##### Table of Contents









UNITED STATES SECURITIES AND EXCHANGE
COMMISSION

Washington, D.C. 20549




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FORM 10-K

|           |  |                                                                                                  |  | 
|---------- |  | ------------------------------------------------------------------------------------------------ |  | 
|(MARK ONE) |  |                                                                                                  |  | 
|x          |  | ANNUAL REPORT PURSUANT TO SECTION 13 OR
    15(d)
    OF THE SECURITIES EXCHANGE ACT OF 1934     |  | 
|          
|           |  | For the fiscal year ended January 25,
    2004                                                   |  | 
|          
|           |  | OR                                                                                               |  | 
|          
|o          |  | TRANSITION REPORT PURSUANT TO SECTION 13 OR
    15(d)
    OF THE SECURITIES EXCHANGE ACT OF 1934 |  | 

For the transition period
from          to                   .

Commission File Number 1-13740



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BORDERS GROUP, INC.

(Exact name of registrant as specified in its
charter)


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

(734) 477-1100

(Registrants telephone number, including
area code)


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

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

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

None

Indicate by check mark whether the registrant:
(1) has filed all reports required to be filed by
Section 13 or 15(d) of the Securities Exchange Act of 1934
during the preceding 12 months (or for such shorter period
that the registrant was required to file such reports), and
(2) has been subject to such filing requirements for the
past 90 days. Yes [X] No [ ]

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

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

The aggregate market value of the voting stock
held by non-affiliates of the registrant was approximately
$1,387,051,607 based upon the closing market price of
$17.95 per share of Common Stock on the New York Stock
Exchange as of July 25, 2003.

Number of shares of Common Stock outstanding as
of March 23, 2004: 78,316,235

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the Registrants Proxy Statement
for the May 20, 2004 Annual Meeting of Stockholders are
incorporated by reference into Part III.



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BORDERS GROUP, INC. INDEX

|                                                  |  |                                                                                           |  |      |    | 
|------------------------------------------------- |  | ----------------------------------------------------------------------------------------- |  | ---- | -- | 
|                                                  |  |                                                                                           |  | Page |   
|                                                  |  |                                                                                           |  |      |   
|PART I                                            |  |                                                                                           |  |     
|Item 1.                                           |  | Business                                                                                  |  |      | 2  | 
|Item 2.                                           |  | Properties                                                                                |  |      | 11 | 
|Item 3.                                           |  | Legal Proceedings                                                                         |  |      | 12 | 
|Item 4.                                           |  | Submission of Matters to a
    Vote of Security Holders                                   |  |      | 13 | 
|PART II                                           |  |                                                                                           |  |     
|Item 5.                                           |  | Market for the
    Registrants Common Equity and Related Stockholder
    Matters         |  |      | 13 | 
|Item 6.                                           |  | Selected Financial Data                                                                   |  |      | 15 | 
|Item 7.                                           |  | Managements Discussion
    and Analysis of Financial Condition and Results of Operations |  |      | 16 | 
|Item 7A.                                          |  | Quantitative and Qualitative
    Disclosures about Market Risk                            |  |      | 37 | 
|Item 8.                                           |  | Financial Statements and
    Supplementary Data                                           |  |      | 39 | 
|Item 9.                                           |  | Changes in and Disagreements
    with Accountants on Accounting and Financial Disclosure  |  |      | 65 | 
|Item 9A.                                          |  | Controls and Procedures                                                                   |  |      | 65 | 
|PART III                                          |  |                                                                                           |  |     
|Item 10.                                          |  | Directors and Executive
    Officers of the Registrant                                    |  |      | 65 | 
|Item 11.                                          |  | Executive Compensation                                                                    |  |      | 65 | 
|Item 12.                                          |  | Security Ownership of
    Certain Beneficial Owners and Management                        |  |      | 65 | 
|Item 13.                                          |  | Certain Relationships and
    Related Party Transactions                                  |  |      | 66 | 
|Item 14.                                          |  | Principal Accountant Fees
    and Services                                                |  |      | 66 | 
|PART IV                                           |  |                                                                                           |  |     
|Item 15.                                          |  | Exhibits, Financial
    Statement Schedules, and Reports on Form 8-K                      |  |      | 66 | 
|Participation Agreement dated as of 11/15/2002   
|Code of Ethics Relating to Financial Reporting   
|Business Conduct Policy                          
|Subsidiaries                                     
|Consent of Ernst & Young LLP                     
|Sec. 302 Certification of Gregory P. Josefowicz  
|Sec. 302 Certification of Edward W. Wilhelm      
|Sec. 906 Certification of Gregory P. Josefowicz  
|Sec. 906 Certification of Edward W. Wilhelm      
|Cautionary Statement under the Private Securities





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##### Table of Contents






PART I






|        |         
|------- | --------
|Item 1. | Business

Forward-Looking Statements

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

General

Borders Group, Inc., through its
subsidiaries, Borders, Inc. (Borders), Walden Book
Company, Inc. (Waldenbooks), Borders U.K. Limited, Borders
Australia Pty Limited and others (individually and collectively,
the Company), is the second largest operator of
book, music and movie superstores and the largest operator of
mall-based bookstores in the world based upon both sales and
number of stores. At January 25, 2004, the Company operated
482 superstores under the Borders name, including 24 in the
United Kingdom, nine in Australia, two in Puerto Rico, and one
each in Singapore and New Zealand. The Company also operated 716
mall-based and other bookstores primarily under the Waldenbooks
name in the United States and 36 bookstores under the Books etc.
name in the United Kingdom.

Segment Information

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

Borders

Borders is a premier operator of book, music and
movie superstores in the United States, offering customers
selection and service that the Company believes to be superior
to other such superstore operators. A key element of the
Companys strategy is to continue its growth and increase
its profitability through the ongoing expansion and refinement
of its Borders superstore operations. In 2003, the Company
opened 41 new Borders superstores, achieved average sales per
square foot of $229 and average sales per superstore of
$5.8 million. Borders superstores also achieved compound
annual net sales growth of 5.4%, 8.0% and 13.6% for the three
years ended January 25, 2004, January 26, 2003 and
January 27, 2002, respectively.

Each Borders superstore offers customers a vast
assortment of books, music and movies, superior customer
service, value pricing and an inviting and comfortable
environment designed to encourage browsing. Borders superstores
carry an average of 97,000 book titles, with individual store
selections ranging from 59,000 titles to 176,000 titles, across
numerous categories, including many hard-to-find titles. As of
January 25, 2004, 435 of the 445 domestic Borders
superstores were in a book, music and movie format, which also
feature an extensive selection of pre-recorded music, with an
emphasis on hard-to-find recordings and categories such as jazz,
classical and world music, and a broad assortment of DVDs,
focusing on new release and catalog movies. A typical Borders
superstore carries approximately 26,000 titles of music and over
9,000 titles of movies.

Borders superstores average 25,200 square
feet in size, including approximately 12,900 square feet
devoted to books, 4,100 square feet devoted to music,
1,300 square feet devoted to a café, 800 square
feet devoted to newsstand, 600 square feet devoted to
movies and 200 square feet devoted to gifts and stationery.
Stores opened in 2003 averaged 20,600 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.

2



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The number of Borders domestic stores located in
each state and the District of Columbia as of January 25,
2004 are listed below:

|                     |  |           |     | 
|-------------------- |  | --------- | --- | 
|                     |  | Number of |    
|State                |  | Stores    |    
|                     |  |           |    
|Alaska               |  |           | 1   | 
|Arizona              |  |           | 10  | 
|California           |  |           | 70  | 
|Colorado             |  |           | 13  | 
|Connecticut          |  |           | 7   | 
|Delaware             |  |           | 2   | 
|District of Columbia |  |           | 3   | 
|Florida              |  |           | 26  | 
|Georgia              |  |           | 15  | 
|Hawaii               |  |           | 6   | 
|Idaho                |  |           | 2   | 
|Illinois             |  |           | 32  | 
|Indiana              |  |           | 11  | 
|Iowa                 |  |           | 3   | 
|Kansas               |  |           | 6   | 
|Kentucky             |  |           | 3   | 
|Louisiana            |  |           | 1   | 
|Maine                |  |           | 2   | 
|Maryland             |  |           | 11  | 
|Massachusetts        |  |           | 13  | 
|Michigan             |  |           | 17  | 
|Minnesota            |  |           | 8   | 
|Mississippi          |  |           | 1   | 
|Missouri             |  |           | 8   | 
|Montana              |  |           | 3   | 
|Nebraska             |  |           | 2   | 
|Nevada               |  |           | 6   | 
|New Hampshire        |  |           | 4   | 
|New Jersey           |  |           | 17  | 
|New Mexico           |  |           | 4   | 
|New York             |  |           | 24  | 
|North Carolina       |  |           | 8   | 
|Ohio                 |  |           | 16  | 
|Oklahoma             |  |           | 4   | 
|Oregon               |  |           | 7   | 
|Pennsylvania         |  |           | 20  | 
|Rhode Island         |  |           | 2   | 
|South Dakota         |  |           | 1   | 
|Tennessee            |  |           | 6   | 
|Texas                |  |           | 18  | 
|Utah                 |  |           | 4   | 
|Vermont              |  |           | 1   | 
|Virginia             |  |           | 11  | 
|Washington           |  |           | 9   | 
|West Virginia        |  |           | 1   | 
|Wisconsin            |  |           | 6   | 
|                     |  |           |    
|Total                |  |           | 445 | 
|                     |  |           |    



Waldenbooks

Waldenbooks is the nations leading operator
of mall-based bookstores in terms of sales and number of stores,
offering customers a convenient source for new releases,
hardcover and paperback bestsellers, periodicals and a standard
selection of other titles. Waldenbooks generates cash flow that
the Company uses to finance the Companys growth
initiatives. Waldenbooks achieved average sales per square foot
of $275 and average sales per store of $1.1 million for
2003. Waldenbooks stores average approximately 3,900 square
feet in size, and carry an average of 17,800 titles, ranging
from 4,900 in an airport store to 29,900 in a large format
store. Waldenbooks also operates one of the longest-running
customer loyalty programs in the nation, the Preferred Reader
Program.

3



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The number of Waldenbooks stores located in each
state and the District of Columbia as of January 25, 2004
are listed below:

|                     |  |           |     | 
|-------------------- |  | --------- | --- | 
|                     |  | Number of |    
|State                |  | Stores    |    
|                     |  |           |    
|Alabama              |  |           | 4   | 
|Alaska               |  |           | 5   | 
|Arizona              |  |           | 8   | 
|Arkansas             |  |           | 6   | 
|California           |  |           | 53  | 
|Colorado             |  |           | 11  | 
|Connecticut          |  |           | 13  | 
|Delaware             |  |           | 3   | 
|District of Columbia |  |           | 2   | 
|Florida              |  |           | 41  | 
|Georgia              |  |           | 21  | 
|Hawaii               |  |           | 11  | 
|Idaho                |  |           | 3   | 
|Illinois             |  |           | 34  | 
|Indiana              |  |           | 16  | 
|Iowa                 |  |           | 11  | 
|Kansas               |  |           | 7   | 
|Kentucky             |  |           | 10  | 
|Louisiana            |  |           | 6   | 
|Maine                |  |           | 2   | 
|Maryland             |  |           | 19  | 
|Massachusetts        |  |           | 23  | 
|Michigan             |  |           | 25  | 
|Minnesota            |  |           | 7   | 
|Mississippi          |  |           | 5   | 
|Missouri             |  |           | 14  | 
|Montana              |  |           | 4   | 
|Nebraska             |  |           | 5   | 
|Nevada               |  |           | 3   | 
|New Hampshire        |  |           | 5   | 
|New Jersey           |  |           | 23  | 
|New Mexico           |  |           | 2   | 
|New York             |  |           | 39  | 
|North Carolina       |  |           | 21  | 
|North Dakota         |  |           | 3   | 
|Ohio                 |  |           | 38  | 
|Oklahoma             |  |           | 10  | 
|Oregon               |  |           | 9   | 
|Pennsylvania         |  |           | 50  | 
|Rhode Island         |  |           | 5   | 
|South Carolina       |  |           | 12  | 
|South Dakota         |  |           | 2   | 
|Tennessee            |  |           | 10  | 
|Texas                |  |           | 44  | 
|Utah                 |  |           | 3   | 
|Vermont              |  |           | 4   | 
|Virginia             |  |           | 27  | 
|Washington           |  |           | 14  | 
|West Virginia        |  |           | 8   | 
|Wisconsin            |  |           | 13  | 
|Wyoming              |  |           | 2   | 
|                     |  |           |    
|Total                |  |           | 716 | 
|                     |  |           |    

International

The Companys International operations began
in 1997 with the acquisition of Books etc. in the United Kingdom
and the opening of a superstore in Singapore. Since then, the
Company has expanded its International operations to establish a
presence on four continents. The Company opened seven
International superstores in 2003.

International superstores as of January 25,
2004 are listed below:

|               |  |           |    | 
|-------------- |  | --------- | -- | 
|               |  | Number of |   
|Country        |  | Stores    |   
|               |  |           |   
|Australia      |  |           | 9  | 
|New Zealand    |  |           | 1  | 
|Puerto Rico    |  |           | 2  | 
|Singapore      |  |           | 1  | 
|United Kingdom |  |           | 24 | 
|               |  |           |   
|Total          |  |           | 37 | 
|               |  |           |   

International superstores, which operate under
the Borders name, achieved average sales per square foot of $340
and average sales per store of $9.2 million for 2003.
International superstores range between 14,200 and
42,400 square feet in size, and are located in both city
center as well as suburban locations. All International
superstores offer book, music and movie products. Furthermore,
the Company believes it has a competitive advantage due to its
depth of

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system-driven assortment and level of service. In
addition, all International superstores offer cafés. Those
cafés located in the United Kingdom are licensed to and
operated by Starbucks Coffee Company (U.K.) Limited. In
addition, the Company licenses the gifts and stationery
departments in its United Kingdom and Singapore superstores to
Paperchase Products Limited. The Company owns 14.7% of
Paperchase Products Limited. Currently, four of the
10 highest-volume Borders superstores are International
stores.


The Company also operated 36 stores under
the Books etc. name in the United Kingdom as of January 25,
2004, which are small-format stores located primarily in central
London or in various airports in the United Kingdom. These
stores primarily offer books and average 4,700 square
feet in size, with the largest being 10,700 square feet and
the smallest being 600 square feet.

Borders.com and Waldenbooks.com

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

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

Also in 2002, Borders entered into an agreement
with Amazon to allow customers ordering certain book, music and
movie products through certain of Amazons Web sites to
purchase and pick up the merchandise at Borders stores in the
United States (Express In-Store Pick Up). Under this agreement,
the Company is the merchant of record for all sales made through
this service, and determines all prices and other terms and
conditions applicable to such sales. The Company fulfills all
products sold through Express In-Store Pick Up. In addition, the
Company assumes all risk, cost and responsibility related to the
sale and fulfillment of all products sold. The Company
recognizes revenue upon customers pick up of the
merchandise at the store. The Company also pays referral fees to
Amazon pursuant to this agreement. This service was offered to
customers beginning November 27, 2002.

In November of 2003, the Company announced a
multi-year extension of the Mirror Sites and Express In-Store
Pick Up agreements with Amazon.

Distribution

The Company believes that its centralized
distribution system, consisting of 13 distribution
facilities worldwide, combined with Borders use of its
proprietary expert system to manage inventory,
significantly enhances its ability to manage inventory on a
store-by-store basis. Inventory is shipped from vendors
primarily to the Companys distribution centers.
Approximately 87% and 71% of the books carried by Borders and
Waldenbooks, respectively, are processed through the
Companys distribution facilities. Approximately 85% of the
inventory that arrives from publishers is processed within
48 hours for shipment to the stores. New release titles and
rush orders are processed within 24 hours. Borders
purchases substantially all of its music and movie merchandise
directly from manufacturers and utilizes the Companys own
distribution center to ship approximately 95% of its music and
movie inventory to its stores.

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As of January 25, 2004, the Company utilized
distribution centers in the following localities:

|                            |  |        |    | 
|--------------------------- |  | ------ | -- | 
|Locality, Country           |  | Number |   
|                            |  |        |   
|Auckland, New Zealand       |  |        | 1  | 
|California, United States   |  |        | 1  | 
|Indiana, United States      |  |        | 1  | 
|Ohio, United States         |  |        | 1  | 
|Pennsylvania, United States |  |        | 1  | 
|Puerto Rico                 |  |        | 2  | 
|Singapore                   |  |        | 1  | 
|St. Columb, United Kingdom  |  |        | 1  | 
|Tennessee, United States    |  |        | 3  | 
|Victoria, Australia         |  |        | 1  | 
|                            |  |        |   
|Total                       |  |        | 13 | 
|                            |  |        |   

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

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

Employees

As of January 25, 2004, the Company had a
total of approximately 15,000 full-time employees and
approximately 17,300 part-time employees. When hiring new
employees, the Company considers a number of factors, including
education, experience, diversity, personality and orientation
toward customer service. All new store employees participate in
a training program that provides up to two weeks of
in-store training in all aspects of customer service and
selling, including title searches for in-stock and in-print
merchandise, merchandising, sorting, operation of point of sale
terminals and store policies and procedures. The Company
believes that its relations with employees are generally
excellent. In general, the Companys employees are not
represented by unions, with the exception of the employees of
two Borders stores. Employees of both stores elected to be
represented by the United Food and Commercial Workers
International Union (UFCW). The employees of one of these stores
have ratified a two-year contract.

Trademarks and Service Marks

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

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Relationship with Kmart

General.Prior to
its initial public offering in May 1995, the Company was a
subsidiary of Kmart Corporation (Kmart); Kmart currently owns no
shares of common stock of the Company. On January 22, 2002,
Kmart filed for reorganization under Chapter 11 of the
U.S. Bankruptcy Code, and emerged from Chapter 11 on
May 6, 2003. Such filings have not affected the operations
of the Company.

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

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

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

7



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##### Table of Contents



Executive Officers of the Company

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

|                      |  |     |  |                                                                
|--------------------- |  | --- |  | ---------------------------------------------------------------
|Name                  |  | Age |  | Position                                                       
|                      |  |     |  |                                                                
|Gregory P. Josefowicz |  | 51  |  | Chairman, President and Chief Executive Officer                
|Vincent E. Altruda    |  | 54  |  | President, Borders Stores Worldwide                            
|Thomas D. Carney      |  | 57  |  | Senior Vice President, General Counsel and
    Secretary       
|Daniel T. Smith       |  | 39  |  | Senior Vice President, Human Resources                         
|Michael G. Spinozzi   |  | 44  |  | Executive Vice President, Chief Marketing Officer              
|Cedric J. Vanzura     |  | 40  |  | President, Waldenbooks and Corporate Information
    Technology
|Edward W. Wilhelm     |  | 45  |  | Senior Vice President, Chief Financial Officer                 

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

Vincent E. Altruda has served as President
of the Companys International operations since December
1997 and as President of Borders Stores Worldwide since February
2004. From February 1997 through December 1997, Mr. Altruda
served as Senior Vice President of Borders Store Development.
From February 1995 through February 1997, Mr. Altruda
served as Senior Vice President of Borders Store Operations.
From December 1992 through February 1995, Mr. Altruda
served as Vice President of Borders Store Operations.

Thomas D. Carney has been Senior 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.

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

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

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

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

Risk Factors

The following risk factors and other information
included in this Annual Report on Form 10-K should be
carefully considered. The risks and uncertainties described
below are not the only ones the Company faces. Additional risks
and uncertainties not presently known to the Company or that the
Company currently deems immaterial also may

8



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impair the Companys business operations. If
any of the following risks occur, the Companys business,
financial condition, operating results and cash flows could be
materially adversely affected.


Expansion Strategy

The Companys growth strategy is dependent
principally on its ability to open new superstores and operate
them profitably. The Company has been engaged in an aggressive
expansion program, pursuant to which it has opened 41 domestic
superstores in 2003. In 2004, however, the Company expects to
open 18 to 20 domestic superstores. The Company is reducing the
number of domestic superstore openings in order to ensure
adequate focus and resources will be available for an expanded
remodel program, through which the Company expects to complete
major remodels of 40 to 50 existing stores. The Company has also
opened seven International superstores in 2003, and expects to
open six to eight International superstores in 2004.

In general, the rate of the Companys
expansion depends, among other things, on general economic and
business conditions affecting consumer confidence and spending,
the availability of qualified management personnel and the
Companys ability to manage the operational aspects of its
growth. It also depends upon the availability of adequate
capital, which in turn depends in a large part upon cash flow
generated by Borders and Waldenbooks.

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

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

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

Waldenbooks

Waldenbooks results are highly dependent
upon conditions in the mall retailing industry, including
overall mall traffic. Mall traffic has been sluggish over the
past several years and the Company expects it to remain sluggish
for the foreseeable future. In addition, increased competition
from superstores has adversely affected Waldenbooks sales.
As a result, Waldenbooks comparable store sales results
have been negatively affected. There can be no assurance that
mall traffic will not decline further or that superstore
competition, or other factors, will not further adversely affect
Waldenbooks sales.

Seasonality

The Companys business is highly seasonal,
with sales generally highest in the fourth quarter. During 2003,
35.5% of the Companys sales and 96.4% of the
Companys operating income were generated in the fourth
quarter. The

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


Competition

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

The music and movie businesses are also highly
competitive and Borders faces competition from large established
music chains, established movie chains, as well as specialty
retail stores, movie rental stores, discount stores, warehouse
clubs and mass merchandisers. In addition, consumers receive
television and mail order offers and have access to mail order
clubs. The largest mail order clubs are affiliated with major
manufacturers of pre-recorded music and may have advantageous
marketing relationships with their affiliates.

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

Consumer Spending Patterns

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

Foreign Exchange Risk

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

Potential for Uninsured Losses and/or
Claims

The Company is subject to the possibility of
uninsured losses from risks such as terrorism, earthquakes, or
floods, for which no, or limited, insurance coverage is
maintained. The Company is also subject to risk of losses which
may arise from adverse litigation results.

Reliance on Key Personnel

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

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##### Table of Contents



Availability of Information

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




Item 2. Properties

Borders leases all of its stores. Borders
store leases have an average initial term of 15 to 20 years
with multiple three- to five-year renewal options. At
January 25, 2004, the average unexpired term under
Borders existing store leases in the United States was
12.6 years prior to the exercise of any options. The
expiration of Borders leases for stores open at
January 25, 2004 are as follows:

|                                                                     |  |           |     | 
|-------------------------------------------------------------------- |  | --------- | --- | 
|                                                                     |  | Number of |    
|Lease Terms to Expire During 12 Months Ending on or about January 31 |  | Stores    |    
|                                                                     |  |           |    
|2004                                                                 |  |           | 10  | 
|2005                                                                 |  |           | 6   | 
|2006                                                                 |  |           | 6   | 
|2007                                                                 |  |           | 7   | 
|2008                                                                 |  |           | 12  | 
|2009 and later                                                       |  |           | 404 | 
|                                                                     |  |           |    
|Total                                                                |  |           | 445 | 
|                                                                     |  |           |    

Waldenbooks leases all of its stores.
Waldenbooks store leases generally have an initial term of
10 years. At present, the average unexpired term under
Waldenbooks existing store leases is approximately
2.5 years. The expiration of Waldenbooks leases for
stores open at January 25, 2004 are as follows:

|                                                                     |  |           |     | 
|-------------------------------------------------------------------- |  | --------- | --- | 
|                                                                     |  | Number of |    
|Lease Terms to Expire During 12 Months Ending on or about January 31 |  | Stores    |    
|                                                                     |  |           |    
|2004                                                                 |  |           | 326 | 
|2005                                                                 |  |           | 95  | 
|2006                                                                 |  |           | 67  | 
|2007                                                                 |  |           | 46  | 
|2008                                                                 |  |           | 67  | 
|2009 and later                                                       |  |           | 115 | 
|                                                                     |  |           |    
|Total                                                                |  |           | 716 | 
|                                                                     |  |           |    

The Company leases all of its International
superstores. International store leases generally have an
initial term of 15 to 25 years. At present, the average
unexpired term under existing International store leases is
approximately 13.7 years. The expiration of International
superstore leases for stores open at January 25, 2004 are
as follows:

|                                                                     |  |           |    | 
|-------------------------------------------------------------------- |  | --------- | -- | 
|                                                                     |  | Number of |   
|Lease Terms to Expire During 12 Months Ending on or about January 31 |  | Stores    |   
|                                                                     |  |           |   
|2004                                                                 |  |           |   | 
|2005                                                                 |  |           | 1  | 
|2006                                                                 |  |           |   | 
|2007                                                                 |  |           | 1  | 
|2008                                                                 |  |           | 2  | 
|2009 and later                                                       |  |           | 33 | 
|                                                                     |  |           |   
|Total                                                                |  |           | 37 | 
|                                                                     |  |           |   

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Books etc. operated 36 stores in the United
Kingdom as of January 25, 2004. 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 10.4 years.

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




Item 3. Legal Proceedings

In August 1998, The Intimate Bookshop, Inc.
(Intimate) and its owner, Wallace Kuralt, filed a lawsuit in the
United States District Court for the Southern District of
New York against the Company, Barnes &
Noble, Inc., and others alleging violations of the
Robinson-Patman Act. On September 30, 2003, the Court
granted the defendants Motion For Summary Judgment and
dismissed the case. Intimate filed a Notice of Appeal and, on
January 30, 2004, the matter was settled for an amount that
is not material.

Two former employees, individually and on behalf
of a purported class consisting of all current and former
employees who worked as assistant managers in Borders stores in
the state of California at any time between April 10, 1996,
and the present, have filed an action against the Company in the
Superior Court of California for the County of
San Francisco. The action alleges that the individual
plaintiffs and the purported class members worked hours for
which they were entitled to receive, but did not receive,
overtime compensation under California law, and that they were
classified as exempt store management employees but were forced
to work more than 50% of their time in non-exempt tasks. The
Amended Complaint, which names two additional plaintiffs,
alleges violations of the California Labor Code and the
California Business and Professions Code. The relief sought
includes compensatory and punitive damages, penalties,
preliminary and permanent injunctions requiring Borders to pay
overtime compensation as required under California and Federal
law, prejudgment interest, costs, and attorneys fees and
such other relief as the court deems proper. On July 29,
2002, the Superior Court of California granted the
plaintiffs motion for class certification in the action.
The class certified consists of all individuals who worked as
Assistant Managers in a Borders superstore in California at any
time between April 10, 1996 and March 18, 2001. The
class was further certified by the Court into the following
subclasses: Assistant Manager-Merchandising; Assistant
Manager-Inventory; Assistant Manager-Human Resources; Assistant
Manager-Music; Assistant Manager-Training; Assistant
Manager-Café. On January 28, 2004, a tentative
settlement, subject to court approval, was reached pursuant to
which the Company has agreed to pay $3.5 million to resolve
all claims asserted in the litigation.

On October 29, 2002, Gary Gerlinger,
individually and on behalf of all other similarly situated
consumers in the United States who, during the period from
August 1, 2001 to the present, purchased books online from
either Amazon or the Company, instituted an action against the
Company and Amazon in the United States District Court for the
Northern District of California. The Complaint alleges that the
agreement pursuant to which an affiliate of Amazon operates
Borders.com as a co-branded site violates federal anti-trust
laws, California statutory law and the common law of unjust
enrichment. The Complaint seeks injunctive relief, damages,
including treble damages or statutory damages where applicable,
attorneys fees, costs and disbursements, disgorgement of all
sums obtained by allegedly wrongful acts, interest and
declaratory relief. The Company has filed an answer denying any
liability and also has filed a motion for summary judgment. The
Court recently issued an order granting the motion as to certain
of plaintiffs claims, denying it as others and requesting
additional briefing on certain issues. The order also denied
certain cross-motions filed by the plaintiff. The Company
intends to vigorously defend the action. The Company has not
included any liability in its consolidated financial statements
in connection with this lawsuit and has expensed as incurred all
legal costs to date. Although an adverse resolution of the
matter could have a material adverse effect on the result of the
operations of the Company for the applicable period or periods,
the Company does not believe that this litigation will have a
material effect on its liquidity or financial position.

Certain states and private litigants have sought
to impose sales or other tax collection efforts on
out-of-jurisdiction companies that engage in e-commerce. The
Company currently is disputing a claim by the state of
California relating to sales taxes that the state alleges should
have been collected on certain Borders.com sales in California
prior to implementation of the Companys Mirror Site
Agreement with Amazon. Also, the Company and Amazon have been
named as defendants in actions filed by a private litigant on
behalf of the States of Nevada and Illinois under the applicable
states False Claims Act relating to the failure to collect
use taxes on Internet sales in Nevada and Illinois for

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periods both before and after the implementation
of the Mirror Site Agreement. The Complaints seek judgments,
jointly and severally, against the defendants for, among other
things, injunctive relief, treble the amount of damages suffered
by the States of Nevada and Illinois as a result of the alleged
violations of the defendants, penalties, costs and expenses,
including legal fees. A similar action previously filed against
the Company in Tennessee has been dismissed and the appeal
period has expired.


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

In addition to the matters described above, the
Company is, from time to time, involved in or affected by other
litigation incidental to the conduct of its businesses. While
some of such matters may involve claims for large sums
(including, from time to time, actions which are asserted to be
maintainable as class action suits) the Company does not believe
that any such other litigation or claims will have a material
adverse effect on its liquidity, financial position, or results
of operations.




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

Not applicable.




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 Companys Common Stock.

|                    |                |      |   |       |     |  |   |       | 
|------------------- | -------------- | ---- | - | ----- | --- |  | - | ----- | 
|                    |                | High |   |       | Low | 
|                    |                |      |   |       |     | 
|Fiscal Quarter 2003 |                |      |   |       |     |  |   |      
|                    | First Quarter  |      | $ | 15.84 |     |  | $ | 13.60 | 
|                    | Second Quarter |      | $ | 18.60 |     |  | $ | 15.50 | 
|                    | Third Quarter  |      | $ | 21.76 |     |  | $ | 17.64 | 
|                    | Fourth Quarter |      | $ | 22.98 |     |  | $ | 21.20 | 
|                   
|Fiscal Quarter 2002 |                |      |   |       |     |  |   |      
|                    | First Quarter  |      | $ | 24.40 |     |  | $ | 21.38 | 
|                    | Second Quarter |      | $ | 24.20 |     |  | $ | 14.90 | 
|                    | Third Quarter  |      | $ | 19.44 |     |  | $ | 15.48 | 
|                    | Fourth Quarter |      | $ | 19.79 |     |  | $ | 15.36 | 

The Companys Common Stock is traded on the
New York Stock Exchange under the symbol BGP.

As of March 23, 2004, 3,126 holders of
record held the Companys Common Stock.

In November 2003, the Board of Directors declared
a quarterly cash dividend of $0.08 per share, which equaled
$6.2 million in total, on the Companys common stock,
payable January 28, 2004 to stockholders of record at the
close of business January 7, 2004. The Company intends to
pay regular quarterly cash dividends, subject to Board approval,
going forward. The declaration and payment of dividends is
subject to the discretion of the Board and to certain
limitations under the Michigan Business Corporation Act. In
addition, the Companys ability to pay dividends is
restricted by certain agreements to which the Company is a
party. See Managements Discussion and Analysis of
Financial Condition and Results of Operations 
Liquidity and Capital Resources.

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The Company has the following equity compensation
plans in effect at January 25, 2004 (number of shares in
thousands):

|                                    |                                 |             |        |        |                |   |       |                  |  |  |       |       | 
|----------------------------------- | ------------------------------- | ----------- | ------ | ------ | -------------- | - | ----- | ---------------- |  |  | ----- | ----- | 
|                                    |                                 | Number of   |        |        | Weighted-      |   |       | Number of        | 
|                                    |                                 | Shares      |        |        | Average        |   |       | Shares Available | 
|Plan Category                       |                                 | Outstanding |        |        | Exercise Price |   |       | for Issuance     | 
|                                    |                                 |             |        |        |                |   |       |                  | 
|Plans approved by stockholders:     |                                 |             |        |        |                |   |       |                  |  |  |       |      
|                                    | 1995 Stock Option Plan          |             |        | 10,290 |                |   | $     | 19.93            |  |  |       | 109   | 
|                                    | Director Plan                   |             |        | 105    |                |   |       | 20.16            |  |  |       |      | 
|                                    | Management Stock Purchase Plan  |             |        |       |                |   |       |                 |  |  |       | 3,369 | 
|Plans not approved by stockholders: |                                 |             |        |        |                |   |       |                  |  |  |       |      
|                                    | 1998 Stock Option Plan          |             |        | 2,158  |                |   |       | 18.26            |  |  |       |      | 
|                                    | International Stock Option Plan |             |        | 490    |                |   |       | 20.28            |  |  |       |      | 
|                                    |                                 |             |        |        |                |   |       |                  | 
|Total plans                         |                                 |             | 13,043 |        |                | $ | 19.67 |                  |  |  | 3,478 |      
|                                    |                                 |             |        |        |                |   |       |                  | 

The exercise price of options granted under the
Plans is fair market value as of the date of grant, and options
have terms of up to 10 years. The number of options granted
to individual employees under the Plans varies according to the
level of the employees position with the Company.

The 1998 Stock Option Plan and the Stock Option
Plan for International Employees, which expired on
December 31, 2003, provided for the grant of stock options
to a broad base of employees of the Company. Executive officers
of the Company are not eligible to participate in either of
these Plans.

14



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|        |                        
|------- | -----------------------
|Item 6. | Selected Financial Data

SELECTED CONSOLIDATED FINANCIAL AND OPERATING
DATA

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

|                                                                              |  |                   |         |   |          |   |         |          |  |   |          |  |  |          |         |   |  |   |         |  
|----------------------------------------------------------------------------- |  | ----------------- | ------- | - | -------- | - | ------- | -------- |  | - | -------- |  |  | -------- | ------- | - |  | - | ------- | -
|                                                                              |  |                  
|                                                                              |  | Fiscal Year Ended |        
|                                                                              |  | Jan. 25,          |         |   | Jan. 26, |   |         | Jan. 27, |  |   | Jan. 28, |  |  | Jan. 23, |        
|                                                                              |  | 2004              |         |   | 2003     |   |         | 2002     |  |   | 2001(1)  |  |  | 2000     |        
|(dollars in millions except per share data)                                   |  |                   |         |   |          |   |         |          |  |   |          |  |  |          |        
|Statement of Operations Data                                                  |  |                   |         |   |          |   |         |          |  |   |          |  |  |          |         |   |  |   |         |  
|Borders sales                                                                 |  | $                 | 2,470.2 |   |          | $ | 2,319.0 |          |  | $ | 2,234.1  |  |  | $        | 2,107.7 |   |  | $ | 1,841.1 |  
|Waldenbooks sales                                                             |  |                   | 820.9   |   |          |   | 852.2   |          |  |   | 902.1    |  |  |          | 944.3   |   |  |   | 959.1   |  
|International sales                                                           |  |                   | 407.5   |   |          |   | 314.9   |          |  |   | 251.7    |  |  |          | 219.2   |   |  |   | 168.2   |  
|                                                                              |  |                   |         |   |          |   |         |          |  |   |          |  |  |          |        
|Total sales                                                                   |  | $                 | 3,698.6 |   |          | $ | 3,486.1 |          |  | $ | 3,387.9  |  |  | $        | 3,271.2 |   |  | $ | 2,968.4 |  
|                                                                              |  |                   |         |   |          |   |         |          |  |   |          |  |  |          |        
|Operating income                                                              |  | $                 | 205.6   |   |          | $ | 193.9   |          |  | $ | 157.0    |  |  | $        | 135.1   |   |  | $ | 171.0   |  
|                                                                             
|Income from continuing operations                                             |  | $                 | 122.1   |   |          | $ | 111.7   |          |  | $ | 87.4     |  |  | $        | 73.8    |   |  | $ | 94.0    |  
|Discontinued operations (net of tax)                                          |  |                   |        |   |          |   |        |          |  |   |         |  |  |          | 30.2    |   |  |   | 3.7     |  
|Cumulative effect of accounting change
    (net of tax)                       |  |                   | 2.1     |   |          |   |        |          |  |   |         |  |  |          |        |   |  |   |        |  
|                                                                              |  |                   |         |   |          |   |         |          |  |   |          |  |  |          |        
|Net income                                                                    |  | $                 | 120.0   |   |          | $ | 111.7   |          |  | $ | 87.4     |  |  | $        | 43.6    |   |  | $ | 90.3    |  
|                                                                              |  |                   |         |   |          |   |         |          |  |   |          |  |  |          |        
|                                                                             
|Per Share Data                                                                |  |                   |         |   |          |   |         |          |  |   |          |  |  |          |         |   |  |   |         |  
|Diluted earnings per common share from continuing
    operations              |  | $                 | 1.54    |   |          | $ | 1.36    |          |  | $ | 1.06     |  |  | $        | 0.92    |   |  | $ | 1.17    |  
|Diluted loss per common share from discontinued
    operations                |  |                   |        |   |          |   |        |          |  |   |         |  |  |          | (0.38   | ) |  |   | (0.04   | )
|Diluted loss per common share from cumulative
    effect of accounting change |  |                   | (0.02   | ) |          |   |        |          |  |   |         |  |  |          |        |   |  |   |        |  
|                                                                              |  |                   |         |   |          |   |         |          |  |   |          |  |  |          |        
|Diluted earnings per common share                                             |  | $                 | 1.52    |   |          | $ | 1.36    |          |  | $ | 1.06     |  |  | $        | 0.54    |   |  | $ | 1.13    |  
|                                                                              |  |                   |         |   |          |   |         |          |  |   |          |  |  |          |        
|Cash dividends declared per common share                                      |  | $                 | 0.08    |   |          | $ |        |          |  | $ |         |  |  | $        |        |   |  | $ |        |  
|                                                                             
|Balance Sheet Data                                                            |  |                   |         |   |          |   |         |          |  |   |          |  |  |          |         |   |  |   |         |  
|Working capital                                                               |  | $                 | 548.6   |   |          | $ | 453.7   |          |  | $ | 335.4    |  |  | $        | 217.2   |   |  | $ | 170.3   |  
|Total assets                                                                  |  | $                 | 2,466.2 |   |          | $ | 2,268.2 |          |  | $ | 2,179.3  |  |  | $        | 2,047.1 |   |  | $ | 1,914.8 |  
|Short-term borrowings                                                         |  | $                 | 140.7   |   |          | $ | 112.1   |          |  | $ | 81.6     |  |  | $        | 143.5   |   |  | $ | 133.4   |  
|Long-term debt, including current portion                                     |  | $                 | 57.3    |   |          | $ | 50.0    |          |  | $ |         |  |  | $        |        |   |  | $ |        |  
|Long-term capital lease obligations, including
    current portion            |  | $                 | 0.4     |   |          | $ | 19.6    |          |  | $ | 51.4     |  |  | $        | 15.8    |   |  | $ | 18.8    |  
|Stockholders equity                                                          |  | $                 | 1,153.0 |   |          | $ | 1,030.6 |          |  | $ | 949.9    |  |  | $        | 846.5   |   |  | $ | 802.6   |  



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

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

General

Borders Group, Inc., through its
subsidiaries, Borders, Inc. (Borders), Walden Book
Company, Inc. (Waldenbooks), Borders U.K. Limited, Borders
Australia Pty Limited and others (individually and collectively,
the Company), is the second largest operator of
book, music and movie superstores and the largest operator of
mall-based bookstores in the world based upon both sales and
number of stores. At January 25, 2004, the Company operated
482 superstores under the Borders name, including 24 in the
United Kingdom, nine in Australia, two in Puerto Rico, and one
each in Singapore and New Zealand. The Company also operated 716
mall-based and other bookstores primarily under the Waldenbooks
name in the United States and 36 bookstores under the Books etc.
name in the United Kingdom.

The Companys business strategy is to
continue its growth and increase its profitability through
(i) expanding and refining its core domestic superstore
business, (ii) driving International growth by expanding
established markets and leveraging infrastructure investments,
(iii) leveraging strategic alliances and in-store Web-based
commerce technologies which enhance the customer experience, and
(iv) maximizing cash flow and profitability at Waldenbooks
through a combination of selective growth and profit
initiatives. Specifically, the Company opened 41 domestic
Borders stores in 2003 and expects to open a reduced number in
2004, in order to ensure adequate focus and resources will be
available for an expanded remodel program, through which the
Company expects to complete major remodels of 40 to 50 existing
stores. International store growth over the next several years
will focus on existing markets, primarily in the United Kingdom
and Australia, with approximately six to eight International
store openings annually. The International segment achieved full
year profitability for the first time in 2003 and full year
profit growth is expected going forward. The Waldenbooks segment
has experienced negative comparable sales percentages for the
past several years, but at a lesser rate in 2003, primarily due
to the overall decrease in mall traffic and the impact of
superstore openings. The Company is continuing to implement its
plan for the optimization of the Waldenbooks store base in
order to improve sales, net income and free cash flow. This plan
could result in further store closing costs or asset impairments
over the next few years, but at a lesser rate going forward. In
addition, Waldenbooks manages the Companys small format
stores, including those in airports and outlet malls and
selective growth in these small format stores is expected in
2004. The Companys objectives with respect to these
initiatives are to continue to grow consolidated sales and
earnings in 2004. In addition, subject to Board approval, the
Company plans to provide returns to stockholders through
quarterly cash dividends and share repurchases by utilizing free
cash flow generated by the business. In May 2003, the Board of
Directors authorized an increase in the amount of share
repurchases to $150 million (plus any proceeds and tax
benefits resulting from stock option exercises and tax benefits
resulting from restricted shares purchased by employees from the
Company). In November 2003, the Board of Directors declared its
first-ever quarterly cash dividend of $0.08 per share on
the Companys common stock, payable January 28, 2004
to stockholders of record at the close of business
January 7, 2004.

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

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

Also in 2002, Borders entered into an agreement
with Amazon to allow customers ordering certain book, music and
movie products through certain of Amazons Web sites to
purchase and pick up their merchandise at Borders stores in the
United States (Express In-Store Pick Up). Under this agreement,
the Company is the merchant of record for all

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sales made through this service, and determines
all prices and other terms and conditions applicable to such
sales. The Company fulfills all products sold through Express
In-Store Pick Up. In addition, the Company assumes all risk,
cost and responsibility related to the sale and fulfillment of
all products sold. The Company recognizes revenue upon
customers pick up of the merchandise at the store, and
classifies this revenue as a component of Sales in
the Companys consolidated statements of operations. The
Company also pays referral fees to Amazon pursuant to this
agreement. This service was offered to customers beginning
November 27, 2002.


In November of 2003, the Company announced a
multi-year extension of the Mirror Sites and Express In-Store
Pick Up agreements with Amazon.

The Companys fiscal year ends on the Sunday
immediately preceding the last Wednesday in January. Fiscal 2003
consisted of 52 weeks and ended January 25, 2004.
Fiscal 2002 consisted of 52 weeks and ended
January 26, 2003. Fiscal 2001 consisted of 52 weeks
and ended January 27, 2002. References herein to years are
to the Companys fiscal years.

Results of Operations

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

|                                                        |                                                          |          |       |       |          |  |       |          |   |  |       |       |  
|------------------------------------------------------- | -------------------------------------------------------- | -------- | ----- | ----- | -------- |  | ----- | -------- | - |  | ----- | ----- | -
|                                                        |                                                          | Jan. 25, |       |       | Jan. 26, |  |       | Jan. 27, |  
|                                                        |                                                          | 2004     |       |       | 2003     |  |       | 2002     |  
|                                                        |                                                          |          |       |       |          |  |       |          |  
|Sales                                                   |                                                          |          | 100.0 | %     |          |  | 100.0 | %        |   |  | 100.0 | %    
|Other revenue                                           |                                                          |          | 0.9   |       |          |  | 0.8   |          |   |  | 0.8   |      
|                                                        |                                                          |          |       |       |          |  |       |          |  
|                                                        | Total revenue                                            |          |       | 100.9 |          |  |       | 100.8    |   |  |       | 100.8 |  
|Cost of merchandise sold (includes occupancy)           |                                                          |          | 72.5  |       |          |  | 72.0  |          |   |  | 71.7  |      
|Fulfillment center and other inventory writedowns       |                                                          |          |      |       |          |  | 0.1   |          |   |  | 0.3   |      
|                                                        |                                                          |          |       |       |          |  |       |          |  
|                                                        | Gross margin                                             |          |       | 28.4  |          |  |       | 28.7     |   |  |       | 28.8  |  
|Selling, general and administrative expenses            |                                                          |          | 22.3  |       |          |  | 22.5  |          |   |  | 23.1  |      
|Legal settlement expense                                |                                                          |          | 0.1   |       |          |  |      |          |   |  | 0.1   |      
|Pre-opening expense                                     |                                                          |          | 0.2   |       |          |  | 0.2   |          |   |  | 0.2   |      
|Asset impairments and other writedowns                  |                                                          |          | 0.3   |       |          |  | 0.4   |          |   |  | 0.7   |      
|Goodwill amortization                                   |                                                          |          |      |       |          |  |      |          |   |  | 0.1   |      
|                                                        |                                                          |          |       |       |          |  |       |          |  
|                                                        | Operating income                                         |          |       | 5.5   |          |  |       | 5.6      |   |  |       | 4.6   |  
|Interest expense                                        |                                                          |          | 0.2   |       |          |  | 0.4   |          |   |  | 0.4   |      
|                                                        |                                                          |          |       |       |          |  |       |          |  
|                                                        | Income before income tax                                 |          |       | 5.3   |          |  |       | 5.2      |   |  |       | 4.2   |  
|Income tax                                              |                                                          |          | 2.0   |       |          |  | 2.0   |          |   |  | 1.6   |      
|                                                        |                                                          |          |       |       |          |  |       |          |  
|                                                        | Income before cumulative effect of accounting
    change |          |       | 3.3   |          |  |       | 3.2      |   |  |       | 2.6   |  
|Cumulative effect of accounting change (net of
    tax) |                                                          |          | 0.1   |       |          |  |      |          |   |  |      |      
|                                                        |                                                          |          |       |       |          |  |       |          |  
|                                                        | Net income                                               |          |       | 3.2   | %        |  |       | 3.2      | % |  |       | 2.6   | %
|                                                        |                                                          |          |       |       |          |  |       |          |  

Consolidated Results  Comparison of
2003 to 2002

Sales

Consolidated sales increased $212.5 million,
or 6.1%, to $3,698.6 million in 2003 from
$3,486.1 million in 2002. This resulted primarily from
increased sales in the Borders and International segments due to
the opening of new superstores. A decrease in sales of the
Waldenbooks segment partially offset the increase in
consolidated sales, due primarily to store closures.

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Comparable store sales for all Borders
superstores increased 0.5% in 2003. Comparable store sales
measures for all Borders superstores, which are based upon a
52-week year, include all stores open more than one year except
those not offering music (of which there are 10, representing
approximately 2% of total sales). New stores are included in the
calculation of comparable store sales measures upon the 13th
month of operation. The comparable store sales increase for 2003
was due primarily to the movie and gifts and stationery
categories, which experienced strong positive comparable store
sales, partially offset by negative comparable store sales in
the music category. Comparable store sales of books remained
relatively flat for the year. Sales of movies improved on a
comparable store basis primarily as the result of increased
sales of digital videodiscs (DVDs). Sales of the gifts and
stationery category also increased, principally the result of
category management initiatives resulting in product
enhancements, improved placements, and a slight increase in
space allocation. Negative comparable store sales in the music
category were consistent with the overall decline in music
industry sales. The impact of price changes on comparable store
sales was not significant.

Waldenbooks comparable store sales
decreased 0.6% in 2003. Waldenbooks comparable store sales
measures, which are based upon a 52-week year, include all
stores open more than one year. New stores are included in the
calculation of comparable store sales measures upon the 13th
month of operation. The Companys seasonal mall-based
kiosks are also included in Waldenbooks comparable store
sales measures. The comparable store sales decrease for 2003 was
primarily due to decreased mall traffic and the impact of
superstore openings. These factors were partially offset by
seasonal kiosks sales, which increased 15.6% over the prior
year, primarily due to an increased number of kiosks and to
improved execution of the Companys kiosk strategy. This
also slightly increased the calendar categorys percentage
of Waldenbooks overall merchandise mix relative to the
book and sideline categories. The impact of price changes on
comparable store sales was not significant.

Other revenue

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

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

Gross margin

Consolidated gross margin increased
$46.0 million, or 4.6%, to $1,047.6 million in 2003
from $1,001.6 million in 2002. As a percentage of sales,
however, consolidated gross margin decreased by 0.3%, to 28.4%
in 2003 from 28.7% in 2002. This primarily resulted from a
decrease in gross margin as a percentage of sales for the
Borders segment, partially offset by an increase in the
International and Waldenbooks segments. The decline in the
Borders segment was primarily due to increased occupancy costs
as a percentage of sales and increased bestseller discounts. The
increase in the International segment resulted from a decrease
in merchandise costs, due to improved vendor terms in the United
Kingdom and the weakness of the U.S. dollar. The increase
in the Waldenbooks segment was due to decreased product costs.

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

Selling, general and administrative
expenses

Consolidated selling, general and administrative
expenses (SG&A) increased $34.1 million, or 4.3%, to
$820.0 million in 2003 from $785.9 million in 2002. As
a percentage of sales, however, it decreased 0.2% to 22.3% in
2003 from 22.5% in 2002. This decrease primarily resulted from
decreases in SG&A expenses as a percentage of sales for the
International and Borders segments, partially offset by an
increase in Waldenbooks SG&A as a percentage of sales.

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International SG&A expenses as a percentage
of sales improved as the result of store payroll expenses, store
operating expenses, administrative payroll, other administrative
expenses and advertising costs increasing at rates less than
sales growth. The Borders decrease was related to increased
income from the Companys gift certificate program,
resulting from favorable redemption trends, and a decrease in
store operating expenses due to disciplined cost controls at the
store level. The Waldenbooks increase was primarily due to
increased store payroll expenses, partially offset by a decrease
in store operating expenses, as a percentage of sales.


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

Legal settlement expense

In January 2004, a tentative settlement, subject
to court approval, was reached pursuant to which the Company has
agreed to pay $3.5 million, categorized as Legal
settlement expense in the consolidated statements of
operations during 2003, to resolve all claims asserted in the
California overtime litigation. This action was brought by two
former employees, individually and on behalf of a purported
class consisting of all current and former employees who worked
as assistant managers in Borders stores in the state of
California at any time between April 10, 1996, and the
present.

Asset impairments and other
writedowns

In 2003, the Company recorded a $6.4 million
writedown related to the impairment of certain long-lived assets
(primarily leasehold improvements, furniture, and fixtures), at
certain underperforming Borders and Waldenbooks stores. In
addition, the Company recorded a $0.6 million charge
related to the closure costs of certain Waldenbooks stores. The
Company also recorded a $4.5 million charge related to the
impairment of certain capitalized technology initiatives,
resulting from the Companys reevaluation of its technology
strategy.

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

Interest expense

Consolidated interest expense decreased
$3.9 million, or 31.0%, to $8.7 million in 2003 from
$12.6 million in 2002. This was primarily due to lower
average debt levels resulting largely from increased cash flow
generated by the Borders segment.

Taxes

The effective tax rate for the years presented
differed from the federal statutory rate primarily as a result
of state income taxes. The Companys effective tax rate
used was 38.0% in 2003 compared to 38.4% in 2002. This was
primarily due to increased profit in foreign jurisdictions which
are taxed at a lower rate than domestic profit.

Cumulative effect of accounting
change

In 2003, Borders recorded a $2.1 million
charge, comprised of non-cash depreciation costs, resulting from
the implementation of Financial Accounting Standards Board
Interpretation No. 46, Consolidation of Variable
Interest Entities (FIN 46).

Net income

Due to the factors mentioned above, net income as
a percentage of sales remained flat at 3.2% in 2003 and 2002,
and net income dollars increased to $120.0 million in 2003
from $111.7 million in 2002.

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Consolidated Results  Comparison of
2002 to 2001

Sales

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

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

Waldenbooks comparable store sales
decreased 3.2% in 2002. Waldenbooks comparable store sales
measures, which are based upon a 52-week year, include all
stores open more than one year. New stores are included in the
calculation of comparable store sales measures upon the 13th
month of operation. The Companys seasonal mall-based
kiosks are also included in Waldenbooks comparable store
sales measures. The comparable store sales decrease for 2002 was
due primarily to decreased mall traffic and the impact of
superstore openings. These factors were partially offset by
seasonal kiosk sales, which increased 14.1% over the prior year,
primarily due to an increased number of kiosks and to improved
execution of the Companys kiosk strategy. This also
slightly increased the calendar categorys percentage of
Waldenbooks overall merchandise mix relative to the book
and sideline categories. The impact of price changes on
comparable store sales was not significant.

Other revenue

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

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

Gross margin

Consolidated gross margin increased
$25.8 million, or 2.6%, to $1,001.6 million in 2002
from $975.8 million in 2001. As a percentage of sales,
consolidated gross margin decreased by 0.1%, to 28.7% in 2002
from 28.8% in 2001. Gross margin in 2001 was negatively impacted
by an $8.7 million charge taken by the Borders segment for
the writedown of inventory affected by the Companys
agreement with Ingram Book Company (Ingram). On March 15,
2001, the Company announced an agreement with Ingram, a
wholesaler of books, spoken audio and magazines, pursuant to
which Ingram provides fulfillment services for the
Companys special order book sales. The agreement included
the sale to Ingram of a large percentage of the book inventory
housed in the Companys fulfillment center in LaVergne,
Tennessee, which handled the function assumed by Ingram.
Excluding this charge, 2002 gross margin as a percentage of
sales decreased approximately 0.3% as compared to 2001,
primarily resulting from decreased gross margin percentages in
the Borders, Waldenbooks, and International segments. This was
primarily due to all segments

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incurring higher occupancy costs as a percentage
of sales. In the Borders and Waldenbooks segments, this was the
result of occupancy costs for stores open more than one year
remaining essentially flat while comparable store sales declined.


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

Selling, general and administrative
expenses

Consolidated SG&A increased
$3.9 million, or 0.5%, to $785.9 million in 2002 from
$782.0 million in 2001. As a percentage of sales, however,
it decreased 0.6% to 22.5% in 2002 from 23.1% in 2001. This
decrease primarily resulted from a decrease in SG&A expenses
as a percentage of sales for the Borders segment and, to a
lesser extent, the International and Waldenbooks segments. The
improvement at Borders was primarily the result of a reduction
in Borders.com operating expenses in 2002 in conjunction with
the Mirror Site agreement with Amazon, coupled with a decrease
in store operating expenses as a percentage of sales due to
disciplined cost controls at the store level. The improvement in
the International segment was primarily the result of general
and administrative payroll costs, store payroll costs and store
operating expenses increasing at rates less than sales growth.
The improvement in the Waldenbooks segment was primarily due to
a decrease in corporate administrative expenses as a percentage
of sales.

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

Legal settlement expense

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

Goodwill amortization

In the first quarter of 2002, the Company adopted
Statement of Financial Accounting Standards No. 142,
Goodwill and Other Intangible Assets (FAS 142).
Adoption had the impact of eliminating the Companys
goodwill amortization and increasing net income by approximately
$2.7 million in 2002. In 2001, the Company recorded
$2.7 million of goodwill amortization.

Asset impairments and other
writedowns

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

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

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Interest expense

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

Taxes

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

Net income

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

Segment Results

The Company is organized based upon the following
operating segments: domestic Borders stores, Waldenbooks
stores, International Borders and Books etc. stores, and
Corporate (consisting of the unallocated portion of interest
expense, certain corporate governance costs and corporate
incentive costs). Amounts relating to the Company-owned and
-operated Borders.com Web site, other than intercompany interest
expense (net of related taxes), have been classified in the
Borders segment for all periods presented. Intercompany interest
charges (net of related taxes) relating to Borders.com have been
included in the Corporate segment. See
Note 15  Segment Information in the
notes to consolidated financial statements for further
information relating to these segments.

Segment data includes charges allocating all
corporate headquarters costs to each segment. Interest income
and expense are allocated to segments based upon the cash flow
generated or absorbed by those segments. The Company utilizes
fixed interest rates, approximating the Companys
medium-term borrowing and investing rates, in calculating
segment interest income and expense.

Borders

|                                      |  |      |         |   |      |   |         |      |  |   |         |  
|------------------------------------- |  | ---- | ------- | - | ---- | - | ------- | ---- |  | - | ------- | -
|                                      |  | 2003 |         |   | 2002 |   |         | 2001 | 
|                                      |  |      |         |   |      |   |         |      | 
|(dollar amounts in millions)          |  |      |         |   |      |  
|Sales                                 |  | $    | 2,470.2 |   |      | $ | 2,319.0 |      |  | $ | 2,234.1 |  
|Net income                            |  | $    | 100.5   |   |      | $ | 102.5   |      |  | $ | 72.1    |  
|Net income as % of sales              |  |      | 4.1     | % |      |   | 4.4     | %    |  |   | 3.2     | %
|Depreciation and amortization expense |  | $    | 70.2    |   |      | $ | 66.7    |      |  | $ | 65.4    |  
|Interest (income) expense             |  | $    | (1.9    | ) |      | $ | 2.5     |      |  | $ | 9.1     |  
|Store openings                        |  |      | 41      |   |      |   | 41      |      |  |   | 29      |  
|Store closings                        |  |      |        |   |      |   |        |      |  |   | 1       |  
|Store count                           |  |      | 445     |   |      |   | 404     |      |  |   | 363     |  

Borders  Comparison of 2003 to
2002

Sales

Borders sales increased
$151.2 million, or 6.5%, to $2,470.2 million in 2003
from $2,319.0 million in 2002. This increase was comprised
of non-comparable sales primarily associated with 2003 and 2002
store openings.

Gross margin

Gross margin as a percentage of sales decreased
approximately 0.7% in 2003 compared to 2002. The largest
contributor to this decrease was a 0.7% increase in store
occupancy costs as a percentage of sales primarily as a result

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of the stores rent, common area
maintenance, property taxes, and insurance expenses representing
a higher percentage of sales. This was primarily due to new
stores rent costs representing a higher percentage of
sales than older stores and the increased lease costs related to
the permanent refinancing of certain stores previously financed
through the Original Lease Facility. In addition, the gross
margin percentage decreased approximately 0.2% due to increased
bestseller discounts. Offsetting these items was an increase in
referral fees of 0.1% and decreased distribution costs of 0.1%.
The overall mix of merchandise sold by Borders stores did not
significantly change, or affect margin rates significantly, in
2003 as compared to 2002.


Gross margin dollars increased approximately 3.9%
in 2003 primarily due to new store openings, partially offset by
the decrease in gross margin percentage noted above.

Selling, general and administrative
expenses

SG&A as a percentage of sales improved 0.4%
in 2003 compared to 2002, primarily as a result of a decrease of
0.3% of administrative costs as a percentage of sales. The
decrease in administrative costs was due to increased income
from the Companys gift certificate program resulting from
favorable redemption trends. In addition there was a decrease of
0.1% in store operating expenses due to disciplined cost
controls at the store level. Store payroll, corporate
administrative payroll and advertising costs remained flat as a
percentage of sales.

SG&A dollars increased approximately 4.7% in
2003 compared to 2002, primarily due to new store openings and
the increased store payroll and operating expenses required.

Asset impairments and other
writedowns

In 2003, the Company recorded a $6.1 million
writedown related to the impairment of assets at certain
underperforming Borders stores. Borders also incurred a
$3.0 million writedown related to the impairment of certain
capitalized technology initiatives.

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

Depreciation and amortization

Depreciation and amortization expense increased
$3.5 million, or 5.2%, to $70.2 million in 2003 from
$66.7 million in 2002. This was primarily the result of
increased depreciation expense recognized on new stores
capital expenditures.

Interest income

Interest increased $4.4 million to
$1.9 million of income in 2003 from expense of
$2.5 million in 2002. This was due to the generation of
increased cash flow, which reduced average borrowing levels at
fixed internal interest rates.

Cumulative effect of accounting
change

In 2003, Borders recorded a $2.1 million
charge, comprised of non-cash depreciation costs, resulting from
the implementation of FIN 46.

Net income

Due to the factors mentioned above, net income as
a percentage of sales decreased to 4.1% in 2003 from 4.4% in
2002, and net income dollars decreased to $100.5 million in
2003 from $102.5 million in 2002.

Effect of terrorist attacks on
September 11, 2001

As a result of the terrorist attacks on
September 11, 2001, a Borders store that operated in the
World Trade Center in New York City was destroyed. The loss
of that stores sales and net income was not material to
the consolidated 2003, 2002 or 2001 results as a whole. The
Company was insured for the replacement value of the assets
destroyed at the

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store and up to 24 months of lost income
from business interruption coverage and has recognized a total
recovery of $18.7 million to date.


During 2003, Borders recognized as income an
insurance reimbursement of $2.8 million related to the
September 11, 2001 loss. Of this, $0.7 million
represented business interruption proceeds for 2003. This was
categorized as Cost of merchandise sold in the
consolidated statements of operations, because the stores
lost income would primarily have been categorized as Gross
margin in the consolidated statements of operations. In
addition, $1.8 million was categorized as an offset to
Selling, general and administrative expenses. This
amount primarily represented the excess of lost assets
replacement value over their net book value. It is the
Companys policy to record gains and losses on asset
disposals as a part of Selling, general and administrative
expenses. The remaining $0.3 million was related to
pre-opening expenses incurred in the opening of replacement
stores in New York City. This was categorized as an offset
to Pre-opening expense on the consolidated
statements of operations.

During 2002, the Company recognized a
$2.9 million gain from insurance proceeds related to the
terrorist attacks. Of this, $1.2 million represented
business interruption proceeds for 2002. The remaining
$1.7 million gain primarily represented the excess of lost
assets replacement value over their net book value.

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

The Company expects to recover additional
insurance amounts, up to a maximum of approximately
$1.2 million, based upon capital expenditures and
pre-opening costs in replacement stores, which will be
recognized when collection of such additional recoveries is
assured.

Borders  Comparison of 2002 to
2001

Sales

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

Gross margin

Gross margin as a percentage of sales increased
approximately 0.2% in 2002 compared to 2001. Gross margin in
2001 was negatively impacted by an $8.7 million charge
taken for the writedown of inventory affected by the
Companys agreement with Ingram. Excluding this charge,
2002 gross margin as a percentage of sales decreased
approximately 0.2%, primarily due to higher store occupancy
costs as a percentage of sales. Store occupancy costs as a
percentage of sales increased 0.6% in 2002 compared to 2001
primarily as a result of the stores rent expense
representing a higher percentage of sales. This was primarily
due to rent expense for stores open more than one year remaining
essentially flat while comparable store sales declined. In
addition, new stores rent costs represented a higher
percentage of sales due to the permanent refinancing in 2002 of
certain stores previously financed through the Original Lease
Facility. Partially offsetting the increase in store occupancy
costs was an increase in referral fees of 0.1%, along with
decreases in product costs of 0.2% and distribution costs of
0.1% as a percentage of sales. The overall mix of book, music,
movie, cafe, and gifts and stationery merchandise sold by
Borders stores did not change significantly in 2002 as compared
to 2001.

Gross margin dollars increased approximately 4.5%
in 2002 primarily due to new store openings and the
$8.7 million charge taken in 2001 for the writedown of
inventory affected by the Companys agreement with Ingram.
Partially offsetting these factors were increased store
occupancy costs associated with new store openings.

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Selling, general and administrative
expenses

SG&A as a percentage of sales improved 0.6%
in 2002 compared to 2001. Of this, 0.3% was primarily due to a
reduction in Borders.com operating expenses in 2002 in
conjunction with the Mirror Site agreement with Amazon. The
remaining improvement was primarily due to a decrease of 0.3% in
store operating expenses as a percentage of sales due to
disciplined cost controls at the store level.

SG&A dollars increased approximately 1.1% in
2002 primarily due to new store openings and the increased store
payroll and operating expenses required.

Asset impairments and other
writedowns

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

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

Depreciation and amortization

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

Interest expense

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

Net income

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

Waldenbooks

|                             |  |      |       |   |      |   |       |      |  |   |       |  
|---------------------------- |  | ---- | ----- | - | ---- | - | ----- | ---- |  | - | ----- | -
|                             |  | 2003 |       |   | 2002 |   |       | 2001 | 
|                             |  |      |       |   |      |   |       |      | 
|                             |  |      |       |  
|(dollar amounts in millions) |  |      |       |   |     
|                             |  |      |       |  
|Sales                        |  | $    | 820.9 |   |      | $ | 852.2 |      |  | $ | 902.1 |  
|Other revenue                |  | $    | 24.1  |   |      | $ | 25.0  |      |  | $ | 25.3  |  
|Net income                   |  | $    | 49.0  |   |      | $ | 41.4  |      |  | $ | 39.5  |  
|Net income as % of sales     |  |      | 6.0   | % |      |   | 4.9   | %    |  |   | 4.4   | %
|Depreciation expense         |  | $    | 18.4  |   |      | $ | 20.7  |      |  | $ | 21.4  |  
|Interest income              |  | $    | 38.8  |   |      | $ | 33.5  |      |  | $ | 28.3  |  
|Store openings               |  |      | 5     |   |      |   | 4     |      |  |   | 11    |  
|Store closings               |  |      | 67    |   |      |   | 53    |      |  |   | 53    |  
|Store count                  |  |      | 716   |   |      |   | 778   |      |  |   | 827   |  

Waldenbooks  Comparison of 2003 to
2002

Sales

Waldenbooks sales decreased
$31.3 million, or 3.7%, to $820.9 million in 2003 from
$852.2 million in 2002. This decrease was comprised of
decreased comparable store sales of $4.9 million and
decreased non-comparable sales associated with 2003 and 2002
store closings of $26.4 million.

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Other revenue

Waldenbooks other revenue, which consists
primarily of membership income from the Preferred Reader
Program, decreased 3.6% to $24.1 million in 2003 from
$25.0 million in 2002.

Gross margin

Gross margin as a percentage of sales increased
0.4% as a percentage of sales in 2003 as compared to 2002,
primarily due to decreased product costs of 0.3% as a percentage
of sales resulting from the increased sales of calendars, which
offered higher gross margin percentages than other categories,
and a decrease in distribution costs of 0.1% as a percentage of
sales related to Borders increased usage of
Waldenbooks distribution facilities (coupled with a
corresponding decrease in Waldenbooks usage).

Gross margin dollars decreased approximately 2.0%
in 2003 primarily due to store closings, partially offset by the
increase in gross margin percentage.

Selling, general and administrative
expenses

SG&A as a percentage of sales increased 0.1%
in 2003 compared to 2002, primarily resulting from a 0.2%
increase in store payroll expenses as a percentage of sales,
partially offset by a 0.1% decrease in store operating expenses
as a percentage of sales.

SG&A dollars decreased 3.3% in 2003 primarily
due to store closings, partially offset by the increase in
SG&A percentage discussed above.

Asset impairments and other
writedowns

In 2003, Waldenbooks incurred $0.3 million
of asset impairment charges related to underperforming
Waldenbooks stores. In addition, the Company recorded an asset
impairment charge of $0.6 million related to the closure
costs of certain Waldenbooks stores. Waldenbooks also incurred a
$1.4 million writedown related to the impairment of certain
capitalized technology initiatives.

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

Depreciation

Depreciation expense decreased $2.3 million,
or 11.1%, to $18.4 million in 2003 from $20.7 million
in 2002. This was primarily due to a lower fixed asset base
resulting from asset impairments and store closings.

Interest income

Interest income increased $5.3 million, or
15.8% to $38.8 million in 2003 from $33.5 million in
2002. This was the result of Waldenbooks continued
positive cash flow at fixed internal interest rates.

Net income

Due to the factors mentioned above, net income as
a percentage of sales increased to 6.0% in 2003 from 4.9% in
2002, while net income dollars increased $7.6 million, or
18.4%, to $49.0 million in 2003 from $41.4 million in
2002.

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Waldenbooks  Comparison of 2002 to
2001

Sales

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

Other revenue

Waldenbooks other revenue, which consists
of membership income from the Preferred Reader Program,
decreased 1.2% to $25.0 million in 2002 from
$25.3 million in 2001.

Gross margin

Gross margin as a percentage of sales decreased
approximately 0.2% in 2002 as compared to 2001. Contributing to
this decrease was a 0.7% increase in store occupancy expenses as
a percentage of sales, due primarily to rent expense for stores
remaining open more than one year remaining essentially flat
while comparable stores sales declined. This was partially
offset by lower product costs of 0.2%, resulting primarily from
the increased sales of calendars, which offered higher gross
margin percentages than other categories. In addition, there was
a decrease of 0.2% in distribution costs, related to
Borders increased usage of Waldenbooks distribution
facilities (coupled with a corresponding decrease in
Waldenbooks usage). Other revenue as a percentage of sales
also improved 0.1%.

Gross margin dollars decreased approximately 6.4%
in 2002, primarily due to store closings, the decrease in
comparable store sales, and the decrease in gross margin
percentage.

Selling, general and administrative
expenses

SG&A as a percentage of sales decreased 0.1%
in 2002 compared to 2001. This decrease was primarily due to a
0.6% decrease in corporate administrative expenses as a
percentage of sales, partially offset by increased store payroll
expenses as a percentage of sales of 0.5%.

SG&A dollars decreased approximately 6.0% in
2002 primarily due to store closings.

Asset impairments and other
writedowns

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

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

Depreciation

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

Interest income

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

Net income

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

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International

|                                      |  |      |       |   |      |   |       |      |  |   |       |   
|------------------------------------- |  | ---- | ----- | - | ---- | - | ----- | ---- |  | - | ----- | --
|                                      |  | 2003 |       |   | 2002 |   |       | 2001 | 
|                                      |  |      |       |   |      |   |       |      | 
|(dollar amounts in millions)          |  |      |       |   |      |  
|Sales                                 |  | $    | 407.5 |   |      | $ | 314.9 |      |  | $ | 251.7 |   
|Net income (loss)                     |  | $    | 0.1   |   |      | $ | (12.3 | )    |  | $ | (7.5  | ) 
|Net income (loss) as % of sales       |  |      |      | % |      |   | (3.9  | )%   |  |   | (3.0  | )%
|Depreciation and amortization expense |  | $    | 12.0  |   |      | $ | 9.7   |      |  | $ | 9.4   |   
|Interest expense                      |  | $    | 19.0  |   |      | $ | 17.2  |      |  | $ | 14.3  |   
|Superstore store openings             |  |      | 7     |   |      |   | 8     |      |  |   | 8     |   
|Superstore store count                |  |      | 37    |   |      |   | 30    |      |  |   | 22    |   
|Books etc. store openings             |  |      | 1     |   |      |   | 1     |      |  |   | 5     |   
|Books etc. store closings             |  |      | 2     |   |      |   |      |      |  |   |      |   
|Books etc. store count                |  |      | 36    |   |      |   | 37    |      |  |   | 36    |   

International  Comparison of 2003
to 2002

Sales

International sales increased $92.6 million,
or 29.4%, to $407.5 million in 2003 from
$314.9 million in 2002, primarily resulting from new
superstore openings. In 2003, the Company opened seven
International superstores and one Books etc. store in the United
Kingdom. In addition, 7.2% of the sales growth year-over-year
was related to favorable exchange rates. The impact of price
changes on comparable store sales was not significant.

Gross margin

Gross margin as a percentage of sales increased
0.8% in 2003 as compared to 2002, primarily the result of a
decrease of 0.6% in merchandise costs as a percentage of sales.
The decrease in merchandise cost as a percentage of sales is
primarily due to improved vendor terms in the Companys
U.K. operations. The weakness of the U.S. dollar also
contributed to the improvement in product costs, primarily
benefiting the Companys operations in countries with a
relatively high percentage of U.S.-sourced merchandise. Also
contributing to the increase in the gross margin percentage was
an increase of 0.4% in third party café income and
improvements of 0.2% in distribution costs as a percentage of
sales, due to the improved leverage and efficiency in servicing
the additional volume of new stores. Partially offsetting these
factors were increased occupancy costs of 0.4% as a percentage
of sales due to new store openings and landlord-imposed rent
adjustments. The overall mix of book, music, movie, café,
and sideline merchandise sold by International superstores, and
the mix of books and sidelines offered by Books etc. stores, did
not change significantly, or affect margin rates significantly,
in 2003 as compared to 2002.

Gross margin dollars increased approximately
33.9% in 2003 primarily due to new store openings along with the
favorable impact of exchange rates on sales.

Selling, general and administrative
expenses

SG&A as a percentage of sales decreased
approximately 2.6% in 2003 compared to 2002. This improvement
was primarily the result of decreases as a percentage of sales
in: store payroll costs of 1.0%, resulting from a change in the
U.K. store management structure to allow more flexibility in
leveraging sales; store operating expenses of 0.6%, due to
leverage achieved in security, supplies, and repairs and
maintenance costs; administrative payroll of 0.5%, due to costs
remaining flat to 2002 levels; administrative expenses of 0.3%,
due to costs remaining relatively flat to 2002 levels; and
advertising expenses of 0.2%, due to reduced spending.

SG&A dollars increased approximately 13.9% in
2003 primarily due to store openings and the increased store
payroll and operating expenses required coupled with the impact
of exchange rates.

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Asset impairments and other
writedowns

In 2003, the International segment incurred a
$0.1 million writedown related to the impairment of certain
capitalized technology initiatives.

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

Depreciation and amortization

Depreciation and amortization expense increased
$2.3 million, or 23.7%, to $12.0 million in 2003 from
$9.7 million in 2002. This was primarily due to
depreciation expense recognized on new stores capital
expenditures.

Interest expense

Interest expense increased $1.8 million, or
10.5%, to $19.0 million in 2003 from $17.2 million in
2002. This was a result of higher average borrowing levels at
fixed internal interest rates.

Net income

Due to the factors mentioned above, net income as
a percentage of sales was slightly positive in 2003 as compared
to a loss of 3.9% in 2002, and net income dollars increased
$12.4 million to $0.1 million in 2003 from a loss of
$12.3 million in 2002.

Exchange rates positively impacted the comparison
of 2003 net income to 2002 net loss by approximately
$1.6 million. Foreign currency transaction gains/ (losses)
were $(0.4) million in 2003 and $0.1 million in 2002.

International  Comparison of 2002
to 2001

Sales

International sales increased $63.2 million,
or 25.1%, to $314.9 million in 2002 from
$251.7 million in 2001, primarily resulting from new
superstore openings. In 2002, the Company opened five
International stores in the United Kingdom and three stores in
Australia. The impact of price changes on comparable store sales
was not significant.

Gross margin

Gross margin as a percentage of sales decreased
0.8% in 2002 as compared to 2001, primarily the result of a 0.6%
increase in occupancy costs as a percentage of sales. Also
impacting the decrease was a 0.3% increase in merchandise costs
as a percentage of sales. The increase in merchandise costs as a
percentage of sales is primarily due to the Companys
growth of its U.K. operations, which have typically experienced
higher product costs than the International segments other
countries. The Companys U.K. operations represented a
larger percentage of the International segments total
operations in 2002 than in 2001. Occupancy costs increased as a
percentage of sales due to new store openings and
landlord-imposed rent adjustments. Partially offsetting these
factors were improvements of 0.1% in distribution costs as a
percentage of sales. The overall mix of book, music, movie,
cafe, and sideline merchandise sold by International
superstores, and the mix of books and sidelines offered by Books
etc. stores, did not change significantly, or affect margin
rates significantly, in 2002 as compared to 2001.

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

Selling, general and administrative
expenses

SG&A as a percentage of sales decreased
approximately 0.5% in 2002 compared to 2001. This improvement
was primarily the result of general and administrative payroll
costs, store payroll costs and store operating expenses, all of

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which increased at rates less than sales growth.
Although general and administrative payroll costs, store payroll
costs and store operating expenses increased in dollars, the
increase in sales reduced these expenses as a percentage of
sales.


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

Asset impairments and other
writedowns

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

Depreciation and amortization

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

Interest expense

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

Net loss

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

Exchange rates positively impacted the comparison
of 2002 net loss to 2001 net loss by approximately
$0.6 million. Foreign currency transaction gains were
$0.1 million and $0.3 million in 2002 and 2001
respectively.

Corporate

|                             |  |      |      |  |      |   |      |      |  |   |      | 
|---------------------------- |  | ---- | ---- |  | ---- | - | ---- | ---- |  | - | ---- | 
|                             |  | 2003 |      |  | 2002 |   |      | 2001 | 
|                             |  |      |      |  |      |   |      |      | 
|                             |  |      |      | 
|(dollar amounts in millions) |  |      |      |  |     
|Interest expense             |  | $    | 30.4 |  |      | $ | 26.4 |      |  | $ | 19.3 | 
|Net loss                     |  | $    | 29.6 |  |      | $ | 19.9 |      |  | $ | 16.7 | 

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

Corporate  Comparison of 2003 to
2002

Net loss dollars increased $9.7 million, or
48.7%, to $29.6 million in 2003 from $19.9 million in
2002. This was primarily due to the tentative settlement of the
California overtime litigation, increased interest expense,
increased corporate incentive payments, increased legal defense
costs and a receivable writedown. Interest expense represents
corporate-level interest costs not charged to the Companys
operating segments.

Corporate  Comparison of 2002 to
2001

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

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Liquidity and Capital Resources

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

Net cash provided by continuing operations was
$228.1 million, $189.2 million, and
$265.0 million in 2003, 2002, and 2001, respectively. The
current year operating cash inflows primarily reflect operating
results net of non-cash charges for depreciation and asset
impairments and other writedowns, as well as an increase in
accounts payable, taxes payable and other long-term liabilities
and a decrease in deferred income taxes. Operating cash outflows
for the period resulted from increases in inventories, other
long-term assets, prepaid expenses and accounts receivable, as
well as a decrease in accrued payroll and other liabilities. The
most significant cash outflow was related to the increase in
inventory, which was partially offset by an increase in accounts
payable. The increase in inventories resulted from new store
growth, which was partially offset by continued efficiencies in
the existing store base.

Net cash used by discontinued operations was
$0.8 million in 2001, which represents the cash needed for
the operations of All Wound Up. In January 2001, the Company
adopted a plan to discontinue operations of All Wound Up, a
seasonal retailer of interactive toys and novelty merchandise
the Company had acquired in March 1999. Accordingly, the
operating results of All Wound Up have been segregated from
continuing operations.

Net cash used for investing in 2003 was
$103.4 million, which primarily funded capital expenditures
for new stores and the refurbishment of existing stores. Capital
expenditures in 2003 reflect the opening of 48 new superstores
and five new Waldenbooks stores, including four new airport
stores. In fiscal 2002 capital expenditures were
$121.5 million, which primarily funded new stores and the
refurbishment of existing stores. Capital expenditures in 2002
reflect the opening of 49 new superstores and four new
Waldenbooks stores. In fiscal 2001 capital expenditures were
$90.7 million, which primarily funded new stores and the
refurbishment of existing stores. Capital expenditures in 2001
reflect the opening of 37 new superstores and 11 new Waldenbooks
stores. Additional capital spending in 2003, 2002 and 2001
reflected the development and installation of in-store Web-based
technology and spending on corporate information technology
streamlining.

In 2003, the Company acquired substantially all
assets used in or related to the operations of two stores in
Louisville, Kentucky from Hawley-Cooke Booksellers, Inc.
The acquisition was not material to the consolidated statements
of operations, the consolidated balance sheets, or the
consolidated statements of cash flows of the Company.

Net cash used for financing was $15.8 in 2003,
resulting primarily from the Companys repurchase of common
stock of $44.0 million, which was partially offset by
proceeds of $27.4 million from exercise of employee stock
options. Net cash provided by financing in 2002 was
$8.4 million, resulting primarily from the issuance of
$50.0 million senior guaranteed notes and the issuance of
common stock under the Companys employee benefit plans of
$18.8 million, partially offset by the repurchase of common
stock of $74.8 million. Net cash used for financing in 2001
was $41.1 million, resulting primarily from the paydown of
the Companys Credit Agreement of $58.2 million and
the repurchase of common stock of $17.7 million, partially
offset by $34.9 million received from the issuance of
common stock under the Companys employee benefit plans.

The Company expects capital expenditures to be
approximately $110.0 million in 2004, resulting primarily
from new domestic superstore openings and a major remodel
program related to 40 to 50 domestic Borders superstore
locations. In addition, capital expenditures will result from
International store openings and investment in information
technology. The Company currently plans to open approximately 18
to 20 domestic Borders superstores and six to eight
international stores in 2004. Average cash requirements for the
opening of a prototype Borders Books and Music superstore are
$2.4 million, representing capital expenditures of
$1.2 million, inventory requirements (net of related
accounts payable) of $1.0 million, and $0.2 million of
pre-opening costs. Average cash requirements to open a new or
expanded Waldenbooks store range from $0.4 million to
$0.7 million, depending on the size and format of the
store. The Company also plans to perform major remodels of 40 to
50 domestic Borders superstore locations. Average cash
requirements for a major remodel of a Borders superstore are
between $0.3 million to $0.4 million. The Company
plans to lease new store locations predominantly under operating
leases.

The Company plans to execute its expansion plans
for Borders superstores and other strategic initiatives
principally with funds generated from operations and financing
if necessary through the Lease Financing Facilities and Credit

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Agreement, discussed below. The Company believes
funds generated from operations, borrowings under the Credit
Agreement and financing through the Lease Financing Facilities
will be sufficient to fund its anticipated capital requirements
for the next several years.


In May 2003, the Board of Directors authorized an
increase in the Companys share repurchase program to
$150.0 million (plus any proceeds and tax benefits
resulting from stock option exercises and tax benefits resulting
from restricted shares purchased by employees from the Company).
The Company currently has a share repurchase program in place
with remaining authorization to repurchase approximately
$143.4 million. During 2003, 2002, and 2001,
$44.0 million, $74.8 million, and $17.7 million
of common stock was repurchased, respectively. The Company plans
to continue the repurchase of its common stock throughout fiscal
2004, subject to the Companys share price and capital
needs.

In November 2003, the Board of Directors declared
a quarterly cash dividend of $0.08 per share, which equaled
$6.2 million in total, on the Companys common stock,
payable January 28, 2004 to stockholders of record at the
close of business January 7, 2004. The Company intends to
pay regular quarterly cash dividends, subject to Board approval,
going forward.

The Company has a Multicurrency Revolving Credit
Agreement (the Credit Agreement), which was amended
in May 2003 and will expire in June 2005. The Credit Agreement
provides for borrowings of up to $450.0 million. Borrowings
under the Credit Agreement bear interest at a variable base rate
plus an increment or LIBOR plus an increment at the
Companys option. The Credit Agreement contains covenants
which limit, among other things, the Companys ability to
incur indebtedness, grant liens, make investments, consolidate
or merge, dispose of assets, repurchase its common stock and/or
declare dividends in excess of an aggregate $225.0 million
over the term of the Agreement (plus any proceeds and tax
benefits resulting from stock option exercises and tax benefits
resulting from restricted shares purchased by employees from the
Company), and requires the Company to meet certain financial
measures regarding fixed coverage, leverage, tangible net worth
and capital expenditures. The declaration and payment of
dividends, if any, is subject to the discretion of the Board and
to certain limitations under the Michigan Business Corporation
Act. In addition, the Companys ability to pay dividends is
restricted by certain agreements to which the Company is a
party. As of January 25, 2004 the Company was in compliance
with all covenants contained within this agreement. The Company
had borrowings outstanding under the Credit Agreement (or a
prior agreement) of $126.9 million at January 25, 2004
and $112.1 million at January 26, 2003.

The Company currently has in place two interest
rate swaps which effectively convert a portion of the Credit
Agreements variable rate exposure to fixed interest rates.
In accordance with Statement of Financial Accounting Standards
No. 133, Accounting For Derivative Instruments and
Hedging Activities (FAS 133), the Company has
designated these swap agreements as cash flow hedges. The
notional amounts of these agreements total $73.0 million
and the agreements expire concurrently with the expiration of
the Credit Agreement.

On July 30, 2002, the Company issued
$50.0 million of senior guaranteed notes (the
Notes) due July 30, 2006 and bearing interest
at 6.31% (payable semi-annually). The proceeds of the sale of
the Notes are being used to refinance existing indebtedness of
the Company and its subsidiaries and for general corporate
purposes. The note purchase agreement relating to the Notes
contains covenants which limit, among other things, the
Companys ability to incur indebtedness, grant liens, make
investments, engage in any merger or consolidation, dispose of
assets or change the nature of its business, and requires the
Company to meet certain financial measures regarding net worth,
total debt coverage and fixed charge coverage. As of
January 25, 2004 the Company was in compliance with all
covenants contained within this agreement.

In August 2003, the Company entered into an
interest rate swap agreement which effectively converted the
fixed interest rate on the Companys Notes to a variable
rate based on LIBOR. In accordance with the provisions of
FAS 133, the Company has designated this swap agreement as
a fair market value hedge. The notional amount of the swap
agreement is $50.0 million, and it expires concurrently
with the due date of the Notes. In March 2004, the Company
entered into an agreement to terminate this swap if a
termination value of $1.6 million is reached.

In the quarter ended January 25, 2004, the
Company began consolidating $19.7 million of debt related
to certain properties consolidated pursuant to FIN 46
(described below) in its consolidated balance sheets.

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The Company has two lease financing facilities
(collectively, the Lease Financing Facilities),
which were amended in May 2003, to finance new stores and other
property owned by unaffiliated entities and leased to the
Company or its subsidiaries. The original facility (the
Original Lease Facility) will expire in June 2004
(2005 if certain conditions are satisfied). In June of 2002, the
Company established a new facility (the New Lease
Facility), which will expire in 2007. The aggregate amount
available under the Lease Financing Facilities is
$25.0 million. Properties to be financed after the
effective date of the New Lease Facility will be financed under
that Facility, and no additional properties will be financed
under the Original Lease Facility. The Lease Financing
Facilities provide financing to lessors of properties leased to
the Company or its subsidiaries through loans from lenders for
up to 95% of a projects cost. Additionally, under the New
Lease Facility, the unaffiliated lessor will make equity
contributions approximating 5% of the cost of each project. The
lessors under the Original Lease Facility have made similar
contributions.

Independent of the Companys obligations
relating to the leases, the Company and certain of its
subsidiaries guarantee payment when due of all amounts required
to be paid to the third-party lenders. The principal amount
guaranteed is limited to approximately 89% of the original cost
of a project so long as the Company is not in default under the
lease relating to such project. The agreements relating to both
of the Lease Financing Facilities contain covenants and events
of default that are similar to those contained in the Credit
Agreement described above. Security interests in the properties
underlying the leases and in the Companys interests in the
leases have been given to the lenders. The Lease Financing
Facilities contain cross default provisions with respect to the
obligations of the Company under the Credit Agreement and
certain other agreements to which the Company is a party. There
also are cross default provisions with respect to the
obligations relating to the Lease Financing Facilities of
Wilmington Trust Company, as owner trustee of a grantor trust
formed for the Lease Financing Facilities, and the unaffiliated
beneficial owner of the grantor trust. At January 25, 2004,
the maximum loss that the Company could incur under these
guarantees approximated $13.8 million.

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

There were two and seven properties financed
through the Original Lease Facility at January 25, 2004 and
January 26, 2003, respectively, with financed values of
$13.8 million and $36.3 million. The two properties
financed through the Original Lease Facility at January 25,
2004 were consolidated by the Company, pursuant to the
provisions of FIN 46, as discussed below. Of the amount
financed under the Original Lease Facility at January 26,
2003, the Company had recorded $19.0 million as capitalized
leases, under Other assets (for the capital lease
assets) and Long-term capital lease obligations (for
the capital lease liabilities) on the consolidated balance
sheets at January 26, 2003. These amounts were treated as
non-cash items on the consolidated statements of cash flows.
There were no borrowings under the New Lease Facility as of
January 25, 2004 or January 26, 2003.

In 2003, lessors permanently financed five
properties that had been previously financed through the
Original Lease Facility with a total value of approximately
$22.5 million, two of which had been capitalized and three
of which had not been capitalized at January 26, 2003.

Pursuant to the requirements of FIN 46, the
Company believes that it is the primary beneficiary of the two
variable interest entities (VIEs) that own the two properties
financed under the Original Lease Facility at January 25,
2004. As a result, the Company began consolidating these VIEs in
the quarter ending January 25, 2004 and recorded land,
property and equipment, net of accumulated depreciation, of
$12.5 million, short-term borrowings of $13.8 million,
and minority interest of $1.3 million at January 25,
2004. These amounts have been treated as non-cash items on the
consolidated statements of cash flows.

The Company also believes it is the primary
beneficiary of two additional VIEs, both of which had borrowings
outstanding under the Original Lease Facility at
January 26, 2003, but whose borrowings had been permanently
financed by the VIEs during 2003. As a result, the Company began
consolidating these VIEs in the quarter ending January 25,
2004, and recorded property and equipment, net of accumulated
depreciation, of $5.5 million, long-term

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debt of $5.9 million, and minority interest
of $0.4 million at January 25, 2004. These amounts
have been treated as non-cash items on the consolidated
statements of cash flows.


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

The following table summarizes the Companys
significant contractual obligations:

|                             |  |             |       |          |           |   |       |           |  |   |            |  |  |       |         |  |  |   |         | 
|---------------------------- |  | ----------- | ----- | -------- | --------- | - | ----- | --------- |  | - | ---------- |  |  | ----- | ------- |  |  | - | ------- | 
|                             |  |            
|                             |  | Fiscal Year |      
|                             |  |             |       | 2009 and |           |   |      
|                             |  | 2004        |       |          | 2005-2006 |   |       | 2007-2008 |  |   | thereafter |  |  | Total |        
|(dollars in millions)        |  |             |       |          |           |   |       |           |  |   |            |  |  |       |        
|Credit Agreement borrowings  |  | $           | 126.9 |          |           | $ |      |           |  | $ |           |  |  | $     |        |  |  | $ | 126.9   | 
|Capital lease obligations    |  |             | 0.4   |          |           |   |      |           |  |   |           |  |  |       |        |  |  |   | 0.4     | 
|Operating lease obligations  |  |             | 314.7 |          |           |   | 590.0 |           |  |   | 558.6      |  |  |       | 2,177.8 |  |  |   | 3,641.1 | 
|Senior guaranteed notes      |  |             |      |          |           |   | 50.0  |           |  |   |           |  |  |       |        |  |  |   | 50.0    | 
|Debt of consolidated VIEs    |  |             | 13.9  |          |           |   | 0.4   |           |  |   | 0.4        |  |  |       | 5.0     |  |  |   | 19.7    | 
|                             |  |             |       |          |           |   |       |           |  |   |            |  |  |       |        
|Total                        |  | $           | 455.9 |          |           | $ | 640.4 |           |  | $ | 559.0      |  |  | $     | 2,182.8 |  |  | $ | 3,838.1 | 
|                             |  |             |       |          |           |   |       |           |  |   |            |  |  |       |        
|Lease Facility guarantees(1) |  | $           | 13.8  |          |           | $ |      |           |  | $ |           |  |  | $     |        |  |  | $ | 13.8    | 



|    |                                       
|--- | --------------------------------------
|(1) | Included as debt of consolidated VIEs.

Seasonality

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

|                        |                         |                           |       |      |      |   |       |         |   |   |         |      |   |   |         |      |  
|----------------------- | ----------------------- | ------------------------- | ----- | ---- | ---- | - | ----- | ------- | - | - | ------- | ---- | - | - | ------- | ---- | -
|                        |                         |                          
|                        |                         | Fiscal 2003 Quarter Ended |      
|                        |                         | April                     |       |      | July |   |       | October |   |   | January |     
|(dollars in millions)   |                         |                           |       |      |      |   |       |         |   |   |         |     
|Sales                   |                         | $                         | 751.4 |      |      | $ | 826.9 |         |   | $ | 807.9   |      |   | $ | 1,312.4 |     
|Operating income (loss) |                         |                           | (5.5  | )    |      |   | 9.8   |         |   |   | 3.0     |      |   |   | 198.3   |     
|% of full year:         |                         |                           |       |      |      |   |       |         |   |   |         |      |   |   |         |     
|                        | Sales                   |                           |       | 20.3 | %    |   |       | 22.4    | % |   |         | 21.8 | % |   |         | 35.5 | %
|                        | Operating income (loss) |                           |       | (2.7 | )    |   |       | 4.8     |   |   |         | 1.5  |   |   |         | 96.4 |  

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

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

Critical Accounting Policies and
Estimates

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

Asset Impairments

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

Goodwill Impairment

Pursuant to the provisions of FAS 142, the
Companys goodwill is tested for impairment annually (or
more frequently if impairment indicators arise). Pursuant to
FAS 142, a reporting unit is defined as an operating
segment or one level below an operating segment (a component),
for which discrete financial information is available and
reviewed by management. The Companys reporting units were
identified as the operating segments Borders, Waldenbooks and
Corporate, and the country components of the International
operating segment. The carrying amounts of the net assets of the
applicable reporting units (including goodwill) are compared to
the estimated fair values of those reporting units. Fair value
is estimated using a discounted cash flow model which depended
on, among other factors, estimates of future sales and expense
trends, liquidity and capitalization. The discount rate used
approximates the weighted average cost of capital of a
hypothetical third party buyer. Changes in any of the
assumptions underlying these estimates may result in the future
impairment of goodwill. As of January 25, 2004, no
impairment of goodwill existed.

Inventory

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

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that which was projected (for either the
shrinkage or non-returnable inventory reserves) could affect the
recorded amounts of inventory and cost of sales.


The Company includes certain distribution and
other expenses in its inventory costs, particularly freight,
distribution payroll, and certain occupancy expenses. In
addition, certain selling, general and administrative expenses
are included in inventory costs. These amounts totaled
approximately $86.9 million and $81.0 million as of
January 25, 2004 and January 26, 2003, respectively.
The extent to which these costs are included in inventory is
based on certain estimates of space and labor allocation.

Leases

All leases, including those for properties
financed through the Lease Financing Facilities, are reviewed
for capital or operating classification at their inception under
the guidance of Statement of Financial Accounting Standards
No. 13, Accounting for Leases (FAS 13), as
amended. The Company uses its incremental borrowing rate in the
assessment of lease classification.

Gift Certificates

The Company sells gift certificates to its
customers and provides for the face value of all certificates
issued within the last 12 months. For certificates older
than 12 months, the Company provides for a portion of the
certificates face value based upon historical redemption
trends. To the extent that future redemption patterns differ
from those historically experienced, significant variations in
the recorded reserves may result.

Advertising and Vendor Incentive
Programs

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

Pursuant to co-operative advertising programs
offered by vendors, the Company contracts with vendors to
promote merchandise for specified time periods. Pursuant to the
provisions of Emerging Issues Task Force Issue No. 02-16,
Accounting by a Customer (Including a Reseller) for
Certain Consideration Received from a Vendor
(EITF 02-16), which the Company adopted effective
January 1, 2003, vendor consideration which represents a
reimbursement of specific, incremental, identifiable costs is
included in the Selling, general and administrative
line on the consolidated statements of operations, along with
the related costs, in the period the promotion takes place.
Consideration which exceeds such costs is classified as a
reduction of the Cost of merchandise sold line on
the consolidated statements of operations. Prior to the adoption
of EITF 02-16, all consideration and costs pursuant to
co-operative advertising programs were included in the
Selling, general and administrative expenses line of
the consolidated statements of operations. The Company has
reclassified the vendor consideration in prior years to conform
to current year presentation and EITF 02-16. Additionally,
the Company has recorded $0.9 million of vendor
consideration as a reduction to its inventory balance at
January 25, 2004.

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

New Accounting Guidance

In November 2002, the Emerging Issues Task Force
issued EITF 02-16, which was effective for all vendor
arrangements entered into after December 31, 2002. The
Consensus requires that consideration received from a vendor be
considered a reduction of the prices of vendors products
and shown as a reduction of cost of sales in the income
statement of the customer. If the consideration represents a
reimbursement of specific incremental identifiable costs
incurred, these amounts should be offset against the related
costs with any excess consideration recorded in cost of

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sales. In fiscal 2003, the Company has
reclassified the prior years vendor consideration to
conform to current year presentation and EITF 02-16.
Additionally, the Company recorded $0.9 million of excess
vendor consideration as a reduction to its inventory balance at
January 25, 2004.


In January 2003, the Financial Accounting
Standards Board (FASB) issued FIN 46. This interpretation
addresses the requirements for business enterprises to
consolidate related entities in which they are the determined to
be the primary beneficiary as a result of their variable
economic interests. The interpretation is intended to provide
guidance in judging multiple economic interests in an entity and
in determining the primary beneficiary. The interpretation
outlines disclosure requirements for variable interest entities
in existence prior to January 31, 2003 and requires
consolidation of variable interest entities created after
January 31, 2003. In addition, the interpretation requires
consolidation of variable interest entities created prior to
January 31, 2003 beginning in the fourth quarter of 2003.
See Liquidity and Capital Resources for further
discussion of the impact on the Company in fiscal 2003.

In April 2003, the FASB issued Statement of
Financial Accounting Standards No. 149, Amendment of
Statement 133 on Derivative Instruments and Hedging
Activities (FAS 149). In general, this statement
amends and clarifies accounting for derivative instruments,
including certain derivative instruments embedded in other
contracts, and for hedging activities under Statement of
Financial Accounting Standards No. 133, Accounting
for Derivative Instruments and Hedging Activities. This
statement is effective for contracts entered into or modified
after June 30, 2003, and for hedging relationships
designated after June 30, 2003. The adoption of
FAS 149 did not have an impact on the Companys
consolidated financial position or disclosures in fiscal 2003.

In May 2003, the FASB issued Statement of
Financial Accounting Standards No. 150, Accounting
for Certain Financial Instruments with Characteristics of both
Liabilities and Equity (FAS 150). This statement
affects the classification, measurement and disclosure
requirements of the following three types of freestanding
financial instruments: 1) mandatorily redeemable shares,
which the issuing company is obligated to buy back with cash or
other assets; 2) instruments that do or may require the
issuer to buy back some of its shares in exchange for cash or
other assets, which includes put options and forward purchase
contracts; and 3) obligations that can be settled with
shares, the monetary value of which is fixed, tied solely or
predominantly to a variable such as a market index, or varies
inversely with the value of the issuers shares. In
general, FAS 150 is effective for all financial instruments
entered into or modified after May 31, 2003, and otherwise
is effective at the beginning of the first interim period
beginning after June 15, 2003. The adoption of FAS 150
did not have an impact on the Companys consolidated
financial position or disclosures in fiscal 2003.

Related Party Transactions

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






|         |                                                               
|-------- | --------------------------------------------------------------
|Item 7A. | Quantitative and Qualitative Disclosures About
    Market Risk

The Company is exposed to market risk during the
normal course of business from changes in interest rates and
foreign currency exchange rates. The exposure to these risks is
managed though a combination of normal operating and financing
activities, which include the use of derivative financial
instruments in the form of interest rate swaps and forward
foreign currency exchange contracts.

Interest rate risk

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

The Company is also subject to risk associated
with the fair value of its $50.0 million of Notes which are
fixed-rate debt. To eliminate this risk, the Company is
currently utilizing an interest rate swap, effectively
converting the Notes fixed interest rate to a variable
rate.

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LIBOR is the rate upon which the Companys
variable rate debt and its payments under the Lease Financing
Facilities are principally based. If LIBOR were to increase 1%
for the full year of 2004 as compared to 2003, the
Companys after-tax earnings, after considering the effects
of its existing interest rate swap agreements, would decrease
approximately $1.4 million based on the Companys
expected average outstanding debt, including its indirect
borrowings under the Original Lease Facility, as of
January 25, 2004.

Foreign currency exchange risk

The Company is subject to foreign currency
exchange exposure for operations with assets and liabilities
that are denominated in currencies other than U.S. Dollars.
On a normal basis, the Company does not attempt to hedge the
foreign currency translation fluctuations in the net investments
in its foreign subsidiaries. The Company does, from time to
time, enter into short-term forward exchange contracts to sell
or purchase foreign currencies at specified rates based on
estimated foreign currency cash flows. It is the policy of the
Company not to purchase financial and/or derivative instruments
for speculative purposes. At January 25, 2004, the Company
had no foreign currency forward contracts outstanding.

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|        |                                                
|------- | -----------------------------------------------
|Item 8. | Financial Statements and Supplementary
    Data

INDEX TO FINANCIAL STATEMENTS

|                                                                                                                                           |  |      |    | 
|------------------------------------------------------------------------------------------------------------------------------------------ |  | ---- | -- | 
|                                                                                                                                           |  | Page |   
|                                                                                                                                           |  |      |   
|Consolidated Statements of Operations for the
    fiscal years ended January 25, 2004, January 26, 2003
    and January 27, 2002           |  |      | 40 | 
|Consolidated Balance Sheets as of
    January 25, 2004 and January 26, 2003                                                                |  |      | 41 | 
|Consolidated Statements of Cash Flows for the
    fiscal years ended January 25, 2004, January 26, 2003
    and January 27, 2002           |  |      | 42 | 
|Consolidated Statements of Stockholders
    Equity for the fiscal years ended January 25, 2004,
    January 26, 2003 and January 27, 2002 |  |      | 43 | 
|Notes to Consolidated Financial Statements                                                                                                 |  |      | 44 | 
|Report of Independent Auditors                                                                                                             |  |      | 64 | 

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##### Table of Contents



CONSOLIDATED STATEMENTS OF
OPERATIONS

(dollars in millions except per share
data)


|                                                        |                                                          |                                                          |            |                                            |          |      |         |          |      |      |         |         |      |      |      | 
|------------------------------------------------------- | -------------------------------------------------------- | -------------------------------------------------------- | ---------- | ------------------------------------------ | -------- | ---- | ------- | -------- | ---- | ---- | ------- | ------- | ---- | ---- | ---- | 
|                                                        |                                                          |                                                         
|                                                        |                                                          | Fiscal Year Ended                                        |           
|                                                        |                                                          | Jan. 25,                                                 |            |                                            | Jan. 26, |      |         | Jan. 27, |     
|                                                        |                                                          | 2004                                                     |            |                                            | 2003     |      |         | 2002     |     
|                                                        |                                                          |                                                          |            |                                            |          |      |         |          |     
|                                                        |                                                          |                                                          |            |                                            |          |     
|Sales                                                   |                                                          | $                                                        | 3,698.6    |                                            |          | $    | 3,486.1 |          |      | $    | 3,387.9 |        
|Other revenue                                           |                                                          |                                                          | 32.4       |                                            |          |      | 28.6    |          |      |      | 26.0    |        
|                                                        |                                                          |                                                          |            |                                            |          |      |         |          |     
|                                                        | Total revenue                                            |                                                          | $          | 3,731.0                                    |          |      | $       | 3,514.7  |      |      | $       | 3,413.9 |     
|Cost of merchandise sold (includes occupancy)           |                                                          |                                                          | 2,682.6    |                                            |          |      | 2,511.3 |          |      |      | 2,428.0 |        
|Fulfillment center and other inventory writedowns       |                                                          |                                                          | 0.8        |                                            |          |      | 1.8     |          |      |      | 10.1    |        
|                                                        |                                                          |                                                          |            |                                            |          |      |         |          |     
|                                                        | Gross margin                                             |                                                          |            | 1,047.6                                    |          |      |         | 1,001.6  |      |      |         | 975.8   |     
|Selling, general and administrative expenses            |                                                          |                                                          | 820.0      |                                            |          |      | 785.9   |          |      |      | 782.0   |        
|Legal settlement expense                                |                                                          |                                                          | 3.5        |                                            |          |      |        |          |      |      | 2.4     |        
|Pre-opening expense                                     |                                                          |                                                          | 7.0        |                                            |          |      | 6.9     |          |      |      | 6.3     |        
|Asset impairments and other writedowns                  |                                                          |                                                          | 11.5       |                                            |          |      | 14.9    |          |      |      | 25.4    |        
|Goodwill amortization                                   |                                                          |                                                          |           |                                            |          |      |        |          |      |      | 2.7     |        
|                                                        |                                                          |                                                          |            |                                            |          |      |         |          |     
|                                                        | Operating income                                         |                                                          |            | 205.6                                      |          |      |         | 193.9    |      |      |         | 157.0   |     
|Interest expense                                        |                                                          |                                                          | 8.7        |                                            |          |      | 12.6    |          |      |      | 14.4    |        
|                                                        |                                                          |                                                          |            |                                            |          |      |         |          |     
|                                                        | Income before income tax                                 |                                                          |            | 196.9                                      |          |      |         | 181.3    |      |      |         | 142.6   |     
|Income tax provision                                    |                                                          |                                                          | 74.8       |                                            |          |      | 69.6    |          |      |      | 55.2    |        
|                                                        |                                                          |                                                          |            |                                            |          |      |         |          |     
|                                                        | Income before cumulative effect of accounting
    change |                                                          |            | 122.1                                      |          |      |         | 111.7    |      |      |         | 87.4    |     
|Cumulative effect of accounting change (net of
    tax) |                                                          |                                                          | 2.1        |                                            |          |      |        |          |      |      |        |        
|                                                        |                                                          |                                                          |            |                                            |          |      |         |          |     
|                                                        | Net income                                               |                                                          | $          | 120.0                                      |          |      | $       | 111.7    |      |      | $       | 87.4    |     
|                                                        |                                                          |                                                          |            |                                            |          |      |         |          |     
|Earnings (loss) per common share data
    (Note 2)      |                                                          |                                                          |            |                                            |          |      |         |          |      |      |         |        
|                                                        | Diluted:                                                 |                                                          |            |                                            |          |      |         |          |      |      |         |         |     
|                                                        |                                                          | Income before cumulative effect of accounting
    change |            | $                                          | 1.54     |      |         | $        | 1.36 |      |         | $       | 1.06 |     
|                                                        |                                                          | Cumulative effect of accounting change (net of
    tax)  |            |                                            | (0.02    | )    |         |          |     |      |         |         |     |     
|                                                        |                                                          |                                                          |            |                                            |          |      |         |          |     
|                                                        |                                                          |                                                          | Net income |                                            | $        | 1.52 |         |          | $    | 1.36 |         |         | $    | 1.06 |     
|                                                        |                                                          |                                                          |            |                                            |          |      |         |          |     
|                                                        |                                                          |                                                          |            | Weighted-average common shares outstanding |          |      | 79.1    |          |      |      | 82.0    |         |      |      | 82.7 | 
|                                                        | Basic:                                                   |                                                          |            |                                            |          |      |         |          |      |      |         |         |     
|                                                        |                                                          | Income before cumulative effect of accounting
    change |            | $                                          | 1.57     |      |         | $        | 1.39 |      |         | $       | 1.08 |     
|                                                        |                                                          | Cumulative effect of accounting change (net of
    tax)  |            |                                            | (0.03    | )    |         |          |     |      |         |         |     |     
|                                                        |                                                          |                                                          |            |                                            |          |      |         |          |     
|                                                        |                                                          |                                                          | Net income |                                            | $        | 1.54 |         |          | $    | 1.39 |         |         | $    | 1.08 |     
|                                                        |                                                          |                                                          |            |                                            |          |      |         |          |     
|                                                        |                                                          |                                                          |            | Weighted-average common shares outstanding |          |      | 77.9    |          |      |      | 80.3    |         |      |      | 80.6 | 

See accompanying notes to consolidated financial
statements.

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##### Table of Contents



CONSOLIDATED BALANCE SHEETS

(dollars in millions except share
amounts)


|                                                            |                                                                                                                                                                     |                                                                   |       |         |          |  |       |         |         | 
|----------------------------------------------------------- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------- | ----------------------------------------------------------------- | ----- | ------- | -------- |  | ----- | ------- | ------- | 
|                                                            |                                                                                                                                                                     |                                                                  
|                                                            |                                                                                                                                                                     | Fiscal Year Ended                                                 |      
|                                                            |                                                                                                                                                                     | Jan. 25,                                                          |       |         | Jan. 26, | 
|                                                            |                                                                                                                                                                     | 2004                                                              |       |         | 2003     | 
|                                                            |                                                                                                                                                                     |                                                                   |       |         |          | 
|                                                            |                                                                                                                                                                     |                                                                   |       |        
|Assets                                                     
|Current assets:                                             |                                                                                                                                                                     |                                                                   |       |         |          |  |       |        
|                                                            | Cash and cash equivalents                                                                                                                                           |                                                                   | $     | 378.8   |          |  | $     | 269.1   |        
|                                                            | Merchandise inventories                                                                                                                                             |                                                                   |       | 1,235.6 |          |  |       | 1,183.3 |        
|                                                            | Accounts receivable and other current assets                                                                                                                        |                                                                   |       | 98.3    |          |  |       | 88.9    |        
|                                                            |                                                                                                                                                                     |                                                                   |       |         |          | 
|                                                            |                                                                                                                                                                     | Total current assets                                              |       |         | 1,712.7  |  |       |         | 1,541.3 | 
|Property and equipment, net                                 |                                                                                                                                                                     |                                                                   | 577.7 |         |          |  | 553.8 |        
|Other assets                                                |                                                                                                                                                                     |                                                                   | 70.2  |         |          |  | 74.5  |        
|Deferred income taxes                                       |                                                                                                                                                                     |                                                                   | 1.3   |         |          |  | 2.1   |        
|Goodwill                                                    |                                                                                                                                                                     |                                                                   | 104.3 |         |          |  | 96.5  |        
|                                                            |                                                                                                                                                                     |                                                                   |       |         |          | 
|                                                            |                                                                                                                                                                     | Total assets                                                      |       | $       | 2,466.2  |  |       | $       | 2,268.2 | 
|                                                            |                                                                                                                                                                     |                                                                   |       |         |          | 
|Liabilities, Minority Interest and
    Stockholders Equity
|Current liabilities:                                        |                                                                                                                                                                     |                                                                   |       |         |          |  |       |        
|                                                            | Short-term borrowings and current portion of
    long-term debt                                                                                                     |                                                                   | $     | 141.2   |          |  | $     | 112.7   |        
|                                                            | Trade accounts payable                                                                                                                                              |                                                                   |       | 595.9   |          |  |       | 565.4   |        
|                                                            | Accrued payroll and other liabilities                                                                                                                               |                                                                   |       | 281.8   |          |  |       | 280.1   |        
|                                                            | Taxes, including income taxes                                                                                                                                       |                                                                   |       | 133.1   |          |  |       | 120.7   |        
|                                                            | Deferred income taxes                                                                                                                                               |                                                                   |       | 12.1    |          |  |       | 8.7     |        
|                                                            |                                                                                                                                                                     |                                                                   |       |         |          | 
|                                                            |                                                                                                                                                                     | Total current liabilities                                         |       |         | 1,164.1  |  |       |         | 1,087.6 | 
|Long-term debt                                              |                                                                                                                                                                     |                                                                   | 57.2  |         |          |  | 50.0  |        
|Long-term capital lease obligations                         |                                                                                                                                                                     |                                                                   |      |         |          |  | 19.0  |        
|Other long-term liabilities                                 |                                                                                                                                                                     |                                                                   | 90.2  |         |          |  | 81.0  |        
|Commitments and contingencies (Note 9)                      |                                                                                                                                                                     |                                                                   |      |         |          |  |      |        
|                                                            |                                                                                                                                                                     |                                                                   |       |         |          | 
|                                                            |                                                                                                                                                                     | Total liabilities                                                 |       |         | 1,311.5  |  |       |         | 1,237.6 | 
|Minority interest                                           |                                                                                                                                                                     |                                                                   | 1.7   |         |          |  |      |        
|                                                            |                                                                                                                                                                     |                                                                   |       |         |          | 
|                                                            |                                                                                                                                                                     | Total liabilities and minority interest                           |       |         | 1,313.2  |  |       |         | 1,237.6 | 
|                                                            |                                                                                                                                                                     |                                                                   |       |         |          | 
|Stockholders equity:                                       |                                                                                                                                                                     |                                                                   |       |         |          |  |       |        
|                                                            | Common stock, 200,000,000 shares authorized;
    78,273,341 and 78,731,922 shares issued and outstanding at
    January 25, 2004 and January 26, 2003, respectively |                                                                   |       | 646.3   |          |  |       | 657.0   |        
|                                                            | Deferred compensation                                                                                                                                               |                                                                   |       | (0.6    | )        |  |       | (0.2    | )      
|                                                            | Accumulated other comprehensive income                                                                                                                              |                                                                   |       | 24.1    |          |  |       | 4.4     |        
|                                                            | Retained earnings                                                                                                                                                   |                                                                   |       | 483.2   |          |  |       | 369.4   |        
|                                                            |                                                                                                                                                                     |                                                                   |       |         |          | 
|                                                            |                                                                                                                                                                     | Total stockholders equity                                        |       |         | 1,153.0  |  |       |         | 1,030.6 | 
|                                                            |                                                                                                                                                                     |                                                                   |       |         |          | 
|                                                            |                                                                                                                                                                     | Total liabilities, minority interest and
    stockholders equity |       | $       | 2,466.2  |  |       | $       | 2,268.2 | 
|                                                            |                                                                                                                                                                     |                                                                   |       |         |          | 

See accompanying notes to consolidated financial
statements.

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CONSOLIDATED STATEMENTS OF CASH
FLOWS

(dollars in millions)


|                                                 |                                                                         |                                                   |                                 |        |          |       |       |          |        |       |       |       |       |       | 
|------------------------------------------------ | ----------------------------------------------------------------------- | ------------------------------------------------- | ------------------------------- | ------ | -------- | ----- | ----- | -------- | ------ | ----- | ----- | ----- | ----- | ----- | 
|                                                 |                                                                         |                                                  
|                                                 |                                                                         | Fiscal Year Ended                                 |                                
|                                                 |                                                                         | Jan. 25,                                          |                                 |        | Jan. 26, |       |       | Jan. 27, |       
|                                                 |                                                                         | 2004                                              |                                 |        | 2003     |       |       | 2002     |       
|                                                 |                                                                         |                                                   |                                 |        |          |       |       |          |       
|                                                 |                                                                         |                                                   |                                 |        |          |      
|Cash provided by (used for):                     |                                                                         |                                                   |                                 |        |          |       |       |          |        |       |       |      
|Operations                                       |                                                                         |                                                   |                                 |        |          |       |       |          |        |       |       |      
|                                                 | Income from continuing operations                                       |                                                   | $                               | 120.0  |          |       | $     | 111.7    |        |       | $     | 87.4  |      
|                                                 | Adjustments to reconcile net income to operating
    cash flows:        |                                                   |                                 |        |          |       |       |          |        |       |       |       |      
|                                                 |                                                                         | Depreciation and amortization                     |                                 |        | 104.1    |       |       |          | 97.1   |       |       |       | 96.2  |      
|                                                 |                                                                         | Decrease in deferred income taxes                 |                                 |        | 6.0      |       |       |          | 14.0   |       |       |       | 6.3   |      
|                                                 |                                                                         | (Increase) decrease in other long-term assets     |                                 |        | (14.0    | )     |       |          | 7.7    |       |       |       | (0.4  | )    
|                                                 |                                                                         | Increase in other long-term liabilities           |                                 |        | 8.3      |       |       |          | 7.0    |       |       |       | 6.4   |      
|                                                 |                                                                         | Asset impairments and other writedowns            |                                 |        | 10.8     |       |       |          | 13.4   |       |       |       | 16.7  |      
|                                                 | Cash provided by (used for) current assets and
    current liabilities: |                                                   |                                 |        |          |       |       |          |        |       |       |       |      
|                                                 |                                                                         | (Increase) decrease in inventories                |                                 |        | (37.9    | )     |       |          | 6.2    |       |       |       | 20.4  |      
|                                                 |                                                                         | (Increase) decrease in accounts receivable        |                                 |        | (3.1     | )     |       |          | (9.3   | )     |       |       | 10.1  |      
|                                                 |                                                                         | Increase in prepaid expenses                      |                                 |        | (3.3     | )     |       |          | (4.6   | )     |       |       | (4.9  | )    
|                                                 |                                                                         | Increase (decrease) in accounts payable           |                                 |        | 25.2     |       |       |          | (77.3  | )     |       |       | 18.2  |      
|                                                 |                                                                         | Increase in taxes payable                         |                                 |        | 17.7     |       |       |          | 30.5   |       |       |       | 15.3  |      
|                                                 |                                                                         | Decrease in accrued payroll and other liabilities |                                 |        | (5.7     | )     |       |          | (7.2   | )     |       |       | (6.7  | )    
|                                                 |                                                                         |                                                   |                                 |        |          |       |       |          |       
|                                                 |                                                                         | Net cash provided by continuing operations        |                                 |        | 228.1    |       |       |          | 189.2  |       |       |       | 265.0 |      
|                                                 |                                                                         | Net cash used for discontinued operations         |                                 |        |         |       |       |          |       |       |       |       | (0.8  | )    
|                                                 |                                                                         |                                                   |                                 |        |          |       |       |          |       
|                                                 |                                                                         |                                                   | Net cash provided by operations |        |          | 228.1 |       |          |        | 189.2 |       |       |       | 264.2 | 
|                                                 |                                                                         |                                                   |                                 |        |          |       |       |          |       
|Investing                                        |                                                                         |                                                   |                                 |        |          |       |       |          |        |       |       |      
|                                                 | Capital expenditures                                                    |                                                   |                                 | (100.5 | )        |       |       | (121.5   | )      |       |       | (90.7 | )    
|                                                 | Acquisition                                                             |                                                   |                                 | (2.9   | )        |       |       |         |        |       |       |      |      
|                                                 |                                                                         |                                                   |                                 |        |          |       |       |          |       
|                                                 |                                                                         | Net cash used for investing                       |                                 |        | (103.4   | )     |       |          | (121.5 | )     |       |       | (90.7 | )    
|                                                 |                                                                         |                                                   |                                 |        |          |       |       |          |       
|Financing                                        |                                                                         |                                                   |                                 |        |          |       |       |          |        |       |       |      
|                                                 | Net funding from long-term debt                                         |                                                   |                                 |       |          |       |       | 50.0     |        |       |       |      |      
|                                                 | Net repayment of long-term capital lease
    obligations                |                                                   |                                 | (0.3   | )        |       |       | (1.0     | )      |       |       | (0.1  | )    
|                                                 | Net repayment of credit facility                                        |                                                   |                                 | 1.1    |          |       |       | 15.4     |        |       |       | (58.2 | )    
|                                                 | Issuance of common stock                                                |                                                   |                                 | 27.4   |          |       |       | 18.8     |        |       |       | 34.9  |      
|                                                 | Repurchase of common stock                                              |                                                   |                                 | (44.0  | )        |       |       | (74.8    | )      |       |       | (17.7 | )    
|                                                 |                                                                         |                                                   |                                 |        |          |       |       |          |       
|                                                 |                                                                         | Net cash provided by (used for) financing         |                                 |        | (15.8    | )     |       |          | 8.4    |       |       |       | (41.1 | )    
|                                                 |                                                                         |                                                   |                                 |        |          |       |       |          |       
|Effect of exchange rates on cash and equivalents |                                                                         |                                                   | 0.8                             |        |          |       | 2.8   |          |        |       | (1.3  | )    
|                                                 |                                                                         |                                                   |                                 |        |          |       |       |          |       
|Net increase in cash and equivalents             |                                                                         |                                                   | 109.7                           |        |          |       | 78.9  |          |        |       | 131.1 |      
|Cash and equivalents at beginning of year        |                                                                         |                                                   | 269.1                           |        |          |       | 190.2 |          |        |       | 59.1  |      
|                                                 |                                                                         |                                                   |                                 |        |          |       |       |          |       
|Cash and equivalents at end of year              |                                                                         | $                                                 | 378.8                           |        |          | $     | 269.1 |          |        | $     | 190.2 |      
|                                                 |                                                                         |                                                   |                                 |        |          |       |       |          |       
|Supplemental cash flow disclosures:              |                                                                         |                                                   |                                 |        |          |       |       |          |        |       |       |      
|                                                 | Interest paid                                                           |                                                   | $                               | 9.2    |          |       | $     | 11.0     |        |       | $     | 14.6  |      
|                                                 | Income taxes paid                                                       |                                                   | $                               | 56.3   |          |       | $     | 26.9     |        |       | $     | 33.9  |      

See accompanying notes to consolidated financial
statements.

42



---



##### Table of Contents



CONSOLIDATED STATEMENTS OF STOCKHOLDERS
EQUITY

(dollars in millions except share
amounts)


|                                                                                    |  |              |            |   |          |             |       |               |  |   |               |   |  |          |       |   |       |   |       |   |  |   |         |  
|----------------------------------------------------------------------------------- |  | ------------ | ---------- | - | -------- | ----------- | ----- | ------------- |  | - | ------------- | - |  | -------- | ----- | - | ----- | - | ----- | - |  | - | ------- | -
|                                                                                    |  |              |            |   |          | Accumulated |       |               |  |   |              
|                                                                                    |  | Common Stock |            |   |          |             | Other |               |  |   |               |  
|                                                                                    |  |              |            |   | Deferred |             |       | Comprehensive |  |   | Retained      |   |  |         
|                                                                                    |  | Shares       |            |   | Amount   |             |       | Compensation  |  |   | Income (Loss) |   |  | Earnings |       |   | Total |  
|                                                                                    |  |              |            |   |          |             |       |               |  |   |               |   |  |          |       |   |       |  
|Balance at January 28, 2001                                                         |  |              | 78,649,501 |   |          | $           | 685.2 |               |  | $ | (1.0          | ) |  | $        | (8.0  | ) |       | $ | 170.3 |   |  | $ | 846.5   |  
|                                                                                    |  |              |            |   |          |             |       |               |  |   |               |   |  |          |       |   |       |  
|Net income                                                                          |  |              |           |   |          |             |      |               |  |   |              |   |  |          |      |   |       |   | 87.4  |   |  |   | 87.4    |  
|Foreign currency translation adjustments                                            |  |              |           |   |          |             |      |               |  |   |              |   |  |          | (4.4  | ) |       |   |      |   |  |   | (4.4    | )
|Cumulative effect of change in accounting
    principle, net of tax benefit of $1.0 |  |              |           |   |          |             |      |               |  |   |              |   |  |          | (1.6  | ) |       |   |      |   |  |   | (1.6    | )
|Change in fair value of derivatives, net of tax
    benefit of $0.9                 |  |              |           |   |          |             |      |               |  |   |              |   |  |          | (1.5  | ) |       |   |      |   |  |   | (1.5    | )
|                                                                                    |  |              |            |   |          |             |       |               |  |   |               |   |  |          |       |   |       |  
|Comprehensive income                                                                |  |              |            |   |          |             |       |               |  |   |               |   |  |          |       |   |       |   |       |   |  |   | 79.9    |  
|Issuance of common stock                                                            |  |              | 3,729,906  |   |          |             | 34.9  |               |  |   |              |   |  |          |      |   |       |   |      |   |  |   | 34.9    |  
|Repurchase and retirement of common stock                                           |  |              | (1,176,440 | ) |          |             | (17.7 | )             |  |   |              |   |  |          |      |   |       |   |      |   |  |   | (17.7   | )
|Tax benefit of equity compensation                                                  |  |              |           |   |          |             | 5.5   |               |  |   |              |   |  |          |      |   |       |   |      |   |  |   | 5.5     |  
|Change in deferred compensation                                                     |  |              |           |   |          |             |      |               |  |   | 0.8           |   |  |          |      |   |       |   |      |   |  |   | 0.8     |  
|                                                                                    |  |              |            |   |          |             |       |               |  |   |               |   |  |          |       |   |       |  
|Balance at January 27, 2002                                                         |  |              | 81,202,967 |   |          | $           | 707.9 |               |  | $ | (0.2          | ) |  | $        | (15.5 | ) |       | $ | 257.7 |   |  | $ | 949.9   |  
|                                                                                    |  |              |            |   |          |             |       |               |  |   |               |   |  |          |       |   |       |  
|Net income                                                                          |  |              |           |   |          |             |      |               |  |   |              |   |  |          |      |   |       |   | 111.7 |   |  |   | 111.7   |  
|Foreign currency translation adjustments                                            |  |              |           |   |          |             |      |               |  |   |              |   |  |          | 17.7  |   |       |   |      |   |  |   | 17.7    |  
|Change in fair value of derivatives, net of tax
    provision of $1.4               |  |              |           |   |          |             |      |               |  |   |              |   |  |          | 2.2   |   |       |   |      |   |  |   | 2.2     |  
|                                                                                    |  |              |            |   |          |             |       |               |  |   |               |   |  |          |       |   |       |  
|Comprehensive income                                                                |  |              |            |   |          |             |       |               |  |   |               |   |  |          |       |   |       |   |       |   |  |   | 131.6   |  
|Issuance of common stock                                                            |  |              | 1,515,955  |   |          |             | 18.8  |               |  |   |              |   |  |          |      |   |       |   |      |   |  |   | 18.8    |  
|Repurchase and retirement of common stock                                           |  |              | (3,987,000 | ) |          |             | (74.8 | )             |  |   |              |   |  |          |      |   |       |   |      |   |  |   | (74.8   | )
|Tax benefit of equity compensation                                                  |  |              |           |   |          |             | 5.1   |               |  |   |              |   |  |          |      |   |       |   |      |   |  |   | 5.1     |  
|                                                                                    |  |              |            |   |          |             |       |               |  |   |               |   |  |          |       |   |       |  
|Balance at January 26, 2003                                                         |  |              | 78,731,922 |   |          | $           | 657.0 |               |  | $ | (0.2          | ) |  | $        | 4.4   |   |       | $ | 369.4 |   |  | $ | 1,030.6 |  
|                                                                                    |  |              |            |   |          |             |       |               |  |   |               |   |  |          |       |   |       |  
|Net income                                                                          |  |              |           |   |          |             |      |               |  |   |              |   |  |          |      |   |       |   | 120.0 |   |  |   | 120.0   |  
|Foreign currency translation adjustments                                            |  |              |           |   |          |             |      |               |  |   |              |   |  |          | 19.0  |   |       |   |      |   |  |   | 19.0    |  
|Change in fair value of derivatives, net of tax
    provision of $0.4               |  |              |           |   |          |             |      |               |  |   |              |   |  |          | 0.7   |   |       |   |      |   |  |   | 0.7     |  
|                                                                                    |  |              |            |   |          |             |       |               |  |   |               |   |  |          |       |   |       |  
|Comprehensive income                                                                |  |              |            |   |          |             |       |               |  |   |               |   |  |          |       |   |       |   |       |   |  |   | 139.7   |  
|Cash dividends declared ($0.08 per common
    share)                                |  |              |           |   |          |             |      |               |  |   |              |   |  |          |      |   |       |   | (6.2  | ) |  |   | (6.2    | )
|Issuance of common stock                                                            |  |              | 2,094,005  |   |          |             | 27.4  |               |  |   |              |   |  |          |      |   |       |   |      |   |  |   | 27.4    |  
|Repurchase and retirement of common stock                                           |  |              | (2,552,586 | ) |          |             | (44.0 | )             |  |   |              |   |  |          |      |   |       |   |      |   |  |   | (44.0   | )
|Tax benefit of equity compensation                                                  |  |              |           |   |          |             | 5.9   |               |  |   |              |   |  |          |      |   |       |   |      |   |  |   | 5.9     |  
|Change in deferred compensation                                                     |  |              |           |   |          |             |      |               |  |   | (0.4          | ) |  |          |      |   |       |   |      |   |  |   | (0.4    | )
|                                                                                    |  |              |            |   |          |             |       |               |  |   |               |   |  |          |       |   |       |  
|Balance at January 25, 2004                                                         |  |              | 78,273,341 |   |          | $           | 646.3 |               |  | $ | (0.6          | ) |  | $        | 24.1  |   |       | $ | 483.2 |   |  | $ | 1,153.0 |  
|                                                                                    |  |              |            |   |          |             |       |               |  |   |               |   |  |          |       |   |       |  

See accompanying notes to consolidated financial
statements.

43



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##### Table of Contents



NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS

(dollars in millions except per share
data)




|         |                                               
|-------- | ----------------------------------------------
|NOTE 1  | SUMMARY OF SIGNIFICANT ACCOUNTING
    POLICIES

Nature of Business:Borders Group, Inc., through its subsidiaries,
Borders, Inc. (Borders), Walden Book Company, Inc.
(Waldenbooks), Borders U.K. Limited, Borders Australia Pty
Limited and others (individually and collectively, the
Company), is an operator of book, music and movie
superstores and mall-based bookstores. At January 25, 2004,
the Company operated 482 superstores under the Borders name,
including 24 in the United Kingdom, nine in Australia, two in
Puerto Rico, and one each in Singapore and New Zealand. The
Company also operated 716 mall-based and other bookstores
primarily under the Waldenbooks name in the United States and 36
bookstores under the Books etc. name in the United Kingdom.

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

Use of Estimates:The preparation of financial statements in conformity with
accounting principles generally accepted in the United States
requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of
the financial statements, as well as 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 2003 consisted
of 52 weeks and ended January 25, 2004. Fiscal 2002
consisted of 52 weeks and ended January 26, 2003.
Fiscal 2001 consisted of 52 weeks and ended
January 27, 2002. References herein to years are to the
Companys fiscal years.

Foreign Currency and Translation of Foreign
Subsidiaries:The functional
currencies of the Companys foreign operations are the
respective local currencies. All assets and liabilities of the
Companys foreign operations are translated into
U.S. dollars at fiscal period-end exchange rates. Income
and expense items are translated at average exchange rates
prevailing during the year. The resulting translation
adjustments are recorded as a component of stockholders
equity and other comprehensive income. Foreign currency
transaction gains/(losses) were $(0.4), $0.1, and $0.3 in 2003,
2002, and 2001, respectively.

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

Inventories:Merchandise inventories are valued on a first-in, first-out
(FIFO) basis at the lower of cost or market using the
retail inventory method. The Company includes certain
distribution and other expenses in its inventory costs, totaling
$86.9 and $81.0 as of January 25, 2004, and
January 26, 2003, respectively.

Property and
Equipment:Property and equipment are
recorded at cost, including capitalized interest, and
depreciated over their estimated useful lives on a straight-line
basis for financial statement purposes and on accelerated
methods for income tax purposes. Most store properties are
leased and improvements are amortized over the term of the
lease, generally over three to 20 years. Other annual rates
used in computing depreciation for financial statement purposes
are 2% to 3% for buildings and 10% to 33% for other fixtures and
equipment. Amortization of assets under capital leases is
included in depreciation expense.

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

Goodwill:Pursuant
to the provisions of Statement of Financial Accounting Standards
No. 142, Goodwill and Other Intangible Assets
(FAS 142), which the Company adopted effective
January 28, 2002, goodwill is not amortized but

44



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##### Table of Contents



NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)


(dollars in millions except per share
data)


is subject to annual impairment tests in
accordance with FAS 142. Adoption of the provisions of
FAS 142 had the impact of eliminating the Companys
goodwill amortization in 2002 and 2003.

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

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

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

Accumulated Other Comprehensive Income
(Loss):Accumulated other
comprehensive income (loss) for the Company includes fair value
changes of derivatives (net of tax) and exchange rate
fluctuations. Disclosure of comprehensive income (loss) is
incorporated into the consolidated statements of
stockholders equity for all years presented. Accumulated
other comprehensive income (loss) includes $(0.2) and $(0.9) for
derivatives and $24.3 and $5.3 for exchange rate fluctuations as
of January 25, 2004 and January 26, 2003, respectively.

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

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

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

The Company had previously categorized referral
fees as a component of Selling, general and administrative
expenses in the Companys consolidated statements of
operations, but has determined that categorization as
Other revenue is more appropriate. Accordingly, the
referral fees have been reclassified for all periods presented.

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

45



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##### Table of Contents



NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)


(dollars in millions except per share
data)


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

In November of 2003, the Company announced a
multi-year extension of the Mirror Sites and Express In-Store
Pick Up agreements with Amazon.

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

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

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

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

Gift Certificates:The Company sells gift certificates to its customers and
provides for the face value of all certificates issued within
the last 12 months. For certificates older than
12 months, the Company provides for a portion of the
certificates face value based upon historical redemption
trends.

Advertising Costs:The Company expenses advertising costs as incurred, and recorded
approximately $35.9, $36.1 and $38.5 of gross advertising
expenses in 2003, 2002 and 2001, respectively.

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

Pursuant to co-operative advertising programs
offered by vendors, the Company contracts with vendors to
promote merchandise for specified time periods. Pursuant to the
provisions of Emerging Issues Task Force Issue No. 02-16,
Accounting by a Customer (Including a Reseller) for
Certain Consideration Received from a Vendor
(EITF 02-16), which the Company adopted effective
January 1, 2003, vendor consideration which represents a
reimbursement of specific, incremental, identifiable costs is
included in the Selling, general and administrative
line on the consolidated statements of operations, along with
the related costs, in the period the promotion takes place.
Consideration which exceeds such costs is classified as a
reduction of the Cost of merchandise sold line on
the consolidated statements of operations. Prior to the adoption
of EITF 02-16, all consideration and costs pursuant to
co-operative advertising programs were included in the
Selling, general and administrative line of the
consolidated statements of operations. The Company has
reclassified the vendor consideration in prior years to conform
to current year presentation and EITF 02-16. Additionally,
the Company recorded $0.9 of vendor consideration as a reduction
to its inventory balance at January 25, 2004.

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

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

46



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##### Table of Contents



NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)


(dollars in millions except per share
data)


Equity-Based
Compensation:The Company accounts for
equity-based compensation under the guidance of Accounting
Principles Board Opinion No. 25, Accounting for Stock
Issued to Employees (APB No. 25). As permitted, the
Company has adopted the disclosure-only option of Statement of
Financial Accounting Standards No. 123, Accounting
for Stock Based Compensation (FAS 123). Total
stock-based employee compensation expense and related earnings
per share amounts for 2002 and 2001 differ from that previously
disclosed due to the inadvertent prior year exclusion of certain
awards. The following table illustrates the effect on net income
and earnings per share if the Company had applied the fair value
recognition provisions of FAS 123 to stock-based employee
compensation:

|                                                                                                                              |                       |      |       |      |      |   |       |      |  |   |      |      | 
|----------------------------------------------------------------------------------------------------------------------------- | --------------------- | ---- | ----- | ---- | ---- | - | ----- | ---- |  | - | ---- | ---- | 
|                                                                                                                              |                       | 2003 |       |      | 2002 |   |       | 2001 | 
|                                                                                                                              |                       |      |       |      |      |   |       |      | 
|Net income, as reported                                                                                                       |                       | $    | 120.0 |      |      | $ | 111.7 |      |  | $ | 87.4 |     
|Add: Stock-based employee expense included in
    reported net income, net of related tax effects                             |                       |      | 0.1   |      |      |   | 0.1   |      |  |   | 0.1  |     
|Deduct: Total stock-based employee compensation
    expense determined under fair value method for all awards, net
    of tax |                       |      | 7.4   |      |      |   | 11.5  |      |  |   | 14.2 |     
|                                                                                                                              |                       |      |       |      |      |   |       |      | 
|Pro forma net income                                                                                                          |                       | $    | 112.7 |      |      | $ | 100.3 |      |  | $ | 73.3 |     
|                                                                                                                              |                       |      |       |      |      |   |       |      | 
|Earnings per share:                                                                                                           |                       |      |       |      |      |   |       |      |  |   |      |     
|                                                                                                                              | Diluted  as reported |      | $     | 1.52 |      |   | $     | 1.36 |  |   | $    | 1.06 | 
|                                                                                                                              | Diluted  pro forma   |      | $     | 1.42 |      |   | $     | 1.22 |  |   | $    | 0.89 | 
|                                                                                                                              | Basic  as reported   |      | $     | 1.54 |      |   | $     | 1.39 |  |   | $    | 1.08 | 
|                                                                                                                              | Basic  pro forma     |      | $     | 1.45 |      |   | $     | 1.25 |  |   | $    | 0.91 | 

See Note 13  Stock-Based
Benefit Plans for further discussion of the Companys
equity-based compensation plans.

New Accounting
Guidance:In November 2002, the
Emerging Issues Task Force issued EITF 02-16, which was
effective for all vendor arrangements entered into after
December 31, 2002. The Consensus requires that
consideration received from a vendor be considered a reduction
of the prices of vendors products and shown as a reduction
of cost of sales in the income statement of the customer. If the
consideration represents a reimbursement of specific incremental
identifiable costs incurred, these amounts should be offset
against the related costs with any excess consideration recorded
in cost of sales. In fiscal 2003, the Company has reclassified
the prior years vendor consideration to conform to current
year presentation and EITF 02-16. Additionally, the Company
recorded $0.9 of vendor consideration as a reduction to its
inventory balance at January 25, 2004.

In January 2003, the Financial Accounting
Standards Board (FASB) issued Interpretation No. 46,
Consolidation of Variable Interest Entities
(FIN 46). This interpretation addresses the requirements
for business enterprises to consolidate related entities in
which they are determined to be the primary beneficiary as a
result of their variable economic interests. The interpretation
is intended to provide guidance in judging multiple economic
interests in an entity and in determining the primary
beneficiary. The interpretation outlines disclosure requirements
for variable interest entities in existence prior to
January 31, 2003 and requires consolidation of variable
interest entities created after January 31, 2003. In
addition, the interpretation requires consolidation of variable
interest entities created prior to January 31, 2003
beginning in the fourth quarter of 2003. See
Note 10  Debt and
Note 11  Leases for further
discussion of the impact on the Company in fiscal 2003.

In April 2003, the FASB issued Statement of
Financial Accounting Standards No. 149, Amendment of
Statement 133 on Derivative Instruments and Hedging
Activities (FAS 149). In general, this statement
amends and clarifies accounting for derivative instruments,
including certain derivative instruments embedded in other
contracts, and for hedging activities under Statement of
Financial Accounting Standards No. 133, Accounting
for Derivative Instruments and Hedging Activities. This
statement is effective for contracts entered into or modified
after June 30, 2003, and for hedging relationships
designated after June 30, 2003. The adoption of
FAS 149 did not have an impact on the Companys
consolidated financial position or disclosures in fiscal 2003.

47



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##### Table of Contents



NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)


(dollars in millions except per share
data)


In May 2003, the FASB issued Statement of
Financial Accounting Standards No. 150, Accounting
for Certain Financial Instruments with Characteristics of both
Liabilities and Equity (FAS 150). This statement
affects the classification, measurement and disclosure
requirements of the following three types of freestanding
financial instruments: 1) mandatorily redeemable shares,
which the issuing company is obligated to buy back with cash or
other assets; 2) instruments that do or may require the
issuer to buy back some of its shares in exchange for cash or
other assets, which includes put options and forward purchase
contracts; and 3) obligations that can be settled with
shares, the monetary value of which is fixed, tied solely or
predominantly to a variable such as a market index, or varies
inversely with the value of the issuers shares. In
general, FAS 150 is effective for all financial instruments
entered into or modified after May 31, 2003, and otherwise
is effective at the beginning of the first interim period
beginning after June 15, 2003. The adoption of FAS 150
did not have an impact on the Companys consolidated
financial position or disclosures in fiscal 2003.

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



|         |                                    
|-------- | -----------------------------------
|NOTE 2  | WEIGHTED-AVERAGE SHARES OUTSTANDING

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

|                                                         |  |      |        |  |      |  |        |      |  |  |        | 
|-------------------------------------------------------- |  | ---- | ------ |  | ---- |  | ------ | ---- |  |  | ------ | 
|                                                         |  | 2003 |        |  | 2002 |  |        | 2001 | 
|                                                         |  |      |        |  |      |  |        |      | 
|Weighted-average common shares
    outstanding  basic   |  |      | 77,905 |  |      |  | 80,280 |      |  |  | 80,559 | 
|Dilutive effect of employee stock options                |  |      | 1,206  |  |      |  | 1,753  |      |  |  | 2,165  | 
|                                                         |  |      |        |  |      |  |        |      | 
|Weighted-average common shares
    outstanding  diluted |  |      | 79,111 |  |      |  | 82,033 |      |  |  | 82,724 | 
|                                                         |  |      |        |  |      |  |        |      | 

Unexercised employee stock options to purchase
4.2 million, 7.5 million, and 4.6 million common
shares as of January 25, 2004, January 26, 2003, and
January 27, 2002, respectively, were not included in the
weighted-average shares outstanding calculation because to do so
would have been antidilutive.



|         |                                           
|-------- | ------------------------------------------
|NOTE 3  | ASSET IMPAIRMENTS AND OTHER
    WRITEDOWNS

Asset Impairments:In accordance with the provisions of FAS 144,
Accounting for the Impairment or Disposal of Long-Lived
Assets, the Company evaluates the carrying values of
long-lived assets whenever changes in circumstances indicate the
carrying amounts of such assets may not be recoverable. In the
fourth quarter of 2003, the Company recorded a charge of $6.4
related to the impairment of certain long-lived assets
(primarily leasehold improvements, furniture, and fixtures),
consisting of the following: $6.1 related to underperforming
domestic Borders superstores and $0.3 related to underperforming
Waldenbooks stores. Also in the fourth quarter of 2003, the
Company incurred a $4.5 charge related to the impairment of
certain capitalized technology initiatives, with $3.0, $1.4, and
$0.1 allocated to the Borders, Waldenbooks and International
segments, respectively.

In the fourth quarter of 2002, the Company
recorded a charge of $14.0 related to the impairment of certain
long-lived assets (primarily leasehold improvements, furniture,
and fixtures), consisting of the following: $2.9 related to
underperforming domestic Borders superstores, $8.2 related to
underperforming Waldenbooks stores and $2.9 related to
underperforming Books etc. stores.

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

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

Store Closings:In
accordance with the provisions of FAS 146, Accounting
for Costs Associated with Exit or Disposal Activities, the
Company expenses when incurred all amounts related to the
discontinuance of operations of stores identified for closure.
These expenses typically pertain to inventory markdowns, asset
impairments, and store payroll

48



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##### Table of Contents



NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)


(dollars in millions except per share
data)


and other costs. When the Company closes any of
its stores, the inventory of the closed stores is either
returned to vendors or marked down and sold. Stores
leasehold improvements, furniture, fixtures and equipment are
generally discarded or sold for nominal amounts.

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

During 2003, the Company recorded a $1.4 charge
for the closing costs relating to the closure of 67
underperforming Waldenbooks stores (net of a $0.9 adjustment of
the prior year reserve resulting from actual costs differing
from estimates). The charge included $0.1 of asset impairments
and $0.5 of store payroll and other costs. These costs are
categorized as Asset impairments and other
writedowns on the consolidated statements of operations.
Also included in the $1.4 charge is a $0.8 charge for inventory
markdowns of the stores to be closed, categorized as
Fulfillment center and other inventory writedowns on
the consolidated statements of operations.

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

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

Pursuant to Waldenbooks store closing
plans, 67 stores were closed during 2003, 53 stores were closed
during 2002 and 53 stores were closed during 2001.

The following table summarizes Waldenbooks
store closing reserve:

|                                    |                         |   |     |      |  
|----------------------------------- | ----------------------- | - | --- | ---- | -
|                                    | 2001 Charge             |   | $   | 3.9  |  
|                                    | 2001 Cash payments      |   |     | (0.5 | )
|                                    |                         |   |    
|Reserve balance at January 27, 2002 |                         | $ | 3.4 |     
|                                    |                         |   |    
|                                    | 2002 Charge             |   |     | 2.8  |  
|                                    | 2002 Reserve adjustment |   |     | (0.6 | )
|                                    | 2002 Cash payments      |   |     | (3.0 | )
|                                    |                         |   |    
|Reserve balance at January 26, 2003 |                         | $ | 2.6 |     
|                                    |                         |   |    
|                                    | 2003 Charge             |   |     | 2.3  |  
|                                    | 2003 Reserve adjustment |   |     | (0.9 | )
|                                    | 2003 Cash payments      |   |     | (2.9 | )
|                                    |                         |   |    
|Reserve balance at January 25, 2004 |                         | $ | 1.1 |     
|                                    |                         |   |    

49



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##### Table of Contents



NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)


(dollars in millions except per share
data)


The following table summarizes the sales and
operating loss for the stores closed in each of the following
fiscal years:

|               |  |      |      |   |      |   |      |      |  |   |      |  
|-------------- |  | ---- | ---- | - | ---- | - | ---- | ---- |  | - | ---- | -
|               |  | 2003 |      |   | 2002 |   |      | 2001 | 
|               |  |      |      |   |      |   |      |      | 
|Sales          |  | $    | 28.6 |   |      | $ | 22.5 |      |  | $ | 22.6 |  
|Operating loss |  |      | (0.6 | ) |      |   | (0.3 | )    |  |   | (0.7 | )

During the fourth quarter of 2003, the Company
recorded a $0.1 charge for the estimated future lease
obligations of a Books etc. store closed in 2003, categorized as
Cost of merchandise sold (includes occupancy) on the
consolidated statements of operations.

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

Fulfillment Center:On March 15, 2001, the Company announced an agreement with
Ingram Book Group (Ingram), a wholesaler of books, spoken audio
and magazines, pursuant to which Ingram provides fulfillment
services for the Companys special order book sales. This
agreement with Ingram resulted in a first quarter 2001 charge of
approximately $16.0 primarily related to the writedown of assets
used by the Company-owned facility to fulfill special order
sales, including warehouse equipment, hardware, and software,
and is included in Asset impairments and other
writedowns on the consolidated statements of operations.
This agreement also resulted in a first quarter 2001 charge of
$12.7 for the writedown of fulfillment center inventory. In the
fourth quarter of 2001, the Company reversed approximately $4.0
of this charge as a result of favorable experience in the
disposition of the inventory. The net charge of $8.7 is
categorized as Fulfillment center and other inventory
writedowns on the consolidated statements of operations.

NOTE 4  GOODWILL

Effective January 28, 2002, the Company
adopted FAS 142, Goodwill and Other Intangible
Assets. As required by FAS 142, the Company no longer
amortizes goodwill, but reviews annually (or more frequently if
impairment indicators arise) for impairment. Upon adoption and
at the annual testing date of January 25, 2004, the Company
determined that there was no impairment of goodwill for any of
its reporting units. The following net income and earnings per
share data have been presented on a pro forma basis to eliminate
goodwill amortization, as required by FAS 142.

|                            |                       |                     |   |       |       |  |   |       |       |  |   |      |      | 
|--------------------------- | --------------------- | ------------------- | - | ----- | ----- |  | - | ----- | ----- |  | - | ---- | ---- | 
|                            |                       | 2003                |   |       | 2002  |  |   | 2001  |      
|                            |                       |                     |   |       |       |  |   |       |      
|Adjusted net income:        |                       |                     |   |       |       |  |   |       |       |  |   |     
|                            | Net income            |                     | $ | 120.0 |       |  | $ | 111.7 |       |  | $ | 87.4 |     
|                            | Goodwill amortization |                     |   |      |       |  |   |      |       |  |   | 2.7  |     
|                            |                       |                     |   |       |       |  |   |       |      
|                            |                       | Adjusted net income |   | $     | 120.0 |  |   | $     | 111.7 |  |   | $    | 90.1 | 
|                            |                       |                     |   |       |       |  |   |       |      
|Diluted earnings per share: |                       |                     |   |       |       |  |   |       |       |  |   |     
|                            | Net income            |                     | $ | 1.52  |       |  | $ | 1.36  |       |  | $ | 1.06 |     
|                            | Goodwill amortization |                     |   |      |       |  |   |      |       |  |   | 0.03 |     
|                            |                       |                     |   |       |       |  |   |       |      
|                            |                       | Adjusted net income |   | $     | 1.52  |  |   | $     | 1.36  |  |   | $    | 1.09 | 
|                            |                       |                     |   |       |       |  |   |       |      
|Basic earnings per share:   |                       |                     |   |       |       |  |   |       |       |  |   |     
|                            | Net income            |                     | $ | 1.54  |       |  | $ | 1.39  |       |  | $ | 1.08 |     
|                            | Goodwill amortization |                     |   |      |       |  |   |      |       |  |   | 0.04 |     
|                            |                       |                     |   |       |       |  |   |       |      
|                            |                       | Adjusted net income |   | $     | 1.54  |  |   | $     | 1.39  |  |   | $    | 1.12 | 
|                            |                       |                     |   |       |       |  |   |       |      

50



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##### Table of Contents



NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)


(dollars in millions except per share
data)


NOTE 5  EFFECT OF TERRORIST
ATTACKS ON SEPTEMBER 11, 2001

As a result of the terrorist attacks on
September 11, 2001, a Borders store that operated in the
World Trade Center in New York City was destroyed. The loss
of that stores sales and net income was not material to
the consolidated 2003, 2002 or 2001 results as a whole. The
Company was insured for the replacement value of the assets
destroyed at the store and up to 24 months of lost income
from business interruption coverage and has recognized a total
recovery of $18.7 to date.

During 2003, Borders recognized as income an
insurance reimbursement of $2.8 related to the
September 11, 2001 loss. Of this, $0.7 represented business
interruption proceeds for 2003. This was categorized as
Cost of merchandise sold in the consolidated
statements of operations, because the stores lost income
would primarily have been categorized as Gross
margin in the consolidated statements of operations. In
addition, $1.8 was categorized as an offset to Selling,
general and administrative expenses. This amount primarily
represented the excess of lost assets replacement value
over their net book value. It is the Companys policy to
record gains and losses on asset disposals as a part of
Selling, general and administrative expenses. The
remaining $0.3 was related to pre-opening expenses incurred in
the opening of replacement stores in New York City. This
was categorized as an offset to Pre-opening expense
on the consolidated statements of operations.

During 2002, the Company recognized a $2.9 gain
from insurance proceeds related to the terrorist attacks. Of
this, $1.2 represented business interruption proceeds for 2002.
The remaining $1.7 primarily represented the excess of lost
assets replacement value over their net book value.

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

The Company expects to recover additional
insurance amounts, up to a maximum of approximately $1.2, based
upon capital expenditures and pre-opening costs in replacement
stores which will be recognized when collection of such
additional recoveries is assured.

NOTE 6  LEGAL
SETTLEMENT

In January 2004, a tentative settlement, subject
to court approval, was reached pursuant to which the Company has
agreed to pay $3.5, categorized as Legal settlement
expense in the consolidated statements of operations
during 2003, to resolve all claims asserted in the California
overtime litigation. This action was brought by two former
employees, individually and on behalf of a purported class
consisting of all current and former employees who worked as
assistant managers in Borders stores in the state of California
at any time between April 10, 1996, and the present.

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

51



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##### Table of Contents



NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)


(dollars in millions except per share
data)


NOTE 7  PROPERTY AND
EQUIPMENT

Property and equipment consists of the following:

|                                                     |                          |      |         |       |      |   |         |       | 
|---------------------------------------------------- | ------------------------ | ---- | ------- | ----- | ---- | - | ------- | ----- | 
|                                                     |                          | 2003 |         |       | 2002 |  
|                                                     |                          |      |         |       |      |  
|Property and equipment                               |                          |      |         |       |      |   |         |      
|                                                     | Land                     |      | $       | 11.8  |      |   | $       | 10.2  | 
|                                                     | Buildings                |      |         | 26.9  |      |   |         | 5.2   | 
|                                                     | Leasehold improvements   |      |         | 429.6 |      |   |         | 384.3 | 
|                                                     | Furniture and fixtures   |      |         | 848.5 |      |   |         | 790.5 | 
|                                                     | Construction in progress |      |         | 24.4  |      |   |         | 31.0  | 
|                                                     |                          |      |         |       |      |  
|                                                     |                          |      | 1,341.2 |       |      |   | 1,221.2 |      
|Less  accumulated depreciation and
    amortization |                          |      | (763.5  | )     |      |   | (667.4  | )    
|                                                     |                          |      |         |       |      |  
|Property and equipment, net                          |                          | $    | 577.7   |       |      | $ | 553.8   |      
|                                                     |                          |      |         |       |      |  

NOTE 8  INCOME TAXES

The income tax provision from operations consists
of the following:

|                           |                 |      |      |      |      |   |      |      |   |   |      |      |  
|-------------------------- | --------------- | ---- | ---- | ---- | ---- | - | ---- | ---- | - | - | ---- | ---- | -
|                           |                 | 2003 |      |      | 2002 |   |      | 2001 |  
|                           |                 |      |      |      |      |   |      |      |  
|Current                    |                 |      |      |      |      |   |      |      |   |   |      |     
|                           | Federal         |      | $    | 61.2 |      |   | $    | 45.1 |   |   | $    | 36.1 |  
|                           | State and local |      |      | 9.1  |      |   |      | 8.0  |   |   |      | 5.5  |  
|                           | Foreign         |      |      | 0.3  |      |   |      |     |   |   |      | 0.2  |  
|Deferred                   |                 |      |      |      |      |   |      |      |   |   |      |     
|                           | Federal         |      |      | 0.2  |      |   |      | 16.8 |   |   |      | 14.4 |  
|                           | State and local |      |      | 0.3  |      |   |      | 0.1  |   |   |      | 0.4  |  
|                           | Foreign         |      |      | 3.7  |      |   |      | (0.4 | ) |   |      | (1.4 | )
|                           |                 |      |      |      |      |   |      |      |  
|Total income tax provision |                 | $    | 74.8 |      |      | $ | 69.6 |      |   | $ | 55.2 |     
|                           |                 |      |      |      |      |   |      |      |  

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

|                                                  |  |      |      |   |      |   |      |      |  |   |      | 
|------------------------------------------------- |  | ---- | ---- | - | ---- | - | ---- | ---- |  | - | ---- | 
|                                                  |  | 2003 |      |   | 2002 |   |      | 2001 | 
|                                                  |  |      |      |   |      |   |      |      | 
|Federal statutory rate                            |  | $    | 69.0 |   |      | $ | 63.5 |      |  | $ | 49.9 | 
|State and local taxes, net of federal tax benefit |  |      | 6.1  |   |      |   | 5.3  |      |  |   | 3.8  | 
|Other                                             |  |      | (0.3 | ) |      |   | 0.8  |      |  |   | 1.5  | 
|                                                  |  |      |      |   |      |   |      |      | 
|Total income tax provision                        |  | $    | 74.8 |   |      | $ | 69.6 |      |  | $ | 55.2 | 
|                                                  |  |      |      |   |      |   |      |      | 

52



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##### Table of Contents



NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)


(dollars in millions except per share
data)


Deferred tax assets and liabilities resulted from
the following:

|                                      |                                        |      |       |      |      |   |      |      | 
|------------------------------------- | -------------------------------------- | ---- | ----- | ---- | ---- | - | ---- | ---- | 
|                                      |                                        | 2003 |       |      | 2002 |  
|                                      |                                        |      |       |      |      |  
|Deferred tax assets                   |                                        |      |       |      |      |   |      |     
|                                      | Accruals and other current liabilities |      | $     | 4.3  |      |   | $    | 5.1  | 
|                                      | Deferred revenue                       |      |       | 4.6  |      |   |      | 5.9  | 
|                                      | Other long-term liabilities            |      |       |     |      |   |      | 1.4  | 
|                                      | Deferred compensation                  |      |       | 2.3  |      |   |      | 0.9  | 
|                                      | Deferred rent                          |      |       | 26.0 |      |   |      | 24.8 | 
|                                      | Net operating losses                   |      |       | 9.7  |      |   |      | 11.4 | 
|                                      | Asset impairments and other writedowns |      |       | 13.7 |      |   |      | 12.7 | 
|                                      |                                        |      |       |      |      |  
|                                      | Total deferred tax assets              |      |       | 60.6 |      |   |      | 62.2 | 
|                                      |                                        |      |       |      |      |  
|Deferred tax liabilities              |                                        |      |       |      |      |   |      |     
|                                      | Inventory                              |      |       | 18.3 |      |   |      | 18.0 | 
|                                      | Property and equipment                 |      |       | 45.8 |      |   |      | 46.6 | 
|                                      | Net state deferred tax liability       |      |       | 3.3  |      |   |      | 3.0  | 
|                                      | Other                                  |      |       | 4.0  |      |   |      | 1.2  | 
|                                      |                                        |      |       |      |      |  
|                                      | Total deferred tax liabilities         |      |       | 71.4 |      |   |      | 68.8 | 
|                                      |                                        |      |       |      |      |  
|Net deferred tax assets (liabilities) |                                        | $    | (10.8 | )    |      | $ | (6.6 | )   
|                                      |                                        |      |       |      |      |  

The Company has tax net operating loss
carryforwards in foreign jurisdictions totaling $23.1 as of
January 25, 2004, $35.3 as of January 26, 2003, and
$33.1 as of January 27, 2002. These losses have an
indefinite carryforward period.

Consolidated domestic income (loss) before taxes
was $195.2 in 2003, $194.7 in 2002, and $149.0 in 2001. The
corresponding amounts for foreign operations were $1.7 in 2003,
$(13.4) in 2002, and $(6.4) in 2001.

NOTE 9  COMMITMENTS AND
CONTINGENCIES

Litigation:Two
former employees, individually and on behalf of a purported
class consisting of all current and former employees who worked
as assistant managers in Borders stores in the state of
California at any time between April 10, 1996, and the
present, have filed an action against the Company in the
Superior Court of California for the County of
San Francisco. The action alleges that the individual
plaintiffs and the purported class members worked hours for
which they were entitled to receive, but did not receive,
overtime compensation under California law, and that they were
classified as exempt store management employees but were forced
to work more than 50% of their time in non-exempt tasks. The
Amended Complaint, which names two additional plaintiffs,
alleges violations of the California Labor Code and the
California Business and Professions Code. The relief sought
includes compensatory and punitive damages, penalties,
preliminary and permanent injunctions requiring Borders to pay
overtime compensation as required under California and Federal
law, prejudgment interest, costs, and attorneys fees and
such other relief as the court deems proper. On July 29,
2002, the Superior Court of California granted the
plaintiffs motion for class certification in the action.
The class certified consists of all individuals who worked as
Assistant Managers in a Borders superstore in California at any
time between April 10, 1996 and March 18, 2001. The
class was further certified by the Court into the following
subclasses: Assistant Manager-Merchandising; Assistant
Manager-Inventory; Assistant Manager-Human Resources; Assistant
Manager-Music; Assistant Manager-Training; Assistant
Manager-Café. On January 28, 2004, a tentative
settlement, subject to court approval, was reached pursuant to
which the Company has

53



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NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)


(dollars in millions except per share
data)


agreed to pay $3.5 to resolve all claims asserted
in the litigation. The Company classified this charge as
Legal settlement expense in the consolidated
statements of operations in 2003. See
Note 6  Legal Settlement for further
discussion.

On October 29, 2002, Gary Gerlinger,
individually and on behalf of all other similarly situated
consumers in the United States who, during the period from
August 1, 2001 to the present, purchased books online from
either Amazon or the Company, instituted an action against the
Company and Amazon in the United States District Court for the
Northern District of California. The Complaint alleges that the
agreement pursuant to which an affiliate of Amazon operates
Borders.com as a co-branded site violates federal anti-trust
laws, California statutory law and the common law of unjust
enrichment. The Complaint seeks injunctive relief, damages,
including treble damages or statutory damages where applicable,
attorneys fees, costs and disbursements, disgorgement of all
sums obtained by allegedly wrongful acts, interest and
declaratory relief. The Company has filed an answer denying any
liability and also has filed a motion for summary judgment. The
Court recently issued an order granting the motion as to certain
of plaintiffs claims, denying it as others and requesting
additional briefing on certain issues. The order also denied
certain cross-motions filed by the plaintiff. The Company
intends to vigorously defend the action. The Company has not
included any liability in its consolidated financial statements
in connection with this lawsuit and has expensed as incurred all
legal costs to date. Although an adverse resolution of the
matter could have a material adverse effect on the result of the
operations of the Company for the applicable period or periods,
the Company does not believe that this litigation will have a
material effect on its liquidity or financial position.

Certain states and private litigants have sought
to impose sales or other tax collection efforts on
out-of-jurisdiction companies that engage in e-commerce. The
Company currently is disputing a claim by the state of
California relating to sales taxes that the state alleges should
have been collected on certain Borders.com sales in California
prior to implementation of the Companys Mirror Site
Agreement with Amazon. Also, the Company and Amazon have been
named as defendants in actions filed by a private litigant on
behalf of the States of Nevada and Illinois under the applicable
states False Claims Act relating to the failure to collect
use taxes on Internet sales in Nevada and Illinois for periods
both before and after the implementation of the Mirror Site
Agreement. The Complaints seek judgments, jointly and severally,
against the defendants for, among other things, injunctive
relief, treble the amount of damages suffered by the States of
Nevada and Illinois as a result of the alleged violations of the
defendants, penalties, costs and expenses, including legal fees.
A similar action previously filed against the Company in
Tennessee has been dismissed and the appeal period has expired.

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

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

Relationship with Kmart 
General:Prior to its initial public
offering in May 1995, the Company was a subsidiary of Kmart
Corporation (Kmart); Kmart currently owns no shares of common
stock of the Company. On January 22, 2002, Kmart filed for
reorganization under Chapter 11 of the U.S. Bankruptcy
Code, and emerged from Chapter 11 on May 6, 2003. Such
filings have not affected the operations of the Company.

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

Tax Allocation and Indemnification
Agreement:Prior to the completion of
its initial public offering (IPO), the Company was included in
the consolidated federal income tax returns of Kmart and filed
on a combined basis with Kmart in certain states. Pursuant to a
tax allocation and indemnification agreement between the Company
and Kmart (Tax Allocation Agreement) the Company will remain
obligated to pay to Kmart any income taxes the Company would
have had to pay if it had filed separate tax returns for the tax
period beginning on January 26, 1995, and ending on
June 1, 1995, the date of the consummation of the IPO (to
the extent that it has not previously paid such

54



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##### Table of Contents



NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)


(dollars in millions except per share
data)


amounts to Kmart). In addition, if the tax
liability attributable to the Company for any previous tax
period during which the Company was included in a consolidated
federal income tax return filed by Kmart or a combined state
return is adjusted as a result of an action of a taxing
authority or a court, then the Company will pay to Kmart the
amount of any increase in such liability and Kmart has agreed to
pay to the Company the amount of any decrease in such liability
(in either case together with interest and penalties). The
Companys tax liability for previous years will not be
affected by any increase or decrease in Kmarts tax
liability if such increase or decrease is not directly
attributable to the Company. After completion of the IPO, the
Company continued to be subject under existing federal
regulations to several liability for the consolidated federal
income taxes for any tax year in which it was a member of any
consolidated group of which Kmart was the common parent.
Pursuant to the Tax Allocation Agreement, however, Kmart agreed
to indemnify the Company for any federal income tax liability of
Kmart or any of its subsidiaries (other than that which is
attributable to the Company) that the Company could be required
to pay and the Company agreed to indemnify Kmart for any of the
Companys separate company taxes.

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



|          |     
|--------- | ----
|NOTE 10  | DEBT

Credit Facility:The
Company has a Multicurrency Revolving Credit Agreement (the
Credit Agreement), which will expire in June 2005.
The Credit Agreement provides for borrowings of up to $450.0.
Borrowings under the Credit Agreement bear interest at a
variable base rate plus an increment or LIBOR plus an increment
at the Companys option. The Credit Agreement contains
covenants which limit, among other things, the Companys
ability to incur indebtedness, grant liens, make investments,
consolidate or merge, declare dividends, dispose of assets,
repurchase its common stock in excess of $225.0 over the term of
the Agreement (plus any proceeds and tax benefits resulting from
stock option exercises and tax benefits resulting from
restricted shares purchased by employees from the Company), and
requires the Company to meet certain financial measures
regarding fixed coverage, leverage, tangible net worth and
capital expenditures. The Company had borrowings outstanding
under the Credit Agreement (or a prior agreement) of $126.9 at
January 25, 2004 and $112.1 at January 26, 2003. The
weighted average interest rate in 2003 and 2002 was
approximately 5.4% and 4.5%, respectively.

55



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##### Table of Contents



NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)


(dollars in millions except per share
data)


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

Debt of Consolidated
VIEs:The Company includes the debt of
certain VIEs consolidated pursuant to FIN 46 (described
below) in its consolidated balance sheets. Scheduled principal
payments of this debt as of January 25, 2004 total $13.9 in
2004, $0.2 in 2005, $0.2 in 2006, $0.2 in 2007, $0.2 in 2008,
$5.0 in all later years, and in the aggregate, total $19.7.

As of January 25, 2004 the Company was in
compliance with its debt covenants.



|          |       
|--------- | ------
|NOTE 11  | LEASES

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

Lease Commitments:Future minimum lease payments under operating leases at
January 25, 2004 total $314.7 in 2004, $300.9 in 2005,
$289.1 in 2006, $286.1 in 2007, $272.5 in 2008, $2,177.8 in all
later years, and in the aggregate, total $3,641.1.

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

|                   |       |      |       |       |      |   |       |       |  |   |       |       | 
|------------------ | ----- | ---- | ----- | ----- | ---- | - | ----- | ----- |  | - | ----- | ----- | 
|                   |       | 2003 |       |       | 2002 |   |       | 2001  | 
|                   |       |      |       |       |      |   |       |       | 
|Minimum rentals    |       | $    | 352.6 |       |      | $ | 322.1 |       |  | $ | 303.1 |      
|Percentage rentals |       |      | 2.0   |       |      |   | 1.6   |       |  |   | 1.8   |      
|                   |       |      |       |       |      |   |       |       | 
|                   | Total |      | $     | 354.6 |      |   | $     | 323.7 |  |   | $     | 304.9 | 
|                   |       |      |       |       |      |   |       |       | 

Capitalized Leases:The Company accounts for certain computer equipment under
capital leases. Scheduled principal payments of capitalized
leases as of January 25, 2004 total $0.4, due in 2004.

Lease Financing
Facilities.The Company has two lease
financing facilities (collectively, the Lease Financing
Facilities), which were amended in May 2003, to finance
new stores and other property owned by unaffiliated entities and
leased to the Company or its subsidiaries. The original facility
(the Original Lease Facility) will expire in June
2004 (2005 if certain conditions are satisfied). In June of
2002, the Company established a new facility (the New
Lease Facility), which will expire in 2007. The aggregate
amount available under the Lease Financing Facilities is $25.0.
Properties to be financed after the effective date of the New
Lease Facility will be financed under that Facility, and no
additional properties will be financed under the Original Lease
Facility. The Lease Financing Facilities provide financing to
lessors of properties leased to the Company or its subsidiaries
through loans from lenders for up to 95% of a projects
cost. Additionally, under the New Lease Facility, the
unaffiliated lessor will make equity contributions approximating
5% of the cost of each project. The lessors under the Original
Lease Facility have made similar contributions.

Independent of the Companys obligations
relating to the leases, the Company and certain of its
subsidiaries guarantee payment when due of all amounts required
to be paid to the third-party lenders. The principal amount
guaranteed is limited to approximately 89% of the original cost
of a project so long as the Company is not in default

56



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##### Table of Contents



NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)


(dollars in millions except per share
data)


under the lease relating to such project. The
agreements relating to both of the Lease Financing Facilities
contain covenants and events of default that are similar to
those contained in the Credit Agreement described above.
Security interests in the properties underlying the leases and
in the Companys interests in the leases have been given to
the lenders. The Lease Financing Facilities contain cross
default provisions with respect to the obligations of the
Company under the Credit Agreement and certain other agreements
to which the Company is a party. There also are cross default
provisions with respect to the obligations relating to the Lease
Financing Facilities of Wilmington Trust Company, as owner
trustee of a grantor trust formed for the Lease Financing
Facilities, and the unaffiliated beneficial owner of the grantor
trust. At January 25, 2004, the maximum loss that the
Company could incur under these guarantees approximated $13.8.

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

There were two and seven properties financed
through the Original Lease Facility at January 25, 2004 and
January 26, 2003, respectively, with financed values of
$13.8 and $36.3. The two properties financed through the
Original Lease Facility at January 25, 2004 were
consolidated by the Company, pursuant to the provisions of
FIN 46, as discussed below. Of the amount financed under
the Original Lease Facility at January 26, 2003, the
Company had recorded $19.0 as capitalized leases, under
Other assets (for the capital lease assets) and
Long-term capital lease obligations (for the capital
lease liabilities) on the consolidated balance sheets at
January 26, 2003. These amounts were treated as non-cash
items on the consolidated statements of cash flows. There were
no borrowings under the New Lease Facility as of
January 25, 2004 or January 26, 2003.

In 2003, lessors permanently financed five
properties that had been previously financed through the
Original Lease Facility with a total value of approximately
$22.5, two of which had been capitalized and three of which had
not been capitalized at January 26, 2003.

Consolidated VIEs:Pursuant to the requirements of FIN 46, the Company
believes that it is the primary beneficiary of the
two variable interest entities (VIEs) that own the
two properties financed under the Original Lease Facility
at January 25, 2004. As a result, the Company began
consolidating these VIEs in the quarter ending January 25,
2004 and recorded land, property and equipment, net of
accumulated depreciation, of $12.5, short-term borrowings of
$13.8, and minority interest of $1.3 at January 25, 2004.
These amounts have been treated as non-cash items on the
consolidated statements of cash flows.

The Company also believes it is the primary
beneficiary of two additional VIEs, both of which had borrowings
outstanding under the Original Lease Facility at
January 26, 2003, but whose borrowings had been permanently
financed by the VIEs during 2003. As a result, the Company began
consolidating these VIEs in the quarter ending January 25,
2004, and recorded property and equipment, net of accumulated
depreciation, of $5.5, long-term debt of $5.9, and minority
interest of $0.4 at January 25, 2004. These amounts have
been treated as non-cash items on the consolidated statements of
cash flows.

Mortgage Notes:During 1994, the Company entered into agreements in which leases
with respect to four Borders locations served as collateral for
certain mortgage pass-through certificates. These mortgage
pass-through certificates included a provision requiring the
Company to repurchase the underlying mortgage notes in certain
events. In the fourth quarter of 2001, the Company was obligated
to purchase the notes for $33.5, due to Kmart Corporations
(the former guarantor of the leases) failure to maintain
investment grade credit ratings. As a result, the Company has
categorized this prepaid rent amount as part of Other
assets in the consolidated balance sheets and is
amortizing the balance over each propertys remaining lease
term. The remaining balance at January 25, 2004 was
approximately $28.8.

57



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##### Table of Contents



NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)


(dollars in millions except per share
data)




|          |                       
|--------- | ----------------------
|NOTE 12  | EMPLOYEE BENEFIT PLANS

Employee Savings
Plan:Employees of the Company who
meet certain requirements as to age and service are eligible to
participate in the Companys Savings Plan. The
Companys expense related to this plan was $4.3, $4.2, and
$3.2 for 2003, 2002 and 2001, respectively.



|          |                          
|--------- | -------------------------
|NOTE 13  | STOCK-BASED BENEFIT PLANS

Stock Option Plans:The Company has various stock option plans pursuant to which the
Company may grant options to purchase its common stock. The
exercise price of options granted under these plans will
generally not be less than the fair value per share of the
Companys common stock at the date of grant with vesting
periods up to six years from grant date and maximum option terms
up to 10 years from grant date. At January 25, 2004,
the Company has 33.9 million shares authorized for the
grant of stock options under these plans.

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

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

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

|                                |                  |           |        |           |                |  |       |       | 
|------------------------------- | ---------------- | --------- | ------ | --------- | -------------- |  | ----- | ----- | 
|                                |                  |           |        | Weighted- |               
|                                |                  | Number    |        |           | Average        | 
|All Plans                       |                  | of Shares |        |           | Exercise Price | 
|                                |                  |           |        |           |                | 
|Outstanding at January 28, 2001 |                  |           | 17,654 |           |                |  | 17.82 |      
|                                | Granted          |           |        | 3,326     |                |  |       | 16.51 | 
|                                | Exercised        |           |        | 2,659     |                |  |       | 12.25 | 
|                                | Forfeited        |           |        | 2,906     |                |  |       | 19.34 | 
|Outstanding at January 27, 2002 |                  |           | 15,415 |           |                |  | 18.11 |      
|                                | Granted          |           |        | 3,232     |                |  |       | 20.02 | 
|                                | Exercised        |           |        | 1,305     |                |  |       | 12.42 | 
|                                | Forfeited        |           |        | 2,273     |                |  |       | 20.52 | 
|Outstanding at January 26, 2003 |                  |           | 15,069 |           |                |  | 18.76 |      
|                                | Granted          |           |        | 1,455     |                |  |       | 21.24 | 
|                                | Exercised        |           |        | 1,907     |                |  |       | 12.90 | 
|                                | Forfeited        |           |        | 1,574     |                |  |       | 20.63 | 
|Outstanding at January 25, 2004 |                  |           | 13,043 |           |                |  | 19.67 |      
|Balance exercisable at          |                  |           |        |           |                |  |       |      
|                                | January 27, 2002 |           |        | 7,619     |                |  |       | 18.22 | 
|                                | January 26, 2003 |           |        | 8,832     |                |  |       | 18.59 | 
|                                | January 25, 2004 |           |        | 8,750     |                |  |       | 19.86 | 

58



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##### Table of Contents



NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)


(dollars in millions except per share
data)


The weighted-average fair values of options at
their grant date where the exercise price equals the market
price on the grant date were $5.93, $6.94, and $6.09 in 2003,
2002 and 2001, respectively.

The Company has the following equity compensation
plans in effect at January 25, 2004 (number of shares in
thousands):

|                                    |                                 |             |        |        |                |   |       |                  |  |  |       |       | 
|----------------------------------- | ------------------------------- | ----------- | ------ | ------ | -------------- | - | ----- | ---------------- |  |  | ----- | ----- | 
|                                    |                                 | Number of   |        |        | Weighted-      |   |       | Number of        | 
|                                    |                                 | Shares      |        |        | Average        |   |       | Shares Available | 
|Plan Category                       |                                 | Outstanding |        |        | Exercise Price |   |       | for Issuance     | 
|                                    |                                 |             |        |        |                |   |       |                  | 
|Plans approved by stockholders:     |                                 |             |        |        |                |   |       |                  |  |  |       |      
|                                    | 1995 Stock Option Plan          |             |        | 10,290 |                |   | $     | 19.93            |  |  |       | 109   | 
|                                    | Director Plan                   |             |        | 105    |                |   |       | 20.16            |  |  |       |      | 
|                                    | Management Stock Purchase Plan  |             |        |       |                |   |       |                 |  |  |       | 3,369 | 
|Plans not approved by stockholders: |                                 |             |        |        |                |   |       |                  |  |  |       |      
|                                    | 1998 Stock Option Plan          |             |        | 2,158  |                |   |       | 18.26            |  |  |       |      | 
|                                    | International Stock Option Plan |             |        | 490    |                |   |       | 20.28            |  |  |       |      | 
|                                    |                                 |             |        |        |                |   |       |                  | 
|Total plans                         |                                 |             | 13,043 |        |                | $ | 19.67 |                  |  |  | 3,478 |      
|                                    |                                 |             |        |        |                |   |       |                  | 

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:

|                        |  |      |           |   |      |  |             |      |  |  |             |  
|----------------------- |  | ---- | --------- | - | ---- |  | ----------- | ---- |  |  | ----------- | -
|                        |  | 2003 |           |   | 2002 |  |             | 2001 | 
|                        |  |      |           |   |      |  |             |      | 
|Risk-free interest rate |  |      | 1.5-3.4   | % |      |  | 2.2-5.3     | %    |  |  | 3.1-5.4     | %
|Expected life           |  |      | 3-5 years |   |      |  | 3-10  years |      |  |  | 3-10  years |  
|Expected volatility     |  |      | 35.2-41.6 | % |      |  | 46.3        | %    |  |  | 33.3-47.5   | %
|Expected dividends      |  |      | 0.0-1.5   | % |      |  | 0.0         | %    |  |  | 0.0         | %

The following table summarizes the information
regarding stock options outstanding at January 25, 2004
(number of shares in thousands):

|                |  |             |       |  |                  |  |     |                  |  |  |           |  |  |                  |       |  |  |  |        | 
|--------------- |  | ----------- | ----- |  | ---------------- |  | --- | ---------------- |  |  | --------- |  |  | ---------------- | ----- |  |  |  | ------ | 
|                |  |             |       | 
|                |  | Outstanding |       |  | Exercisable      | 
|                |  |             |       |  |                  | 
|Range of        |  | Number of   |       |  | Weighted-Average |  |     | Weighted-Average |  |  | Number of |  |  | Weighted-Average |      
|Exercise Prices |  | Shares      |       |  | Remaining Life   |  |     | Exercise Price   |  |  | Shares    |  |  | Exercise Price   |      
|                |  |             |       |  |                  |  |     |                  |  |  |           |  |  |                  |      
|$6.81-$10.22    |  |             | 832   |  |                  |  | 1.4 |                  |  |  | $ 8.69    |  |  |                  | 832   |  |  |  | $ 8.69 | 
|$10.23-$13.63   |  |             | 1,789 |  |                  |  | 2.7 |                  |  |  | 12.86     |  |  |                  | 1,729 |  |  |  | 12.86  | 
|$13.64-$17.03   |  |             | 2,594 |  |                  |  | 3.7 |                  |  |  | 14.73     |  |  |                  | 1,737 |  |  |  | 14.66  | 
|$17.04-$20.44   |  |             | 2,193 |  |                  |  | 4.6 |                  |  |  | 17.62     |  |  |                  | 856   |  |  |  | 17.84  | 
|$20.45-$27.25   |  |             | 2,727 |  |                  |  | 4.5 |                  |  |  | 22.66     |  |  |                  | 750   |  |  |  | 23.89  | 
|$27.26-$30.66   |  |             | 2,360 |  |                  |  | 3.4 |                  |  |  | 29.79     |  |  |                  | 2,360 |  |  |  | 29.79  | 
|$30.67-$34.06   |  |             | 548   |  |                  |  | 3.9 |                  |  |  | 31.67     |  |  |                  | 486   |  |  |  | 31.62  | 

59



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##### Table of Contents



NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)


(dollars in millions except per share
data)


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

|                                         |                 |           |  |  |                  |  |  |                   |       |  |  |  |       | 
|---------------------------------------- | --------------- | --------- |  |  | ---------------- |  |  | ----------------- | ----- |  |  |  | ----- | 
|                                         |                 | Number of |  |  | Weighted-Average |  |  | Weighted-Average  |      
|                                         |                 | Shares    |  |  | Purchase Price   |  |  | at Grant Date FMV |      
|                                         |                 |           |  |  |                  |  |  |                   |      
|Stock issued under stock purchase plans: |                 |           |  |  |                  |  |  |                   |       |  |  | 
|                                         | Management plan |           |  |  |                  |  |  |                   |       |  |  |  |      
|                                         |                 | 2001      |  |  | 24               |  |  |                   | 13.26 |  |  |  | 16.57 | 
|                                         |                 | 2002      |  |  | 28               |  |  |                   | 18.26 |  |  |  | 23.91 | 
|                                         |                 | 2003      |  |  | 82               |  |  |                   | 13.56 |  |  |  | 17.29 | 
|                                         | Employee plan   |           |  |  |                  |  |  |                   |       |  |  |  |      
|                                         |                 | 2001      |  |  | 35               |  |  |                   | 16.52 |  |  |  | 19.43 | 
|                                         |                 | 2002      |  |  | 35               |  |  |                   | 15.29 |  |  |  | 17.99 | 
|                                         |                 | 2003      |  |  | 34               |  |  |                   | 15.24 |  |  |  | 17.92 | 

NOTE 14  FINANCIAL
INSTRUMENTS

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

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

The Company recognizes the fair value of its
derivatives on the consolidated balance sheets. Changes in the
fair value of a derivative that is designated as, and meets all
the required criteria for, a cash flow hedge are recorded in
accumulated other comprehensive income and reclassified into
earnings as the underlying hedged item affects earnings. Amounts
reclassified into earnings related to cash flow hedges are
included in interest expense. For the year ended
January 25, 2004, unrealized after-tax net gains of $0.7
related to cash flow hedges were recorded in other comprehensive
income. As of January 25, 2004, $0.2 net unrealized
losses related to interest rate swaps were included in
accumulated other comprehensive income, none of which is
expected to be reclassified into earnings during the next
12 months. The hedge ineffectiveness for the year ending
January 25, 2004 was not material.

A portion of the Companys borrowings is
based on a fixed interest rate. In August 2003, the Company
entered into an interest rate swap to convert the fixed rate,
upon which the $50.0 of Notes are based, to a variable rate
based on LIBOR. In accordance with the provisions of
FAS 133, the Company has designated this swap agreement as
a fair market value hedge. In March 2004 the Company entered
into an agreement to terminate this swap if a termination value
of $1.6 is reached. Changes in the fair value of a derivative
that is designated as, and meets all the required criteria for,
a fair market value hedge are recorded in the Companys
consolidated statements of operations, as are changes in the
fair value of the hedged debt.

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NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)


(dollars in millions except per share
data)


As of January 25, 2004, and January 26,
2003, the Company had the following interest rate swaps in
effect:

|                 |         |  |             |  |          |        |  |  |                   |  |  |   |      |  
|---------------- | ------- |  | ----------- |  | -------- | ------ |  |  | ----------------- |  |  | - | ---- | -
|                
|January 25, 2004 |        
|Notional Amount  |         |  | Strike Rate |  |          | Period |  |  | Fair Market Value | 
|                 |         |  |             |  |          |        |  |  |                   | 
|$                | 36.5(a) |  |             |  | 4.9%     |        |  |  | 10/98-6/05        |  |  | $ | (0.4 | )
|$                | 36.5(a) |  |             |  | 4.7%     |        |  |  | 9/98-6/05         |  |  | $ | (0.1 | )
|$                | 50.0    |  |             |  | variable |        |  |  | 8/03-7/06         |  |  | $ | 1.4  |  



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

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



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

NOTE 15  SEGMENT
INFORMATION

The Company is organized based upon the following
operating segments: domestic Borders stores, Waldenbooks
stores, International Borders and Books etc. stores, and
Corporate (consisting of the unallocated portion of interest
expense, certain corporate governance costs and corporate
incentive costs). Amounts relating to the Company-owned and
-operated Borders.com Web site, other than intercompany interest
expense (net of related taxes), have been classified in the
Borders segment for all periods presented. Intercompany interest
charges (net of related taxes) relating to Borders.com have been
included in the Corporate segment.

The accounting policies of the segments are the
same as those described in the Summary of Significant
Accounting Policies. Segment data includes charges
allocating all corporate headquarters costs to each segment.
Transactions between segments, consisting principally of
inventory transfers, are recorded primarily at cost. Interest
income and expense are allocated to segments based upon the cash
flow generated or absorbed by those segments. The Company
utilizes fixed interest rates, approximating the Companys
medium-term borrowing and investing rates, in calculating
segment interest income and expense. The Company evaluates the
performance of its segments and allocates resources to them
based on anticipated future contribution.

|                          |               |                        |   |         |         |  |   |         |         |  |   |         |         | 
|------------------------- | ------------- | ---------------------- | - | ------- | ------- |  | - | ------- | ------- |  | - | ------- | ------- | 
|                          |               | 2003                   |   |         | 2002    |  |   | 2001    |        
|                          |               |                        |   |         |         |  |   |         |        
|Sales                     |               |                        |   |         |         |  |   |         |         |  |   |        
|                          | Borders       |                        | $ | 2,470.2 |         |  | $ | 2,319.0 |         |  | $ | 2,234.1 |        
|                          | Waldenbooks   |                        |   | 820.9   |         |  |   | 852.2   |         |  |   | 902.1   |        
|                          | International |                        |   | 407.5   |         |  |   | 314.9   |         |  |   | 251.7   |        
|                          |               |                        |   |         |         |  |   |         |        
|                          |               | Total sales            |   | $       | 3,698.6 |  |   | $       | 3,486.1 |  |   | $       | 3,387.9 | 
|                          |               |                        |   |         |         |  |   |         |        
|Interest expense (income) |               |                        |   |         |         |  |   |         |         |  |   |        
|                          | Borders       |                        | $ | (1.9    | )       |  | $ | 2.5     |         |  | $ | 9.1     |        
|                          | Waldenbooks   |                        |   | (38.8   | )       |  |   | (33.5   | )       |  |   | (28.3   | )      
|                          | International |                        |   | 19.0    |         |  |   | 17.2    |         |  |   | 14.3    |        
|                          | Corporate     |                        |   | 30.4    |         |  |   | 26.4    |         |  |   | 19.3    |        
|                          |               |                        |   |         |         |  |   |         |        
|                          |               | Total interest expense |   | $       | 8.7     |  |   | $       | 12.6    |  |   | $       | 14.4    | 
|                          |               |                        |   |         |         |  |   |         |        

61



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NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)


(dollars in millions except per share
data)


|                                      |               |                                             |   |         |         |  |   |         |         |  |   |         |         | 
|------------------------------------- | ------------- | ------------------------------------------- | - | ------- | ------- |  | - | ------- | ------- |  | - | ------- | ------- | 
|                                      |               | 2003                                        |   |         | 2002    |  |   | 2001    |        
|                                      |               |                                             |   |         |         |  |   |         |        
|Income tax provision (benefit)        |               |                                             |   |         |         |  |   |         |         |  |   |        
|                                      | Borders       |                                             | $ | 63.8    |         |  | $ | 64.2    |         |  | $ | 48.8    |        
|                                      | Waldenbooks   |                                             |   | 30.5    |         |  |   | 24.5    |         |  |   | 23.7    |        
|                                      | International |                                             |   | (2.9    | )       |  |   | (6.1    | )       |  |   | (6.4    | )      
|                                      | Corporate     |                                             |   | (16.6   | )       |  |   | (13.0   | )       |  |   | (10.9   | )      
|                                      |               |                                             |   |         |         |  |   |         |        
|                                      |               | Total income tax expense                    |   | $       | 74.8    |  |   | $       | 69.6    |  |   | $       | 55.2    | 
|                                      |               |                                             |   |         |         |  |   |         |        
|Depreciation and amortization expense |               |                                             |   |         |         |  |   |         |         |  |   |        
|                                      | Borders       |                                             | $ | 70.2    |         |  | $ | 66.7    |         |  | $ | 65.4    |        
|                                      | Waldenbooks   |                                             |   | 18.4    |         |  |   | 20.7    |         |  |   | 21.4    |        
|                                      | International |                                             |   | 12.0    |         |  |   | 9.7     |         |  |   | 9.4     |        
|                                      | Corporate     |                                             |   |        |         |  |   |        |         |  |   |        |        
|                                      |               |                                             |   |         |         |  |   |         |        
|                                      |               | Total depreciation and amortization expense |   | $       | 100.6   |  |   | $       | 97.1    |  |   | $       | 96.2    | 
|                                      |               |                                             |   |         |         |  |   |         |        
|Net income (loss)                     |               |                                             |   |         |         |  |   |         |         |  |   |        
|                                      | Borders       |                                             | $ | 100.5   |         |  | $ | 102.5   |         |  | $ | 72.1    |        
|                                      | Waldenbooks   |                                             |   | 49.0    |         |  |   | 41.4    |         |  |   | 39.5    |        
|                                      | International |                                             |   | 0.1     |         |  |   | (12.3   | )       |  |   | (7.5    | )      
|                                      | Corporate     |                                             |   | (29.6   | )       |  |   | (19.9   | )       |  |   | (16.7   | )      
|                                      |               |                                             |   |         |         |  |   |         |        
|                                      |               | Total net income                            |   | $       | 120.0   |  |   | $       | 111.7   |  |   | $       | 87.4    | 
|                                      |               |                                             |   |         |         |  |   |         |        
|Total assets                          |               |                                             |   |         |         |  |   |         |         |  |   |        
|                                      | Borders       |                                             | $ | 1,360.9 |         |  | $ | 1,310.0 |         |  | $ | 1,339.3 |        
|                                      | Waldenbooks   |                                             |   | 320.5   |         |  |   | 334.1   |         |  |   | 380.0   |        
|                                      | International |                                             |   | 365.0   |         |  |   | 320.3   |         |  |   | 257.7   |        
|                                      | Corporate     |                                             |   | 419.8   |         |  |   | 303.8   |         |  |   | 202.3   |        
|                                      |               |                                             |   |         |         |  |   |         |        
|                                      |               | Total assets                                |   | $       | 2,466.2 |  |   | $       | 2,268.2 |  |   | $       | 2,179.3 | 
|                                      |               |                                             |   |         |         |  |   |         |        
|Capital expenditures                  |               |                                             |   |         |         |  |   |         |         |  |   |        
|                                      | Borders       |                                             | $ | 65.7    |         |  | $ | 66.0    |         |  | $ | 40.5    |        
|                                      | Waldenbooks   |                                             |   | 5.8     |         |  |   | 7.3     |         |  |   | 7.5     |        
|                                      | International |                                             |   | 14.0    |         |  |   | 24.4    |         |  |   | 24.6    |        
|                                      | Corporate     |                                             |   | 15.0    |         |  |   | 23.8    |         |  |   | 18.1    |        
|                                      |               |                                             |   |         |         |  |   |         |        
|                                      |               | Total capital expenditures                  |   | $       | 100.5   |  |   | $       | 121.5   |  |   | $       | 90.7    | 
|                                      |               |                                             |   |         |         |  |   |         |        

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

|              |       |      |      |      |      |   |      |      |  |   |     |      | 
|------------- | ----- | ---- | ---- | ---- | ---- | - | ---- | ---- |  | - | --- | ---- | 
|              |       | 2003 |      |      | 2002 |   |      | 2001 | 
|              |       |      |      |      |      |   |      |      | 
|Borders       |       | $    | 11.4 |      |      | $ | 10.0 |      |  | $ | 8.5 |     
|Walden        |       |      | 5.8  |      |      |   | 5.3  |      |  |   | 3.9 |     
|International |       |      |     |      |      |   |     |      |  |   |    |     
|              |       |      |      |      |      |   |      |      | 
|              | Total |      | $    | 17.2 |      |   | $    | 15.3 |  |   | $   | 12.4 | 
|              |       |      |      |      |      |   |      |      | 

62



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NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)


(dollars in millions except per share
data)


Long-lived assets by geographic area are as
follows:

|                   |               |                         |   |       |       |  |   |       |       |  |   |       |       | 
|------------------ | ------------- | ----------------------- | - | ----- | ----- |  | - | ----- | ----- |  | - | ----- | ----- | 
|                   |               | 2003                    |   |       | 2002  |  |   | 2001  |      
|                   |               |                         |   |       |       |  |   |       |      
|Long-lived assets: |               |                         |   |       |       |  |   |       |       |  |   |      
|                   | Domestic      |                         | $ | 535.6 |       |  | $ | 532.9 |       |  | $ | 580.3 |      
|                   | International |                         |   | 217.9 |       |  |   | 194.0 |       |  |   | 156.9 |      
|                   |               |                         |   |       |       |  |   |       |      
|                   |               | Total long-lived assets |   | $     | 753.5 |  |   | $     | 726.9 |  |   | $     | 737.2 | 
|                   |               |                         |   |       |       |  |   |       |      

NOTE 16  UNAUDITED QUARTERLY
FINANCIAL DATA

|                                                                |                                          |                           |       |       |      |   |       |         |  |   |         |      |  |   |         |      | 
|--------------------------------------------------------------- | ---------------------------------------- | ------------------------- | ----- | ----- | ---- | - | ----- | ------- |  | - | ------- | ---- |  | - | ------- | ---- | 
|                                                                |                                          |                          
|                                                                |                                          | Fiscal 2003 Quarter Ended |      
|                                                                |                                          | April                     |       |       | July |   |       | October |  |   | January |     
|                                                                |                                          |                           |       |       |      |   |       |         |  |   |         |     
|Total revenue                                                   |                                          | $                         | 758.7 |       |      | $ | 834.3 |         |  | $ | 817.1   |      |  | $ | 1,320.9 |     
|Gross margin                                                    |                                          |                           | 189.0 |       |      |   | 212.6 |         |  |   | 206.1   |      |  |   | 439.9   |     
|Income (loss) before cumulative effect of
    accounting change |                                          |                           | (4.8  | )     |      |   | 4.5   |         |  |   | 0.5     |      |  |   | 121.9   |     
|                                                                | Diluted earnings (loss) per common share |                           |       | (0.06 | )    |   |       | 0.06    |  |   |         | 0.01 |  |   |         | 1.53 | 
|                                                                | Basic earnings (loss) per common share   |                           |       | (0.06 | )    |   |       | 0.06    |  |   |         | 0.01 |  |   |         | 1.56 | 
|Net income (loss)                                               |                                          |                           | (4.8  | )     |      |   | 4.5   |         |  |   | 0.5     |      |  |   | 119.8   |     
|                                                                | Diluted earnings (loss) per common share |                           |       | (0.06 | )    |   |       | 0.06    |  |   |         | 0.01 |  |   |         | 1.50 | 
|                                                                | Basic earnings (loss) per common share   |                           |       | (0.06 | )    |   |       | 0.06    |  |   |         | 0.01 |  |   |         | 1.53 | 

|                  |                                          |                           |       |      |      |   |       |         |  |   |         |       |   |   |         |      | 
|----------------- | ---------------------------------------- | ------------------------- | ----- | ---- | ---- | - | ----- | ------- |  | - | ------- | ----- | - | - | ------- | ---- | 
|                  |                                          |                          
|                  |                                          | Fiscal 2002 Quarter Ended |      
|                  |                                          | April                     |       |      | July |   |       | October |  |   | January |      
|                  |                                          |                           |       |      |      |   |       |         |  |   |         |      
|Total revenue     |                                          | $                         | 758.5 |      |      | $ | 770.6 |         |  | $ | 757.0   |       |   | $ | 1,228.6 |     
|Gross margin      |                                          |                           | 199.1 |      |      |   | 201.1 |         |  |   | 193.3   |       |   |   | 408.1   |     
|Net income (loss) |                                          |                           | 3.9   |      |      |   | 3.4   |         |  |   | (1.8    | )     |   |   | 106.2   |     
|                  | Diluted earnings (loss) per common share |                           |       | 0.05 |      |   |       | 0.04    |  |   |         | (0.02 | ) |   |         | 1.32 | 
|                  | Basic earnings (loss) per common share   |                           |       | 0.05 |      |   |       | 0.04    |  |   |         | (0.02 | ) |   |         | 1.34 | 

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

63



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##### Table of Contents



REPORT OF INDEPENDENT AUDITORS

To The Board of Directors and Stockholders

of Borders Group, Inc.


We have audited the accompanying consolidated
balance sheets of Borders Group, Inc. as of
January 25, 2004 and January 26, 2003, and the related
consolidated statements of operations, stockholders
equity, and cash flows for each of the three years in the period
ended January 25, 2004. These financial statements are the
responsibility of the Companys management. Our
responsibility is to express an opinion on these financial
statements based on our audits.

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

In our opinion, the financial statements referred
to above present fairly, in all material respects, the
consolidated financial position of Borders Group, Inc. at
January 25, 2004 and January 26, 2003, and the
consolidated results of its operations and its cash flows for
each of the three years in the period ended January 25,
2004, in conformity with accounting principles generally
accepted in the United States.

As discussed in Note 4 to the consolidated
financial statements, effective January 28, 2002 the
Company adopted the provisions of Financial Accounting Standards
Board Statement No. 142, Goodwill and Other Intangible
Assets.

As discussed in Note 11 to the consolidated
financial statements, effective January 25, 2004 the
Company adopted the provisions of Financial Accounting Standards
Board Interpretation No. 46, Consolidation of Variable
Interest Entities.



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

Detroit, Michigan

March 11, 2004


64



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##### Table of Contents








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

Not applicable.






|         |                        
|-------- | -----------------------
|Item 9A. | Controls and Procedures

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

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




PART III






|         |                                                       
|-------- | ------------------------------------------------------
|Item 10. | Directors and Executive Officers of the
    Registrant

Information regarding the executive officers of
the Company required by this Item 10 is set forth in
Item 1 of Part I herein under the caption
Executive Officers of the Company. Information
pertaining to directors of the Company required by Item 10
is included under the caption Election of Directors
in the Companys Proxy Statement dated April 14, 2004
for the Companys May 20, 2004 Annual Meeting of
Stockholders, and is incorporated herein by reference.
Information relating to compliance with Section 16(a) of
the Securities Exchange Act of 1934, as amended, is set forth in
the Proxy Statement and incorporated herein by reference.

Section 16(a) Beneficial Ownership
Reporting Compliance

The information required by this section is
incorporated herein by reference to the information under the
caption Section 16(a) Beneficial Ownership Reporting
Compliance in the Proxy Statement dated April 14,
2004 for the Companys May 20, 2004 Annual Meeting of
Stockholders.

Code of Ethics and Other Corporate
Governance Information

Information regarding the Companys Business
Conduct Policy and its Code of Ethics Relating to Financial
Reporting, as well the names of the individuals determined by
the Board of Directors to be audit committee financial
experts, is included in the Election of
Directors  Board of Directors Meetings and
Committees and Election of Directors 
Corporate Governance sections of the Companys Proxy
Statement dated April 14, 2004 for the Companys
May 20, 2004 Annual Meeting of Stockholders, and is
incorporated herein by reference.






|         |                       
|-------- | ----------------------
|Item 11. | Executive Compensation

The information required by this Item 11 is
incorporated herein by reference to the information under the
captions Executive Compensation and
Compensation of Directors in the Proxy Statement
dated April 14, 2004 for the Companys May 20,
2004 Annual Meeting of Stockholders.






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

The information required by this Item 12 is
incorporated herein by reference to the information under the
heading Beneficial Ownership of Common Stock in the
Proxy Statement dated April 14, 2004 for the Companys
May 20, 2004 Annual Meeting of Stockholders.

65



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##### Table of Contents








|         |                                                         
|-------- | --------------------------------------------------------
|Item 13. | Certain Relationships and Related Party
    Transactions

Not applicable.




Item 14: Principal Accountant Fees and
Services

The information required by this Item 14 is
incorporated herein by reference to the information under the
heading Fees Paid to Independent Auditors in the
Proxy Statement dated April 14, 2004 for the Companys
May 20, 2004 Annual Meeting of Stockholders.




PART IV






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

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

|                                                                                                                                           |  |      |    | 
|------------------------------------------------------------------------------------------------------------------------------------------ |  | ---- | -- | 
|                                                                                                                                           |  | Page |   
|                                                                                                                                           |  |      |   
|Consolidated Statements of Operations for the
    fiscal years ended January 25, 2004, January 26, 2003
    and January 27, 2002           |  |      | 40 | 
|Consolidated Balance Sheets as of
    January 25, 2004 and January 26, 2003                                                                |  |      | 41 | 
|Consolidated Statements of Cash Flows for the
    fiscal years ended January 25, 2004, January 26, 2003
    and January 27, 2002           |  |      | 42 | 
|Consolidated Statements of Stockholders
    Equity for the fiscal years ended January 25, 2004,
    January 26, 2003 and January 27, 2002 |  |      | 43 | 
|Notes to Consolidated Financial Statements                                                                                                 |  |      | 44 | 
|Report of Independent Auditors                                                                                                             |  |      | 64 | 

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

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

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

| |         |         |             |                                                                                                                            
| | ------- | ------- | ----------- | ---------------------------------------------------------------------------------------------------------------------------
| | Exhibit |        
| | Number  |         | Description
| |         |         |            
| | 2       | .1(4)   |             | Agreement and plan of Merger dated as of
    April 8, 1997 between Michigan Borders Group, Inc. and
    Borders Group, Inc.
| | 3       | .1(9)   |             | Restated Articles of Incorporation of Borders
    Group, Inc.                                                              
| | 3       | .2(14)  |             | Restated bylaws of Borders Group, Inc.                                                                                     
| | 10      | .1(14)  |             | Form of Severance Agreement                                                                                                
| | 10      | .2(4)   |             | Borders Group, Inc. Stock Option Plan                                                                                      
| | 10      | .3(14)  |             | Amendment to the Borders Group, Inc. Stock
    Option Plan                                                                 
| | 10      | .4(2)   |             | Tax Allocation Agreement dated May 24, 1995
    between Borders Group, Inc. and Kmart Corporation                          
| | 10      | .5(2)   |             | Lease Guaranty Agreement dated May 24, 1995
    between Borders Group, Inc. and Kmart Corporation                          
| | 10      | .6(15)  |             | First Amendment to Lease Guaranty Agreement
    between Borders Group, Inc. and Kmart Corporation                          
| | 10      | .7(1)   |             | Borders Group, Inc. Management Stock
    Purchase Plan.                                                                    
| | 10      | .8(6)   |             | First Amendment to the Borders Group, Inc.
    Management Stock Purchase Plan                                              
| | 10      | .9(7)   |             | Second Amendment to the Borders Group, Inc.
    Management Stock Purchase Plan                                             
| | 10      | .10(9)  |             | Third Amendment to the Borders Group, Inc.
    Management Stock Purchase Plan                                              
| | 10      | .11(14) |             | Fourth Amendment to the Borders Group, Inc.
    Management Stock Purchase Plan                                             

66



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##### Table of Contents



| |         |         |             |                                                                                                                                                                                                                                                                                                                 
| | ------- | ------- | ----------- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | Exhibit |         |            
| | Number  |         | Description
| |         |         |            
| | 10      | .12(16) |             | Fifth Amendment to the Borders Group, Inc.
    Management Stock Purchase Plan                                                                                                                                                                                                                                   
| | 10      | .13(16) |             | Sixth Amendment to the Borders Group, Inc.
    Management Stock Purchase Plan                                                                                                                                                                                                                                   
| | 10      | .14(1)  |             | Borders Group, Inc. Employee Stock Purchase
    Plan                                                                                                                                                                                                                                                            
| | 10      | .15(3)  |             | First Amendment to the Borders Group, Inc.
    Employee Stock Purchase Plan                                                                                                                                                                                                                                     
| | 10      | .16(9)  |             | Second Amendment to the Borders Group, Inc.
    Employee Stock Purchase Plan                                                                                                                                                                                                                                    
| | 10      | .17(9)  |             | Third Amendment to the Borders Group, Inc.
    Employee Stock Purchase Plan                                                                                                                                                                                                                                     
| | 10      | .18(13) |             | Borders Group, Inc. Annual Incentive Bonus
    Plan                                                                                                                                                                                                                                                             
| | 10      | .24(5)  |             | Amended and Restated Multicurrency Credit
    Agreement among Borders Group, Inc., its subsidiaries and
    Parties thereto                                                                                                                                                                                     
| | 10      | .25(5)  |             | Amended and Restated Participation Agreement
    among Borders Group, Inc., its subsidiaries and Parties
    thereto                                                                                                                                                                                            
| | 10      | .26(5)  |             | Appendix A to Participation Agreement among
    Borders Group, Inc., its subsidiaries and Parties thereto                                                                                                                                                                                                       
| | 10      | .27(5)  |             | Amended and Restated Credit Agreement among
    Borders Group, Inc., its subsidiaries and Parties thereto                                                                                                                                                                                                       
| | 10      | .28(5)  |             | Amended and Restated Guarantee Credit Agreement
    among Borders Group, Inc., its subsidiaries and Parties
    thereto                                                                                                                                                                                         
| | 10      | .29(10) |             | Omnibus Amendment No. 1 to Amended and
    Restated Guarantee Credit Agreement among Borders
    Group, Inc., its subsidiaries and Parties thereto                                                                                                                                                              
| | 10      | .30(8)  |             | Borders Group, Inc. Stock Option Plan for
    International Employees                                                                                                                                                                                                                                           
| | 10      | .31(9)  |             | 1998 Borders Group, Inc. Stock Option Plan                                                                                                                                                                                                                                                                      
| | 10      | .32(12) |             | Agreement dated November 15, 1999, between
    Borders Group, Inc. and Gregory P. Josefowicz                                                                                                                                                                                                                    
| | 10      | .33(9)  |             | Participation Agreement dated as of
    December 1, 1998 by and among Borders Group, Inc.,
    Borders, Inc. and Parties thereto                                                                                                                                                                                
| | 10      | .35(11) |             | Amendment No. 1 to 1998 Borders
    Group, Inc. Stock Option Plan                                                                                                                                                                                                                                               
| | 10      | .37(12) |             | Amended Schedule II to the Amended and
    Restated Credit Agreement among Borders Group, Inc., its
    subsidiaries and Parties thereto                                                                                                                                                                        
| | 10      | .38(14) |             | Participation Agreement dated as of
    January 22, 2001 by and among Borders Group, Inc.,
    Borders, Inc. and Parties thereto                                                                                                                                                                                
| | 10      | .39(14) |             | Form of Lease Guaranty Related to Lease Facility
    Agreement                                                                                                                                                                                                                                                  
| | 10      | .40(14) |             | Form of Environmental Indemnity Related to Lease
    Facility Agreement                                                                                                                                                                                                                                         
| | 10      | .41(17) |             | Multicurrency Revolving Credit Agreement dated as
    of June 21, 2002 among Borders Group, Inc., certain of
    its subsidiaries and other Parties thereto.                                                                                                                                                    
| | 10      | .42(17) |             | Omnibus Amendment dated as of June 21, 2002
    relating to the Amended and Restated Participation Agreement,
    the Amended and Restated Credit Agreement, the Amended and
    Restated Guarantee Agreement, and certain other agreements among
    Borders Group, Inc., its subsidiaries and Parties thereto.
| | 10      | .43(17) |             | Master Agreement dated as of June 21, 2002
    among Borders Group, Inc., certain of its subsidiaries and
    the other Parties thereto.                                                                                                                                                                        
| | 10      | .44(17) |             | Loan Agreement dated as of June 21, 2002
    among Atlantic Financial Group, LTD, the Financial Institutions
    party thereto, and Suntrust Bank relating to the Borders
    Group, Inc. Lease Financing Facility.                                                                                             
| | 10      | .45(17) |             | Guaranty Agreement dated as of June 21, 2002
    from Borders Group, Inc., and certain of its subsidiaries.                                                                                                                                                                                                     
| | 10      | .46(17) |             | Construction Agency Agreement dated as of
    June 21, 2002 among Borders Inc. and Atlantic Financial
    Group, LTD.                                                                                                                                                                                           
| | 10      | .47(17) |             | Master Lease Agreement dated as of June 21,
    2002 between Borders Inc., certain other subsidiaries of Borders
    Group, Inc. and Atlantic Financial Group, LTD.                                                                                                                                             
| | 10      | .48(17) |             | Note Purchase Agreement dated as of July 30,
    2002 relating to the 6.31% Senior Guaranteed Notes of
    Borders Group, Inc.                                                                                                                                                                                  

67



---



##### Table of Contents



| |         |         |             |                                                                                                                                                                                                                                                                                                                                           
| | ------- | ------- | ----------- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | Exhibit |         |            
| | Number  |         | Description
| |         |         |            
| | 10      | .49(18) |             | Amendment No. 2 to the Credit Agreement
    dated as of August 12, 2002 among Borders Group Inc.,
    certain of its subsidiaries and other Parties thereto.                                                                                                                                                                              
| | 10      | .50(18) |             | Amendment No. 1 to the Multicurrency
    Revolving Credit Agreement dated as of September 18, 2002
    among Borders Group Inc., certain of its subsidiaries and other
    Parties thereto.                                                                                                                                               
| | 10      | .51(19) |             | Amendment No. 2 to the Multicurrency
    Revolving Credit Agreement dated as of May 20, 2003 among
    Borders Group Inc., certain of its subsidiaries and other
    Parties thereto.                                                                                                                                                     
| | 10      | .52(19) |             | Omnibus Amendment No. 2 dated as of
    May 20, 2003, relating to the Amended and Restated
    Participation Agreement, the Amended and restated Credit
    Agreement, the Amended and Restated Guarantee Agreement, and
    certain other agreements among Borders Group Inc., certain of
    its subsidiaries and other Parties thereto.
| | 10      | .53(19) |             | Amendment No. 1 to the Master Agreement
    dated as of May 20, 2003 among Borders Group Inc., certain
    of its subsidiaries and other Parties thereto.                                                                                                                                                                                 
| | 10      | .54(20) |             | Borders Group, Inc. Long Term Incentive Plan                                                                                                                                                                                                                                                                                              
| | 10      | .55     |             | Participation Agreement dated as of
    November 15, 2002 by and among Borders Group, Inc.,
    Borders, Inc. and Parties thereto                                                                                                                                                                                                         
| | 14      | .1      |             | Code of Ethics Relating to Financial Reporting                                                                                                                                                                                                                                                                                            
| | 14      | .2      |             | Business Conduct Policy                                                                                                                                                                                                                                                                                                                   
| | 21      | .1      |             | Subsidiaries of Registrant                                                                                                                                                                                                                                                                                                                
| | 23      | .1      |             | Consent of Ernst & Young LLP                                                                                                                                                                                                                                                                                                              
| | 31      | .1      |             | Statement of Gregory P. Josefowicz, Chairman,
    President and Chief Executive Officer of Borders
    Group, Inc. pursuant to Section 302 of the
    Sarbanes-Oxley Act of 2002                                                                                                                                                          
| | 31      | .2      |             | Statement of Edward W. Wilhelm, Senior Vice
    President and Chief Financial Officer of Borders
    Group, Inc. pursuant to Section 302 of the
    Sarbanes-Oxley Act of 2002                                                                                                                                                            
| | 32      | .1      |             | Statement of Gregory P. Josefowicz, Chairman,
    President and Chief Executive Officer of Borders
    Group, Inc. pursuant to Section 906 of the
    Sarbanes-Oxley Act of 2002                                                                                                                                                          
| | 32      | .2      |             | Statement of Edward W. Wilhelm, Senior Vice
    President and Chief Financial Officer of Borders
    Group, Inc. pursuant to Section 906 of the
    Sarbanes-Oxley Act of 2002                                                                                                                                                            
| | 99      | .1      |             | Cautionary Statement under the Private Securities
    Litigation Reform Act of 1995  Safe
    Harbor for Forward-Looking Statements                                                                                                                                                                                                    



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

68



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##### Table of Contents





|     |                                                                                                                                               
|---- | ----------------------------------------------------------------------------------------------------------------------------------------------
|(10) | Incorporated by reference from the Companys
    Quarterly Report on Form 10-Q for the quarter ended
    July 25, 1999 (File No. 1-13740).    
|    
|(11) | Incorporated by reference from the Companys
    Quarterly Report on Form 10-Q for the quarter ended
    October 24, 1999 (File No. 1-13740). 
|    
|(12) | Incorporated by reference from the Companys
    Annual Report on Form 10-K for the year ended
    January 23, 2000 (File No. 1-13740).       
|    
|(13) | Incorporated by reference from the Companys
    Proxy Statement dated May 24, 2000 (File No. 1-13740).                                       
|    
|(14) | Incorporated by reference from the Companys
    Annual Report on Form 10-K for the year ended
    January 27, 2002 (File No. 1-13740).       
|    
|(15) | Incorporated by reference from the Companys
    Quarterly Report on Form 10-Q for the quarter ended
    April 29, 2001 (File No. 1-13740).   
|    
|(16) | Incorporated by reference from the Companys
    Annual Report on Form 10-K for the year ended
    January 26, 2003 (File No. 1-13740).       
|    
|(17) | Incorporated by reference from the Companys
    Quarterly Report on Form 10-Q for the quarter ended
    July 28, 2002 (File No. 1-13740).    
|    
|(18) | Incorporated by reference from the Companys
    Quarterly Report on Form 10-Q for the quarter ended
    October 27, 2002 (Filed No. 1-13740).
|    
|(19) | Incorporated by reference from the Companys
    Quarterly Report on Form 10-Q for the quarter ended
    April 27, 2003 (Filed No. 1-13740).  
|    
|(20) | Incorporated by reference from the Companys
    Quarterly Report on Form 10-Q for the quarter ended
    July 27, 2003 (Filed No. 1-13740).   

(b) Financial Statement Schedules:

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

(c) Reports on Form 8-K:

During the fiscal year ended January 25,
2004 there were three reports filed on Form 8-K. The report
dated and filed on May 22, 2003 was filed under
Item 9. Regulation FD Disclosure and furnished a press
release with earnings information for the quarter ended
April 27, 2003. The report dated and filed on
August 22, 2003 was filed under Item 9.
Regulation FD Disclosure and furnished a press release with
earnings information for the quarter ended July 27, 2003.
The report dated and filed on November 20, 2003 was filed
under Item 9. Regulation FD Disclosure and furnished a
press release with earnings information for the quarter ended
October 26, 2003. Subsequent to the year ended
January 25, 2004 and prior to the filing of this
Form 10-K, there were two reports filed on Form 8-K.
The report dated and filed on February 11, 2004 was filed
under Item 9. Regulation FD Disclosure and furnished a
press release with sales information for the quarter and year
ended January 25, 2004. The report dated and filed on
March 11, 2004 was filed under Item 9.
Regulation FD Disclosure and furnished a press release with
earnings information for the quarter and year ended
January 25, 2004.

(d) Financial Statement Schedules:

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

69



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##### Table of Contents



SIGNATURES

Pursuant to the requirements of Section 13
or 15(d) of the Securities Exchange Act of 1934, the Registrant
has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.



| |                    
| | -------------------
| | BORDERS GROUP, INC.
| | (Registrant)       



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

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

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

|                                                   |  |                                                                                                    |  |                |  | 
|-------------------------------------------------- |  | -------------------------------------------------------------------------------------------------- |  | -------------- |  | 
|                                                   |  |                                                                                                    |  |                |  | 
|Name                                               |  | Title                                                                                              |  | Date          
|                                                   |  |                                                                                                    |  |               
|                                                  
|/s/ GREGORY P. JOSEFOWICZGregory P. Josefowicz     |  | Chairman, Chief Executive Officer, and President                                                   |  | March 25, 2004
|                                                  
|/s/ EDWARD W. WILHELMEdward W. Wilhelm             |  | Senior Vice President and Chief Financial Officer
    (Principal Financial and Accounting Officer) |  | March 25, 2004
|                                                  
|/s/ JOEL J. COHENJoel J. Cohen                     |  | Director                                                                                           |  | March 25, 2004
|                                                  
|/s/ ROBERT F. DIROMUALDORobert F. DiRomualdo       |  | Director                                                                                           |  | March 25, 2004
|                                                  
|/s/ PETER R. FORMANEKPeter R. Formanek             |  | Director                                                                                           |  | March 25, 2004
|                                                  
|/s/ AMY B. LANEAmy B. Lane                         |  | Director                                                                                           |  | March 25, 2004
|                                                  
|/s/ VICTOR L. LUNDVictor L. Lund                   |  | Director                                                                                           |  | March 25, 2004
|                                                  
|/s/ DR. EDNA GREENE MEDFORDDr. Edna Greene Medford |  | Director                                                                                           |  | March 25, 2004
|                                                  
|/s/ GEORGE R. MRKONICGeorge R. Mrkonic             |  | Director                                                                                           |  | March 25, 2004
|                                                  
|/s/ LAWRENCE I. POLLOCKLawrence I. Pollock         |  | Director                                                                                           |  | March 25, 2004
|                                                  
|/s/ BETH M. PRITCHARDBeth M. Pritchard             |  | Director                                                                                           |  | March 25, 2004

70



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##### Table of Contents



EXHIBIT INDEX

|        |    |         |             |                                                                                                                                                   
|------- | -- | ------- | ----------- | --------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit |    |         |            
|Number  |    |         | Description
|        |    |         |            
|        | 2  | .1(4)   |             | Agreement and plan of Merger dated as of
    April 8, 1997 between Michigan Borders Group, Inc. and
    Borders Group, Inc.                       
|        | 3  | .1(9)   |             | Restated Articles of Incorporation of Borders
    Group, Inc.                                                                                     
|        | 3  | .2(14)  |             | Restated bylaws of Borders Group, Inc.                                                                                                            
|        | 10 | .1(14)  |             | Form of Severance Agreement                                                                                                                       
|        | 10 | .2(4)   |             | Borders Group, Inc. Stock Option Plan                                                                                                             
|        | 10 | .3(14)  |             | Amendment to the Borders Group, Inc. Stock
    Option Plan                                                                                        
|        | 10 | .4(2)   |             | Tax Allocation Agreement dated May 24, 1995
    between Borders Group, Inc. and Kmart Corporation                                                 
|        | 10 | .5(2)   |             | Lease Guaranty Agreement dated May 24, 1995
    between Borders Group, Inc. and Kmart Corporation                                                 
|        | 10 | .6(15)  |             | First Amendment to Lease Guaranty Agreement
    between Borders Group, Inc. and Kmart Corporation                                                 
|        | 10 | .7(1)   |             | Borders Group, Inc. Management Stock
    Purchase Plan.                                                                                           
|        | 10 | .8(6)   |             | First Amendment to the Borders Group, Inc.
    Management Stock Purchase Plan                                                                     
|        | 10 | .9(7)   |             | Second Amendment to the Borders Group, Inc.
    Management Stock Purchase Plan                                                                    
|        | 10 | .10(9)  |             | Third Amendment to the Borders Group, Inc.
    Management Stock Purchase Plan                                                                     
|        | 10 | .11(14) |             | Fourth Amendment to the Borders Group, Inc.
    Management Stock Purchase Plan                                                                    
|        | 10 | .12(16) |             | Fifth Amendment to the Borders Group, Inc.
    Management Stock Purchase Plan                                                                     
|        | 10 | .13(16) |             | Sixth Amendment to the Borders Group, Inc.
    Management Stock Purchase Plan                                                                     
|        | 10 | .14(1)  |             | Borders Group, Inc. Employee Stock Purchase
    Plan                                                                                              
|        | 10 | .15(3)  |             | First Amendment to the Borders Group, Inc.
    Employee Stock Purchase Plan                                                                       
|        | 10 | .16(9)  |             | Second Amendment to the Borders Group, Inc.
    Employee Stock Purchase Plan                                                                      
|        | 10 | .17(9)  |             | Third Amendment to the Borders Group, Inc.
    Employee Stock Purchase Plan                                                                       
|        | 10 | .18(13) |             | Borders Group, Inc. Annual Incentive Bonus
    Plan                                                                                               
|        | 10 | .24(5)  |             | Amended and Restated Multicurrency Credit
    Agreement among Borders Group, Inc., its subsidiaries and
    Parties thereto                       
|        | 10 | .25(5)  |             | Amended and Restated Participation Agreement
    among Borders Group, Inc., its subsidiaries and Parties
    thereto                              
|        | 10 | .26(5)  |             | Appendix A to Participation Agreement among
    Borders Group, Inc., its subsidiaries and Parties thereto                                         
|        | 10 | .27(5)  |             | Amended and Restated Credit Agreement among
    Borders Group, Inc., its subsidiaries and Parties thereto                                         
|        | 10 | .28(5)  |             | Amended and Restated Guarantee Credit Agreement
    among Borders Group, Inc., its subsidiaries and Parties
    thereto                           
|        | 10 | .29(10) |             | Omnibus Amendment No. 1 to Amended and
    Restated Guarantee Credit Agreement among Borders
    Group, Inc., its subsidiaries and Parties thereto
|        | 10 | .30(8)  |             | Borders Group, Inc. Stock Option Plan for
    International Employees                                                                             
|        | 10 | .31(9)  |             | 1998 Borders Group, Inc. Stock Option Plan                                                                                                        
|        | 10 | .32(12) |             | Agreement dated November 15, 1999, between
    Borders Group, Inc. and Gregory P. Josefowicz                                                      
|        | 10 | .33(9)  |             | Participation Agreement dated as of
    December 1, 1998 by and among Borders Group, Inc.,
    Borders, Inc. and Parties thereto                  
|        | 10 | .35(11) |             | Amendment No. 1 to 1998 Borders
    Group, Inc. Stock Option Plan                                                                                 
|        | 10 | .37(12) |             | Amended Schedule II to the Amended and
    Restated Credit Agreement among Borders Group, Inc., its
    subsidiaries and Parties thereto          
|        | 10 | .38(14) |             | Participation Agreement dated as of
    January 22, 2001 by and among Borders Group, Inc.,
    Borders, Inc. and Parties thereto                  
|        | 10 | .39(14) |             | Form of Lease Guaranty Related to Lease Facility
    Agreement                                                                                    



---



##### Table of Contents



|        |    |         |             |                                                                                                                                                                                                                                                                                                                                           
|------- | -- | ------- | ----------- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit |    |         |            
|Number  |    |         | Description
|        |    |         |            
|        | 10 | .40(14) |             | Form of Environmental Indemnity Related to Lease
    Facility Agreement                                                                                                                                                                                                                                                                   
|        | 10 | .41(17) |             | Multicurrency Revolving Credit Agreement dated as
    of June 21, 2002 among Borders Group, Inc., certain of
    its subsidiaries and other Parties thereto.                                                                                                                                                                              
|        | 10 | .42(17) |             | Omnibus Amendment dated as of June 21, 2002
    relating to the Amended and Restated Participation Agreement,
    the Amended and Restated Credit Agreement, the Amended and
    Restated Guarantee Agreement, and certain other agreements among
    Borders Group, Inc., its subsidiaries and Parties thereto.                          
|        | 10 | .43(17) |             | Master Agreement dated as of June 21, 2002
    among Borders Group, Inc., certain of its subsidiaries and
    the other Parties thereto.                                                                                                                                                                                                  
|        | 10 | .44(17) |             | Loan Agreement dated as of June 21, 2002
    among Atlantic Financial Group, LTD, the Financial Institutions
    party thereto, and Suntrust Bank relating to the Borders
    Group, Inc. Lease Financing Facility.                                                                                                                       
|        | 10 | .45(17) |             | Guaranty Agreement dated as of June 21, 2002
    from Borders Group, Inc., and certain of its subsidiaries.                                                                                                                                                                                                                               
|        | 10 | .46(17) |             | Construction Agency Agreement dated as of
    June 21, 2002 among Borders Inc. and Atlantic Financial
    Group, LTD.                                                                                                                                                                                                                     
|        | 10 | .47(17) |             | Master Lease Agreement dated as of June 21,
    2002 between Borders Inc., certain other subsidiaries of Borders
    Group, Inc. and Atlantic Financial Group, LTD.                                                                                                                                                                       
|        | 10 | .48(17) |             | Note Purchase Agreement dated as of July 30,
    2002 relating to the 6.31% Senior Guaranteed Notes of
    Borders Group, Inc.                                                                                                                                                                                                            
|        | 10 | .49(18) |             | Amendment No. 2 to the Credit Agreement
    dated as of August 12, 2002 among Borders Group Inc.,
    certain of its subsidiaries and other Parties thereto.                                                                                                                                                                              
|        | 10 | .50(18) |             | Amendment No. 1 to the Multicurrency
    Revolving Credit Agreement dated as of September 18, 2002
    among Borders Group Inc., certain of its subsidiaries and other
    Parties thereto.                                                                                                                                               
|        | 10 | .51(19) |             | Amendment No. 2 to the Multicurrency
    Revolving Credit Agreement dated as of May 20, 2003 among
    Borders Group Inc., certain of its subsidiaries and other
    Parties thereto.                                                                                                                                                     
|        | 10 | .52(19) |             | Omnibus Amendment No. 2 dated as of
    May 20, 2003, relating to the Amended and Restated
    Participation Agreement, the Amended and restated Credit
    Agreement, the Amended and Restated Guarantee Agreement, and
    certain other agreements among Borders Group Inc., certain of
    its subsidiaries and other Parties thereto.
|        | 10 | .53(19) |             | Amendment No. 1 to the Master Agreement
    dated as of May 20, 2003 among Borders Group Inc., certain
    of its subsidiaries and other Parties thereto.                                                                                                                                                                                 
|        | 10 | .54(20) |             | Borders Group, Inc. Long Term Incentive Plan                                                                                                                                                                                                                                                                                              
|        | 10 | .55     |             | Participation Agreement dated as of
    November 15, 2002 by and among Borders Group, Inc.,
    Borders, Inc. and Parties thereto                                                                                                                                                                                                         
|        | 14 | .1      |             | Code of Ethics Relating to Financial Reporting                                                                                                                                                                                                                                                                                            
|        | 14 | .2      |             | Business Conduct Policy                                                                                                                                                                                                                                                                                                                   
|        | 21 | .1      |             | Subsidiaries of Registrant                                                                                                                                                                                                                                                                                                                
|        | 23 | .1      |             | Consent of Ernst & Young LLP                                                                                                                                                                                                                                                                                                              
|        | 31 | .1      |             | Statement of Gregory P. Josefowicz, Chairman,
    President and Chief Executive Officer of Borders Group, Inc.
    pursuant to Section 302 of the Sarbanes-Oxley Act of 2002                                                                                                                                                              
|        | 31 | .2      |             | Statement of Edward W. Wilhelm, Senior Vice
    President and Chief Financial Officer of Borders
    Group, Inc. pursuant to Section 302 of the
    Sarbanes-Oxley Act of 2002                                                                                                                                                            
|        | 32 | .1      |             | Statement of Gregory P. Josefowicz, Chairman,
    President and Chief Executive Officer of Borders
    Group, Inc. pursuant to Section 906 of the
    Sarbanes-Oxley Act of 2002                                                                                                                                                          
|        | 32 | .2      |             | Statement of Edward W. Wilhelm, Senior Vice
    President and Chief Financial Officer of Borders
    Group, Inc. pursuant to Section 906 of the
    Sarbanes-Oxley Act of 2002                                                                                                                                                            
|        | 99 | .1      |             | Cautionary Statement under the Private Securities
    Litigation Reform Act of 1995  Safe
    Harbor for Forward-Looking Statements                                                                                                                                                                                                    



|    |                                                                                                              
|--- | -------------------------------------------------------------------------------------------------------------
|(1) | Incorporated by reference from the Companys
    Registration Statement on Form S-1 (File
    No. 333-90918).



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##### Table of Contents





|     |                                                                                                                                              
|---- | ---------------------------------------------------------------------------------------------------------------------------------------------
|(2)  | Incorporated by reference from the Companys
    Quarterly Report on Form 10-Q for the quarter ended
    April 23, 1995 (File No. 1-13740).  
|    
|(3)  | Incorporated by reference from the Companys
    Registration Statement on Form S-1 (File
    No. 333-80643).                                
|    
|(4)  | Incorporated by reference from the Companys
    Proxy Statement dated April 9, 1997 of Borders
    Group, Inc. (File No. 1-13740).          
|    
|(5)  | Incorporated by reference from the Companys
    Quarterly Report on Form 10-Q for the quarter ended
    October 26, 1997 (File No. 1-13740).
|    
|(6)  | Incorporated by reference from the Companys
    Quarterly Report on Form 10-Q for the quarter ended
    October 22, 1995 (File No. 1-13740).
|    
|(7)  | Incorporated by reference from the Companys
    Annual Report on Form 10-K for the year ended
    January 25, 1998 (File No. 1-13740).      
|    
|(8)  | Incorporated by reference from the Companys
    Quarterly Report on Form 10-Q for the quarter ended
    July 26, 1998 (File No. 1-13740).   
|    
|(9)  | Incorporated by reference from the Companys
    Annual Report on Form 10-K for the year ended
    January 24, 1999 (File No. 1-13740).      
|    
|(10) | Incorporated by reference from the Companys
    Quarterly Report on Form 10-Q for the quarter ended
    July 25, 1999 (File No. 1-13740).   
|    
|(11) | Incorporated by reference from the Companys
    Quarterly Report on Form 10-Q for the quarter ended
    October 24, 1999 (File No. 1-13740).
|    
|(12) | Incorporated by reference from the Companys
    Annual Report on Form 10-K for the year ended
    January 23, 2000 (File No. 1-13740).      
|    
|(13) | Incorporated by reference from the Companys
    Proxy Statement dated May 24, 2000 (File No. 1-13740).                                      
|    
|(14) | Incorporated by reference from the Companys
    Annual Report on Form 10-K for the year ended
    January 27, 2002 (File No. 1-13740).      
|    
|(15) | Incorporated by reference from the Companys
    Quarterly Report on Form 10-Q for the quarter ended
    April 29, 2001 (File No. 1-13740).  
|    
|(16) | Incorporated by reference from the Companys
    Annual Report on Form 10-K for the year ended
    January 26, 2003 (File No. 1-13740).      
|    
|(17) | Incorporated by reference from the Companys
    Quarterly Report on Form 10-Q for the quarter ended
    July 28, 2002 (File No. 1-13740).   
|    
|(18) | Incorporated by reference from the Companys
    Quarterly Report on Form 10-Q for the quarter ended
    October 27, 2002 (Filed No. 1-13740)
|    
|(19) | Incorporated by reference from the Companys
    Quarterly Report on Form 10-Q for the quarter ended
    April 27, 2003 (Filed No. 1-13740). 
|    
|(20) | Incorporated by reference from the Companys
    Quarterly Report on Form 10-Q for the quarter ended
    July 27, 2003 (Filed No. 1-13740).