SECURITIES
      AND EXCHANGE COMMISSION





Washington,
      D.C. 20549





FORM
      10 -
      Q


(Mark One)


[X]
            QUARTERLY
                REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THESECURITIES
                EXCHANGE ACT OF 1934For
                the quarterly period ended July 29, 2006OR[
                ]
            TRANSITION
                REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THESECURITIES
                EXCHANGE ACT OF 1934





For
      the
      transition period from ______ to _______.





Commission
      file number 1-13740





BORDERS
      GROUP, INC.


(Exact
      name of registrant as specified in its charter)





MICHIGAN
            
            38-3294588(State
                or other jurisdiction of
            
            (I.R.S.
                Employerincorporation
                or organization)
            
            Identification
                No.)





100
      Phoenix Drive, Ann Arbor, Michigan 48108


(Address
      of principal executive offices)


(zip
      code)





(734)
      477-1100


(Registrant's
      telephone number, including area code)







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




Indicate
      by check mark whether the registrant is a large accelerated filer, an
      accelerated filer, or a non-accelerated filer. See definition of “accelerated
      filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check
      one):




Large
      accelerated filer x Accelerated
      filer  ̈ Non-accelerated
      filer  ̈




Indicate
      by check mark whether the registrant is a shell company (as defined in Rule
      12b-2 of the Act).    Yes  ̈ No x





The
      number of shares of common stock outstanding at August 25, 2006 was
      62,039,803.














**BORDERS
      GROUP, INC.**





**INDEX**


Part
                I - Financial Information**Page**Item
                1. Financial
                Statements
            
            
            1Item
                2. Management's
                Discussion and Analysis ofFinancial
                Condition and Results ofOperations
            
            
            11Item
                3.  Quantitative
                and Qualitative Disclosures aboutMarket
                Risk
            
            
            27Item
                4.  Controls and
                Procedures
            
            
            27Part
                II - Other informationItem
                1.  Legal
                Proceedings
            
            
            27Item
                1ARisk
                Factors
            
            
            27Item
                2.  Unregistered
                Sales of Equity Securities and Use of
            
            
            28ProceedsItem
                3.  Defaults Upon
                Senior Securities
            
            
            N/AItem
                4.  Submission of
                Matters to a Vote of
            
            
            28SecurityholdersItem
                5.  Other
                Information
            
            
            N/AItem
                6.  Exhibits
            
            
            29Signatures
            
            
            30





i


**BORDERS
      GROUP, INC.**


**CONDENSED
      CONSOLIDATED STATEMENTS OF OPERATIONS**


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


**(UNAUDITED)**





**13****Weeks
                Ended****July
                29,**
              **2006**
            
            **July
                23,**
              **2005**Sales
            
            $
            856.0
            
            $
            891.6Other
                revenue
            
            
            10.3
            
            
            9.5Total
                revenue
            
            
            866.3
            
            
            901.1Cost
                of merchandise sold, including occupancy costs
            
            
            661.5
            
            
            669.9Gross
                margin
            
            
            204.8
            
            
            231.2Selling,
                general and administrative expenses
            
            
            223.3
            
            
            224.0Pre-opening
                expense
            
            
            2.3
            
            
            1.5Asset
                impairments and other writedowns
            
            
            2.0
            
            
            0.3Operating
                income (loss)
            
            
            (22.8
            )
            
            5.4Interest
                expense
            
            
            7.7
            
            
            3.3Income
                (loss) before income tax
            
            
            (30.5
            )
            
            2.1Income
                tax provision (benefit)
            
            
            (12.1
            )
            
            0.8Net
                income (loss)
            
            $
            (18.4
            )
            $
            1.3Earnings
                (loss) per common share data*Diluted:*Income
                (loss) per common share
            
            $
            (0.29
            )
            $
            0.02Weighted
                average common shares outstanding (in millions)
            
            
            63.6
            
            
            72.3*Basic:*Income
                (loss) per common share
            
            $
            (0.29
            )
            $
            0.02Weighted
                average common shares outstanding (in millions)
            
            
            63.6
            
            
            70.7Dividends
                declared per common share
            
            $
            0.10
            
            $
            0.09








See
      accompanying Notes to Unaudited Condensed Consolidated Financial
      Statements.





1


**BORDERS
      GROUP, INC.**


**CONDENSED
      CONSOLIDATED STATEMENTS OF OPERATIONS**


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


**(UNAUDITED)**





**26****Weeks
                Ended****July
                29,**
              **2****006**
            
            **July
                23,**
              **2005**Sales
            
            $
            1,716.0
            
            $
            1,738.8Other
                revenue
            
            
            18.1
            
            
            19.6Total
                revenue
            
            
            1,734.1
            
            
            1,758.4Cost
                of merchandise sold, including occupancy costs
            
            
            1,328.6
            
            
            1,310.6Gross
                margin
            
            
            405.5
            
            
            447.8Selling,
                general and administrative expenses
            
            
            448.7
            
            
            445.3Pre-opening
                expense
            
            
            4.2
            
            
            2.7Asset
                impairments and other writedowns
            
            
            2.6
            
            
            0.6Operating
                loss
            
            
            (50.0
            )
            
            (0.8
            )Interest
                expense
            
            
            13.1
            
            
            5.5Loss
                before income tax
            
            
            (63.1
            )
            
            (6.3
            )Income
                tax benefit
            
            
            (24.5
            )
            
            (2.3
            )Net
                loss
            
            $
            (38.6
            )
            $
            (4.0
            )Loss
                per common share data*Diluted:*Loss
                per common share
            
            $
            (0.60
            )
            $
            (0.06
            )Weighted
                average common shares outstanding (in millions)
            
            
            64.0
            
            
            71.9*Basic:*Loss
                per common share
            
            $
            (0.60
            )
            $
            (0.06
            )Weighted
                average common shares outstanding (in millions)
            
            
            64.0
            
            
            71.9Dividends
                declared per common share
            
            $
            0.20
            
            $
            0.18








See
      accompanying Notes to Unaudited Condensed Consolidated Financial
      Statements.


2


**BORDERS
      GROUP, INC.**


**CONDENSED
      CONSOLIDATED BALANCE SHEETS**


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


**(UNAUDITED)**








******July
                29,**
              **2006**
            
            ******July
                23,**
              **2005**
            
            **January
                28,**
              **2006****Assets**Current
                assets:Cash
                and cash equivalents
            
            $
            89.1
            
            $
            77.2
            
            $
            81.6Merchandise
                inventories
            
            
            1,391.7
            
            
            1,346.6
            
            
            1,405.9Accounts
                receivable and other current assets
            
            
            166.5
            
            
            117.4
            
            
            150.3Total
                current assets
            
            
            1,647.3
            
            
            1,541.2
            
            
            1,637.8Property
                and equipment, net of accumulated depreciation of$1,023.1,
                $954.4 and $966.5 at July 29, 2006, July 23,2005
                and January 28, 2006, respectively
            
            
            741.3
            
            
            652.8
            
            
            703.9Other
                assets
            
            
            63.2
            
            
            85.3
            
            
            79.7Deferred
                income taxes
            
            
            40.9
            
            
            13.9
            
            
            26.3Goodwill
            
            
            128.3
            
            
            122.7
            
            
            124.5Total
                assets
            
            $
            2,621.0
            
            $
            2,415.9
            
            $
            2,572.2**Liabilities,
                Minority Interest and Stockholders’ Equity**Current
                liabilities:Short-term
                borrowings and current portion of long-term debt
            
            $
            560.5
            
            $
            147.5
            
            $
            207.1Trade
                accounts payable
            
            
            544.7
            
            
            612.1
            
            
            660.3Accrued
                payroll and other liabilities
            
            
            271.4
            
            
            255.7
            
            
            293.4Taxes,
                including income taxes
            
            
            13.0
            
            
            64.8
            
            
            135.8Deferred
                income taxes
            
            
            29.8
            
            
            15.0
            
            
            14.5Total
                current liabilities
            
            
            1,419.4
            
            
            1,095.1
            
            
            1,311.1Long-term
                debt
            
            
            5.3
            
            
            55.0
            
            
            5.4Other
                long-term liabilities
            
            
            355.8
            
            
            300.6
            
            
            326.6Total
                liabilities
            
            
            1,780.5
            
            
            1,450.7
            
            
            1,643.1Minority
                interest
            
            
            1.4
            
            
            1.3
            
            
            1.3Total
                liabilities and minority interest
            
            
            1,781.9
            
            
            1,452.0
            
            
            1,644.4Stockholders'
                equity:Common
                stock; 300,000,000 shares authorized;62,195,625,
                70,171,671, and 64,149,397 shares issuedand
                outstanding at July 29, 2006, July 23, 2005 andJanuary
                28, 2006, respectively
            
            
            253.0
            
            
            424.2
            
            
            293.9Accumulated
                other comprehensive income
            
            
            23.0
            
            
            17.6
            
            
            19.4Retained
                earnings
            
            
            563.1
            
            
            522.1
            
            
            614.5Total
                stockholders' equity
            
            
            839.1
            
            
            963.9
            
            
            927.8Total
                liabilities, minority interest and stockholders' equity
            
            $
            2,621.0
            
            $
            2,415.9
            
            $
            2,572.2








See
      accompanying Notes to Unaudited Condensed Consolidated Financial
      Statements.





3


**BORDERS
      GROUP, INC.**


**CONDENSED
      CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY**


**FOR
      THE 26 WEEKS ENDED JULY 29, 2006**


**(dollars
      in millions except share amounts)**


**(UNAUDITED)**








**Common
                Stock**
            
            **Accumulated**
              **Other**
              **Comprehensive**
            
            **Retained****Shares**
            
            **Amount**
            
            **Income**
            
            **Earnings**
            
            **Total**Balance
                at January 28, 2006
            
            
            64,149,397
            
            $
            293.9
            
            $
            19.4
            
            $
            614.5
            
            $
            927.8Net
                loss
            
            
            -
            
            
            -
            
            
            -
            
            
            (38.6
            )
            
            (38.6
            )Currency
                translation adjustment
            
            
            -
            
            
            -
            
            
            3.6
            
            
            -
            
            
            3.6Comprehensive
                loss
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            (35.0
            )Cash
                dividends declared ($0.20 per
              common
                share)
            
            
            -
            
            
            -
            
            
            -
            
            
            (12.8
            )
            
            (12.8
            )Issuance
                of common stock
            
            
            1,066,551
            
            
            17.6
            
            
            -
            
            
            -
            
            
            17.6Repurchase
                and retirement ofcommon
                stock
            
            
            (3,020,323
            )
            
            (61.4
            )
            
            -
            
            
            -
            
            
            (61.4
            )Tax
                benefit of equitycompensation
            
            
            -
            
            
            2.9
            
            
            -
            
            
            -
            
            
            2.9Balance
                at July 29, 2006
            
            
            62,195,625
            
            $
            253.0
            
            $
            23.0
            
            $
            563.1
            
            $
            839.1











See
      accompanying Notes to Unaudited Condensed Consolidated Financial
      Statements.





4


**BORDERS
      GROUP, INC.**


**CONDENSED
      CONSOLIDATED STATEMENTS OF CASH FLOWS**


**(dollars
      in millions)**


**(UNAUDITED)**








**26
                Weeks Ended****July
                29,**
              **2006**
            
            **July
                23,**
              **2005**Cash
                provided by (used for):OperationsNet
                loss
            
            $
            (38.6
            )
            $
            (4.0
            )Adjustments
                to reconcile net loss to operating cash flows:Depreciation
            
            
            61.1
            
            
            59.1Gain
                on sale of investments
            
            
            (5.0
            )
            
            -Loss
                on disposal of assets
            
            
            3.3
            
            
            2.4Decrease
                in deferred income taxes
            
            
            1.2
            
            
            -(Increase)
                decrease in other long-term assets
            
            
            0.2
            
            
            (1.0
            )Increase
                in other long-term liabilities
            
            
            20.9
            
            
            10.3Cash
                provided by (used for) current assets and current
                liabilities:(Increase)
                decrease in inventories
            
            
            19.0
            
            
            (46.5
            )Decrease
                in accounts receivable
            
            
            1.8
            
            
            12.9Increase
                in prepaid expenses
            
            
            (11.5
            )
            
            (14.6
            )Decrease
                in accounts payable
            
            
            (117.6
            )
            
            (0.3
            )Decrease
                in taxes payable
            
            
            (122.7
            )
            
            (49.6
            )Decrease
                in expenses payable and accrued liabilities
            
            
            (30.4
            )
            
            (44.4
            )Net
                cash used for operations
            
            
            (218.3
            )
            
            (75.7
            )InvestingCapital
                expenditures
            
            
            (87.2
            )
            
            (85.2
            )Proceeds
                from sale of investments
            
            
            21.6
            
            
            95.4Net
                cash (used for) provided by investing
            
            
            (65.6
            )
            
            10.2FinancingProceeds
                from the excess tax benefit of stock option exercises
            
            
            2.9
            
            
            -Net
                funding from credit facility
            
            
            345.4
            
            
            15.8Issuance
                of common stock
            
            
            17.6
            
            
            14.3Payment
                of cash dividends
            
            
            (12.8
            )
            
            (12.9
            )Repurchase
                of common stock
            
            
            (61.4
            )
            
            (117.5
            )Net
                cash (used for) provided by financing
            
            
            291.7
            
            
            (100.3
            )Effect
                of exchange rates on cash and equivalents
            
            
            (0.3
            )
            
            (1.8
            )Net
                increase (decrease) in cash and equivalents
            
            
            7.5
            
            
            (167.6
            )Cash
                and equivalents at beginning of year
            
            
            81.6
            
            
            244.8Cash
                and equivalents at end of period
            
            $
            89.1
            
            $
            77.2








See
      accompanying Notes to Unaudited Condensed Consolidated Financial
      Statements.








5


**BORDERS
      GROUP, INC.**


**NOTES
      TO UNAUDITED CONDENSED**


**CONSOLIDATED
      FINANCIAL STATEMENTS**


**(Dollars
      in millions except per share data)**





**NOTE
      1 - BASIS OF PRESENTATION**





The
      accompanying unaudited condensed consolidated financial statements of Borders
      Group, Inc. (“the Company”) have been prepared in accordance with Rule 10-01 of
      Regulation S-X and do not include all the information and notes required by
      accounting principles generally accepted in the United States for complete
      financial statements. All adjustments, consisting only of normal recurring
      adjustments, have been made which, in the opinion of management, are necessary
      for a fair presentation of the results of the interim periods. The results
      of
      operations for such interim periods are not necessarily indicative of results
      of
      operations for a full year. The unaudited condensed consolidated financial
      statements should be read in conjunction with the Company's consolidated
      financial statements and notes thereto, included in its Annual Report on Form
      10-K for the fiscal year ended January 28, 2006.





The
      Company’s fiscal year ends on the Saturday closest to the last day of January.
      Fiscal 2006 will consist of 53 weeks, and will end on February 3, 2007.
      References herein to years are to the Company’s fiscal years.





At
      July
      29, 2006, the Company operated 535 superstores under the Borders name, including
      476 in the United States, 37 in the United Kingdom, 16 in Australia, three
      in
      Puerto Rico, two in New Zealand and one in Singapore. The Company also operated
      655 mall-based and other bookstores, including stores operated under the
      Waldenbooks, Borders Express and Borders Outlet names, as well as
      Borders-branded airport stores, and 32 bookstores under the Books etc. name
      in
      the United Kingdom. In
      addition, the Company owned and operated United Kingdom-based Paperchase
      Products Limited (“Paperchase”), a designer and retailer of stationery, cards
      and gifts. As of July 29, 2006, Paperchase operated 92 stores, primarily in
      the
      United Kingdom, and Paperchase shops have been added to nearly 175 domestic
      Borders superstores.





**NOTE
      2 - COMMITMENTS AND CONTINGENCIES**





*Litigation:* Two
      former employees, individually and on behalf of a purported class consisting
      of
      all current and former employees who work or worked as Inventory Managers or
      Sales Managers in Borders stores in the State of California at any time from
      September 30, 2001 through the trial date, have filed an action against the
      Company in the Superior Court of California for the County of San Francisco.
      The
      Complaint alleges, among other things, that the individual plaintiffs and the
      purported class members were improperly classified as exempt employees and
      that
      the Company violated the California Labor Code and the California Business
      and
      Professions Code by failing to (i) pay required overtime, (ii) provide meal
      periods, rest periods, and accurate itemized wage statements, (iii) keep
      accurate records of employees’ hours of work, and (iv) pay all compensation owed
      at the time of termination of employment to certain members of the purported
      class. The relief sought includes damages, restitution, penalties, injunctive
      relief, interest, costs, and attorneys’ fees and such other relief as the court
      deems proper. The Company has not included any liability in its consolidated
      financial statements in connection with this matter and has expensed as incurred
      all legal costs to date.





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.com,
      Inc. (“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 (the “Web 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. On November 1, 2005, the Court granted the
      Company’s Motion to Dismiss all of the remaining claims of the plaintiff. The
      anti-trust claims were dismissed with prejudice, and the unfair competition
      claims were dismissed without prejudice. The plaintiff has appealed the
      decision. The Company has not included any liability in its consolidated
      financial statements in connection with this matter and has expensed as incurred
      all legal costs to date.





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
      and Amazon have been named as defendants in actions filed by a private litigant
      on behalf of the state of Illinois under the state’s False Claims Act relating
      to the failure to collect use taxes on Internet sales in Illinois for periods
      both before and after the implementation of the Web Site Agreement. The
      Complaints seek judgments, jointly and severally, against





6


**BORDERS
      GROUP, INC.**


**NOTES
      TO UNAUDITED CONDENSED**


**CONSOLIDATED
      FINANCIAL STATEMENTS**


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





the
      defendants for, among other things, injunctive relief, treble the amount of
      damages suffered by the state of Illinois as a result of the alleged violations
      of the defendants, penalties, costs and expenses, including legal fees. Similar
      actions previously filed against the Company in Tennessee and Nevada have been
      dismissed.





Although
      an adverse resolution of any of the matters described above could have a
      material adverse effect on the results of the operations of the Company for
      the
      applicable period or periods, the Company does not believe that these matters
      will have a material 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.





**NOTE
      3 - FINANCING**





*Credit
      Facility:* The
      Company has a Multicurrency Revolving Credit Agreement (the “Credit Agreement”),
      which was amended in October 2005 and will expire in October 2010. The Credit
      Agreement provides for borrowings of up to $700.0 secured by eligible inventory
      and accounts receivable and related assets. Borrowings under the Credit
      Agreement are limited to a specified percentage of eligible inventories and
      accounts receivable and bear interest at a variable base rate plus an increment
      or LIBOR plus an increment at the Company’s option. The Credit Agreement (i)
      includes a fixed charge coverage ratio requirement of 1.1 to 1 that is
      applicable only if outstanding borrowings under the facility exceed 90% of
      permitted borrowings thereunder, (ii) contains covenants that limit, among
      other
      things, the Company’s ability to incur indebtedness, grant liens, make
      investments, consolidate or merge or dispose of assets, (iii) prohibits dividend
      payments and share repurchases that would result in borrowings under the
      facility exceeding 90% of permitted borrowings thereunder, and (iv) contains
      default provisions that are typical for this type of financing, including a
      cross default provision relating to other indebtedness of more than $25.0.
      The
      Company had borrowings outstanding under the Credit Agreement (or a prior
      agreement) of $506.9 at July 29, 2006, $138.6 at July 23, 2005 and $153.6 at
      January 28, 2006. See “Note 7 - Subsequent Events” for further discussion of the
      Credit Agreement.





*Term
      Loan:* On July
      30, 2002, the Company issued $50.0 of senior guaranteed notes (the “Notes”) due
      July 30, 2006 and bearing interest at 6.31% (payable semi-annually). The
      proceeds of the sale of the Notes were used to refinance existing indebtedness
      of the Company and its subsidiaries and for general corporate purposes. The
      note
      purchase agreement relating to the Notes contains covenants which limit, among
      other things, the Company’s ability to incur indebtedness, grant liens, make
      investments, engage in any merger or consolidation, dispose of assets or change
      the nature of its business, and requires the Company to meet certain financial
      measures regarding net worth, total debt coverage and fixed charge coverage.
      In
      July 2004, the note purchase agreement was amended to permit the amendment
      to
      the Credit Agreement described above and to provide for a parity lien to secure
      the Notes on the same collateral as secures borrowings under the Credit
      Agreement. See “Note 7 - Subsequent Events” for further discussion of the
      Notes.





*Debt
      of Consolidated VIEs:* At July
      29, 2006, the Company is the primary beneficiary of two variable interest
      entities (“VIEs”), due to the Company’s guarantee of the debt of these entities.
      As a result, the Company consolidates these VIEs and has recorded property
      and
      equipment, net of accumulated depreciation, of $5.2, long-term debt (including
      current portion) of $5.5 and minority interest of $0.3 at July 29, 2006.





As
      of
      July 29, 2006 the Company was in compliance with its debt
      covenants.





**NOTE
      4 - STOCK-BASED BENEFIT PLANS**





In
      December 2004, the Financial Accounting Standards Board (“FASB”) issued FAS
      123(R), which is a revision of FAS 123. FAS 123(R) supersedes APB No. 25, and
      amends Statement of Financial Accounting Standards No. 95, “Statement of Cash
      Flows.” Generally, the approach in FAS 123(R) is similar to the approach
      described in FAS 123. However, FAS 123(R) requires all share-based payments
      to
      employees, including grants of employee stock options, restricted stock and
      performance-based shares, to be recognized in the income statement based on
      their fair values. In the first quarter of fiscal 2006, the Company adopted
      FAS
      123(R) using the modified prospective method. Under the modified prospective
      method, compensation cost is recognized for all share-based





7


**BORDERS
      GROUP, INC.**


**NOTES
      TO UNAUDITED CONDENSED**


**CONSOLIDATED
      FINANCIAL STATEMENTS**


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





payments
      granted after the adoption of FAS 123(R) and for all awards granted to employees
      prior to the adoption date of FAS 123(R) that remain unvested on the adoption
      date. Accordingly, no restatements were made to prior periods.





*2004
      Long-Term Incentive Plan:* The
      Company maintains the 2004 Long-Term Incentive Plan (the “2004 Plan”), pursuant
      to which the Company may grant stock-based awards to employees and non-employee
      directors of the Company, including restricted shares and share units of its
      common stock and options to purchase its common stock. The 2004 Plan was
      approved by shareholders in May 2004, and replaced all prior stock-based benefit
      plans on a go-forward basis. Three million shares were authorized for the grant
      of stock-based awards under the 2004 Plan (plus any shares forfeited or
      cancelled under the 2004 Plan or any prior plan).





Under
      the
      2004 Plan, the exercise price of options granted will not be less than the
      fair
      value per share of the Company’s common stock at the date of grant. The plan
      provides for vesting periods as determined by the Compensation Committee of
      the
      Company’s Board of Directors.





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 2004 Plan will generally
      be restricted from sale or transfer for at least two and up to four years from
      the date of purchase.





The
      Company recognizes compensation expense for the discount on restricted shares
      of
      common stock purchased under the 2004 Plan (or prior 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 grants performance-based share units of its common stock (“RSUs”) to its
      senior management personnel. RSUs vest in amounts based on the achievement
      of
      performance goals, primarily earnings per share. The Compensation Committee
      of
      the Company’s Board of Directors establishes the RSUs performance criteria and
      vesting period. The Company also grants time-vested restricted stock to its
      senior management personnel.





The
      Company previously recognized compensation expense for the RSUs granted under
      the 2004 Plan using variable accounting, in accordance with the provisions
      of
      Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to
      Employees” (“APB No. 25”). Under variable accounting, estimates of compensation
      costs were recorded and updated each period until the measurement date, based
      on
      changes in the Company’s share price and the estimated vesting period of the
      RSUs. Beginning in 2006, the Company recognizes compensation expense for the
      RSUs in accordance with the provisions of Statement of Financial Accounting
      Standards No. 123 (revised 2004), “Share-Based Payment” (“FAS 123(R)”). In
      accordance with FAS 123(R), the Company records compensation cost based on
      the
      fair market value of the RSUs on the date of grant.





*Employee
      Stock Purchase Plan:* The
      Company maintained an employee stock purchase plan (the “Employee Plan”), which
      allowed the Company’s associates not eligible under the 2004 Plan to purchase
      shares of the Company’s common stock at a 15% discount from their fair market
      value. The Employee Plan expired as of December 31, 2005.





8


**BORDERS
      GROUP, INC.**


**NOTES
      TO UNAUDITED CONDENSED**


**CONSOLIDATED
      FINANCIAL STATEMENTS**


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





Prior
      to
      the adoption of FAS 123(R), the Company applied APB No. 25 in accounting for
      its
      employee stock compensation plans. Accordingly, no compensation expense was
      recognized for its stock option issuances. 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:





**13
                Weeks Ended**
            
            **26
                Weeks Ended****July
                23,**
              **2005**
            
            **July
                23,**
              **2005**Net
                income (loss), as reported
            
            $
            1.3
            
            $
            (4.0
            )Add:
                Stock-based employee expense included in reported
              net
                income, net of related tax effects
            
            
            -
            
            
            0.1Deduct:
                Total stock-based employee compensation expense
              determined
                under fair value method for all awards, net
              of
                tax
            
            
            1.5
            
            
            2.4Pro
                forma net income (loss)
            
            $
            (0.2
            )
            $
            (6.3
            )Earnings
                (loss) per share:Basic
                -- as reported
            
            $
            0.02
            
            $
            (0.06
            )Basic
                -- pro forma
            
            $
            -
            
            $
            (0.09
            )Diluted
                -- as reported
            
            $
            0.02
            
            $
            (0.06
            )Diluted
                -- pro forma
            
            $
            -
            
            $
            (0.09
            )





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





**All
                Plans**
            
            **Number**
              **of
                Shares**
            
            **Weighted-**
              **Average**
              **Exercise
                Price**
            
            **Aggregate
                Intrinsic****Value**
            
            **Weighted-Average
                Contract****Life**Outstanding
                at January 28, 2006
            
            
            6,365
            
            $
            22.98Granted
            
            
            525
            
            $
            18.57Exercised
            
            
            966
            
            $
            15.92Forfeited
            
            
            422
            
            $
            25.28Outstanding
                at July 29, 2006
            
            
            5,502
            
            $
            23.62
            
            $
            130.0
            
            
            2.4
                yearsBalance
                exercisable atJuly
                29, 2006
            
            
            4,515
            
            $
            24.39
            
            $
            110.1
            
            
            1.7
                years





The
      weighted-average fair values of options at their grant date where the exercise
      price equals the market price on the grant date were $3.5 and $5.2 during the
      13
      weeks ending July 29, 2006 and July 23, 2005 respectively, and $3.8 and $6.4
      during the 26 weeks ending July 29, 2006 and July 23, 2005.





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(R). The following assumptions were used in the calculation:





**13
                Weeks Ended**
            **26
                Weeks Ended****July
                29,**
              **2006**
            **July
                23,**
              **2005**
            **July
                29,**
              **2006**
            **July
                23,**
              **2005**Risk-free
                interest rate
            5.1%
            3.8-4.0%
            4.7-5.1%
            3.8-4.0%Expected
                life
            3
                years
            5
                years
            3-5
                years
            3-5
                yearsExpected
                volatility
            25.5%
            27.6%
            25.2-25.5%
            27.6%Expected
                dividends
            2.3%
            1.4-1.5%
            1.6-2.3%
            1.3-1.5%







Under
      FAS 123(R), the Company recognized $0.3 or $0.00 per share net of
      $0.1  tax
      benefit, of stock-based compensation expense related to stock options and
      employee stock purchases in the 13 weeks ended July 29, 2006, and $0.6 or
      $0.01 per share net of $0.2  tax
      benefit, of stock-based compensation expense related to stock options and
      employee stock purchases in the 26 weeks ended July 29, 2006. Stock-based
      compensation expense is included in Selling, general and administrative
      expenses. Upon adoption of FAS 123(R), the balance of $0.4 of deferred
      compensation was charged to additional paid-in capital.


9


**BORDERS
      GROUP, INC.**


**NOTES
      TO UNAUDITED CONDENSED**


**CONSOLIDATED
      FINANCIAL STATEMENTS**


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





**NOTE
      5- SEGMENT INFORMATION**





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





Segment
      data includes charges allocating all corporate support 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.





**13
                Weeks Ended**
            
            **26
                Weeks Ended********July
                29,**
              **2006**
            
            ******July
                23,**
              **2005**
            
            ******July
                29,**
              **2006**
            
            ******July
                23,**
              **2005**SalesBorders
            
            $
            600.1
            
            $
            618.5
            
            $
            1,206.5
            
            $
            1,197.9Waldenbooks
            
            
            126.5
            
            
            151.0
            
            
            253.7
            
            
            294.1International
            
            
            129.4
            
            
            122.1
            
            
            255.8
            
            
            246.8Total
                sales
            
            $
            856.0
            
            $
            891.6
            
            $
            1,716.0
            
            $
            1,738.8Net
                income (loss)Borders
            
            $
            8.7
            
            $
            14.7
            
            $
            12.3
            
            $
            22.7Waldenbooks
            
            
            (1.7
            )
            
            0.5
            
            
            (5.2
            )
            
            1.0International
            
            
            (14.2
            )
            
            (5.2
            )
            
            (23.7
            )
            
            (11.0
            )Corporate
            
            
            (11.2
            )
            
            (8.7
            )
            
            (22.0
            )
            
            (16.7
            )Total
                net income (loss)
            
            $
            (18.4
            )
            $
            1.3
            
            $
            (38.6
            )
            $
            (4.0
            )Total
                assetsBorders
            
            
            
            
            
            
            
            $
            1,598.2
            
            $
            1,507.2Waldenbooks
            
            
            
            
            
            
            
            
            356.0
            
            
            338.8International
            
            
            
            
            
            
            
            
            500.7
            
            
            443.0Corporate
            
            
            
            
            
            
            
            
            166.1
            
            
            126.9Total
                assets
            
            
            
            
            
            
            
            $
            2,621.0
            
            $
            2,415.9





Total
      assets for the Corporate segment include certain corporate headquarters property
      and equipment, net of accumulated depreciation, of $85.7 and $79.3 at July
      29,
      2006 and July 23, 2005, respectively, 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:





**13
                Weeks Ended**
            
            **26
                Weeks Ended********July
                29,**
              **2006**
            
            ******July
                23,**
              **2005**
            
            ******July
                29,**
              **2006**
            
            ******July
                23,**
              **2005**Borders
            
            $
            3.2
            
            $
            2.5
            
            $
            6.3
            
            $
            5.0Waldenbooks
            
            
            1.5
            
            
            1.2
            
            
            3.0
            
            
            2.3International
            
            
            -
            
            
            0.1
            
            
            0.1
            
            
            0.1Total
            
            $
            4.7
            
            $
            3.8
            
            $
            9.4
            
            $
            7.4


10


**BORDERS
      GROUP, INC.**


**NOTES
      TO UNAUDITED CONDENSED**


**CONSOLIDATED
      FINANCIAL STATEMENTS**


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





**NOTE
      6- CORRECTION OF PRIOR PERIOD ERRORS**





In
      the
      first quarter of 2006, the Company corrected an error in the calculation of
      gross margin within its International segment, specifically in Books etc. The
      correction of the error, which relates to fiscal 2005, resulted in a decrease
      in
      Inventory for the Company’s International segment by $1.9, and increased the
      segment’s Cost of sales by the same amount. The after-tax impact of this
      non-cash adjustment was $1.2.





In
      the
      second quarter of 2006, the Company corrected errors in the reserve for aged
      non-returnable inventory within its International segment, specifically in
      Books
      etc. and United Kingdom Superstores. The correction of the errors, which relate
      to fiscal 2005 and prior, resulted in a decrease in Inventory for the Company’s
      International segment by $2.8, and increased the segment’s Cost of sales by the
      same amount. The after-tax impact of this non-cash adjustment was
      $1.9.





Also
      in
      the second quarter of 2006, the Company corrected an error in the calculation
      of
      transaction currency gains and losses within its International segment. The
      correction of the error, which relates to the first quarter of 2006, resulted
      in
      an increase in Selling, general & administrative expense of $1.2. The
      after-tax impact of this adjustment was $0.7.





**NOTE
      7- SUBSEQUENT EVENTS**





On
      July
      31, 2006, the Company amended and restated its Credit Agreement. The principal
      purpose was to increase the total commitment under the Credit Agreement to
      $1,125.0 from $700.0, and to extend the term of such Agreement until July 31,
      2011.





Also
      subsequent to the quarter ended July 29, 2006, the Company repaid the Notes
      with
      funds from the Credit Agreement.





**Item
      2. 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 (UK) 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 July 29, 2006, the Company operated 535 superstores under the Borders
      name, including 476 in the United States, 37 in the United Kingdom, 16 in
      Australia, three in Puerto Rico, two in New Zealand and one in Singapore. The
      Company also operated 655 mall-based and other bookstores, including stores
      operated under the Waldenbooks, Borders Express and Borders Outlet names, as
      well as Borders-branded airport stores, and 32 bookstores under the Books etc.
      name in the United Kingdom. In addition, the Company owned and operated United
      Kingdom-based Paperchase Products Limited (“Paperchase”), a designer and
      retailer of stationery, cards and gifts. As of July 29, 2006, Paperchase
      operated 92 stores, primarily in the United Kingdom, and Paperchase shops have
      been added to nearly 175 domestic Borders superstores.





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 technologies which enhance the customer experience, and (iv) improving
      cash flow and profitability at Waldenbooks Specialty Retail through a
      combination of selective growth, closure of under-performing stores and profit
      initiatives. Specifically, the Company has been engaged in an aggressive
      expansion and remodel program, pursuant to which it opened 15 domestic Borders
      superstores and completed major remodels of 100 existing domestic superstores
      in
      2005. In 2006, the Company expects to open approximately 31 domestic superstores
      and complete major remodels of approximately 100 existing domestic superstores.
      Beginning in 2005, new stores opened, and the majority of stores remodeled,
      feature cafe offerings by Seattle’s Best Coffee and gifts and stationery
      merchandise by Paperchase. International store growth over the next several
      years will focus on existing markets, primarily in the United Kingdom and
      Australia, with approximately 12 to 14 International store openings planned
      in
      2006. The Waldenbooks Specialty Retail segment has experienced negative
      comparable store sales percentages for the past several years, primarily due
      to
      the overall decrease in mall traffic, sluggish bestsellers and the impact of
      superstore openings. The Company is continuing to implement its plan for the
      optimization of the Waldenbooks Specialty Retail store base in order to improve




11


sales,
        net income and free cash flow. The Company expects the Waldenbooks Specialty
        Retail segment to produce negative cash flow in 2006, with cash flow defined
        as
        operating cash less capital expenditures. This plan could also result in
        further
        store closing costs or asset impairments over the next few years. In
        addition, Waldenbooks Specialty Retail manages the Company’s seasonal businesses
        and other small format stores, including those in airports and outlet malls.
        Selective growth in the seasonal business and in airport stores is expected
        in
        2006. The Company’s objectives with respect to these initiatives are to continue
        to grow consolidated sales and earnings per share and earn an acceptable
        return
        on its investment.





During
      the first quarter of 2006, the Company launched Borders Rewards, a loyalty
      program designed to reward customers who shop at the Company’s stores throughout
      the U.S. Membership in Borders Rewards is free, with no enrollment costs or
      annual fees. Members earn rewards every time they shop, enjoy exclusive savings
      and may earn Personal Shopping Days every month. In addition, five percent
      of
      all qualifying purchases made by members throughout the year go into a personal
      Holiday Savings account, which can be used on holiday purchases made from
      November 15 through January 15.





The
      Company has signed an agreement with Berjaya Corporation Berhad (“Berjaya”), a
      publicly-listed diversified corporation headquartered in Malaysia, to establish
      a franchise arrangement under which Berjaya will operate Borders stores in
      Malaysia. As of July 29, 2006, Berjaya operated three Borders stores in
      Malaysia. The Company has also signed an agreement with Al Maya Group (“Al
      Maya”), a diversified corporation headquartered in the United Arab Emirates, to
      establish a franchise agreement under which Al Maya or its affiliates will
      operate Borders stores in the United Arab Emirates and other Gulf Cooperation
      Council (“GCC”) countries, the first of which is expected to open in Dubai
      during the fourth quarter of fiscal 2006.





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 January 2006, the Board of Directors authorized
      an
      increase in the amount of potential share repurchases to $250.0 million. In
      December 2005, the Board of Directors voted to increase the quarterly cash
      dividend by 11.1% to $0.10 per share on the Company’s common stock.





The
      Company, through its subsidiaries, has agreements with Amazon.com, Inc.
      (“Amazon”) to operate Web sites utilizing the Borders.com, Waldenbooks.com,
      Borders.co.uk and Booksetc.co.uk URLs (the “Web Sites”). Under these agreements,
      Amazon is the merchant of record for all sales made through the Web 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
      Web
      Sites and retains all payments from customers. The Company receives referral
      fees for products purchased through the Web Sites. The agreements contain mutual
      indemnification provisions, including provisions that define between the parties
      the responsibilities with respect to any liabilities for sales, use and similar
      taxes, including penalties and interest, associated with products sold on the
      Web Sites. Currently, taxes are not collected with respect to products sold
      on
      the Web Sites except in certain states.





**Results
      of Operations**





The
      following table presents the Company's consolidated statements of operations
      data, as a percentage of sales, for the periods indicated.





**13
                Weeks Ended**
            
            **26
                Weeks Ended****July
                29, 2006**
            
            **July
                23, 2005**
            
            **July
                29, 2006**
            
            **July
                23, 2005**Sales
            
            
            100.0
            %
            
            100.0
            %
            
            100.0
            %
            
            100.0
            %Other
                revenue
            
            
            1.2
            
            
            1.1
            
            
            1.0
            
            
            1.1Total
                revenue
            
            
            101.2
            
            
            101.1
            
            
            101.0
            
            
            101.1Cost
                of merchandise sold (includes occupancy)
            
            
            77.3
            
            
            75.2
            
            
            77.4
            
            
            75.5Gross
                margin
            
            
            23.9
            
            
            25.9
            
            
            23.6
            
            
            25.6Selling,
                general and administrative expenses
            
            
            26.1
            
            
            25.1
            
            
            26.1
            
            
            25.4Pre-opening
                expense
            
            
            0.3
            
            
            0.2
            
            
            0.2
            
            
            0.2Asset
                impairments and other writedowns
            
            
            0.2
            
            
            -
            
            
            0.1
            
            
            -Operating
                income (loss)
            
            
            (2.7
            )
            
            0.6
            
            
            (2.8
            )
            
            -Interest
                expense
            
            
            0.9
            
            
            0.4
            
            
            0.8
            
            
            0.3Income
                (loss) before income tax
            
            
            (3.6
            )
            
            0.2
            
            
            (3.6
            )
            
            (0.3
            )Income
                tax provision (benefit)
            
            
            (1.4
            )
            
            0.1
            
            
            (1.4
            )
            
            (0.1
            )Net
                income (loss)
            
            
            (2.2
            )%
            
            0.1
            %
            
            (2.2
            )%
            
            (0.2
            )%





12





**Consolidated
      Results -- Comparison of the 13 weeks ended July 29, 2006 to the 13 weeks ended
      July 23, 2005**





***Sales***





Consolidated
      sales decreased $35.6 million, or 4.0%, to $856.0 million in 2006 from $891.6
      million in 2005. This resulted from decreased sales in the domestic Borders
      superstores and Waldenbooks Specialty Retail segments, partially offset by
      increased sales in the International segment.





Comparable
      store sales measures include stores open more than one year, with new stores
      included in the calculation upon their 13th month of operation. Domestic Borders
      superstores’ comparable store sales exclude those stores not offering music, of
      which there are 12, representing approximately 2% of total sales. Comparable
      store sales measures for Waldenbooks Specialty Retail include the Company’s
      mall-based seasonal businesses, and comparable store sales measures for
      International Borders superstores include sales from licensed departments
      operating within the superstores. International comparable store sales are
      calculated in local currency.





Comparable
      store sales for domestic Borders superstores decreased 5.3% in the 13 weeks
      ended July 29, 2006. The comparable store sales decrease for 2006 was due
      primarily to the book category, driven by a challenging comparison to a year
      ago
      when the sixth book in the Harry Potter series was released, as well as weakness
      in hardcover bestsellers. Also contributing to the comparable store sales
      decline were negative comparable store sales in the music and movie categories.
      The cafe and gift and stationery categories positively impacted comparable
      store
      sales in remodeled stores, resulting primarily from the conversions of cafes
      to
      the Seattle’s Best Coffee brand and gift and stationery departments to the
      Paperchase brand. The impact of price changes on comparable store sales was
      not
      significant.





Waldenbooks
      Specialty Retail comparable store sales decreased 12.1% in the 13 weeks ended
      July 29, 2006. The comparable store sales decrease was primarily due to the
      2005
      release of the latest Harry Potter title, as well as weakness in hardcover
      bestsellers which impacted Waldenbooks Specialty Retail to a greater degree
      than
      Borders superstores. The impact of price changes on comparable store sales
      was
      not significant.





Comparable
      store sales for International Borders superstores decreased 3.4% in 2006. The
      decrease was due to negative comparable store sales in all markets, most
      significantly in the United Kingdom, primarily resulting from the 2005 release
      of the latest Harry Potter title, as well as an increased competitive
      environment. The impact of price changes on comparable store sales was not
      significant.





***Other
      revenue***





Other
      revenue for the Borders and International segments primarily consists of income
      recognized from unredeemed gift cards, as well as wholesale revenue earned
      through sales of merchandise to Berjaya, as part of a franchise agreement under
      which Berjaya operates Borders stores in Malaysia. Other revenue for the Borders
      segment also includes wholesale revenue earned through sales of merchandise
      to
      other retailers, as well as referral fees received from Amazon as part of the
      Web Site agreement. Other revenue for the International segment also includes
      license fees received from Starbucks Coffee Company (U.K.) Limited. Other
      revenue in the Waldenbooks Specialty Retail segment primarily consists of income
      recognized from unredeemed gift cards.





Until
      October 2004, Waldenbooks sold memberships in its Preferred Reader Program,
      which offered members discounts on purchases and other benefits. Waldenbooks
      has
      phased out its Preferred Reader Program and has replaced it with other
      promotional programs in order to maximize long-term sales and earnings. The
      Company recognized membership income on a straight-line basis over the 12-month
      term of the membership, and categorized the income as “Other revenue” in the
      Company’s consolidated statements of operations. Discounts on purchases were
      netted against “Sales” in the Company’s consolidated statements of
      operations.





Other
      revenue has increased $0.8 million, or 8.4%, to $10.3 million in 2006 from
      $9.5
      million in 2005. This was due to an increase in the domestic Borders superstores
      segment, partially offset by a decrease in the Waldenbooks Specialty Retail
      segment. Other revenue for the International segment remained flat in 2006
      as
      compared to 2005. The domestic Borders superstores’ increase was primarily due
      to increased 2006 income recognized from unredeemed gift cards as well as
      increased referral fees received from Amazon as part of the Web Site agreement.
      The Waldenbooks Specialty Retail decrease was due to the elimination of the
      Preferred Reader Program, partially offset by increased income recognized from
      unredeemed gift cards.





13


***Gross
      margin***





Consolidated
      gross margin decreased $26.4 million, or 11.4%, to $204.8 million in 2006 from
      $231.2 million in 2005. As a percentage of sales, consolidated gross margin
      decreased 2.0%, to 23.9% in 2006 from 25.9% in 2005. This was due to a decrease
      in all segments’ gross margin as a percentage of sales. The decrease in the
      Borders segment was primarily the result of increased promotional discounts,
      mainly due to the Company’s loyalty program, Borders Rewards, as well as
      increased supply chain and occupancy costs as a percentage of sales. The
      decrease in the Waldenbooks Specialty Retail segment was primarily due to
      increased occupancy costs as a percentage of sales due to the decline in
      comparable store sales. The decrease in the International segment resulted
      from
      the correction of a prior year error in the reserve for aged non-returnable
      inventory in Books etc. and United Kingdom superstores, and an increase in
      occupancy costs as a percentage of sales, primarily due to the decline in
      comparable store sales.





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
      and
      store occupancy from cost of sales and include those costs in other financial
      statement lines.





***Selling,
      general and administrative expenses***





Consolidated
      selling, general and administrative expenses (SG&A) decreased $0.7 million,
      or 0.3%, to $223.3 million in 2006 from $224.0 million in 2005. As a percentage
      of sales, SG&A increased 1.0%, to 26.1% in 2006 from 25.1% in 2005. This
      increase primarily resulted from increased SG&A expenses as a percentage of
      sales for the Waldenbooks Specialty Retail and International segments, partially
      offset by a decrease in the domestic Borders superstores segment. The
      Waldenbooks Specialty Retail increase was primarily due to increases, as a
      percentage of sales, of store payroll and operating expenses and corporate
      operating expenses, driven by the decline in comparable store sales.
      International SG&A expenses as percentage of sales increased primarily as a
      result of increased store and corporate expenses and advertising costs, also
      driven by the decline in comparable store sales. Also negatively impacting
      the
      International segment was the correction of a prior period error in the
      calculation of transaction currency gains and losses. Domestic Borders
      superstores SG&A expenses as a percentage of sales decreased primarily due
      to decreased corporate payroll and operating costs, as well as a gain on the
      sale of investments, partially offset by increased store payroll costs as a
      percentage of sales due to the decline in comparable store 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.





***Interest
      expense***





Consolidated
      interest expense increased $4.4 million, or 133.3%, to $7.7 million in 2006
      from
      $3.3 million in 2005. This was primarily a result of increased borrowings to
      fund capital expenditures, inventory investment and common stock
      repurchases.





***Taxes***





The
      effective tax rate differed for the quarters presented from the federal
      statutory rate primarily as a result of a change in the mix of earnings between
      high and low tax jurisdictions. The Company's annual effective tax rate used
      was
      39.0% in 2006 compared to 37.0% in 2005. This increase is primarily due to
      a
      greater portion of earnings being realized in jurisdictions with higher tax
      rates.





***Net
      income (loss)***





Due
      to
      the factors mentioned above, net income as a percentage of sales decreased
      to a
      net loss of 2.2% in 2006 from net income of 0.1% in 2005, and net income dollars
      decreased to a net loss of $18.4 million in 2006 from net income of $1.3 million
      in 2005.





14


**Consolidated
      Results -- Comparison of the 26 weeks ended July 29, 2006 to the 26 weeks ended
      July 23, 2005**





***Sales***





Consolidated
      sales decreased $22.8 million, or 1.3%, to $1,716.0 million in 2006 from
      $1,738.8 million in 2005. This resulted primarily from decreased sales in the
      Waldenbooks Specialty Retail segment, partially offset by an increase in the
      domestic Borders superstores and International segments.





Comparable
      store sales measures include stores open more than one year, with new stores
      included in the calculation upon their 13th month of operation. Domestic Borders
      superstores’ comparable store sales exclude those stores not offering music, of
      which there are 12, representing approximately 2% of total sales. Comparable
      store sales measures for Waldenbooks Specialty Retail include the Company’s
      mall-based seasonal businesses, and comparable store sales measures for
      International Borders superstores include sales from licensed departments
      operating within the superstores. International comparable store sales are
      calculated in local currency.





Comparable
      store sales for domestic Borders superstores decreased 2.4% in the 26 weeks
      ended July 29, 2006. The comparable store sales decrease for 2006 was due
      primarily to the book category, driven by a challenging comparison to a year
      ago
      when the sixth book in the Harry Potter series was released, as well as weakness
      in hardcover bestsellers. Also contributing to the comparable store sales
      decline were negative comparable store sales in the music category. The cafe
      and
      gift and stationery categories positively impacted comparable store sales in
      remodeled stores, resulting primarily from the conversions of cafes to the
      Seattle’s Best Coffee brand and gift and stationery departments to the
      Paperchase brand. The impact of price changes on comparable store sales was
      not
      significant.





Waldenbooks’
      comparable store sales decreased 9.8% in the 26 weeks ended July 29, 2006.
      The
      comparable store sales decrease was primarily due to the
      2005
      release of the latest Harry Potter title ,
      as well
      as weakness in hardcover bestsellers which impacted Waldenbooks Specialty Retail
      to a greater degree than Borders superstores. The impact of price changes on
      comparable store sales was not significant.





Comparable
      store sales for International Borders superstores decreased 1.6% in 2006. The
      decrease was due to negative comparable store sales in the United Kingdom,
      Singapore, Puerto Rico and New Zealand, partially offset by positive comparable
      store sales in Australia. The most significant decline in comparable store
      sales
      was in the United Kingdom, primarily resulting from the 2005 release of the
      latest Harry Potter title, as well as an increased competitive environment.
      The
      impact of price changes on comparable store sales was not significant.





***Other
      revenue***





Other
      revenue for the Borders and International segments primarily consists of income
      recognized from unredeemed gift cards, as well as wholesale revenue earned
      through sales of merchandise to Berjaya, as part of a franchise agreement under
      which Berjaya operates Borders stores in Malaysia. Other revenue for the Borders
      segment also includes wholesale revenue earned through sales of merchandise
      to
      other retailers, as well as referral fees received from Amazon as part of the
      Web Site agreement. Other revenue for the International segment also includes
      license fees received from Starbucks Coffee Company (U.K.) Limited. Other
      revenue in the Waldenbooks Specialty Retail segment primarily consists of income
      recognized from unredeemed gift cards.





Until
      October 2004, Waldenbooks sold memberships in its Preferred Reader Program,
      which offered members discounts on purchases and other benefits. Waldenbooks
      has
      phased out its Preferred Reader Program and has replaced it with other
      promotional programs in order to maximize long-term sales and earnings. The
      Company recognizes membership income on a straight-line basis over the 12-month
      term of the Preferred Reader 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.





Other
      revenue has decreased $1.5 million, or 7.7%, to $18.1 million in 2006 from
      $19.6
      million in 2005. The decrease is due to decreases in all segments. The decrease
      in domestic Borders superstores was due to greater wholesale revenue earned
      through the franchise agreement with Berjaya in 2005, partially offset by
      increased income recognized from unredeemed gift cards as well as increased
      referral fees received from Amazon as part of the Web Site agreement in 2006.
      The decrease in Waldenbooks Specialty Retail was primarily due to the
      elimination of the Preferred Reader Program, partially offset by an increase
      in
      income recognized from unredeemed gift cards. The decrease in International
      was
      due primarily to greater wholesale revenue earned through the franchise
      agreement with Berjaya in 2005, partially offset by increased license fees
      received from Starbucks Coffee Company (U.K.) Limited in 2006, due to increased
      store count.





15


***Gross
      margin***





Consolidated
      gross margin decreased $42.3 million, or 9.4%, to $405.5 million in 2006 from
      $447.8 million in 2005. As a percentage of sales, consolidated gross margin
      decreased 2.0%, to 23.6% in 2006 from 25.6% in 2005. This was due to a decrease
      in all segments’ gross margin as a percentage of sales. The decrease in the
      domestic Borders superstores segment was primarily the result of increased
      supply chain costs, primarily related to the cost of opening the Company’s new
      distribution center, increased promotional discounts and increased occupancy
      costs. The decrease in the Waldenbooks Specialty Retail segment was primarily
      due to increased occupancy costs resulting from the decline in comparable store
      sales, increased product markdowns, and decreased other revenue, due the
      elimination of the Preferred Reader Program. The decrease in the International
      segment primarily resulted from increased occupancy costs, due to the decline
      in
      comparable store sales, as well as the correction of prior year errors in the
      calculation of gross margin in Books etc. and the reserve for aged
      non-returnable inventory in Books etc. and United Kingdom
      superstores.





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
      and
      store occupancy from cost of sales and include those costs in other financial
      statement lines.





***Selling,
      general and administrative expenses***





Consolidated
      selling, general and administrative expenses (SG&A) increased $3.4 million,
      or 0.8%, to $448.7 million in 2006 from $445.3 million in 2005. As a percentage
      of sales, SG&A increased 0.7%, to 26.1% in 2006 from 25.4% in 2005. This
      increase primarily resulted from increased SG&A expenses as a percentage of
      sales for the Waldenbooks Specialty Retail and International segments, partially
      offset by a decrease in the domestic Borders superstores segment. The
      Waldenbooks Specialty Retail increase was primarily due to increases, as a
      percentage of sales, of store payroll and operating expenses and corporate
      operating expenses, driven by the decline in comparable store sales.
      International SG&A expenses as percentage of sales increased primarily as a
      result of increased store and corporate expenses and advertising costs, also
      driven by the decline in comparable store sales. Domestic Borders superstores
      SG&A expenses as a percentage of sales decreased primarily due to decreased
      corporate payroll and operating costs, as well as income received from the
      Visa
      Check/MasterMoney Antitrust Litigation and a gain on the sale of investments,
      partially offset by increased store payroll and advertising costs as a
      percentage of sales, both primarily the result of the launch of Borders Rewards.





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.





***Interest
      expense***





Consolidated
      interest expense increased $7.6 million, or 138.2%, to $13.1 million in 2006
      from $5.5 million in 2005. This was primarily a result of increased borrowings
      to fund capital expenditures, inventory investment and common stock
      repurchases.





***Taxes***





The
      effective tax rate differed for the quarters presented from the federal
      statutory rate primarily as a result of a change in the mix of earnings between
      high and low tax jurisdictions. The Company's annual effective tax rate used
      was
      39.0% in 2006 compared to 37.0% in 2005. This increase is primarily due to
      a
      greater portion of earnings being realized in jurisdictions with higher tax
      rates.





***Net
      income (loss)***





Due
      to
      the factors mentioned above, net loss as a percentage of sales increased to
      2.2%
      in 2006 from 0.2% in 2005, and net loss dollars increased to $38.6 million
      in
      2006 from $4.0 million in 2005.





**Segment
      Results**





The
      Company is organized based upon the following operating segments: domestic
      Borders superstores, Waldenbooks Specialty Retail stores, International stores
      (including Borders, Books etc. and Paperchase stores), and Corporate (consisting
      of interest expense




16


related
      to corporate activities, certain corporate governance costs and corporate
      incentive costs). See “Note 5 - 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.





**Domestic
      Borders Superstores**





**13
                Weeks Ended**
            
            **26
                Weeks Ended******(dollar
                amounts in millions)
            
            **July
                29, 2006**
            
            **July
                23, 2005**
            
            **July
                29, 2006**
            
            **July
                  23, 2005**Sales
            
            $
            600.1
            
            $
            618.5
            
            $
            1,206.5
            
            $
            1,197.9Other
                revenue
            
            $
            7.2
            
            $
            6.2
            
            $
            12.3
            
            $
            12.6Net
                income
            
            $
            8.7
            
            $
            14.7
            
            $
            12.3
            
            $
            22.7Net
                income as % of sales
            
            
            1.4
            %
            
            2.4
            %
            
            1.0
            %
            
            1.9
            %Depreciation
                expense
            
            $
            21.5
            
            $
            21.3
            
            $
            42.3
            
            $
            43.0Interest
                income
            
            $
            3.3
            
            $
            2.8
            
            $
            7.7
            
            $
            5.7Store
                openings
            
            
            2
            
            
            4
            
            
            7
            
            
            4Store
                closings
            
            
            4
            
            
            1
            
            
            4
            
            
            2Store
                count
            
            
            476
            
            
            464
            
            
            476
            
            
            464





**Domestic
      Borders Superstores - Comparison of the 13 weeks ended July 29, 2006 to the
      13
      weeks ended July 23, 2005**





***Sales***





Borders'
      sales decreased $18.4 million, or 3.0%, to $600.1 million in 2006 from $618.5
      million in 2005. This decrease was comprised of comparable store sales decreases
      of $32.5 million, partially offset by non-comparable sales primarily associated
      with 2006 and 2005 store openings of $14.1 million.





***Other
      revenue***





Other
      revenue increased $1.0 million, or 16.1%, to $7.2 million in 2006 from $6.2
      million in 2005. This increase was primarily due to increased income recognized
      from unredeemed gift cards as well as increased referral fees received from
      Amazon as part of the Web Site agreement in 2006.





***Gross
      margin***





Gross
      margin as a percentage of sales decreased 1.6%, to 26.5% in 2006 from 28.1%
      in
      2005. This was primarily due to increased promotional discounts of 0.8% as
      a
      percentage of sales, mainly related to the Company’s loyalty program, Borders
      Rewards. Also contributing to the decline in gross margin were increased supply
      chain costs of 0.9% as a percentage of sales, primarily related to the cost
      of
      opening the Company’s new distribution center in Pennsylvania, as well as
      increased occupancy costs of 0.6% as a percentage of sales, due to the
      de-leveraging of occupancy costs driven by negative comparable store sales.
      Partially offsetting these items were decreased product costs of 0.7% as a
      percentage of sales.





Gross
      margin dollars decreased $14.5 million, or 8.3%, to $159.3 million in 2006
      from
      $173.8 million in 2005, which was primarily due to decreased comparable store
      sales and the decrease in gross margin as a percentage of sales noted above,
      partially offset by new store openings.





***Selling,
      general and administrative expenses***





SG&A
      as a percentage of sales decreased 0.3%, to 24.2% in 2006 from 24.5% in 2005,
      primarily due to decreased corporate payroll and operating expenses of 0.7%
      as a
      percentage of sales, mainly due to disciplined cost controls at the corporate
      level. In addition, the improvement in SG&A was positively impacted by a
      gain on the sale of investments. Partially offsetting these improvements were
      increased utility costs and increased store payroll and operating expenses
      of
      0.4% as a percentage of sales, due to the decrease in comparable store
      sales.


17





SG&A
      dollars decreased $6.6 million, or 4.4%, to $144.9 million in 2006 from $151.5
      million in 2005, primarily due to income received from the sale of investments
      of $5.0 million. Partially offsetting this decrease were increased utility
      costs.








***Depreciation
      expense***





Depreciation
      expense increased $0.2 million, or 0.9%, to $21.5 million in 2006 from $21.3
      million in 2005. This was primarily the result of increased depreciation expense
      recognized on new and remodeled stores’ capital expenditures, as well as
      accelerated depreciation related to store remodels.





***Interest
      income***





Borders
      interest income increased $0.5 million, or 17.9%, to $3.3 million in 2006 from
      $2.8 million in 2005. This was the result of Borders’ continued positive cash
      flow at fixed internal interest rates.





***Net
      income***





Due
      to
      the factors mentioned above, net income as a percentage of sales decreased
      to
      1.4% in 2006 from 2.4% in 2005, and net income dollars decreased $6.0 million,
      or 40.8%, to $8.7 million in 2006 from $14.7 million in 2005.





**Domestic
      Borders Superstores - Comparison of the 26 weeks ended July 29, 2006 to the
      26
      weeks ended July 23, 2005**





***Sales***





Borders'
      sales increased $8.6 million, or 0.7%, to $1,206.5 million in 2006 from $1,197.9
      million in 2005. This increase was comprised of non-comparable sales primarily
      associated with 2006 and 2005 store openings of $37.3 million, partially offset
      by comparable store sales decreases of $28.7 million.





***Other
      revenue***





Other
      revenue decreased $0.3 million, or 2.4%, to $12.3 million in 2006 from $12.6
      million in 2005. This was primarily due to higher wholesale revenue earned
      through sales of merchandise in 2005, related to the opening and initial stock
      of inventory of the first franchise store operated by Berjaya in April of
      2005. This
      decrease was partially offset by increased 2006 income recognized from
      unredeemed gift cards as well as increased referral fees received from Amazon
      as
      part of the Web Site agreement.





***Gross
      margin***





Gross
      margin as a percentage of sales decreased 1.6%, to 26.0% in 2006 from 27.6%
      in
      2005. This was primarily due to increased supply chain costs of 0.7% as a
      percentage of sales, primarily related to the cost of opening of the Company’s
      new distribution center in Pennsylvania. Also contributing to the decline in
      gross margin were increased promotional discounts of 0.6% as a percentage of
      sales, mainly related to the Company’s loyalty program, Borders Rewards, as well
      as increased occupancy costs of 0.3% as a percentage of sales, due to the
      de-leveraging of occupancy costs driven by negative comparable store sales.





Gross
      margin dollars decreased $16.5 million, or 5.0%, to $314.3 million in 2006
      from
      $330.8 million in 2005, which was primarily due to decreased comparable store
      sales and the decrease in gross margin as a percentage of sales noted above,
      partially offset by new store openings.





***Selling,
      general and administrative expenses***





SG&A
      as a percentage of sales decreased 0.3%, to 24.6% in 2006 from 24.9% in 2005,
      primarily due to decreased corporate payroll expenses of 0.5% as a percentage
      of
      sales, resulting from disciplined cost controls at the corporate level. Also
      contributing to the decrease in SG&A was a decrease of 0.3% in operating
      expenses as a percentage of sales, due to income received from the Visa
      Check/MasterMoney Antitrust Litigation settlement and a gain on the sale of
      investments. The Visa Check/MasterMoney Antitrust Litigation was a class action
      lawsuit brought against Visa and MasterCard related to their debit card
      policies. Also partially offsetting these decreases were increased store payroll
      expense of 0.3% as a percentage of sales and increased advertising expense
      of
      0.2% as a percentage of sales, both primarily related to the launch of the
      Company’s loyalty program, Borders Rewards. In addition, utility costs




18


increased
      in 2006 as compared to 2005.





SG&A
      dollars decreased $1.1 million, or 0.4%, to $296.9 million in 2006 from $298.0
      million in 2005, primarily due to decreased corporate payroll, as well as income
      received from the Visa Check/MasterMoney Antitrust Litigation settlement of
      $2.6
      million. Also contributing to the decrease in SG&A was income received from
      the sale of investments of $5.0 million. Partially offsetting these decreases
      were increased utility costs and increased advertising expense to support the
      launch of the Company’s loyalty program, Borders Rewards.





***Depreciation
      expense***





Depreciation
      expense decreased $0.7 million, or 1.6%, to $42.3 million in 2006 from $43.0
      million in 2005. This was primarily the result of one of the Company’s
      distribution centers becoming fully depreciated during the fourth quarter of
      2005, partially offset by increased depreciation expense recognized on new
      and
      remodeled stores’ capital expenditures and accelerated depreciation related to
      store remodels.





***Interest
      income***





Borders
      interest income increased $2.0 million, or 35.1%, to $7.7 million in 2006 from
      $5.7 million in 2005. This was the result of Borders’ continued positive cash
      flow at fixed internal interest rates.





***Net
      income***





Due
      to
      the factors mentioned above, net income as a percentage of sales decreased
      to
      1.0% in 2006 from 1.9% in 2005, and net income dollars decreased $10.4 million,
      or 45.8%, to $12.3 million in 2006 from $22.7 million in 2005.





**Waldenbooks
      Specialty Retail**





**13
                Weeks Ended**
            
            **26
                Weeks Ended**(dollar
                amounts in millions)
            
            **July
                29, 2006**
            
            **July
                23, 2005**
            
            **July
                29, 2006**
            
            **July
                23, 2005**Sales
            
            $
            126.5
            
            $
            151.0
            
            $
            253.7
            
            $
            294.1Other
                revenue
            
            $
            0.8
            
            $
            1.0
            
            $
            1.3
            
            $
            2.2Net
                income (loss)
            
            $
            (1.7
            )
            $
            0.5
            
            $
            (5.2
            )
            $
            1.0Net
                income as % of sales
            
            
            (1.3
            )%
            
            0.3
            %
            
            (2.0
            )%
            
            0.3
            %Depreciation
                expense
            
            $
            4.3
            
            $
            3.6
            
            $
            8.5
            
            $
            7.0Interest
                income
            
            $
            9.8
            
            $
            11.0
            
            $
            20.0
            
            $
            21.9Store
                Openings
            
            
            -
            
            
            8
            
            
            3
            
            
            11Store
                Closings
            
            
            10
            
            
            6
            
            
            26
            
            
            12Store
                Count
            
            
            655
            
            
            704
            
            
            655
            
            
            704





**Waldenbooks
      Specialty Retail - Comparison of the 13 weeks ended July 29, 2006 to the 13
      weeks ended July 23, 2005**





***Sales***





Waldenbooks
      Specialty Retail sales decreased $24.5 million, or 16.2%, to $126.5 million
      in
      2006 from $151.0 million in 2005. This decrease was comprised of decreased
      comparable store sales of $16.7 million and decreased non-comparable sales
      associated with 2006 and 2005 store closings of $7.8 million.





***Other
      revenue***





Other
      revenue decreased $0.2 million, or 20.0%, to $0.8 million in 2006 from $1.0
      million in 2005. This was primarily due to the elimination of the Preferred
      Reader Program, partially offset by increased 2006 income recognized from
      unredeemed gift cards.





***Gross
      margin***





Gross
      margin as a percentage of sales decreased 1.0%, to 20.0% in 2006 from 21.0%
      in
      2005. This was primarily due to increased occupancy costs as a percentage of
      sales of 2.2%, primarily due to the de-leveraging of occupancy costs driven
      by
      negative




19


comparable
      store sales. Partially offsetting the increase in occupancy as a percentage
      of
      sales were decreased product markdowns of 1.2% as a percentage of sales.





Gross
      margin dollars decreased $6.5 million, or 20.5%, to $25.2 million in 2006 from
      $31.7 million in 2005, primarily due to store closures, the decline in
      comparable store sales and the decrease in gross margin percentage noted above.





***Selling,
      general and administrative expenses***





SG&A
      as a percentage of sales increased 2.1%, to 29.6% in 2006 from 27.5% in
      2005. This was
      primarily due to increased store payroll and operating expenses of 1.4% as
      a
      percentage of sales and increased corporate operating expenses of 1.1% as a
      percentage of sales, resulting from the decrease in comparable store sales.
      Partially offsetting this increase were decreased corporate payroll expenses
      of
      0.2% as a percentage of sales, and decreased advertising costs of 0.2% as a
      percentage of sales.





SG&A
      dollars decreased $4.0 million, or 9.6%, to $37.5 million in 2006 from $41.5
      million in 2005, primarily due to store closures.





***Depreciation
      expense***





Depreciation
      expense increased $0.7 million, or 19.4%, to $4.3 million in 2006 from $3.6
      million in 2005. This was primarily due to depreciation recognized on assets
      of
      stores that have been converted to Borders Express during 2006 and 2005, as
      well
      as depreciation on Waldenbooks’ new merchandising system, which was put in
      service during the third quarter of 2005, partially offset by lower depreciation
      resulting from prior year asset impairments and store closings.





***Interest
      income***





Interest
      income decreased $1.2 million, or 10.9%, to $9.8 million in 2006 from $11.0
      million in 2005. This was the result of a decline in Waldenbooks Specialty
      Retail’s cash flow, primarily due to the decline in comparable store
      sales.





***Net
      income (loss)***





Due
      to
      the factors mentioned above, net income as a percentage of sales decreased
      to a
      net loss of 1.3% in 2006 from net income of 0.3% in 2005, and net income dollars
      decreased $2.2 million to a net loss of $1.7 million in 2006 from net income
      of
      $0.5 million in 2005.





**Waldenbooks
      Specialty Retail - Comparison of the 26 weeks ended July 29, 2006 to the 26
      weeks ended July 23, 2005**





***Sales***





Waldenbooks
      Specialty Retail sales decreased $40.4 million, or 13.7%, to $253.7 million
      in
      2006 from $294.1 million in 2005. This decrease was comprised of decreased
      comparable store sales of $26.6 million and decreased non-comparable sales
      associated with 2006 and 2005 store closings of $13.8 million.





***Other
      revenue***





Other
      revenue decreased $0.9 million, or 40.9%, to $1.3 million in 2006 from $2.2
      million in 2005. This was primarily due to the elimination of the Preferred
      Reader Program, partially offset by increased income recognized from unredeemed
      gift cards.





***Gross
      margin***





Gross
      margin as a percentage of sales decreased 2.6%, to 19.4% in 2006 from 22.0%
      in
      2005. This was primarily due to increased occupancy costs as a percentage of
      sales of 2.0%, primarily due to the de-leveraging of occupancy costs driven
      by
      negative comparable store sales. Also contributing to the decline in gross
      margin as a percentage of sales were increased product markdowns and other
      costs
      of 0.3% as a percentage of sales, and a decrease in other revenue of 0.3% as
      a
      percentage of sales, due to the elimination of the Preferred Reader Program.





Gross
      margin dollars decreased $15.5 million, or 24.0%, to $49.1 million in 2006
      from
      $64.6 million in 2005, primarily due to store closures, the decline in
      comparable store sales and the decrease in gross margin percentage noted
      above.





20





***Selling,
      general and administrative expenses***





SG&A
      as a percentage of sales increased 1.7%, to 30.3% in 2006 from 28.6% in 2005.
      This was primarily due to increased store payroll and operating expenses of
      1.3%
      as a percentage of sales, and increased corporate operating expenses of 0.8%
      as
      a percentage of sales, resulting from the decrease in comparable store sales.
      Partially offsetting these increases was income received from the Visa
      Check/MasterMoney Antitrust Litigation settlement. Also partially offsetting
      the
      increase in these costs were decreased corporate payroll expenses of 0.2% as
      a
      percentage of sales, and decreased advertising costs of 0.2% as a percentage
      of
      sales.





SG&A
      dollars decreased $7.3 million, or 8.7%, to $76.8 million in 2006 from $84.1
      million in 2005 primarily due to store closures and income received from the
      Visa Check/MasterMoney Antitrust Litigation settlement of $0.9 million.
      Partially offsetting these decreases were increased utility costs.





***Depreciation
      expense***





Depreciation
      expense increased $1.5 million, or 21.4%, to $8.5 million in 2006 from $7.0
      million in 2005. This was primarily due to depreciation recognized on assets
      of
      stores that have been converted to Borders Express during 2006 and 2005, as
      well
      as depreciation on Waldenbooks’ new merchandising system, which was put in
      service during the third quarter of 2005, partially offset by lower depreciation
      resulting from prior year asset impairments and store closings.





***Interest
      income***





Interest
      income decreased $1.9 million, or 8.7%, to $20.0 million in 2006 from $21.9
      million in 2005. This was the result of a decline in Waldenbooks Specialty
      Retail’s cash flow, primarily due to the decline in comparable store
      sales.





***Net
      income (loss)***





Due
      to
      the factors mentioned above, net income as a percentage of sales decreased
      to a
      net loss of 2.0% in 2006 from net income of 0.3% in 2005, and net income dollars
      decreased $6.2 million to a net loss of $5.2 million in 2006 from net income
      of
      $1.0 million in 2005.





**International**





**13
                Weeks Ended**
            
            **26
                Weeks Ended******(dollar
                amounts in millions)
            
            **July
                29, 2006**
            
            **July
                23, 2005**
            
            **July
                29, 2006**
            
            **July
                23, 2005**Sales
            
            $
            129.4
            
            $
            122.1
            
            $
            255.8
            
            $
            246.8Other
                revenue
            
            $
            2.3
            
            $
            2.3
            
            $
            4.5
            
            $
            4.8Net
                loss
            
            $
            (14.2
            )
            $
            (5.2
            )
            $
            (23.7
            )
            $
            (11.0
            )Net
                loss as % of sales
            
            
            (11.0
            )%
            
            (4.3
            )%
            
            (9.3
            )%
            
            (4.5
            )%Depreciation
                expense
            
            $
            5.3
            
            $
            4.6
            
            $
            10.3
            
            $
            9.1Interest
                expense
            
            $
            5.9
            
            $
            5.3
            
            $
            11.1
            
            $
            10.4Superstore
                Store Openings
            
            
            3
            
            
            1
            
            
            4
            
            
            5Superstore
                Store Count
            
            
            59
            
            
            47
            
            
            59
            
            
            47Books
                etc. Store Closings
            
            
            -
            
            
            2
            
            
            1
            
            
            2Books
                etc. Store Count
            
            
            32
            
            
            33
            
            
            32
            
            
            33





**International
      - Comparison of the 13 weeks ended July 29, 2006 to the 13 weeks ended July
      23,
      2005**





***Sales***





International
      sales increased $7.3 million, or 6.0%, to $129.4 million in 2006 from $122.1
      million in 2005. Of this increase in sales, 0.3%, or $0.4 million, was due
      to
      the translation of foreign currencies to U.S. dollars. The remaining 5.7% was
      the result of new superstore openings, partially offset by a decline in
      comparable store sales.








21


***Other
      revenue***





Other
      revenue remained flat at $2.3 million in 2006 compared to 2005. This was due
      to
      increased license fees received from Starbucks Coffee Company (U.K.) Limited
      in
      2006, due to increased store count, offset by decreased wholesale revenue earned
      through sales of merchandise to Berjaya.





***Gross
      margin***





Gross
      margin as a percentage of sales decreased 5.4%, to 15.6% in 2006 from 21.0%
      in
      2005, primarily the result of the correction of a prior year error in the
      reserve for aged non-returnable inventory in Books etc. and United Kingdom
      superstores of 3.6% as a percentage of sales. Additionally, the decrease was
      the
      result of higher occupancy costs of 2.1% as a percentage of sales, mainly due
      to
      the decline in comparable store sales. Partially offsetting these items were
      decreased product markdowns of 0.3% as a percentage of sales.





Gross
      margin dollars decreased $5.4 million, or 21.0%, to $20.3 million in 2006 from
      $25.7 million in 2005. The decrease is due to the decline in the gross margin
      rate, partially offset by new superstore openings. Excluding the result of
      translation of foreign currencies to U.S. dollars, gross margin would have
      decreased an additional $0.1 million.





***Selling,
      general and administrative expenses***





SG&A
      as a percentage of sales increased 3.7%, to 27.6% in 2006 from 23.9% in 2005.
      This was primarily the result of increased corporate payroll and operating
      expenses of 1.2% as a percentage of sales, and increased store payroll and
      operating expenses of 1.1% as a percentage of sales. These increases were due
      to
      the decline in comparable store sales and the increased spending needed to
      support international new store growth. Also contributing to the increase was
      the correction of a prior period error in the calculation of transaction
      currency gains and losses of 1.0% as a percentage of sales, and increased
      advertising costs of 0.4% as a percentage of sales.





SG&A
      dollars increased $6.5 million, or 22.3%, to $35.7 million in 2006 from $29.2
      million in 2005. Of this increase, $0.1 million is the result of translation
      of
      foreign currencies to U.S. dollars. The remainder of the increase is primarily
      due to new store openings and the increased store payroll and operating expenses
      required, as well as the error correction mentioned previously and increased
      advertising spending.





***Depreciation
      expense***





Depreciation
      expense increased $0.7 million, or 15.2%, to $5.3 million in 2006 from $4.6
      million in 2005. This was primarily due to depreciation expense recognized
      on
      new stores' capital expenditures.





***Interest
      expense***





Interest
      expense increased $0.6 million, or 11.3%, to $5.9 million in 2006 from $5.3
      million in 2005. This was primarily due to increased borrowings used to fund
      new
      stores’ inventory and capital expenditures.





***Net
      loss***





Due
      to
      the factors mentioned above, net loss as a percentage of sales increased to
      11.0% in 2006 as compared to 4.3% in 2005, and net loss dollars increased $9.0
      million, or 173.1%, to $14.2 million in 2006 from $5.2 million in
      2005.





**International
      - Comparison of the 26 weeks ended July 29, 2006 to the 26 weeks ended July
      23,
      2005**





***Sales***





International
      sales increased $9.0 million, or 3.6%, to $255.8 million in 2006 from $246.8
      million in 2005, primarily resulting from new superstore openings, partially
      offset by negative comparable store sales. The translation of foreign currencies
      to U.S. dollars negatively impacted sales 3.2%, or $8.0 million.





22


***Other
      revenue***





Other
      revenue decreased $0.3 million, or 6.3%, to $4.5 million in 2006 from $4.8
      million in 2005. This was primarily due to higher wholesale revenue earned
      through sales of merchandise in 2005, related to the opening and initial stock
      of inventory of the first franchise store operated by Berjaya in April of 2005,
      partially offset by increased license fees received from Starbucks Coffee
      Company (U.K.) Limited in 2006, due to increased store count.





***Gross
      margin***





Gross
      margin as a percentage of sales decreased 4.7%, to 16.5% in 2006 from 21.2%
      in
      2005, primarily the result of an increase in occupancy costs of 2.0% as a
      percentage of sales, mainly due to the decline in comparable store sales, and
      the correction of prior year errors in the calculation of gross margin in Books
      etc. and the reserve for aged non-returnable inventory in Books etc. and United
      Kingdom superstores of 1.8% as a percentage of sales. Also negatively affecting
      gross margin were increased product markdowns of 0.9% as a percentage of
      sales.





Gross
      margin dollars decreased $10.3 million, or 19.7%, to $42.1 million in 2006
      from
      $52.4 million in 2005. Of this decrease, $1.2 million is the result of
      translation of foreign currencies to U.S. dollars. The remainder of the decrease
      is due to the decline in the gross margin rate, partially offset by new
      superstore openings.





***Selling,
      general and administrative expenses***





SG&A
      as a percentage of sales increased 2.3%, to 26.4% in 2006 from 24.1% in 2005.
      This was primarily the result of increased corporate payroll and operating
      expenses of 1.2% as a percentage of sales and increased store payroll and
      operating expenses of 1.0% as a percentage of sales, resulting from the decline
      in comparable store sales and increased spending to support international new
      store growth. Also contributing to the increase were higher advertising costs
      of
      0.1% as a percentage of sales.





SG&A
      dollars increased $7.9 million, or 13.3%, to $67.4 million in 2006 from $59.5
      million in 2005. The increase is primarily due to new store openings and the
      increased store payroll and operating expenses required, as well as increased
      advertising spending. Excluding the result of translation of foreign currencies
      to U.S. dollars, SG&A would have increased an additional $2.0 million.





***Depreciation
      expense***





Depreciation
      expense increased $1.2 million, or 13.2%, to $10.3 million in 2006 from $9.1
      million in 2005. This was primarily due to depreciation expense recognized
      on
      new stores' capital expenditures.





***Interest
      expense***





Interest
      expense increased $0.7 million, or 6.7%, to $11.1 million in 2006 from $10.4
      million in 2005. This was primarily due to increased borrowings used to fund
      new
      stores’ inventory and capital expenditures.





***Net
      loss***





Due
      to
      the factors mentioned above, net loss as a percentage of sales increased to
      9.3%
      in 2006 as compared to 4.5% in 2005, and net loss dollars increased $12.7
      million, or 115.5%, to $23.7 million in 2006 from $11.0 million in
      2005.





**Corporate**





**13
                Weeks Ended**
            
            **26
                Weeks Ended**(dollar
                amounts in millions)
            
            **July
                29, 2006**
            
            **July
                23, 2005**
            
            **July
                29, 2006**
            
            **July
                23, 2005**Net
                loss
            
            $
            (11.2
            )
            $
            (8.7
            )
            $
            (22.0
            )
            $
            (16.7
            )Interest
                expense
            
            $
            14.9
            
            $
            11.8
            
            $
            29.7
            
            $
            22.7





The
      Corporate segment includes interest expense related to corporate activities,
      various corporate governance costs and corporate incentive costs.


23





**Corporate
      - Comparison of the 13 weeks ended July 29, 2006 to the 13 weeks ended July
      23,
      2005**





Net
      loss
      dollars increased $2.5 million, or 28.7%, to $11.2 million in 2006 from $8.7
      million in 2005. This was primarily due to increased interest expense for this
      segment resulting from borrowings to fund common stock repurchases. Interest
      expense represents corporate-level interest costs not charged to the Company's
      other segments.





**Corporate
      - Comparison of the 26 weeks ended July 29, 2006 to the 26 weeks ended July
      23,
      2005**





Net
      loss
      dollars increased $5.3 million, or 31.7%, to $22.0 million in 2006 from $16.7
      million in 2005. This was primarily due to increased interest expense for this
      segment resulting from borrowings to fund common stock repurchases. Interest
      expense represents corporate-level interest costs not charged to the Company's
      other segments.





**Liquidity
      and Capital Resources**





The
      Company's principal capital requirements are to fund the opening of new stores,
      the refurbishment of existing stores, continued investment in new corporate
      information technology systems and maintenance spending on stores, distribution
      centers and corporate information technology.





Net
      cash
      used for operations was $218.3 million and $75.7 million for the 26 weeks ended
      July 29, 2006 and July 23, 2005, respectively. Operating cash outflows for
      the
      period reflect operating results and decreases in taxes payable, accounts
      payable and expenses payable and accrued liabilities, as well an increase in
      prepaid expenses. The most significant of these was the decrease in taxes
      payable, which resulted from payment of the Company’s estimated 2005 taxes, and
      the decrease in accounts payable which is primarily due to the timing of fiscal
      July month-end in 2006 being later in the calendar month than in 2005. The
      current year operating cash inflows primarily reflect non-cash charges for
      depreciation and a loss on the disposal of assets related to the remodel
      program, as well as a decrease in inventories, accounts receivable and other
      long-term assets and an increase in other long-term liabilities. Also affecting
      operating cash was an adjustment to net income resulting from a gain on the
      sale
      of investments.





Net
      cash
      used for investing was $65.6 million in 2006, which primarily resulted from
      capital expenditures, offset by the sale of investments of $21.6 million. Net
      cash provided by investing was $10.2 million in 2005, which primarily resulted
      from the sale of auction rate securities of $95.4 million.




In
      fiscal
      2006, capital expenditures were $87.2 million, which primarily funded capital
      expenditures for new stores, the refurbishment of existing stores, new corporate
      information technology systems and maintenance of existing stores, distribution
      centers and management information systems. In 2006, this included the
      remodeling of 70 domestic Borders superstores and the conversion of 14
      Waldenbooks stores to Borders Express. Additional capital spending in 2006
      reflects the opening of 11 new Borders superstores, as well as one new airport
      store and two new outlet stores operated by the Waldenbooks Specialty Retail
      segment. In fiscal 2005, capital expenditures were $85.2 million, which
      primarily funded the remodeling of 45 domestic Borders superstores and the
      conversion of 48 Waldenbooks stores to Borders Express, as well as investments
      in new merchandising systems. Additional capital spending in 2005 reflected
      the
      opening of five new Borders superstores, as well as four new airport stores
      and
      seven new outlet stores operated by the Waldenbooks segment.





Net
      cash
      provided by financing in 2006 was $291.7 million, resulting from funding from
      the Company’s credit facility of $345.4 million, proceeds from stock option
      exercises of $17.6 million and proceeds from the excess tax benefit of stock
      option exercises of $2.9 million, partially offset by the repurchase of common
      stock totaling $61.4 million and the payment of the Company’s quarterly cash
      dividends of $12.8 million. Net cash used for financing in 2005 was $100.3
      million, resulting from the repurchase of common stock totaling $117.5 million
      and the payment of the Company’s quarterly cash dividends of $12.9 million,
      partially offset by $14.3 million of proceeds from stock option exercises and
      funding from the Company’s credit facility of $15.8 million.





The
      Company expects capital expenditures to approximate $200.0 million in 2006,
      resulting primarily from new superstore openings and a store remodel program,
      through which the Company plans to complete major remodels of approximately
      100
      domestic Borders superstore locations, most of which will include conversion
      to
      Seattle’s Best cafes and Paperchase gifts and stationery shops, and plans to
      convert approximately 15 Waldenbooks stores to Borders Express. In addition,
      capital expenditures will result from International store openings, the new
      distribution center, continued investment in new buying, merchandising and
      warehouse management systems and maintenance spending for new stores,
      distribution centers and management information systems. The Company currently
      plans to open approximately 31 domestic Borders superstores and 12 to 14
      International stores in 2006. Average




24


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 $0.3 million to $0.8 million,
      depending on the size and format of the store. Average cash requirements for
      a
      major remodel of a Borders superstore are between $0.1 million to $0.5 million,
      and average cash requirements for a Borders Express conversion are less than
      $0.1 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,
      financing through the Credit Agreement and other sources of new financing as
      deemed necessary, discussed below. The Company believes funds generated from
      operations, borrowings under the Credit Agreement and from other sources, as
      necessary, will be sufficient to fund its anticipated capital requirements
      for
      the next several years.





In
      January 2006, the Board of Directors authorized $250.0 million of potential
      share repurchases. During the 26 weeks ended July 29, 2006 and July 23, 2005,
      $61.4 million and $117.5 million of common stock were repurchased, respectively.
      The Company plans to continue the repurchase of its common stock throughout
      fiscal 2006, subject to the Company’s share price and capital needs and
      availability.





In
      2004,
      the Company began paying a regular quarterly dividend, and intends to pay
      regular quarterly cash dividends, subject to Board approval, going forward.
      In
      December 2005, the Board of Directors increased the quarterly dividend by 11.1%
      to $0.10 per share. 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.





The
      Company has a Multicurrency Revolving Credit Agreement (the “Credit Agreement”),
      which was restated as of July 31, 2006, and which will expire in July 2011.
      The
      Credit Agreement provides for borrowings of up to $1,125.0 million secured
      by
      eligible inventory and accounts receivable and related assets. Borrowings under
      the Credit Agreement are limited to a specified percentage of eligible
      inventories and accounts receivable and bear interest at a variable base rate
      plus the applicable increment or LIBOR plus the applicable increment at the
      Company’s option. The Credit Agreement (i) includes a fixed charge coverage
      ratio requirement of 1.1 to 1 that is applicable only if outstanding borrowings
      under the facility exceed 90% of permitted borrowings thereunder, (ii) contains
      covenants that limit, among other things, the Company’s ability to incur
      indebtedness, grant liens, make investments, consolidate or merge or dispose
      of
      assets, (iii) prohibits dividend payments and share repurchases that would
      result in borrowings under the facility exceeding 90% of permitted borrowings
      thereunder, and (iv) contains default provisions that are typical for this
      type
      of financing, including a cross default provision relating to other indebtedness
      of more than $25.0 million. As of July 29, 2006 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 $506.9 million
      at July 29, 2006, $138.6 million at July 23, 2005 and $153.6 million at January
      28, 2006.





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 were used to refinance
      existing indebtedness of the Company and its subsidiaries and for general
      corporate purposes. The note purchase agreement relating to the Notes contains
      covenants which limit, among other things, the Company’s ability to incur
      indebtedness, grant liens, make investments, engage in any merger or
      consolidation, dispose of assets or change the nature of its business, and
      requires the Company to meet certain financial measures regarding net worth,
      total debt coverage and fixed charge coverage. As of July 29, 2006 the Company
      was in compliance with all covenants contained within this agreement. The
      Company repaid the Notes with funds from the Credit Agreement on July 31,
      2006.





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
      designated this swap agreement as a fair market value hedge. The notional amount
      of the swap agreement is $50.0 million, and the agreement expires concurrently
      with the due date of the Notes. The Company settled this swap agreement on
      July
      31, 2006, when the Notes were repaid.





**Off-Balance
      Sheet Arrangements**





The
      Company is the primary beneficiary of two variable interest entities (“VIEs”)
      due to the Company’s guarantee of the debt of these entities. As a result, the
      Company consolidates these VIEs and has recorded property and equipment, net
      of
      accumulated depreciation, of $5.2 million, long-term debt (including current
      portion) of $5.5 million and minority interest of $0.3 million at July 29,
      2006.
      These amounts have been treated as non-cash items on the consolidated statements
      of cash flows.





25


**Seasonality**





The
      Company’s business is highly seasonal, with significantly higher sales and
      substantially all operating income realized during the fourth quarter.




**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. Such
      estimates have been disclosed in the Company's last
      Annual Report on Form
      10-K
      for the fiscal year ended January 28, 2006. There
      have been no significant changes in these estimates during the second quarter
      of
      fiscal 2006.





**New
      Accounting Guidance**





In
      February 2006, the FASB issued Statement of Financial Accounting Standards
      No.
      155, “Accounting for Certain Hybrid Instruments” (“FAS 155”). FAS 155 allows
      financial instruments that have embedded derivatives to be accounted for as
      a
      whole (eliminating the need to bifurcate the derivative from its host) if the
      holder elects to account for the whole instrument on a fair value basis. This
      statement is effective for all financial instruments acquired or issued after
      the beginning of an entity’s first fiscal year that begins after September 15,
      2006. The Company does not expect the adoption of FAS 155 to have a material
      impact on its consolidated financial position or results of
      operations.





In
      June
      2006, the FASB issued Statement of FASB Interpretation No. 48, “Accounting
      for Uncertainty in Income Taxes - an Interpretation of FASB Statement
      No. 109” (“FIN 48”). FIN 48 requires
      that the tax effects of a position be recognized only if it is
“more-likely-than-not” to be sustained based solely on its technical merits as
      of the reporting date. The more-likely-than-not threshold represents a positive
      assertion by management that a company is entitled to the economic benefits
      of a
      tax position. If a tax position is not considered more-likely-than-not to be
      sustained based solely on its technical merits, no benefits of the position
      are
      to be recognized. Moreover, the more-likely-than-not threshold must continue
      to
      be met in each reporting period to support continued recognition of a benefit.
      This Interpretation is effective as of the beginning of the first fiscal year
      beginning after December 15, 2006. The Company does
      not
      expect the adoption of FIN 48 to have a material impact on its consolidated financial position or results of operations.





Also
      in
      June 2006, the FASB ratified the Emerging Issues Task Force (“EITF”) consensus
      on EITF Issue No. 06-3, “How Taxes Collected from Customers and Remitted to
      Governmental Authorities Should Be Presented in the Income Statement (That
      Is,
      Gross versus Net Presentation) (“EITF 06-3”). EITF 06-3 states that the
      classification of taxes as gross or net is an accounting policy decision that
      is
      dependent on the type of tax and that similar taxes are to be presented in
      a
      similar manner. EITF 06-3 is effective for reporting periods beginning after
      December 15, 2006. The Company does
      not
      expect the adoption of EITF
      06-3 to
      have
      an impact on its consolidated financial position or results of operations.





**Related
      Party Transactions**





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





**Forward
      Looking Statements**





This
      Quarterly Report on Form 10-Q contains forward-looking statements as defined
      in
      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.





26


**Item
      3. 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.





There
      have been no material changes in this Item since the Company’s last Annual
      Report on Form 10-K for the fiscal year ended January 28, 2006.





**Item
      4. 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-15(e) and 15d-15(e) under the Securities Exchange Act
      of
      1934, as amended (the “Exchange Act”), as of July 29, 2006 (the “Evaluation
      Date”). Based on such evaluation, such officers have concluded that, as of the
      Evaluation Date, the Company’s disclosure controls and procedures were 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. In reaching its conclusion,
      the Company’s Chief Executive Officer and Chief Financial Officer took into
      account the event described in the final paragraph of this Item 4.





*Changes
      in Internal Control:* During
      the quarter ended July 29, 2006, the Company continued implementation of a
      new
      merchandising system in Waldenbooks, which it began during the third quarter
      of
      2005. The Company believes the controls over the processes affected by the
      implementation are functioning effectively as of July 29, 2006.





During
      the quarter ended July 29, 2006, the Company undertook a review of both its
      disclosure controls and procedures and its internal control over financial
      reporting specific to the International segment. As a result of this review,
      the
      Company discovered errors in the reserve for aged non-returnable inventory
      in
      the Books etc. and United Kingdom Superstores divisions, and an error in the
      calculation of transaction currency gains and losses. The Company has corrected
      these errors, and as of the Evaluation Date, does not believe that it resulted
      from any material weakness in its internal control over financial reporting.
      The
      Company will continue its review of internal controls specific to the
      International segment and will also continue to take steps to remediate the
      procedures which led to the errors.





**Part
      II - Other Information**





**Item
      1. Legal Proceedings**





For
      a
      description of certain legal proceedings affecting the Company, please review
      “Note 2 - Commitments and Contingencies”, on page 6 of this Report, which is
      incorporated herein by reference.





**Item
      1A. Risk Factors**





The
      Company is subject to numerous risks and uncertainties which could adversely
      affect the Company ’s
      business, financial condition, operating results and cash flows. Such risks
      and
      uncertainties have been disclosed in the Company's last
      Annual Report on Form
      10-K
      for the fiscal year ended January 28, 2006. There
      have been no significant changes in these risks
      and
      uncertainties during
      the first quarter of fiscal 2006.





27


**Item
      2. Unregistered Sales of Equity Securities and Use of
      Proceeds**





(c)
            The
                table below presents the total number of shares repurchased during
                the
                second quarter of fiscal 2006.





**Fiscal
                Period**
            
            **Total
                Number of Shares (1)**
            
            **Average
                Price Paid per Share**
              **(2)**
            
            **Total
                Number of Shares Purchased as Part of Publicly Announced Plans or
                Programs
                (3)**
            
            **Approximate
                Dollar Value of Shares that May Yet Be Purchased Under the Plans
                or
                Programs**April
                30 2006
              through
              May
                27, 2006
            
            
            50,000
            
            $
            21.17
            
            
            50,000
            
            $
            222,735,422May
                28, 2006
              through
              June
                24, 2006
            
            
            1,100,476
            
            $
            19.78
            
            
            1,100,000
            
            $
            200,977,759June
                25, 2006
              through
              July
                29, 2006
            
            
            1,128,364
            
            $
            18.50
            
            
            1,125,000
            
            $
            180,167,427Total
            
            
            2,278,840
            
            $
            19.18
            
            
            2,275,000
            
            $
            180,167,427





(1)
            During
                the second quarter of 2006, the company retired 3,840 shares which
                were
                acquired pursuant to the Company’s employee benefit
                plans.





(2)
            Average
                price paid per share includes commissions and is rounded to the nearest
                two decimal places.





(3)
            On
                January 11, 2006, the Company announced that the Board of Directors
                authorized an increase in the amount of share repurchases to $250
                million.





**Item
      4. Submission of Matters to a Vote of Securityholders**





The
      following actions were taken at the Annual Meeting of the Company held on May
      25, 2006, with the votes on such matters being indicated as below:





1.  The
      following individuals were elected to serve as directors for one year terms
      expiring in 2007:





******Name**
            ******For**
            **Withheld**Donald
                G. Campbell
            58,056,022
            1,226,988Joel
                J. Cohen
            58,724,364
            558,646Gregory
                P. Josefowicz
            57,995,563
            1,287,447Amy
                B. Lane
            58,717,311
            565,699Brian
                T. Light
            58,731,609
            551,401Victor
                L. Lund
            58,724,149
            558,861Dr.
                Edna Greene Medford
            58,722,955
            560,055Lawrence
                I. Pollock
            58,052,811
            1,230,199Beth
                M. Pritchard
            58,712,917
            570,093Michael
                Weiss
            51,801,901
            7,481,109





28


2.
      Ratification of the selection of Ernst & Young LLP as the Company’s
      independent registered public accounting firm for fiscal 2006:





For
            58,061,248
                SharesAgainst
            1,206,048
                SharesAbstain
            15,714
                SharesBroker
                Non-Votes
            0
                Shares





3.
      Shareholder proposal entitled “Director Election Majority Vote
      Standard.”





For
            30,931,384
                SharesAgainst
            21,294,744
                SharesAbstain
            675,012
                SharesBroker
                Non-Votes
            6,381,870
                Shares





4.
      Shareholder proposal entitled “Separate the Roles of CEO and Board
      Chair.”





For
            33,124,311
                SharesAgainst
            19,669,691
                SharesAbstain
            107,138
                SharesBroker
                Non-Votes
            6,381,870
                Shares





**Item
      6. Exhibits**





Exhibits:





3.1(1)
            Restated
                Articles of Incorporation of Borders Group, Inc.3.2(2)
            Restated
                bylaws of Borders Group, Inc.3.3(3)
            First
                Amendment to the Restated Bylaws of Borders Group, Inc.10.30(3)
            Employment
                Agreement between Mr. Jones and the Company10.31(4)
            Second
                Amended and Restated Multicurrency Revolving Credit Agreement dated
                as of
                July 31, 2006 among Borders Group, Inc., its subsidiaries and Parties
                thereto31.1
            Statement
                of George L. Jones, President and Chief Executive Officer of Borders
                Group, Inc. pursuant to Section 302 of the Sarbanes-Oxley Act of
                200231.2
            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
                200232.1
            Statement
                of George L. Jones, President and Chief Executive Officer of Borders
                Group, Inc. pursuant to Section 906 of the Sarbanes-Oxley Act of
                200232.2
            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(1)
            Incorporated
                by reference from the Company’s Annual Report on Form 10-K dated January
                24, 1999 (File No. 1-13740).(2)
            Incorporated
                by reference from the Company’s Annual Report on Form 10-K dated January
                27, 2002 (File No. 1-13740).(3)
            Incorporated
                by reference from the Company’s Current Report on Form 8-K dated July 13,
                2006 (File No. 1-13740).(4)
            Incorporated
                by reference from the Company’s Current Report on Form 8-K dated July 31,
                2006 (File No. 1-13740).











29


**SIGNATURES**





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





BORDERS
      GROUP, INC.


(REGISTRANT)





Date:
      August 31, 2006        By: /s/
      Edward W. Wilhelm


Edward
      W.
      Wilhelm


Senior
      Vice President and


Chief
      Financial Officer


(Principal
      Financial and


Accounting
      Officer)





30


**EXHIBIT
      INDEX**


**DESCRIPTION
      OF EXHIBITS**





Exhibits:





3.1(1)
            Restated
                Articles of Incorporation of Borders Group, Inc.3.2(2)
            Restated
                bylaws of Borders Group, Inc.3.3(3)
            First
                Amendment to the Restated Bylaws of Borders Group, Inc.10.30(3)
            Employment
                Agreement between Mr. Jones and the Company10.31(4)
            Second
                Amended and Restated Multicurrency Revolving Credit Agreement dated
                as of
                July 31, 2006 among Borders Group, Inc., its subsidiaries and Parties
                thereto31.1
            Statement
                of George L. Jones, President and Chief Executive Officer of Borders
                Group, Inc. pursuant to Section 302 of the Sarbanes-Oxley Act of
                200231.2
            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
                200232.1
            Statement
                of George L. Jones, President and Chief Executive Officer of Borders
                Group, Inc. pursuant to Section 906 of the Sarbanes-Oxley Act of
                200232.2
            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(1)
            Incorporated
                by reference from the Company’s Annual Report on Form 10-K dated January
                24, 1999 (File No. 1-13740).(2)
            Incorporated
                by reference from the Company’s Annual Report on Form 10-K dated January
                27, 2002 (File No. 1-13740).(3)
            Incorporated
                by reference from the Company’s Current Report on Form 8-K dated July 13,
                2006 (File No. 1-13740).(4)
            Incorporated
                by reference from the Company’s Current Report on Form 8-K dated July 31,
                2006 (File No. 1-13740).





31