TABLE>
 
<TABLE>
<CAPTION>
                                                                      FISCAL 1996 QUARTER ENDED
                                                                --------------------------------------
                                                                APRIL      JULY     OCTOBER    JANUARY
                                                                -----      ----     -------    -------
<S>                                                             <C>       <C>       <C>        <C>
SALES.......................................................    $404.0    $414.3    $413.5     $727.0
Cost of merchandise sold (includes occupancy)...............     310.8     316.4     314.3      496.3
Operating Income (loss).....................................      (3.7)     (2.0)     (2.9)     111.7
Net Income (loss)...........................................      (3.4)     (2.2)     (2.7)      66.2
Basic earnings (loss) per common share......................     (0.05)    (0.03)    (0.04)      0.88
Diluted earnings (loss) per common share....................     (0.05)    (0.03)    (0.04)      0.82
</TABLE>
 
     Earnings per share amounts for each quarter are required to be computed
independently and may not equal the amount computed for the total year.
 
                                       32
<PAGE>   34
 
                       REPORT OF INDEPENDENT ACCOUNTANTS
 
To the Stockholders and Board of Directors
of Borders Group, Inc.
 
     In our opinion, the accompanying consolidated balance sheets and the
related consolidated statements of operations, of cash flows and of
stockholders' equity present fairly, in all material respects, the financial
position of Borders Group, Inc. and its subsidiaries at January 25, 1998 and
January 26, 1997, and the results of their operations and their cash flows for
each of the three years in the period ended January 25, 1998, in conformity with
generally accepted accounting principles. 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 of these statements in accordance with generally accepted auditing
standards which 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, assessing the
accounting principles used and significant estimates made by management, and
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for the opinion expressed above.
 
     As discussed in Note 5 and Note 6 to the consolidated financial statements,
the Company changed its accounting for goodwill impairment and adopted Statement
of Financial Accounting Standards No. 121, "Accounting for the Impairment of
Long-Lived Assets and for Long-Lived Assets to Be Disposed Of," in 1995.
 
PRICE WATERHOUSE LLP
 
Bloomfield Hills, Michigan
March 9, 1998
 
                                       33
<PAGE>   35
 
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
 
     Not Applicable.
 
                                       34
<PAGE>   36
 
                                    PART III
 
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
 
     Set forth below is certain information regarding the directors and
executive officers of the Company:
 
<TABLE>
<CAPTION>
             NAME                AGE                            POSITION
             ----                ---                            --------
<S>                              <C>   <C>
Robert F. DiRomualdo...........  53    Chairman, Chief Executive Officer and Director

George R. Mrkonic..............  45    Vice Chairman and Director

Bruce A. Quinnell..............  48    President and Chief Operating Officer

Vincent E. Altruda.............  48    President, International

Thomas D. Carney...............  51    Vice President, General Counsel and Secretary

Richard L. Flanagan............  45    President, Borders Store Operations

Timothy J. Hopkins.............  44    President, Borders Group, Inc. Merchandising, Marketing
                                       and Distribution

Richard D. Joseph..............  41    Chairman and Chief Executive Officer, Books etc. Ltd.

Kenneth E. Scheve..............  51    Senior Vice President and Chief Financial Officer

Ronald S. Staffieri............  48    Chief Administrative Officer

Cedric J. Vanzura..............  34    Senior Vice President, Electronic Commerce and Fulfillment
                                       Services

Kathryn L. Winkelhaus..........  42    President, Walden Store Operations

Peter R. Formanek..............  54    Director

Amy B. Lane....................  45    Director

Victor L. Lund.................  50    Director

Larry Pollock..................  50    Director

Leonard A. Schlesinger.........  45    Director
</TABLE>
 
     The Company's Certificate provides, among other things, that Directors will
be elected annually for one year terms. Directors hold office until their
successors are elected and qualified.
 
     Robert F. DiRomualdo has served as the Chairman and Chief Executive Officer
and a Director of the Company since its formation in August 1994. Prior to the
formation of the Company, Mr. DiRomualdo was President and Chief Executive
Officer of Borders from January 1989 to February 1994. From February 1994 to
August 1994, Mr. DiRomualdo was responsible for overall operations at Borders
and Walden.
 
     George R. Mrkonic has served as the Vice Chairman of the Company since
December 1994, and a Director since its formation in August 1994. He has also
served as President of the Company from December 1994 until January 1997. Prior
to joining the Company, Mr. Mrkonic served as Executive Vice President,
Specialty Retailing Group of Kmart Corporation, where he had overall
responsibility for the specialty retailing operations of Kmart including, among
others, Borders and Walden, from November 1990 to November 1994. Mr. Mrkonic is
also a director of Champion Enterprises, Inc., a manufacturer and seller of
manufactured homes and mid-sized buses and Syntel, Inc., a computer software and
development company.
 
     Bruce A. Quinnell has served as President and Chief Operating Officer of
the Company since February 1997. Mr. Quinnell served as President and Chief
Operating Officer of Walden from November 1994 to February 1997. From January
1994 to November 1994, Mr. Quinnell held the position of Executive Vice
President and Chief Operating Officer of Walden. Prior to joining Walden, Mr.
Quinnell was Executive Vice President, Finance and Administration for PACE
Membership Warehouse, Inc., a former subsidiary of Kmart, from October 1992 to
January 1994. From September 1987 until October 1992, Mr. Quinnell was Chief
Financial Officer of Dollar General Corp., a general merchandise retailer.
 
                                       35
<PAGE>   37
 
     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 Development.
 
     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.
 
     Richard L. Flanagan has served as President of Borders Store Operations
since February 1997. From February 1994 until February 1997, Mr. Flanagan served
as President and Chief Operating Officer of Borders. Prior thereto, Mr. Flanagan
served as Chief Financial Officer of Borders from April 1991 to February 1994.
From 1987 until April 1991, Mr. Flanagan was Vice President and Chief Financial
Officer of Ellwood Group, Inc., a steel manufacturer.
 
     Timothy J. Hopkins has served as Merchandising President of the Company
since February 1997. From 1995 to February 1997, Mr. Hopkins served as Sr. Vice
President, Merchandising and Marketing for Walden. Prior to joining the company,
Mr. Hopkins served as Vice President, International and also Vice President,
Merchandising with QVC Network from 1992 through 1995.
 
     Richard D. Joseph is the Chairman and Chief Executive Officer of Books etc.
and has served in executive positions with Books etc. since he co-founded the
company in 1981.
 
     Kenneth E. Scheve has served as Vice President Finance for Borders Group
Inc. since February 1997. From 1994 through February 1997, Mr. Scheve served as
Vice President, Finance for Walden. Prior to joining the company, Mr. Scheve
served as Director -- Internal Audit, Specialty Retailing Group of Kmart
Corporation from 1991 through 1994.
 
     Ronald S. Staffieri has been Chief Administrative Officer of the Company
since January 1998. From July 1997 to January 1998, Mr. Staffieri served as
President of Borders Outlet. Prior to joining the Company Mr. Staffieri was
President and Chief Executive Officer of Lil' Things, a chain of children's
superstores, from 1994 until January of 1997. From 1990 until 1994, Mr.
Staffieri served as President and Chief Executive Officer of Kaybee Toy Stores,
a division of Melville Corporation, and as a Vice President of Melville
Corporation and a member of its Operating Committee.
 
     In June of 1997, Lil' Things filed a voluntary petition for reorganization
under Chapter 11 of the United States Bankruptcy Code and the business was
liquidated in December of 1997.
 
     Cedric J. Vanzura has been Vice President, Planning and Finance, Treasurer
since August 1996. From November 1994 until August 1996. Mr. Vanzura served as
Vice President, Group Planning and Resource Management. From May 1994 to
November 1994, Mr. Vanzura held the position of Director, Business Development,
Specialty Retail Group of Kmart. Prior to joining Kmart, from 1990 to 1994, Mr.
Vanzura was a Senior Consultant and then a Manager, Management Consulting, at
Deloitte & Touche Management Consulting.
 
     Kathryn L. Winkelhaus has served as President of Walden Store Operations
since February 1997. From 1992 through 1997, Ms. Winkelhaus served as Sr. Vice
President, Store Operations for Walden. Ms. Winkelhaus has held several
positions of increasing levels of responsibility in store operations since
joining the company in 1979.
 
     Peter R. Formanek has served as a director of the Company since August,
1995. Mr. Formanek was co-founder of Autozone Inc., a retailer of aftermarket
automotive parts, and served as President and Chief Operating Officer of
Autozone, Inc. from 1986 until his retirement in May, 1994. He currently is a
director of The Perrigo Company, a manufacturer of store brand over-the-counter
drug and personal care products and vitamins.
 
                                       36
<PAGE>   38
 
     Amy B. Lane has served as a director of the Company since August, 1995. In
January 1997, Ms. Lane became Managing Director, Investment Banking Group, of
Merrill Lynch. From 1989 through 1996, she served as a Managing Director,
Corporate Finance, of Salomon Brothers Inc., including service as Co-Head of
Salomon Brothers Investment Banking Group covering the retail industry.
 
     Victor L. Lund has served as a director of the Company since July, 1997.
Mr. Lund has served as Chairman of the Board of American Stores Company, a food
and drug retailer, since June 1995 and as its Chief Executive Officer since
August 1992. He was President of American Stores Company from August 1992 until
June 1995. Mr. Lund also serves as a director of American Stores Company.
 
     Larry Pollock has served as a director of the Company since August, 1995.
Mr. Pollock became Executive Vice President and Chief Operating Officer of
HomePlace, Inc., a chain of home furnishings and housewares superstores, in
January of 1997 and was elected President of HomePlace, Inc. in October of 1997.
From 1994 until 1996, he served as the President, Chief Operating Officer and a
director of Zale Corporation, a jewelry retailer. From 1990 through 1993, Mr.
Pollock served as President and Chief Operating Officer of Karten's Jewelers,
Inc., a New England jewelry chain. Mr. Pollock is a partner of Independent Group
L.P., a privately-held radio broadcasting company based in Cleveland, Ohio, and
a director of New West Eyeworks, Inc., a retail optical company.
 
     In January of 1998, HomePlace, Inc. filed a voluntary petition in the
United States Bankruptcy Court for the District of Delaware for reorganization
under Chapter 11 of the Bankruptcy Code.
 
     Leonard A. Schlesinger has served as a director of the Company since
August, 1995. Mr. Schlesinger is currently the George Fisher Baker, Jr.
Professor of Business Administration at the Harvard Business School. He has
served as a faculty member at the Harvard Business School for more than five
years. Mr. Schlesinger serves as a director of The Limited, Inc., a specialty
retailer, Pegasystems, Inc., a customer service software company, and GC
Companies, Inc., a motion picture exhibition company.
 
     Officers of the Company are elected on an annual basis and serve at the
discretion of the Board of Directors.
 
COMMITTEES
 
     The Audit Committee was established for the purpose of reviewing and making
recommendations regarding the Company's employment of independent accountants,
the annual audit of the Company's financial statements and the Company's
internal controls, accounting practices and policies. The current members of the
Audit Committee are Mr. Lund and Ms. Lane.
 
     The Compensation Committee was established for the purpose of making
recommendations to the Board of Directors regarding the nature and amount of
compensation for executive officers of the Company. The Compensation Committee
also administers certain of the Company's employee benefit plans. The current
members of the Compensation Committee are Mr. Formanek, Mr. Pollock, and Mr.
Schlesinger.
 
COMPENSATION OF DIRECTORS
 
     For service as a director during 1997, each director who is not an employee
of the Company received $25,000 in restricted shares of Common Stock (the
"Restricted Shares") paid at the beginning of the relevant calendar year, or, in
the case of Mr. Lund, a percentage of such amount based upon the period during
1997 in which he served as a director. The restrictions on such Restricted
Shares will generally lapse one year from the date of grant. Each director who
is not an employee of the Company also received $1,000 in Common Stock for each
board meeting attended, and $500 in Common Stock for each committee meeting
attended, paid at the end of the calendar quarter in which the meetings
occurred. Such Common Stock cannot be sold until at least six months after the
date of grant.
 
     Commencing in 1998, in lieu of the annual retainer and meeting fees
described above, each director who is not an employee of the Company will
receive 2,000 Restricted Shares at the beginning of each year, subject to a
maximum value of $75,000.
 
                                       37
<PAGE>   39
 
     On the date of each of the Company's Annual Meetings, each eligible
director receives an option to purchase 5,000 shares of common stock of the
Company. The exercise price of option granted under the Plan is the fair market
value on the date of grant. To be eligible to receive option grants at the
Annual Meetings to be held in 1998 and 1999 and thereafter, a director generally
must have held at least 15,000 and 20,000 shares, respectively, for the one-year
period prior to the date of the meeting.
 
     Each option vests and becomes exercisable on the third anniversary of the
date of grant except that (i) an option is forfeited in its entirety if the
director ceases, at any time prior to his or her exercise of the option, to hold
the minimum number of shares that he or she was required to hold for the one
year period prior to the grant to be eligible therefor; (ii) all outstanding
options vest and become immediately exercisable in the event of a change in
control of the Company, and (iii) all options held by a director who has served
as a director for six years or more vest and become immediately exercisable as
of the date upon which he or she ceases to serve as a director.
 
     An option may be exercised only during the period that the optionee serves
as a director of the Company or within three months after termination of such
service and only if it is vested and has not expired at the time of termination.
However, if the director ceases to serve as such as a result of death or if the
individual has served as a director of the Company for more than 10 years, such
three month period is extended to three years.
 
ITEM 11. EXECUTIVE COMPENSATION
 
     The information required by this Item 11 is incorporated herein by
reference to the information under the caption "Executive Compensation" in the
Proxy Statement for the Company's May 14, 1998 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 for the Company's May 14, 1998 Annual Meeting of
Stockholders.
 
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED PARTY TRANSACTIONS
 
     N/A
 
                                       38
<PAGE>   40
 
                                    PART IV
 
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
 
     (a) The following exhibits are filed herewith unless otherwise indicated:
 
<TABLE>
<CAPTION>
EXHIBIT
 NUMBER                            DESCRIPTION
-------                            -----------
<C>        <S>
 2.1(6)    Agreement and Plan of Merger dated as of April 8, 1997
           between Michigan Borders Group, Inc. and Borders Group, Inc.
 3.1(6)    Articles of Incorporation of Borders Group, Inc.
 3.3(6)    Bylaws of the Borders Group, Inc.
10.1(1)    Stockholder Agreement dated as of February 17, 1995, between
           Borders Group, Inc. and Kmart Corporation.
10.2(2)    Employment Agreement dated as of February 1, 1995 between
           Borders Group, Inc. and Robert F. DiRomualdo.
10.3(1)    Employment Agreement dated as of November 15, 1994 among
           Borders Group, Inc., Walden Book Company, Inc. and George R.
           Mrkonic.
10.4(5)    Form of Severance Agreement.
10.5(1)    1992 Stock Appreciation Rights Plan of Borders, Inc.
10.6(6)    Borders Group, Inc. Stock Option Plan.
10.7(3)    Tax Allocation Agreement dated May 24, 1995 between Borders
           Group, Inc. and Kmart Corporation.
10.8(3)    Lease Guaranty Agreement dated May 24, 1995 between Borders
           Group, Inc. and Kmart Corporation.
10.9(2)    Management Stock Purchase Plan.
10.10(7)   First Amendment to the Management Stock Purchase Plan.
10.11      Second Amendment to the Management Stock Purchase Plan.
10.12(2)   Employee Stock Purchase Plan.
10.13(4)   First Amendment to the Employee Stock Purchase Plan.
10.14(6)   Annual Incentive Bonus Plan.
10.15(2)   Director Stock Plan.
10.16      First Amendment to the Director Stock Plan.
10.17      Second Amendment to the Director Stock Plan.
10.18(7)   Amended and Restated Multicurrency Credit Agreement among
           Borders Group, Inc., its subsidiaries and Parties thereto.
10.19(7)   Amended and Restated Participation Agreement among Borders
           Group, Inc., its subsidiaries and parties thereto.
10.20(7)   Appendix A to Participation Agreement among Borders Group,
           Inc., its subsidiaries and parties thereto.
10.21(7)   Amended and Restated Credit Agreement among Borders Group,
           Inc., its subsidiaries and Parties thereto.
10.22(7)   Amended and Restated Guarantee Agreement among Borders
           Group, Inc., its subsidiaries and Parties thereto.
10.23(5)   Agreement dated April 19, 1996, between Borders Group, Inc.
           and Richard L. Flanagan.
10.24(5)   Agreement dated April 19, 1996, between Borders Group, Inc.
           and Bruce A. Quinnell.
18.1 (3)   Letter of Price Waterhouse LLP dated July 17, 1995.
21.1       Subsidiaries of Registrant.
23.1       Consent of Price Waterhouse LLP.
27         Financial Data Schedule.
</TABLE>
 
                                       39
<PAGE>   41
 
-------------------------
(1) Incorporated by reference from the Company's Registration Statement on Form
    S-4 (File No. 33-90016).
 
(2) Incorporated by reference from the Company's Registration Statement on Form
    S-1 (File No. 33-90918).
 
(3) Incorporated by reference from the Company's Quarterly Report on Form 10-Q
    for the quarter ended April 23, 1995 (File No. 1-13740).
 
(4) Incorporated by reference from the Company's Registration Statement on Form
    S-1 (File No. 33-80643).
 
(5) Incorporated by reference from the Company's Annual Report on Form 10-K for
    the year ended January 28, 1996 (File No. 1-13740).
 
(6) Incorporated by reference from the Company's Proxy Statement dated April 9,
    1997 of Borders Group, Inc. (File No. 1-13740).
 
(7) Incorporated by reference from the Company's Quarterly Report on Form 10-Q
    for the quarter ended October 26, 1997 (File No. 1-13740).
 
(8) Incorporated by reference from the Company's Quarterly Report on Form 10-Q
    for the quarter ended October 22, 1995 (File 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 the 13 week period ended October 26, 1997, one report was filed on
form 8-K under Item 9 -- Sales of Equity Securities Pursuant to Regulation 5
which related to the acquisition of Books etc. This report was dated October 21,
1997 and filed on November 4, 1997 (File No. 1-13740).
 
                                       40
<PAGE>   42
 
                                   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/ ROBERT F. DIROMUALDO
                                             -----------------------------------
                                                    Robert F. DiRomualdo
                                                Chairman and Chief Executive
                                                           Officer
 
     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.
 
<TABLE>
<CAPTION>
                    NAME                                          TITLE                           DATE
                    ----                                          -----                           ----
<S>                                               <C>                                      <C>
 
          /s/ ROBERT F. DIROMUALDO                  Chairman, Chief Executive Officer        April 24, 1998
---------------------------------------------       and Director
            Robert F. DiRomualdo
 
            /s/ GEORGE R. MRKONIC                   Vice Chairman and Director               April 24, 1998
---------------------------------------------
              George R. Mrkonic
 
            /s/ KENNETH E. SCHEVE                   Senior Vice President and Chief          April 24, 1998
---------------------------------------------       Financial Officer (Principal
              Kenneth E. Scheve                     Financial and Accounting Officer)
 
            /s/ PETER R. FORMANEK                   Director                                 April 24, 1998
---------------------------------------------
              Peter R. Formanek
 
               /s/ AMY B. LANE                      Director                                 April 24, 1998
---------------------------------------------
                 Amy B. Lane
 
             /s/ VICTOR L. LUND                     Director                                 April 24, 1998
---------------------------------------------
               Victor L. Lund
 
              /s/ LARRY POLLOCK                     Director                                 April 24, 1998
---------------------------------------------
                Larry Pollock
 
         /s/ LEONARD A. SCHLESINGER                 Director                                 April 24, 1998
---------------------------------------------
           Leonard A. Schlesinger
</TABLE>
 
                                       41
<PAGE>   43
 
                                 EXHIBIT INDEX
 
<TABLE>
<CAPTION>
EXHIBIT
 NUMBER                            DESCRIPTION
-------                            -----------
<C>        <S>
 2.1(6)    Agreement and Plan of Merger dated as of April 8, 1997
           between Michigan Borders Group, Inc. and Borders Group, Inc.
 3.1(6)    Articles of Incorporation of Borders Group, Inc.
 3.3(6)    Bylaws of the Borders Group, Inc.
10.1(1)    Stockholder Agreement dated as of February 17, 1995, between
           Borders Group, Inc. and Kmart Corporation.
10.2(2)    Employment Agreement dated as of February 1, 1995 between
           Borders Group, Inc. and Robert F. DiRomualdo.
10.3(1)    Employment Agreement dated as of November 15, 1994 among
           Borders Group, Inc., Walden Book Company, Inc. and George R.
           Mrkonic.
10.4(5)    Form of Severance Agreement.
10.5(1)    1992 Stock Appreciation Rights Plan of Borders, Inc.
10.6(6)    Borders Group, Inc. Stock Option Plan.
10.7(3)    Tax Allocation Agreement dated May 24, 1995 between Borders
           Group, Inc. and Kmart Corporation.
10.8(3)    Lease Guaranty Agreement dated May 24, 1995 between Borders
           Group, Inc. and Kmart Corporation.
10.9(2)    Management Stock Purchase Plan.
10.10(7)   First Amendment to the Management Stock Purchase Plan.
10.11      Second Amendment to the Management Stock Purchase Plan.
10.12(2)   Employee Stock Purchase Plan.
10.13(4)   First Amendment to the Employee Stock Purchase Plan.
10.14(6)   Annual Incentive Bonus Plan.
10.15(2)   Director Stock Plan.
10.16      First Amendment to the Director Stock Plan.
10.17      Second Amendment to the Director Stock Plan.
10.18(7)   Amended and Restated Multicurrency Credit Agreement among
           Borders Group, Inc., its subsidiaries and Parties thereto.
10.19(7)   Amended and Restated Participation Agreement among Borders
           Group, Inc., its subsidiaries and parties thereto.
10.20(7)   Appendix A to Participation Agreement among Borders Group,
           Inc., its subsidiaries and parties thereto.
10.21(7)   Amended and Restated Credit Agreement among Borders Group,
           Inc., its subsidiaries and Parties thereto.
10.22(7)   Amended and Restated Guarantee Agreement among Borders
           Group, Inc., its subsidiaries and Parties thereto.
10.23(5)   Agreement dated April 19, 1996, between Borders Group, Inc.
           and Richard L. Flanagan.
10.24(5)   Agreement dated April 19, 1996, between Borders Group, Inc.
           and Bruce A. Quinnell.
18.1 (3)   Letter of Price Waterhouse LLP dated July 17, 1995.
21.1       Subsidiaries of Registrant.
23.1       Consent of Price Waterhouse LLP.
27         Financial Data Schedule.
</TABLE>
 
                                       42
<PAGE>   44
 
-------------------------
(1) Incorporated by reference from the Company's Registration Statement on Form
    S-4 (File No. 33-90016).
 
(2) Incorporated by reference from the Company's Registration Statement on Form
    S-1 (File No. 33-90918).
 
(3) Incorporated by reference from the Company's Quarterly Report on Form 10-Q
    for the quarter ended April 23, 1995 (File No. 1-13740).
 
(4) Incorporated by reference from the Company's Registration Statement on Form
    S-1 (File No. 33-80643).
 
(5) Incorporated by reference from the Company's Annual Report on Form 10-K for
    the year ended January 28, 1996 (File No. 1-13740).
 
(6) Incorporated by reference from the Company's Proxy Statement dated April 9,
    1997 of Borders Group, Inc. (File No. 1-13740).
 
(7) Incorporated by reference from the Company's Quarterly Report on Form 10-Q
    for the quarter ended October 26, 1997 (File No. 1-13740).
 
(8) Incorporated by reference from the Company's Quarterly Report on Form 10-Q
    for the quarter ended October 22, 1995 (File No. 1-13740).
 
                                       43