Document:

<PAGE>

Exhibit 10.21
-------------

                               AMENDMENT NO. 1 TO
                           SECOND AMENDED AND RESTATED
                       LIMITED LIABILITY COMPANY AGREEMENT
                            OF BARNESANDNOBLE.COM LLC

                  THIS AMENDMENT NO. 1 (this "Amendment") amends the Second
Amended and Restated Limited Liability Company Agreement (the "Restated
Agreement") of barnesandnoble.com llc, a Delaware limited liability company (the
"Company"), made and entered into, effective as of May 28, 1999, by and among
Barnes & Noble, Inc., a corporation organized and existing under the laws of
Delaware, with its principal place of business at 122 Fifth Avenue, New York,
New York 10011 ("BN"), B&N.com Holding Corp., a corporation organized and
existing under the laws of Delaware, with its principal place of business at 122
Fifth Avenue, New York, New York 10011 ("BN Holding"), barnesandnoble.com inc.,
a corporation organized and existing under the laws of Delaware, with its
principal place of business at 76 Ninth Avenue, New York, New York 10011 (the
"Public Corp."), Bertelsmann AG, an Aktiengesellschaft organized and existing
under the laws of Germany, with its principal place of business at
Carl-Bertelsmann-Strasse 270, 33311 Gutersloh, Germany ("BAG"), and BOL.US
Online, Inc., a corporation organized and existing under the laws of Delaware,
with its principal place of business at 1540 Broadway, New York, New York 10036
("USO").

                  WHEREAS, the Company was formed as a limited liability company
pursuant to the Delaware Limited Liability Company Law (6 Del. C. Sections
18-101, et seq.) by the filing of a Certificate of Formation with the Office of
the Secretary of State of the State of Delaware on October 27, 1998;

                  WHEREAS, the parties entered into the Restated Agreement to
reflect the addition of the Public Corp. as a Member and the sole Manager of the
LLC pursuant to the terms and conditions of the Restated Agreement; and

                  WHEREAS, the parties hereto desire to amend the Restated
Agreement, effective as of May 28, 1999, to accurately reflect their
understanding with respect to Section 5.4(c) and Schedule I of the Restated
Agreement;

                  NOW, THEREFORE, the parties hereto hereby agree as follows:

         Amendment to Section 5.4(c). Section 5.4(c) of the Restated Agreement
is hereby amended and restated in its entirety to read as follows:

         "When the Gross Asset Value of a Company asset differs from its basis
for federal or other income tax purposes, solely for purposes of the relevant
tax and not for purposes of computing Capital Account balances, income, gain,
loss, deduction and credit with respect to such asset shall be allocated among
the Members (i) with respect to any contributions of assets to the Company on or
after May 28, 1999, under the traditional method allowed pursuant to Treasury
Regulations Section 1.704-3(b), unless otherwise determined by BN Holding and
USO, and (ii) with respect to all contributions of assets to the Company before
May 28, 1999, under the remedial allocation method under Treasury Regulation
Section 1.704-3(d). The members agree

<PAGE>

that, as of October 31, 1998, all such differences related to goodwill, and the
corresponding remedial allocations shall be made ratably over a fifteen (15)
year period."

         Amendment to Schedule I. Schedule I of the Restated Agreement is hereby
amended and replaced in its entirety by Schedule I attached hereto.

         References. Any references in the Restated Agreement to "the
Agreement", "this Agreement", "hereof", "herein", "hereunder" or terms of
similar import shall mean the Restated Agreement as amended by this Amendment.

         No Other Changes. Except as amended hereby, all other terms and
provisions of the Restated Agreement remain unchanged and in full force and
effect.

         Counterparts. This Amendment may be executed in counterparts which
together shall constitute one and the same instrument.

         IN WITNESS WHEREOF, the parties hereto have executed this Amendment
this 14th day of January, 2000, effective and effectuating their agreement as of
May 28, 1999.

                                              Bertelsmann AG

                                              By: /s/ Thomas Middelhoff
                                                  ---------------------
                                              Name: Thomas Middelhoff
                                              Title:   Chief Executive Officer

                                              BOL.US Online, Inc.

                                              By:  /s/ Robert Sorrentino
                                                   ---------------------
                                              Name:    Robert Sorrentino
                                              Title:   President

                                              Barnes & Noble, Inc.

                                              By:  /s/ Leonard Riggio
                                                   ------------------
                                              Name:    Leonard Riggio
                                              Title:   Chairman

                                              B&N.com Holding Corp.

                                              By:  /s/ Leonard Riggio
                                                   ------------------
                                              Name:    Leonard Riggio
                                              Title:   Chairman

                                              barnesandnoble.com inc.

                                              By:  /s/ Leonard Riggio
                                                   ------------------
                                              Name:    Leonard Riggio
                                              Title:   Chairman

<PAGE>

                                   SCHEDULE I
                                   ----------

                   MEMBERS; MEMBERSHIP UNITS; CAPITAL ACCOUNTS

Member                     Membership Units                   Capital
------                     ----------------                   Account
                                                              --------
barnesandnoble.com inc.    28,750,002                   $  517,500,000
                           Membership Units

B&N.com Holding Corp.      57,500,000                   $1,035,000,000
                           Membership Units

BOL.US Online, Inc.        57,500,000                   $1,035,000,000
                           Membership Units

<PAGE>

SELECTED CONSOLIDATED FINANCIAL DATA

        The selected consolidated financial data of Barnes & Noble, Inc. and its
wholly owned subsidiaries (collectively, the Company) set forth on the following
pages should be read in conjunction with the consolidated financial statements
and notes included elsewhere in this report. The Company's fiscal year is
comprised of 52 or 53 weeks, ending on the Saturday closest to the last day of
January. The Statement of Operations Data for the 52 weeks ended January 29,
2000 (fiscal 1999), the 52 weeks ended January 30, 1999 (fiscal 1998) and the 52
weeks ended January 31, 1998 (fiscal 1997) and the Balance Sheet Data as of
January 29, 2000 and January 30, 1999 are derived from, and are qualified by
reference to, audited consolidated financial statements which are included
elsewhere in this report. The Statement of Operations Data for the 53 weeks
ended February 1, 1997 (fiscal 1996) and 52 weeks ended January 27, 1996 (fiscal
1995) and the Balance Sheet Data as of January 31, 1998, February 1, 1997 and
January 27, 1996 are derived from audited consolidated financial statements not
included in this report. Certain prior-period amounts have been reclassified for
comparative purposes.

<TABLE>
<CAPTION>
Fiscal Year                                        1999(1)         1998          1997          1996          1995
                                                   -------         ----          ----          ----          ----
(Thousands of dollars, except per share data)
---------------------------------------------
<S>                                               <C>          <C>           <C>           <C>            <C>
STATEMENT OF OPERATIONS DATA:
Sales
   Barnes & Noble stores                           $2,821,549   2,515,352     2,245,531     1,861,177      1,349,830
   B. Dalton stores                                   426,018     468,414       509,389       564,926        603,204
   Barnes & Noble.com                                      --          --        14,601            --             --
   Other                                               14,728      21,842        27,331        22,021         23,866
                                                    ---------   ----------    ----------    ----------    -----------
       Total bookstore sales                        3,262,295   3,005,608     2,796,852     2,448,124      1,976,900
   Babbage's Etc. stores                              223,748          --            --            --             --
                                                    ---------   ----------    ----------    ----------    -----------
       Total sales                                  3,486,043   3,005,608     2,796,852     2,448,124      1,976,900
   Cost of sales and occupancy                      2,483,729   2,142,717     2,019,291     1,785,392      1,444,555
                                                    ---------   ----------    ----------    ----------    -----------
   Gross profit                                     1,002,314     862,891       777,561       662,732        532,345
Selling and administrative expenses                   651,099     580,609       542,336       467,777        383,692
Depreciation and amortization                         112,304      88,345        76,951        59,806         47,881
Pre-opening expenses                                    6,801       8,795        12,918        17,571         12,160
Restructuring charge(2)                                    --          --            --            --        123,768
                                                    ---------   ----------    ----------    ----------    -----------
   Operating profit (loss)                            232,110     185,142       145,356       117,578        (35,156)
Interest expense, net and amortization of
   deferred financing fees(3)                         (23,765)    (24,412)      (37,666)      (38,286)       (28,142)
Equity in net loss of Barnes & Noble.com(4)           (42,047)    (71,334)           --            --             --
Gain on formation of Barnes & Noble.com(5)             25,000      63,759            --            --             --
Other income(6)                                        27,337       3,414         1,913         2,090             --
                                                    ---------   ----------    ----------    ----------    -----------
   Earnings (loss) before provision
     (benefit) for income taxes,
     extraordinary charge and cumulative
     effect of a change in accounting
     principle                                        218,635     156,569       109,603        81,382        (63,298)
Provision (benefit) for income taxes                   89,637      64,193        44,935        30,157        (10,322)
                                                    ---------   ----------    ----------    ----------    -----------
   Earnings (loss) before extraordinary
     charge and cumulative effect of a
     change in accounting principle                   128,998      92,376        64,668        51,225        (52,976)
Extraordinary charge(7)                                   --           --       (11,499)           --             --
Cumulative effect of a change in
   accounting principle                                (4,500)         --            --            --             --
                                                    ---------   ----------    ----------    ----------    -----------
   Net earnings (loss)                              $ 124,498      92,376        53,169        51,225        (52,976)
                                                    =========   ==========    ==========    ==========    ===========

Earnings (loss) per common share
   Basic
     Earnings (loss) before extraordinary
       charge and cumulative effect of a
       change in accounting principle               $    1.87        1.35          0.96          0.77          (0.85)
     Extraordinary charge                           $      --          --         (0.17)           --             --
     Cumulative effect of a change in
       accounting principle                         $   (0.07)         --            --            --             --

</TABLE>

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<PAGE>

<TABLE>
<CAPTION>
Fiscal Year                                        1999(1)         1998          1997          1996          1995
                                                   -------         ----          ----          ----          ----
(Thousands of dollars, except per share data)
---------------------------------------------
<S>                                               <C>          <C>           <C>           <C>            <C>

     Net earnings (loss)                            $   1.80          1.35          0.79          0.77          (0.85)

    Diluted
        Earnings (loss) before extraordinary
            charge and cumulative effect of a
            change in accounting                    $   1.81          1.29          0.93          0.75          (0.85)
            principle
        Extraordinary charge                        $     --            --         (0.17)           --             --
        Cumulative effect of a change in
            accounting principle                    $  (0.06)           --            --            --             --
        Net earnings (loss)                         $   1.75          1.29          0.76          0.75          (0.85)

Weighted average common shares outstanding
   Basic                                          69,005,000    68,435,000    67,237,000    66,103,000     62,434,000
   Diluted                                        71,354,000    71,677,000    69,836,000    67,886,000     62,434,000

OTHER OPERATING DATA:
Number of stores
   Barnes & Noble stores(8)                              542           520           483           431            358
   B. Dalton stores(9)                                   400           489           528           577            639
   Babbage's Etc. stores(10)                             526            --            --            --             --
                                                  ----------    ----------    ----------    ----------    ------------
     Total                                             1,468         1,009         1,011         1,008            997
                                                  ==========    ==========    ==========    ==========    ============
Comparable store sales increase
   (decrease)(11)
   Barnes & Noble stores                                 6.1%          5.0%          9.4%          7.3%           6.9%
   B. Dalton stores                                      0.1          (1.4)         (1.1)         (1.0)          (4.3)
   Babbage's Etc. stores                                12.5            --            --            --             --

Capital expenditures                              $  146,294       141,388       121,903       171,885        154,913

BALANCE SHEET DATA:
Working capital                                   $  318,668       315,989       264,719       212,692        226,500
Total assets                                      $2,413,791     1,807,597     1,591,171     1,446,647      1,315,342
Long-term debt, less current portions             $  431,600       249,100       284,800       290,000        262,400
Shareholders' equity                              $  846,360       678,789       531,755       455,989        400,235
</TABLE>

(1)      Fiscal 1999 includes the results of operations of Babbage's Etc. from
         October 28, 1999, the date of acquisition.

(2)      Restructuring charge includes restructuring and asset impairment losses
         recognized upon adoption of Statement of Financial Accounting Standards
         No. 121, "Impairment of Long-Lived Assets and Assets to be Disposed
         Of."

(3)      Interest expense for fiscal 1999, 1998, 1997, 1996 and 1995 is net of
         interest income of $1,449, $976, $446, $2,288 and $2,138, respectively.

(4)      On November 12, 1998, the Company and Bertelsmann AG (Bertelsmann)
         completed the formation of a limited liability company to operate the
         online retail bookselling operations of the Company's wholly owned
         subsidiary, barnesandnoble.com inc. (Barnes & Noble.com Inc.). Barnes &
         Noble.com Inc. began operations in fiscal 1997. As a result of the
         formation of barnesandnoble.com llc (Barnes & Noble.com), the Company
         began accounting for its interest in Barnes & Noble.com under the

                                       2
<PAGE>

         equity method of accounting as of the beginning of fiscal 1998. Fiscal
         1998 reflects a 100 percent equity interest in Barnes & Noble.com for
         the first three quarters ended October 31, 1998 (also the effective
         date of the limited liability company agreement), and a 50 percent
         equity interest beginning on November 1, 1998 through the end of the
         fiscal year. As a result of the Barnes & Noble.com Inc. initial public
         offering (IPO) on May 25, 1999, the Company retained a 40 percent
         interest in Barnes & Noble.com. Accordingly, fiscal 1999 reflects the
         Company's 50 percent interest in the net losses of Barnes & Noble.com
         through the date of the IPO and 40 percent thereafter.

(5)      As a result of the formation of the limited liability company, the
         Company recognized a pre-tax gain during fiscal 1998 in the amount of
         $126,435, of which $63,759 has been recognized in earnings based on the
         $75,000 received directly from Bertelsmann and $62,676 ($36,351 after
         taxes) has been reflected in additional paid-in capital based on the
         Company's share of the incremental equity of the joint venture
         resulting from the $150,000 Bertelsmann contribution. As a result of
         the Barnes & Noble.com Inc. IPO, the Company and Bertelsmann each
         retained a 40 percent interest in Barnes & Noble.com. The Company
         recorded an increase in additional paid-in capital of $200,272
         ($116,158 after taxes) representing the Company's incremental share in
         the equity in Barnes & Noble.com. In addition, the Company recognized a
         pre-tax gain of $25,000 in fiscal 1999 as a result of cash received in
         connection with the joint venture agreement with Bertelsmann.

(6)      Included in other income in fiscal 1999 are pre-tax gains of $22,356
         and $10,975 recognized in connection with the Company's investments in
         NuvoMedia Inc. and Chapters Inc., respectively, as well as a one-time
         charge of $5,000 attributable to the termination of the Ingram
         acquisition and losses from equity investments of $994.

(7)      Reflects a net extraordinary charge during fiscal 1997 due to the early
         extinguishment of debt, consisting of: (i) a pre-tax charge of $11,281
         associated with the redemption premium on the Company's senior
         subordinated notes; (ii) the associated write-off of $8,209 of
         unamortized deferred finance costs; and (iii) the related tax benefits
         of $7,991 on the extraordinary charge.

(8)      Also includes 10 Bookstop and 23 Bookstar stores as of January 29,
         2000.

(9)     Also includes 10 Doubleday Book Shops, five Scribner's Bookstores and
        five smaller format bookstores operated under the

                                       3
<PAGE>

         Barnes & Noble trade name representing the Company's original retail
         strategy as of January 29, 2000.

(10)     Includes 265 Software Etc., 216 Babbage's, 40 GameStop and five smaller
         format stores as of January 29, 2000.

(11)     Comparable store sales increase (decrease) is calculated on a 52-week
         basis, and includes sales of stores that have been open for 12 months
         for B. Dalton stores and 15 months for Barnes & Noble stores (due to
         the high sales volume associated with grand openings). Comparable store
         sales for fiscal years 1999, 1998 and 1997 include relocated Barnes &
         Noble stores and exclude B. Dalton stores which the Company has closed
         or has a formal plan to close. Comparable store sales increase for
         Babbage's Etc. is calculated on a 52-week basis, and includes sales of
         stores that have been open for 12 months.

                                       4
<PAGE>

MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS

        The Company's fiscal year is comprised of 52 or 53 weeks, ending on the
Saturday closest to the last day of January. As used in this section, "fiscal
1999" represents the 52 weeks ended January 29, 2000, "fiscal 1998" represents
the 52 weeks ended January 30, 1999 and "fiscal 1997" represents the 52 weeks
ended January 31, 1998.

General

        Barnes & Noble, Inc. (Barnes & Noble or the Company), the nation's
largest bookseller(1), as of January 29, 2000 operates 942 bookstores and 526
video game and entertainment software stores. Of the 942 bookstores, 542 operate
under the Barnes & Noble Booksellers, Bookstop and Bookstar trade names (38 of
which were opened in fiscal 1999) and 400 operate under the B. Dalton
Bookseller, Doubleday Book Shops and Scribner's Bookstore trade names. Through
its 40 percent interest in barnesandnoble.com llc (Barnes & Noble.com), the
Company is the second largest seller of books on the Internet and is the
exclusive bookseller on America Online (AOL). The Company, through its recent
acquisition of Babbage's Etc. LLC (Babbage's Etc.), operates 526 video game and
entertainment software stores under the Babbage's, Software Etc. and GameStop
trade names, and a Web site, gamestop.com. The Company employed approximately
37,400 full- and part-time employees and created nearly 3,000 new jobs
nationwide during fiscal 1999.

        Barnes & Noble is the largest operator of book "super" stores in the
United States(1) with 542 Barnes & Noble bookstores located in 49 states and the
District of Columbia as of January 29, 2000. With more than 30 years of
bookselling experience, management has a strong sense of customers' changing
needs and the Company leads book retailing with a "community store" concept.
Barnes & Noble's typical bookstore offers a comprehensive title base, a cafe, a
children's section, a music department, a magazine section and a calendar of
ongoing events, including author appearances and children's activities, that
make each Barnes & Noble bookstore an active part of its community.

        Barnes & Noble bookstores range in size from 10,000 to 60,000 square
feet depending upon market size, and each store features an authoritative
selection of books, ranging from 60,000 to 175,000 titles. The comprehensive
title selection is diverse and reflects local interests. In addition, Barnes &
Noble emphasizes books published by small and independent publishers and
university presses. Bestsellers represent only 3% of Barnes & Noble bookstore
sales. Complementing this extensive on-site selection, all Barnes & Noble
bookstores provide customers with access to the millions of books available to
online shoppers while offering an option to have the book sent to the store or
shipped directly to the customer. During fiscal 1999 the Company completed its
rollout of BookMaster, the Company's new in-store operating system, in all
Barnes & Noble bookstores. BookMaster enhances the Company's existing
merchandise replenishment systems, resulting in higher in-stock positions and
better productivity at the store level through efficiencies in receiving,
cashiering and returns processing.

         During fiscal 1999, the Company added 1.0 million square feet to the
Barnes & Noble bookstore base, bringing the total square footage to 12.7 million
square feet, a 7% increase over the prior year. Barnes & Noble bookstores
contributed more than 86% of the Company's total bookstore sales in fiscal 1999.
The Company plans to open between 40 and 45 Barnes & Noble bookstores in fiscal
2000 which are expected to average 26,000 square feet in size.

--------
(1) Based upon sales reported in trade publications and public filings.

                                       5
<PAGE>

        At the end of fiscal 1999, the Company operated 400 B. Dalton bookstores
in 45 states and the District of Columbia. B. Dalton bookstores employ
merchandising strategies that target the "Middle-American" consumer book market,
offering a wide range of bestsellers and general-interest titles. Most B. Dalton
bookstores range in size from 2,800 to 6,000 square feet, and while they are
appropriate to the size of adjacent mall tenants, the opening of superstores in
nearby locations continues to have a significant impact on B. Dalton bookstores.

        The Company is continuing to execute a strategy to maximize returns from
its B. Dalton bookstores in response to declining sales attributable primarily
to superstore competition. Part of the Company's strategy has been to close
underperforming stores, which has resulted in the closing of between 40 to 90 B.
Dalton bookstores per year since 1989.

        In 1998, the Company and Bertelsmann AG (Bertelsmann) completed the
formation of a limited liability company to operate the online retail
bookselling operations of the Company's wholly owned subsidiary,
barnesandnoble.com inc. (Barnes & Noble.com Inc.). The new entity, Barnes &
Noble.com, was formed by combining the online bookselling operations of the
Company with funds contributed by the international media company Bertelsmann,
one of the largest integrated media companies in the world. In 1999, Barnes &
Noble.com Inc. completed an initial public offering (IPO) of 28.75 million
shares of Class A Common Stock and used the proceeds to purchase a 20 percent
interest in Barnes & Noble.com. As a result, the Company and Bertelsmann each
retained a 40 percent interest in Barnes & Noble.com.

        Barnes & Noble.com has become one of the world's largest Web sites and
the fourth largest e-commerce site, according to Media Metrix. Focused largely
on the sale of books, music, software, magazines, prints, posters and related
products, Barnes & Noble.com has capitalized on the recognized brand value of
the Barnes & Noble name to become the second largest, and one of the fastest
growing, online distributors of books. Customers can choose from millions of new
and out-of-print titles and enjoy a variety of related content such as author
chats, book synopses and reader reviews. The site also offers thousands of
bargain books discounted up to 91 percent, the most popular software and
magazine titles, as well as gift items for every occasion. Barnes & Noble.com
recently launched its Prints & Posters Gallery, a unique collection of images
that can be produced on demand on museum-quality canvas or high-quality paper,
and its eCards service, an exclusive selection of greeting card images that can
be personalized and enhanced with animation and music. With access to Barnes &
Noble's more than 750,000 in-stock titles, Barnes & Noble.com has the largest
standing inventory of any online bookseller ready for immediate delivery. The
URL http://www.bn.com makes the site easy to find. The Barnes & Noble.com
affiliate network has more than 300,000 members and maintains strategic
alliances with major Web portals and content sites, such as AOL, Lycos and MSN.
Barnes & Noble.com is also a leader in business-to-business e-commerce with its
unique Business Solutions program.

         Barnes & Noble further differentiates its product offerings from those
of its competitors by publishing books under its own imprints for sale in its
retail stores and through Barnes & Noble.com's online and direct-mail book
sales. With publishing and distribution rights to over 2,000 titles, Barnes &
Noble Books offers customers high-quality books at exceptional values, while
generating attractive gross margins.

        On October 28, 1999, the Company acquired Babbage's Etc., one of the
nation's largest operators of video game and entertainment software stores. As a
result of the acquisition, the Company currently

                                       6
<PAGE>

operates 526 video game and entertainment software stores located in 47 states
and Puerto Rico. The Company's video game and entertainment software stores
range in size from 500 to 5,000 square feet (averaging 1,500 square feet)
depending upon market demographics. Stores feature video game hardware and
software, PC entertainment software and a multitude of accessories.

Results of Operations

        The Company's sales, operating profit, comparable store sales, store
openings, store closings, number of stores open and square feet of selling space
at year end are set forth below:

<TABLE>
<CAPTION>
Fiscal Year                                                             1999             1998              1997
                                                                     ----------        ---------         ---------
(Thousands of dollars)
<S>                                                                  <C>               <C>               <C>
Sales
Bookstores (1)                                                       $3,262,295        3,005,608         2,796,852
Video game and entertainment software stores                            223,748               --                --
                                                                     ----------        ---------         ---------
   Total                                                             $3,486,043        3,005,608         2,796,852
                                                                     ==========        =========         =========
Operating Profit
Bookstores (1)                                                         $216,678          185,142           145,356
Video game and entertainment software stores                             15,432               --                --
                                                                     ----------        ---------         ---------
   Total                                                               $232,110          185,142           145,356
                                                                     ==========        =========         =========
Comparable Store Sales Increase (Decrease)(2)
Barnes & Noble stores                                                       6.1%             5.0%              9.4%
B. Dalton stores                                                            0.1             (1.4)             (1.1)
Babbage's Etc. stores                                                      12.5               --                --
                                                                     ==========        =========         =========
Stores Opened
Barnes & Noble stores                                                        38               50                65
B. Dalton stores                                                             --                4                 4
                                                                     ----------        ---------         ---------
   Total                                                                     38               54                69
                                                                     ==========        =========         =========
Stores Closed
Barnes & Noble stores                                                        16               13                13
B. Dalton stores                                                             89               43                53
                                                                     ----------        ---------         ---------
   Total                                                                    105               56                66
                                                                     ==========        =========         =========
Number of Stores Open at Year End
Barnes & Noble stores                                                       542              520               483
B. Dalton stores                                                            400              489               528
Babbage's Etc. stores                                                       526               --                --
                                                                     ----------        ---------         ---------
   Total                                                                  1,468            1,009             1,011
                                                                     ==========        =========         =========
Square Feet of Selling Space at Year End (in millions)
Barnes & Noble stores                                                      12.7             11.9              10.8
B. Dalton stores                                                            1.6              1.9               2.0
Babbage's Etc. stores                                                       0.8               --                --
                                                                     ----------        ---------         ---------
   Total                                                                   15.1             13.8              12.8
                                                                     ==========        =========         =========
</TABLE>

                                       7
<PAGE>

(1)  Included in fiscal 1997 are sales and operating losses associated with
     Barnes & Noble.com of $14,601 and ($15,395), respectively. Beginning in
     fiscal 1998 the Company's consolidated statement of operations presents its
     equity in the results of operations of Barnes & Noble.com as a single line
     item below operating profit in accordance with the equity method of
     accounting. The Company's equity in the net loss of Barnes & Noble.com for
     fiscal 1999 and fiscal 1998 was ($42,047) and ($71,334), respectively.

(2)  Comparable store sales for B. Dalton stores are determined using stores
     open at least 12 months. Comparable store sales for Barnes & Noble stores
     are determined using stores open at least 15 months, due to the high sales
     volume associated with grand openings. Comparable store sales for Babbage's
     Etc. are calculated on a 52-week basis, and include sales of stores that
     have been open for 12 months.

The following table sets forth, for the periods indicated, the percentage
relationship that certain items bear to total sales of the Company:
<TABLE>
<CAPTION>

Fiscal Year                                                    1999               1998             1997
                                                           ------------       ------------     ------------
<S>                                                        <C>                <C>              <C>
Sales                                                             100.0%             100.0%           100.0%
Cost of sales and occupancy                                        71.2               71.3             72.2
                                                           ------------       ------------     ------------
   Gross margin                                                    28.8               28.7             27.8
Selling and administrative expenses                                18.7               19.3             19.4
Depreciation and amortization                                       3.2                2.9              2.8
Pre-opening expenses                                                0.2                0.3              0.4
                                                           ------------       ------------     ------------
   Operating margin*                                                6.7                6.2              5.2
Interest expense,  net and amortization of deferred
   financing fees                                                  (0.7)              (0.8)            (1.4)
Equity in net loss of Barnes & Noble.com                           (1.2)              (2.4)              --
Gain on formation of Barnes & Noble.com                             0.7                2.1               --
Other income                                                        0.8                0.1              0.1
                                                           ------------       ------------     ------------
   Earnings before provision for income taxes,
     extraordinary charge and cumulative effect of
     a change in accounting principle*                              6.3                5.2              3.9
Provision for income taxes*                                         2.6                2.1              1.6
                                                           ------------       ------------     ------------
   Earnings before extraordinary charge and
     cumulative effect of a change in accounting
     principle*                                                     3.7                3.1              2.3
Extraordinary charge, net                                            --                 --              0.4
                                                           ------------       ------------     ------------
   Earnings before cumulative effect of a change
     in accounting principle                                        3.7                3.1              1.9
   Cumulative effect of a change in accounting
     principle                                                     (0.1)                --               --
                                                           ------------       ------------     ------------
Net earnings                                                        3.6%               3.1%             1.9%
                                                           ============       ============     ============
</TABLE>

                                       8
<PAGE>

*If operating margin, earnings before provision for income taxes, extraordinary
charge and cumulative effect of a change in accounting principle, provision for
income taxes and earnings before extraordinary charge and cumulative effect of a
change in accounting principle were presented without Barnes & Noble.com during
fiscal 1997, the percentage relationship that these items would bear to total
sales of the Company would be 5.8%, 4.5%, 1.8% and 2.7%.

                                       9
<PAGE>

52 Weeks Ended January 29, 2000 Compared with 52 Weeks Ended January 30, 1999

Sales

        The Company's sales increased 16.0% during fiscal 1999 to $3.486 billion
from $3.006 billion during fiscal 1998. Contributing to this improvement was a
7.4% increase attributable to the inclusion of Babbage's Etc.'s sales for the
fourth quarter of 1999. Babbage's Etc., one of the nation's largest operators of
video game and entertainment software stores, was acquired by the Company on
October 28, 1999. Fiscal 1999 sales from Barnes & Noble "super" stores, which
contributed 80.9% of total sales or 86.5% of total bookstore sales, increased
12.2% to $2.822 billion from $2.515 billion in fiscal 1998.

        The increase in bookstore sales was primarily attributable to the 6.1%
growth in Barnes & Noble comparable store sales, full year sales from the 50 new
stores opened during fiscal 1998 and the opening of an additional 38 Barnes &
Noble stores during 1999. This increase was partially offset by declining sales
of B. Dalton, due to 89 store closings.

Cost of Sales and Occupancy

        The Company's cost of sales and occupancy includes costs such as rental
expense, common area maintenance, merchant association dues, lease-required
advertising and adjustments for LIFO.

        Cost of sales and occupancy increased to $2.484 billion in fiscal 1999
from $2.143 billion in fiscal 1998 primarily due to the inclusion of Babbage's
Etc.'s cost of sales and occupancy in the fourth quarter of 1999. The Company's
gross margin rate increased to 28.8% in fiscal 1999 from 28.7% in fiscal 1998.
This increase was attributable to improved leverage on occupancy costs as well
as a favorable merchandise mix in the bookstores, partially offset by lower
gross margins in the video game and entertainment software stores.

Selling and Administrative Expenses

        Selling and administrative expenses increased $70.5 million, or 12.1% to
$651.1 million in fiscal 1999 from $580.6 million in fiscal 1998 partially due
to the inclusion of Babbage's Etc.'s selling and administrative expenses in the
fourth quarter of 1999. Selling and administrative expenses decreased to 18.7%
of sales during fiscal 1999 from 19.3% during fiscal 1998.

Depreciation and Amortization

        Depreciation and amortization increased $24.0 million, or 27.1%, to
$112.3 million in fiscal 1999 from $88.3 million in fiscal 1998. The increase
was primarily the result of the depreciation related to Barnes & Noble stores
opened during fiscal 1999 and fiscal 1998, as well as the depreciation on the
Company's BookMaster system and the inclusion of Babbage's Etc.'s fourth quarter
depreciation and amortization of $3.6 million.

Pre-Opening Expenses

        Pre-opening expenses declined in fiscal 1999 to $6.8 million from $8.8
million in fiscal 1998 reflecting the opening of fewer new stores compared with
prior years and the first quarter adoption of

                                       10
<PAGE>

Statement of Position 98-5, "Reporting on Costs of Start-up Activities" (SOP
98-5). SOP 98-5 requires an entity to expense all start-up activities (as
defined) as incurred. Prior to 1999, the Company amortized costs associated with
the opening of new stores over the respective store's first 12 months of
operations. The Company recorded a one-time non-cash charge reflecting the
cumulative effect of a change in accounting principle in the amount of $4,500
after taxes, representing such start-up costs capitalized as of the beginning of
fiscal year 1999. Since adoption, the Company has expensed all such start-up
costs as incurred. The effect of the change in accounting principle on earnings
in 1999 was immaterial.

Operating Profit

        Operating profit increased to $232.1 million in fiscal 1999 from $185.1
million in fiscal 1998. Fiscal 1999 operating profit includes Babbage's Etc.'s
fourth quarter 1999 operating profit of $15.4 million. Bookstore operating
profit increased 17.1% to $216.7 million. Bookstore operating margin improved to
6.6% of sales during fiscal 1999 from 6.2% of sales in fiscal 1998 reflecting
better occupancy leverage and a more favorable product mix.

Interest Expense, Net and Amortization of Deferred Financing Fees

        Interest expense, net of interest income, and amortization of deferred
financing fees decreased 2.5% to $23.8 million in fiscal 1999 from $24.4 million
in fiscal 1998 despite the inclusion of $3.1 million of additional interest
expense attributable to the Babbage's Etc. acquisition in fiscal 1999. The
decline was the result of strong cash flows and more favorable interest rates
under the Company's senior credit facility.

Equity in Net Loss of Barnes & Noble.com

         As a result of the formation of the limited liability company with
Bertelsmann, the Company began accounting for its interest in Barnes & Noble.com
under the equity method of accounting as of the beginning of fiscal 1998. The
Company's equity in the net loss of Barnes & Noble.com for fiscal 1998 was $71.3
million. The Company's share in the net loss of Barnes & Noble.com for fiscal
1998 was based on a 100 percent equity interest for the first three quarters
ended October 31, 1998 (the effective date of the limited liability company
agreement), and a 50 percent equity interest beginning on November 1, 1998
through the end of the fiscal year.

         As a result of the Barnes & Noble.com Inc. IPO on May 25, 1999, the
Company and Bertelsmann each retained a 40 percent interest in Barnes &
Noble.com. Accordingly, the Company's share in the net loss of Barnes &
Noble.com for fiscal 1999 was based on a 50 percent equity interest from the
beginning of fiscal 1999 through May 25, 1999 and 40 percent thereafter. The
Company's equity in the net loss of Barnes & Noble.com for fiscal 1999 was $42.0
million.

Gain on Formation of Barnes & Noble.com

        As a result of the formation of the limited liability company, resulting
in the receipt of $75 million by the Company from Bertelsmann, a gain was
recorded in fiscal 1998 in the amount of $63.8 million. The gain represents the
excess of the amount received over the portion of the net assets of Barnes &
Noble.com sold by the Company to Bertelsmann.

        Under the terms of the November 12, 1998 joint venture agreement between
the Company and

                                       11
<PAGE>

Bertelsmann, the Company received a $25 million payment from Bertelsmann in
fiscal 1999 in connection with the Barnes & Noble.com IPO.

Other Income

        Other income increased to $27.3 million in fiscal 1999 from $3.4 million
in fiscal 1998. This increase was primarily attributable to the following
transactions which occurred in fiscal 1999:

        The Company and the Ingram Book Group (Ingram) announced their agreement
to terminate the Company's planned acquisition of Ingram. The Company's
application before the Federal Trade Commission for the purchase was formally
withdrawn. As a result, other income reflects a one-time charge of $5.0 million
for acquisition costs. These costs relate primarily to legal, accounting and
other transaction related costs incurred in connection with the proposed
acquisition of Ingram.

        The Company sold a portion of its investment in Chapters Inc. (Chapters)
resulting in a pre-tax gain of $11.0 million.

        The Company recognized a pre-tax gain of $22.4 million in connection
with the sale of its investment in NuvoMedia Inc. (NuvoMedia) to Gemstar
International Ltd., a publicly traded company.

Provision for Income Taxes

        Barnes & Noble's effective tax rate was 41 percent during both fiscal
1999 and fiscal 1998.

                                       12
<PAGE>

Earnings

        Fiscal 1999 earnings increased $32.1 million, or 34.8%, to $124.5
million (or $1.75 per diluted share) from $92.4 million (or $1.29 per diluted
share) during fiscal 1998. Components of earnings per share are as follows:

<TABLE>
<CAPTION>
Fiscal Year                                                                   1999                 1998
                                                                           ------------        ------------
<S>                                                                        <C>                 <C>
Retail Earnings Per Share
      Bookstores                                                                  $1.62                1.32
      Babbage's Etc.                                                               0.10                  --
                                                                           ------------        ------------
Retail EPS                                                                        $1.72                1.32

EPS Impact of Investing Activities
      Cash:
      Gain on Barnes & Noble.com                                                  $0.21                0.53
      Gain on partial sale of Chapters                                             0.09                  --

      Non-cash:
      Share in net losses of Barnes & Noble.com                                   (0.35)              (0.59)
      Share of net earnings (losses) from other equity investments                (0.01)               0.03
      Gain on sale of investment in NuvoMedia                                      0.19                  --
                                                                           ------------        ------------
Total Investing Activities                                                        $0.13               (0.03)

Other Adjustments
      Ingram write-off                                                           $(0.04)                 --
      Change in accounting for pre-opening costs                                  (0.06)                 --
                                                                           ------------        ------------
Total Other Adjustments                                                          $(0.10)                 --
                                                                           ------------        ------------
Consolidated EPS                                                                  $1.75                1.29
                                                                           ============        ============
</TABLE>

                                       13
<PAGE>

52 Weeks Ended January 30, 1999 Compared with 52 Weeks Ended January 31, 1998

Sales

        The Company's sales increased 7.5% during fiscal 1998 to $3.006 billion
from $2.797 billion during fiscal 1997. Fiscal 1998 sales from Barnes & Noble
stores, which contributed 83.7% of total sales, increased 12.0% to $2.515
billion from $2.246 billion in fiscal 1997.

        The increase in sales was primarily due to the 5.0% increase in Barnes &
Noble comparable store sales and the opening of an additional 50 Barnes & Noble
stores during 1998. This increase was slightly offset by declining sales of B.
Dalton, due to 43 store closings and a comparable store sales decline of 1.4%.
In addition, fiscal 1997 includes Barnes & Noble.com sales of $14.6 million
whereas fiscal 1998 does not include sales for Barnes & Noble.com due to the
conversion to the equity method of accounting as of the beginning of the year.
Excluding Barnes & Noble.com sales in fiscal 1997, retail sales increased 8.0%
during fiscal 1998.

Cost of Sales and Occupancy

         The Company's cost of sales and occupancy includes costs such as rental
expense, common area maintenance, merchant association dues, lease-required
advertising and adjustments for LIFO.

        Cost of sales and occupancy increased to $2.143 billion in fiscal 1998
from $2.019 billion in fiscal 1997. The Company's gross margin rate increased to
28.7% in fiscal 1998 from 27.8% in fiscal 1997. Excluding Barnes & Noble.com in
fiscal 1997 the retail gross margin rate was 27.9%. The fiscal 1998 improvement
in gross margin reflects more direct buying, increased distribution center
efficiencies, better shrinkage control and a more-favorable merchandise mix.

Selling and Administrative Expenses

        Selling and administrative expenses increased $38.3 million, or 7.1% to
$580.6 million in fiscal 1998 from $542.3 million in fiscal 1997. Selling and
administrative expenses decreased slightly to 19.3% of sales during fiscal 1998
from 19.4% during fiscal 1997 primarily as a result of the start-up expenses
from Barnes & Noble.com included in the fiscal 1997 results. Excluding Barnes &
Noble.com, retail selling and administrative expenses would have been 18.9% of
sales in fiscal 1997 and total retail selling and administrative expenses would
have increased 10.1% in fiscal 1998. The fiscal 1998 increase in retail selling
and administrative expenses reflects the opening of an additional 50 Barnes &
Noble stores, the full year implementation of a new wage plan and expenses
associated with new store system enhancements.

Depreciation and Amortization

        Depreciation and amortization increased $11.3 million, or 14.8%, to
$88.3 million in fiscal 1998 from $77.0 million in fiscal 1997. The increase was
primarily the result of the new Barnes & Noble stores opened during fiscal 1998
and fiscal 1997, as well as new store system enhancements made during fiscal
1998.

                                       14
<PAGE>

Pre-Opening Expenses

        Pre-opening expenses declined in fiscal 1998 to $8.8 million from $12.9
million in fiscal 1997 reflecting fewer new stores compared with prior years.

Operating Profit

        Operating profit increased to $185.1 million in fiscal 1998 from $145.4
million in fiscal 1997. Excluding the $15.4 million operating loss for Barnes &
Noble.com included in fiscal 1997, retail operating margin improved to 6.2% of
sales during fiscal 1998 from 5.8% of sales in fiscal 1997.

Interest Expense, Net and Amortization of Deferred Financing Fees

        Interest expense, net of interest income, and amortization of deferred
financing fees decreased 35.2% or $13.3 million in fiscal 1998 to $24.4 million
from $37.7 million in fiscal 1997. The decline was the result of the retirement
of $190 million in 11 7/8% senior subordinated notes on January 15, 1998 as well
as the more-favorable rate environment and lower spreads over the London
Interbank Offer Rate (LIBOR) in effect since the November 1997 refinancing.

Equity in Net Loss of Barnes & Noble.com

         As a result of the formation of the limited liability company with
Bertelsmann, the Company began accounting for its interest in Barnes & Noble.com
under the equity method of accounting as of the beginning of fiscal 1998. The
Company's equity in the net loss of Barnes & Noble.com for fiscal 1998 was $71.3
million. This reflects a 100 percent equity interest for the first three
quarters ended October 31, 1998 (also the effective date of the limited
liability company agreement), and a 50 percent equity interest beginning on
November 1, 1998 through the end of the fiscal year. Had the Company reported
the results of Barnes & Noble.com under the equity method of accounting during
fiscal 1997, its fiscal 1997 equity in the net loss of Barnes & Noble.com would
have been $15.4 million.

Gain on Formation of Barnes & Noble.com

         As a result of the formation of the limited liability company,
resulting in the receipt of $75 million by the Company from Bertelsmann, a gain
was recorded in fiscal 1998 in the amount of $63.8 million. The gain represents
the excess of the amount received over the portion of the net assets of Barnes &
Noble.com sold by the Company to Bertelsmann.

Other Income

         Other income increased to $3.4 million in fiscal 1998 from $1.9 million
in fiscal 1997 as a result of increased equity earnings from minority
investments in Chapters and Calendar Club LLC.

Provision for Income Taxes

        Barnes & Noble's effective tax rate was 41 percent during both fiscal
1998 and fiscal 1997.

                                       15
<PAGE>

Earnings

        Fiscal 1998 earnings before extraordinary charge increased $27.7
million, or 42.8%, to $92.4 million (or $1.29 per diluted share) from $64.7
million (or $0.93 per diluted share) during fiscal 1997. Before the effect of
Barnes & Noble.com, retail earnings before extraordinary charge increased $23.0
million, or 31.3% to $96.8 million (or $1.35 per diluted share) from $73.8
million (or $1.06 per diluted share).

Seasonality

        The Company's business, like that of many retailers, is seasonal, with
the major portion of sales and operating profit realized during the quarter
which includes the Christmas selling season. The Company has now reported
operating profit for 15 consecutive quarters.

Liquidity and Capital Resources

        Working capital requirements are generally at their highest during the
Company's fiscal quarter ending on or about January 31 due to the higher
payments to vendors for holiday season merchandise purchases and the
replenishment of merchandise inventories following this period of increased
sales. In addition, the Company's sales and merchandise inventory levels will
fluctuate from quarter-to-quarter as a result of the number and timing of new
store openings, as well as the amount and timing of sales contributed by new
stores.

        Cash flows from operating activities, funds available under its
revolving credit facility and vendor financing continue to provide the Company
with liquidity and capital resources for store expansion, seasonal working
capital requirements and capital investments.

        Cash Flow

        Cash flows provided from operating activities were $187.3 million,
$177.7 million and $167.3 million during fiscal 1999, 1998 and 1997,
respectively. In fiscal 1999, the improvement in cash flows was primarily due to
the improvement in net earnings. Fiscal 1997 cash flows from operating
activities without Barnes & Noble.com were $180.0 million. The slight decrease
in retail operating cash flows in fiscal 1998 was due to a strategic increase in
the distribution center standing inventory, the implementation of a new wage
plan in fiscal 1998 and increased operating expenses associated with
implementing the Company's new store system enhancements.

        Retail earnings before interest, taxes, depreciation and amortization
(EBITDA) increased $70.9 million or 25.9% to $344.4 million in fiscal 1999 from
$273.5 million in fiscal 1998. This significant improvement in EBITDA is a
combination of the inclusion of Babbage's Etc. and the continuing maturation of
the Barnes & Noble stores. Total debt to retail EBITDA (excluding the effect of
the Babbage's Etc. acquisition) decreased to .68 times in fiscal 1999 from .91
times in fiscal 1998. Including the effect of the acquisition of Babbage's Etc.,
total debt to retail EBITDA increased to 1.25 times in fiscal 1999, primarily
attributable to the debt incurred to fund the acquisition of Babbage's Etc. The
weighted-average age per square foot of the Company's 542 Barnes & Noble stores
was 3.9 years as of January 29, 2000 and is expected to increase to
approximately 4.5 years by February 3, 2001. As the relatively young Barnes &
Noble stores mature, and as the number of new stores opened during the fiscal
year decreases as a percentage of the existing store base, the increasing
operating profits of Barnes &

                                       16
<PAGE>

Noble stores are expected to generate a greater portion of cash flows required
for working capital, including new store inventories as well as capital
expenditures and other initiatives. Additionally, due to the Barnes & Noble.com
IPO in fiscal 1999, retail cash flows are now fully available to support the
Company's working capital requirements.

        Capital Structure

        Continued strong cash flows from operations and a continued emphasis on
working capital management, once again strengthened the Company's balance sheet
in fiscal 1999. Shareholders' equity increased 24.7% to $846.4 million as of
January 29, 2000, from $678.8 million as of January 30, 1999. Return on average
equity increased to 16.3% in fiscal 1999 from 15.3% during fiscal 1998.

        The Company has an $850 million senior credit facility (the Facility),
obtained in November 1997, with a syndicate led by The Chase Manhattan Bank. The
Facility is structured as a five-year revolving credit. The Facility permits
borrowings at various interest rate options based on the prime rate or LIBOR
depending upon certain financial tests. In addition, the agreement requires the
Company to pay a commitment fee up to 0.25% of the unused portion depending upon
certain financial tests. The Facility contains covenants, limitations and events
of default typical of credit facilities of this size and nature.

        The amount outstanding under the Facility has been classified as
long-term debt in the accompanying consolidated balance sheets due to both its
terms and the Company's intent and ability to maintain principal amounts
outstanding through November 2002.

        Borrowings under the Company's senior credit facilities averaged $397.1
million, $380.3 million and $105.1 million and peaked at $693.5 million, $535.0
million and $304.9 million during fiscal 1999, 1998 and 1997, respectively.
Despite the increase in average and peak borrowings in fiscal 1999 primarily
attributable to the Babbage's Etc. acquisition, interest expense decreased 2.5%
to $23.8 million in fiscal 1999 from $24.4 million in fiscal 1998 as a result of
more favorable interest rates under the Company's senior credit facility. The
ratio of debt to equity increased to 0.51:1.00 as of January 29, 2000 from
0.37:1.00 as of January 30, 1999, primarily attributable to the increased
borrowings to fund the Babbage's Etc. acquisition.

        Capital Investment

        Capital expenditures totaled $146.3 million, $141.4 million and $121.9
million during fiscal 1999, 1998 and 1997, respectively. Capital expenditures in
fiscal 2000, primarily for the opening of between 40 and 45 new Barnes & Noble
stores and 90 new Babbage's Etc. stores, are expected to be between $120 million
and $130 million, although commitment to such expenditures has not yet been
made.

        Based on current operating levels and the store expansion planned for
the next fiscal year, management believes cash flows generated from operating
activities, short-term vendor financing and its borrowing capacity under its
revolving credit facility will be sufficient to meet the Company's working
capital and debt service requirements, and support the development of its short-
and long-term strategies for at least the next 12 months.

         In fiscal 1999, the Board of Directors authorized a common stock
repurchase program for the purchase of up to $250.0 million of the Company's
common shares. As of January 29, 2000, the Company has repurchased 4,025,900
shares at a cost of approximately $86.8 million under this program. The

                                       17
<PAGE>

repurchased shares are held in treasury.

         On July 10, 1998, the Board of Directors of the Company declared a
dividend of one Preferred Share Purchase Right (a Right) for each outstanding
share of the Company's common stock (Common Stock). The distribution of the
Rights was automatically made on July 21, 1998 to stockholders of record on that
date. Each Right entitles the holder to purchase from the Company one
four-hundredth of a share of a new series of preferred stock, designated as
Series H Preferred Stock, par value $.001 per share (the Preferred Stock), at a
price of $225 per one four-hundredth of a share. The Rights will be exercisable
only if a person or group acquires 15 percent or more of the Company's
outstanding Common Stock or announces a tender offer or exchange offer, the
consummation of which would result in such person or group owning 15 percent or
more of the Company's outstanding Common Stock. For a further discussion of the
terms of the Preferred Stock and Rights see Note 13 of Notes to Consolidated
Financial Statements.

Formation of Barnes & Noble.com

         On November 12, 1998, the Company and Bertelsmann completed the
formation of a joint venture to operate the online retail bookselling operations
of the Company's wholly owned subsidiary, Barnes & Noble.com Inc. The new
entity, Barnes & Noble.com, was structured as a limited liability company. Under
the terms of the relevant agreements, effective as of October 31, 1998, the
Company and Bertelsmann each retained a 50 percent membership interest in Barnes
& Noble.com. The Company contributed substantially all of the assets and
liabilities of its online operations to the joint venture and Bertelsmann paid
$75.0 million to the Company and made a $150.0 million cash contribution to the
joint venture. Bertelsmann also agreed to contribute an additional $50.0 million
to the joint venture for future working capital requirements. The Company
recognized a pre-tax gain during fiscal 1998 in the amount of $126.4 million, of
which $63.8 million was recognized in earnings based on the $75.0 million
received directly and $62.7 million ($36.4 million after taxes) was reflected in
additional paid-in capital based on the Company's share of the incremental
equity of the joint venture resulting from the $150.0 million Bertelsmann
contribution.

         On May 25, 1999, Barnes & Noble.com Inc. completed an IPO of 28.75
million shares of Class A Common Stock and used the proceeds to purchase a 20
percent interest in Barnes & Noble.com. As a result, the Company and Bertelsmann
each retained a 40 percent interest in Barnes & Noble.com. The Company recorded
an increase in additional paid-in capital of $200.3 million ($116.2 million
after taxes) representing the Company's incremental share in the equity of
Barnes & Noble.com. The Company will continue to account for its investment
under the equity method.

         Under the terms of the November 12, 1998 joint venture agreement
between the Company and Bertelsmann, the Company received a $25.0 million
payment from Bertelsmann in connection with the IPO.

         The accompanying consolidated financial statements, in accordance with
the equity method of accounting, reflect the Company's investment in Barnes &
Noble.com as a single line item in the consolidated balance sheets as of January
29, 2000 and January 30, 1999 and reflect the Company's interest in the net loss
of Barnes & Noble.com as a single line item in the consolidated statements of
operations for fiscal years 1999 and 1998, as if the formation of the joint
venture had occurred at the beginning of fiscal 1998. The Company's share in the
net loss of Barnes & Noble.com for fiscal 1998 was based on a 100 percent equity
interest for the first three quarters ended October 31, 1998 (the effective date
of the limited liability company agreement), and a 50 percent equity interest
beginning on

                                       18
<PAGE>

November 1, 1998 through the end of the fiscal year.

         As a result of the Barnes & Noble.com Inc. IPO on May 25, 1999, the
Company and Bertelsmann each retained a 40 percent interest in Barnes &
Noble.com. Accordingly, the Company's share in the net loss of Barnes &
Noble.com for fiscal 1999 was based on a 50 percent equity interest from the
beginning of fiscal 1999 through May 25, 1999 and 40 percent thereafter. The
accompanying consolidated financial statements reflect the financial position
and results of operations of Barnes & Noble.com as a consolidated wholly owned
subsidiary in fiscal 1997.

Acquisition of Babbage's Etc.

        On October 28, 1999, the Company acquired Babbage's Etc., one of the
nation's largest operators of video game and entertainment software stores, for
approximately $183 million in cash plus the assumption of $26 million in certain
liabilities. If financial performance targets are met over the next two fiscal
years, Barnes & Noble will make additional payments of approximately $10 million
in 2001 and approximately $10 million in 2002. The acquisition was accounted for
by the purchase method. The excess of purchase price over the net assets
acquired, in the amount of approximately $202 million has been recorded as
goodwill and is being amortized using the straight-line method over an estimated
useful life of 30 years. Babbage's Etc.'s results of operations for the fourth
quarter ended January 29, 2000 are included in the consolidated financial
statements.

Newly Issued Accounting Pronouncements

         In June 1998, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards No. 133, "Accounting for Derivative
Instruments and Hedging Activities" (SFAS 133) which establishes accounting and
reporting standards for derivative instruments and hedging activities. SFAS 133
requires companies to recognize all derivatives contracts as either assets or
liabilities in the balance sheet and to measure them at fair value. The Company
will adopt SFAS 133 as required for its first quarterly filing of fiscal year
2001.

         The Company from time to time enters into interest rate swap agreements
for the purpose of hedging risks attributable to changing interest rates
associated with the Company's revolving credit facility, and, in general, such
hedges have been fully effective. The Company may from time to time, enter into
interest rate swaps in the future and these transactions are expected to
substantially offset the effects of changes in the underlying variable interest
rates. The Company does not believe that adoption of SFAS 133 will have a
material effect on its consolidated financial statements.

         In December 1999, the Securities and Exchange Commission staff released
Staff Accounting Bulletin No. 101, "Revenue Recognition in Financial Statements"
(SAB 101), which provides guidance on the recognition, presentation and
disclosure of revenue in financial statements. SAB 101 did not impact the
Company's revenue recognition policies.

Year 2000

         The Company completed its Year 2000 compliance plan during 1999. The
total costs incurred to implement the plan were approximately $4.3 million. The
conversion to the Year 2000 occurred without any disruptions to the Company's
critical business systems either internally or from outside sources. The Company
has no reason to believe that Year 2000 failures will materially affect it in
the future. However,

                                       19
<PAGE>

since it may take several additional months before it is known whether the
Company or third party vendors, suppliers or service providers may have
encountered Year 2000 problems, no assurances can be given that the Company will
not experience disruptions as a result of Year 2000 compliance failures. The
Company will continue to monitor Year 2000 exposures both internally and with
its vendors, suppliers and service providers. Such monitoring will be ongoing
and encompassed in normal operations. Associated costs are not expected to be
significant.

Disclosure Regarding Forward-Looking Statements

         This report may contain certain forward-looking statements (as such
term is defined in the Private Securities Litigation Reform Act of 1995) and
information relating to the Company that are based on the beliefs of the
management of the Company as well as assumptions made by and information
currently available to the management of the Company. When used in this report,
the words "anticipate," "believe," "estimate," "expect," "intend," "plan" and
similar expressions, as they relate to the Company or the management of the
Company, identify forward-looking statements. Such statements reflect the
current views of the Company with respect to future events, the outcome of which
is subject to certain risks, including among others general economic and market
conditions, decreased consumer demand for the Company's products, possible
disruptions in the Company's computer or telephone systems, increased or
unanticipated costs or effects associated with Year 2000 compliance by the
Company or its service or supply providers, possible work stoppages or increases
in labor costs, possible increases in shipping rates or interruptions in
shipping service, effects of competition, possible disruptions or delays in the
opening of new stores or the inability to obtain suitable sites for new stores,
higher than anticipated store closing or relocation costs, higher interest
rates, the performance of the Company's online initiatives such as Barnes &
Noble.com, unanticipated increases in merchandise or occupancy costs,
unanticipated adverse litigation results or effects, and other factors which may
be outside of the Company's control. In addition, the video game market has
historically been cyclical in nature and dependent upon the introduction of new
generation systems and related interactive software. Should one or more of these
risks or uncertainties materialize, or should underlying assumptions prove
incorrect, actual results or outcomes may vary materially from those described
as anticipated, believed, estimated, expected, intended or planned. Subsequent
written and oral forward-looking statements attributable to the Company or
persons acting on its behalf are expressly qualified in their entirety by the
cautionary statements in this paragraph.

                                       20
<PAGE>

CONSOLIDATED STATEMENTS OF OPERATIONS

<TABLE>
<CAPTION>
Fiscal Year                                                                           1999            1998            1997
                                                                                      ----            ----            ----
(Thousands of dollars, except per share data)
---------------------------------------------
<S>                                                                                  <C>               <C>            <C>
Sales                                                                                $3,486,043        3,005,608      2,796,852
Cost of sales and occupancy                                                           2,483,729        2,142,717      2,019,291
                                                                                      ---------        ---------      ---------
   Gross profit                                                                       1,002,314          862,891        777,561
                                                                                      ---------          -------        -------
Selling and administrative expenses                                                     651,099          580,609        542,336
Depreciation and amortization                                                           112,304           88,345         76,951
Pre-opening expenses                                                                      6,801            8,795         12,918
                                                                                      ---------        ---------      ---------
   Operating profit                                                                     232,110          185,142        145,356
Interest (net of interest income of $1,449, $976 and $446, respectively) and
   amortization of deferred financing fees                                              (23,765)         (24,412)       (37,666)
Equity in net loss of Barnes & Noble.com                                                (42,047)         (71,334)            --
Gain on formation of Barnes & Noble.com                                                  25,000           63,759             --
Other income                                                                             27,337            3,414          1,913
                                                                                      ---------        ---------      ---------
   Earnings before provision for income taxes, extraordinary charge and
     cumulative effect of a change in accounting principle                              218,635          156,569        109,603
Provision for income taxes                                                               89,637           64,193         44,935
                                                                                      ---------        ---------      ---------

   Earnings before  extraordinary charge and cumulative effect of a change in
     accounting principle                                                               128,998           92,376         64,668
Extraordinary charge due to early extinguishment of debt, net of tax
   benefits of $7,991                                                                        --               --        (11,499)
Cumulative effect of a change in accounting principle, net of tax benefits
   of $3,125                                                                             (4,500)              --             --
                                                                                      ---------        ---------      ---------

   Net earnings                                                                        $124,498           92,376         53,169
                                                                                      =========        =========      =========
Earnings per common share
   Basic
     Earnings before extraordinary charge and cumulative effect of a change
       in accounting principle                                                          $  1.87             1.35           0.96
     Extraordinary charge due to early extinguishment of debt, net of  tax
       benefits                                                                         $    --               --          (0.17)
     Cumulative effect of a change in accounting principle, net of tax
       benefits                                                                         $ (0.07)              --             --
     Net earnings                                                                       $  1.80             1.35           0.79
   Diluted
     Earnings before extraordinary charge and cumulative effect of a change
       in accounting principle                                                          $  1.81             1.29           0.93
     Extraordinary charge due to early extinguishment of debt, net of tax
       benefits                                                                         $    --               --          (0.17)
     Cumulative effect of a change in accounting principle, net of tax
       benefits                                                                         $ (0.06)              --             --
     Net earnings                                                                       $  1.75             1.29           0.76

Weighted average common shares outstanding
   Basic                                                                             69,005,000       68,435,000     67,237,000
   Diluted                                                                           71,354,000       71,677,000     69,836,000
</TABLE>

See accompanying notes to consolidated financial statements.

                                       21
<PAGE>

CONSOLIDATED BALANCE SHEETS

<TABLE>
<CAPTION>
(Thousands of dollars, except per share data)                                January 29, 2000      January 30, 1999
---------------------------------------------                                ----------------      ----------------
<S>                                                                          <C>                   <C>
Assets
Current assets:
   Cash and cash equivalents                                                       $   24,247                31,081
   Receivables, net                                                                    58,240                57,523
   Merchandise inventories                                                          1,102,453               945,073
   Prepaid expenses and other current assets                                           56,579                54,634
                                                                                   ----------             ---------
     Total current assets                                                           1,241,519             1,088,311
                                                                                   ----------             ---------
Property and equipment:
   Land and land improvements                                                           3,247                 3,197
   Buildings and leasehold improvements                                               417,535               383,292
   Fixtures and equipment                                                             565,345               440,488
                                                                                   ----------             ---------
                                                                                      986,127               826,977
   Less accumulated depreciation and amortization                                     418,078               316,631
                                                                                   ----------             ---------
     Net property and equipment                                                       568,049               510,346
                                                                                   ----------             ---------
Intangible assets, net                                                                298,011                86,980

Investment in Barnes & Noble.com                                                      240,531                82,307

Other noncurrent assets                                                                65,681                39,653
                                                                                   ----------             ---------

     Total assets                                                                  $2,413,791             1,807,597
                                                                                   ==========             =========
Liabilities and Shareholders' Equity
Current liabilities:
   Accounts payable                                                                $  599,376               498,237
   Accrued liabilities                                                                323,475               274,085
                                                                                   ----------             ---------
     Total current liabilities                                                        922,851               772,322
                                                                                   ----------             ---------
Long-term debt                                                                        431,600               249,100

Deferred income taxes                                                                 125,006                32,449

Other long-term liabilities                                                            87,974                74,937

Shareholders' equity:
   Common stock; $.001 par value; 300,000,000 shares authorized;
     69,553,839 and 68,759,111 shares issued, respectively                                 70                    69
   Additional paid-in capital                                                         654,584               523,517
   Accumulated other comprehensive loss                                               (1,198)                    --
   Retained earnings                                                                  279,701               155,203
   Treasury stock, at cost, 4,025,900 shares at January 29, 2000                     (86,797)                    --
                                                                                   ----------             ---------
     Total shareholders' equity                                                       846,360               678,789
                                                                                   ----------             ---------
Commitments and contingencies                                                              --                    --
                                                                                   ----------             ---------

     Total liabilities and shareholders' equity                                    $2,413,791             1,807,597
                                                                                   ==========             =========
</TABLE>

See accompanying notes to consolidated financial statements.

                                       22
<PAGE>

CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY

<TABLE>
<CAPTION>
                                                                                Accumulated
                                                              Additional              Other                Treasury
                                                   Common        Paid-in      Comprehensive    Retained    Stock at
(Thousands of dollars)                              Stock        Capital               Loss    Earnings        Cost     Total
----------------------                             ------     ----------    ---------------   ---------    --------    -----
<S>                                            <C>             <C>          <C>               <C>          <C>         <C>
Balance at February 1, 1997                     $    66        446,265           --            9,658            --      455,989

Comprehensive earnings:
   Net earnings                                      --             --           --           53,169            --
Total comprehensive earnings                                                                                             53,169

Exercise of 1,545,580 common stock
   options, including tax benefits of
   $8,253                                             2         22,595           --               --            --       22,597
                                                ---------    ---------    -------------  -----------  ------------ ------------

Balance at January 31, 1998                          68        468,860           --           62,827            --      531,755

Comprehensive earnings:
   Net earnings                                      --             --           --           92,376            --
Total comprehensive earnings                                                                                             92,376

Exercise of 837,281 common stock
   options, including tax benefits of
   $9,002                                             1         18,306           --               --            --       18,307
Barnes & Noble.com issuance of
   membership units (net of deferred
   income taxes of $26,325)                          --         36,351           --               --            --       36,351
                                                -------      ---------    -------------  ------------ ------------ ------------
Balance at January 30, 1999                          69        523,517           --          155,203            --      678,789

Comprehensive earnings:
   Net earnings                                      --             --           --          124,498            --
   Other comprehensive loss (net of
      deferred income taxes of $839)                 --             --           (1,198)          --            --
Total comprehensive earnings                                                                                            123,300

Exercise of 794,728 common stock
   options, including tax benefits of
   $6,302                                             1         14,909           --               --            --       14,910
Barnes & Noble.com Inc. IPO (net of
   deferred income taxes of $84,114)                 --        116,158           --               --            --      116,158
Treasury stock acquired, 4,025,900 shares            --             --           --               --       (86,797)     (86,797)
                                                -------      ---------    -------------   ----------      --------     --------

Balance at January 29, 2000                     $    70        654,584           (1,198)     279,701       (86,797)     846,360
                                                =======        =======    =============      =======      ========      =======
</TABLE>

See accompanying notes to consolidated financial statements.

                                       23
<PAGE>

CONSOLIDATED STATEMENTS OF CASH FLOWS

<TABLE>
<CAPTION>
Fiscal Year                                                                       1999         1998         1997
                                                                                  ----         ----         ----
(Thousands of dollars)
----------------------
<S>                                                                              <C>          <C>          <C>
Cash flows from operating activities:
   Net earnings                                                                  $ 124,498       92,376       53,169
   Adjustments to reconcile net earnings to net cash flows from
     operating activities:
   Depreciation and amortization                                                   112,693       88,721       78,629
   Loss on disposal of property and equipment                                        5,636        3,291          853
   Deferred taxes                                                                    9,877       14,761       11,598
   Extraordinary charge due to early extinguishment of debt, net of tax
     benefits                                                                           --           --       11,499
   Increase in other long-term liabilities for scheduled rent increases
     in long-term leases                                                            13,472       14,031       16,350
   Cumulative effect of a change in accounting principle, net of taxes               4,500           --           --
   Other income                                                                    (27,337)      (3,414)      (1,913)
   Gain on formation of Barnes & Noble.com                                         (25,000)     (63,759)          --
   Equity in net loss of Barnes & Noble.com                                         42,047       71,334           --
   Changes in operating assets and liabilities, net                                (73,055)     (39,673)      (2,884)
                                                                                 ---------    ---------    ---------
     Net cash flows from operating activities                                      187,331      177,668      167,301
                                                                                 ---------    ---------    ---------

Cash flows from investing activities:
   Acquisition of consolidated subsidiaries, net of cash received                 (175,760)         --           --
   Purchases of property and equipment                                            (146,294)    (141,378)    (121,903)
   Investment in Barnes & Noble.com                                                     --      (75,394)          --
   Proceeds from formation of Barnes & Noble.com                                    25,000       75,000           --
   Proceeds from the partial sale of Chapters                                       21,558           --           --
   Purchase of investment in iUniverse.com                                         (20,000)          --           --
   Net increase in other noncurrent assets                                          (9,282)        (119)     (11,264)
                                                                                 ---------    ---------    ---------
     Net cash flows from investing activities                                     (304,778)    (141,891)    (133,167)
                                                                                 ---------    ---------    ---------
Cash flows from financing activities:
   Net increase (decrease) in revolving credit facility                            182,500      (35,700)     244,800
   Repayment of long-term debt                                                          --           --     (290,000)
   Proceeds from exercise of common stock options including related tax
     benefits                                                                       14,910       18,307       22,597
   Payment of note premium                                                              --           --      (11,281)
   Purchase of treasury stock through repurchase program                           (86,797)          --           --
                                                                                 ---------    ---------    ---------
     Net cash flows from financing activities                                      110,613      (17,393)     (33,884)
                                                                                 ---------    ---------    ---------
Net increase (decrease) in cash and cash equivalents                                (6,834)      18,384          250
Cash and cash equivalents at beginning of year                                      31,081       12,697       12,447
                                                                                 ---------    ---------    ---------

Cash and cash equivalents at end of year                                         $  24,247       31,081       12,697
                                                                                 =========    =========    =========
Changes in operating assets and liabilities, net:
   Receivables, net                                                              $   3,795      (14,012)       1,700
   Merchandise inventories                                                         (69,059)     (93,491)    (119,904)
   Prepaid expenses and other current assets                                        (8,543)      (1,047)       9,721
   Accounts payable and accrued liabilities                                            752       68,877      105,599
                                                                                 ---------    ---------    ---------
     Changes in operating assets and liabilities, net                            $ (73,055)     (39,673)      (2,884)
                                                                                 =========    =========    =========

Supplemental cash flow information:
   Cash paid during the period for:
     Interest                                                                    $  24,911       25,243       37,845
     Income taxes                                                                $  72,342       18,225       20,282

Supplemental disclosure of subsidiaries acquired:
    Assets acquired                                                              $ 201,910
    Liabilities assumed                                                             26,150
                                                                                 ---------
        Cash paid                                                                $ 175,760
                                                                                 =========
</TABLE>

See accompanying notes to consolidated financial statements.

                                       24
<PAGE>

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Thousands of dollars, except per share data)

For the 52 weeks ended January 29, 2000 (fiscal 1999), January 30, 1999 (fiscal
1998) and January 31, 1998 (fiscal 1997).

1.  Summary of Significant Accounting Policies

Business

         Barnes & Noble, Inc. (Barnes & Noble), through its wholly owned
subsidiaries (collectively, the Company), is primarily engaged in the sale of
books, video games and entertainment software products. The Company employs two
principal bookselling strategies: its "super" store strategy through its wholly
owned subsidiary Barnes & Noble Booksellers, Inc., under its Barnes & Noble
Booksellers, Bookstop and Bookstar trade names (hereafter collectively referred
to as Barnes & Noble stores) and its mall strategy through its wholly owned
subsidiaries B. Dalton Bookseller, Inc. and Doubleday Book Shops, Inc., under
its B. Dalton stores, Doubleday Book Shops and Scribner's Bookstore trade names
(hereafter collectively referred to as B. Dalton stores). The Company is also
engaged in the online retailing of books and other products through a 40 percent
interest in barnesandnoble.com llc (Barnes & Noble.com), as more fully described
in Note 7. The Company, through its recent acquisition of Babbage's Etc. LLC,
operates video game and entertainment software stores under the Babbage's,
Software Etc. and GameStop trade names, and a Web site, gamestop.com (hereafter
collectively referred to as Babbage's Etc.).

Consolidation

        The consolidated financial statements include the accounts of Barnes &
Noble and its wholly owned subsidiaries. Investments in affiliates in which
ownership interests range from 20 percent to 50 percent, principally Barnes &
Noble.com, are accounted for under the equity method. The Company's investment
in Barnes & Noble.com has been presented in the accompanying consolidated
financial statements under the equity method as of the beginning of fiscal 1998
and as a consolidated wholly owned subsidiary for all of fiscal 1997. All
significant intercompany accounts and transactions have been eliminated in
consolidation.

Use of Estimates

         In preparing financial statements in conformity with generally accepted
accounting principles, the Company is required to make estimates and assumptions
that affect the reported amounts of assets and liabilities and the disclosure of
contingent assets and liabilities at the date of the financial statements and
revenues and expenses during the reporting period. Actual results could differ
from those estimates.

Cash and Cash Equivalents

        The Company considers all short-term, highly liquid instruments
purchased with an original maturity of three months or less to be cash
equivalents.

                                       25
<PAGE>

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS CONTINUED

Merchandise Inventories

         Merchandise inventories are stated at the lower of cost or market. Cost
is determined primarily by the retail inventory method on the first-in,
first-out (FIFO) basis for 83 percent and 86 percent of the Company's
merchandise inventories as of January 29, 2000 and January 30, 1999,
respectively. Merchandise inventories of Babbage's Etc., which represent 6
percent of merchandise inventories as of January 29, 2000, are recorded based on
the average cost method. The remaining merchandise inventories are valued on the
last-in, first-out (LIFO) method.

         If substantially all of the merchandise inventories currently valued at
LIFO costs were valued at current costs, merchandise inventories would remain
unchanged as of January 29, 2000 and January 30, 1999.

Property and Equipment

         Property and equipment are carried at cost, less accumulated
depreciation and amortization. For financial reporting purposes, depreciation is
computed using the straight-line method over estimated useful lives. For tax
purposes, different methods are used. Maintenance and repairs are expensed as
incurred, while betterments and major remodeling costs are capitalized.
Leasehold improvements are capitalized and amortized over the shorter of their
estimated useful lives or the terms of the respective leases. Capitalized lease
acquisition costs are being amortized over the lease terms of the underlying
leases. Costs incurred in purchasing management information systems are
capitalized and included in property and equipment. These costs are amortized
over their estimated useful lives from the date the systems become operational.

Intangible Assets and Amortization

        The costs in excess of net assets of businesses acquired are carried as
intangible assets, net of accumulated amortization, in the accompanying
consolidated balance sheets. The net intangible assets, consisting primarily of
goodwill and trade names of $272,505 and $25,506 as of January 29, 2000 and
$59,365 and $27,615 as of January 30, 1999, are amortized using the
straight-line method over periods ranging from 30 to 40 years.

        Amortization of goodwill and trade names included in depreciation and
amortization in the accompanying consolidated statements of operations is
$5,148, $3,257 and $3,257 during fiscal 1999, 1998 and 1997, respectively.
Accumulated amortization at January 29, 2000 and January 30, 1999 was $49,699
and $44,551, respectively.

        The Company periodically evaluates the recoverability of goodwill and
considers whether this goodwill should be completely or partially written off or
the amortization periods accelerated. The Company assesses the recoverability of
this goodwill based upon several factors, including management's intention with
respect to the acquired operations and those operations' projected undiscounted
store-level cash flows.

Deferred Charges

         Costs incurred to obtain long-term financing are amortized over the
terms of the respective debt agreements using the straight-line method, which
approximates the interest method. Unamortized costs

                                       26
<PAGE>

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS CONTINUED

included in other noncurrent assets as of January 29, 2000 and January 30, 1999
were $1,969 and $1,397, respectively. Unamortized costs of $8,209 were included
in the extraordinary loss due to the early extinguishment of debt for fiscal
1997. Amortization expense included in interest and amortization of deferred
financing fees is $389, $376 and $1,678 during fiscal 1999, 1998 and 1997,
respectively.

Marketable Equity Securities

         All marketable equity securities included in other noncurrent assets
are classified as available-for-sale under FASB Statement No. 115, with
unrealized gains and losses (net of taxes) shown as a component of shareholders'
equity.

Revenue Recognition

        Revenue from sales of the Company's products is recognized at the time
of sale.

        The Company sells memberships which entitle purchasers to additional
discounts. The membership revenue is deferred and recognized as income over the
12-month membership period.

        Sales returns (which are not significant) are recognized at the time
returns are made.

Pre-opening Expenses

         In April 1998, the Accounting Standards Executive Committee issued
Statement of Position 98-5, "Reporting on the Costs of Start-Up Activities" (SOP
98-5). SOP 98-5 requires an entity to expense all start-up activities, as
defined, when incurred. Prior to 1999, the Company amortized costs associated
with the opening of new stores over the respective store's first 12 months of
operations. In accordance with SOP 98-5, the Company recorded a one-time
non-cash charge reflecting the cumulative effect of a change in accounting
principle in the amount of $4,500 after taxes, representing such start-up costs
capitalized as of the beginning of fiscal year 1999. Since adoption, the Company
has expensed all such start-up costs as incurred. The effect of the change in
accounting principle on earnings in 1999 was immaterial.

Closed Store Expenses

        Upon a formal decision to close or relocate a store, the Company charges
unrecoverable costs to expense. Such costs include the net book value of
abandoned fixtures and leasehold improvements and a provision for future lease
obligations, net of expected sublease recoveries. Costs associated with store
closings of $5,447 and $1,208 during fiscal 1999 and fiscal 1998, respectively,
are included in selling and administrative expenses in the accompanying
consolidated statements of operations.

Net Earnings Per Common Share

        Basic earnings per share is computed by dividing income available to
common shareholders by the weighted-average number of common shares outstanding.
Diluted earnings per share reflect, in periods in which they have a dilutive
effect, the impact of common shares issuable upon exercise of stock options.

                                       27
<PAGE>

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS CONTINUED

Income Taxes

        The provision for income taxes includes federal, state and local income
taxes currently payable and those deferred because of temporary differences
between the financial statement and tax bases of assets and liabilities. The
deferred tax assets and liabilities are measured using the enacted tax rates and
laws that are expected to be in effect when the differences reverse.

Stock Options

        The Company accounts for all transactions under which employees receive
shares of stock or other equity instruments in the Company or the Company incurs
liabilities to employees in amounts based on the price of its stock in
accordance with the provisions of Accounting Principles Board Opinion No. 25,
"Accounting for Stock Issued to Employees."

Reclassifications

        Certain prior-period amounts have been reclassified for comparative
purposes to conform with the 1999 presentation.

Reporting Period

        The Company's fiscal year is comprised of 52 or 53 weeks, ending on the
Saturday closest to the last day of January. The reporting periods ended January
29, 2000, January 30, 1999 and January 31, 1998 each consisted of 52 weeks.

2.  Receivables, Net

        Receivables represent customer, bankcard, landlord and other receivables
due within one year as follows:

                                                  January 29,      January 30,
                                                     2000             1999
                                                  -----------      -----------
Trade accounts                                      $9,558            6,743
Bankcard receivables                                21,309           19,421
Receivables from landlords for
  leasehold improvements                            12,807           23,659
Other receivables                                   14,566            7,700
                                                   -------           ------
Total receivables, net                             $58,240           57,523
                                                   =======           ======

3.  Debt

        On November 18, 1997, the Company obtained an $850,000 five-year senior
revolving credit facility (the Revolving Credit Facility) with a syndicate led
by The Chase Manhattan Bank. The Revolving Credit Facility refinanced an
existing $450,000 revolving credit and $100,000 term loan facility (the Old
Facility). The Revolving Credit Facility permits borrowings at various interest
rate

                                       28
<PAGE>

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS CONTINUED

options based on the prime rate or London Interbank Offer Rate (LIBOR)
depending upon certain financial tests. In addition, the agreement requires the
Company to pay a commitment fee up to 0.25 percent of the unused portion
depending upon certain financial tests. The Revolving Credit Facility contains
covenants, limitations and events of default typical of credit facilities of
this size and nature, including financial covenants which require the Company to
meet, among other things, cash flow and interest coverage ratios and which limit
capital expenditures. The Revolving Credit Facility is secured by the capital
stock, accounts receivable and general intangibles of the Company's
subsidiaries.

        Net proceeds from the Revolving Credit Facility are available for
general corporate purposes and were used to redeem all of the Company's
outstanding $190,000 11-7/8 percent senior subordinated notes on January 15,
1998. As a result of the refinancings, the Company recorded an extraordinary
charge of $11,499 (net of applicable taxes) due to the early extinguishment of
debt during fiscal 1997. The extraordinary charge represents the payment of a
call premium associated with the redemption of the senior subordinated notes of
$6,656 (net of applicable taxes) and the write-off of unamortized fees of $4,843
(net of applicable taxes).

        The Company from time to time enters into interest rate swap agreements
to manage interest costs and risk associated with changes in interest rates.
These agreements effectively convert underlying variable-rate debt based on
prime rate or LIBOR to fixed-rate debt through the exchange of fixed and
floating interest payment obligations without the exchange of underlying
principal amounts. As of January 29, 2000 and January 30, 1999 the Company had
outstanding $85,000 and $125,000 of swaps, respectively, with maturities ranging
from 2000 to 2003. The Company recorded interest expense associated with these
agreements of $470 and $440 during fiscal years 1999 and 1998, respectively.

         Selected information related to the Company's revolving credit facility
is as follows:

Fiscal Year                                         1999      1998       1997
-----------                                       --------   -------   -------

Balance at end of year                            $431,600   249,100   284,800
Average balance outstanding during the year       $397,114   380,315   105,127
Maximum borrowings outstanding during the year    $693,500   535,000   304,900
Weighted average interest rate during the year       6.01%     6.29%     7.12%
Interest rate at end of year                         6.26%     5.77%     6.60%

        Fees expensed with respect to the unused portion of the Company's
revolving credit commitment were $664, $733 and $1,204, during fiscal 1999, 1998
and 1997, respectively.

         The amounts outstanding under the Company's Revolving Credit Facility
of $431,600 and $249,100 as of January 29, 2000 and January 30, 1999,
respectively, have been classified as long-term debt based on the terms of the
credit agreement and the Company's intention to maintain principal amounts
outstanding through November 2002.

        The Company has no agreements to maintain compensating balances.

4.  Fair Values of Financial Instruments

         The carrying values of cash and cash equivalents reported in the
accompanying consolidated balance sheets approximate fair value due to the
short-term maturities of these assets. The aggregate fair

                                       29
<PAGE>

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS CONTINUED

value of the Revolving Credit Facility approximates its carrying amount, because
of its recent and frequent repricing based upon market conditions. Investments
in publicly traded securities accounted for under Statement of Financial
Accounting Standards No. 115, "Accounting for Certain Investments in Debt and
Equity Securities" (SFAS 115) are carried at amounts approximating fair value.

         The Company maintains an investment in Chapters Inc. (Chapters), a
Canadian book retailer. The carrying value and fair value (based on quoted
market prices and conversion rates) of this investment was $18,827 and $33,201,
respectively, at January 30, 1999. Due to the partial sale of its investment in
Chapters, as more fully discussed in Note 5, the Company currently accounts for
this investment as an available-for-sale security.

         Interest rate swap agreements are valued based on market quotes
obtained from dealers. The carrying value and estimated fair value of the
interest rate swaps asset (liability) was $0 and $447, respectively, at January
29, 2000, and $0 and ($2,189), respectively, at January 30, 1999.

5.  Marketable Equity Securities

         Marketable equity securities are carried on the balance sheet at their
fair market value as a component of other noncurrent assets. The Company did not
have any marketable equity securities on January 30, 1999 as defined by SFAS
115. The following marketable equity securities have been classified as
available-for-sale securities:

<TABLE>
<CAPTION>
                                                     Unrealized       January 29, 2000
                                           Cost        Losses           Market Value
                                       ----------    -------------    ----------------
<S>                                    <C>           <C>              <C>
        Gemstar International Ltd.       $27,137         $(1,684)             $25,453
        Chapters                           8,294            (353)               7,941
                                       ----------    -------------      --------------

                                         $35,431         $(2,037)             $33,394
                                       ==========    =============      ==============
</TABLE>

         In fiscal 1998, the Company accounted for its investment in NuvoMedia
Inc. (NuvoMedia) under the cost method. In fiscal 1999, NuvoMedia was acquired
by Gemstar International Ltd. (Gemstar), a publicly traded company. Under the
terms of the agreement, NuvoMedia shareholders received Gemstar shares in
exchange for their ownership interests.

         Prior to fiscal 1999, the Company accounted for its investment in
Chapters under the equity method. During fiscal 1999, the Company sold a portion
of its investment in Chapters. Subsequent to the partial sale of its investment,
the Company retained a seven percent interest in Chapters and accordingly, has
recorded the remaining investment as an available-for-sale security.

                                       30
<PAGE>

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS CONTINUED

6. Other Income

     The following table sets forth the components of other income (expense), in
thousands of dollars:

<TABLE>
<CAPTION>
          Fiscal Year                                         1999          1998         1997
                                                        -----------    ----------    ---------

<S>                                                     <C>            <C>           <C>
          Gain on sale of NuvoMedia (1)                    $22,356            --           --
          Gain on partial sale of Chapters (2)              10,975            --           --
          Equity in net earnings (losses) of
               Chapters (2)                                   (101)        1,140        1,016
          Equity in net losses of iUniverse.com (3)         (2,121)           --           --
          Equity in net earnings of Calendar Club
               LLC (4)                                       1,228        2,274           897
          Termination of planned acquisition of
               Ingram Book Group (5)                        (5,000)           --           --
                                                        -----------    ----------    ---------

                                                           $27,337         3,414        1,913
                                                        ===========    ==========    =========
</TABLE>

(1)           In fiscal 1999, in connection with the sale of NuvoMedia as more
              fully discussed in Note 5, the Company recognized a pre-tax gain
              of $22,356.

(2)           During fiscal 1999, the Company sold a portion of its investment
              in Chapters resulting in a pre-tax gain of $10,975. Prior to this
              transaction, the Company accounted for its investment in Chapters
              under the equity method.

(3)           During 1999, the Company acquired a 41 percent interest in
              iUniverse.com for $20,000. Subsequent to the fiscal 1999 year end,
              the Company invested an additional $8,000 in iUniverse.com thereby
              increasing its percentage ownership interest to 49 percent. This
              investment is being accounted for under the equity method and is
              reflected as a component of other noncurrent assets.

(4)           The Company's 50 percent interest in Calendar Club LLC (Calendar
              Club) is being accounted for under the equity method and is
              reflected as a component of other noncurrent assets.

(5)           In 1999, the Company and the Ingram Book Group (Ingram) announced
              their agreement to terminate the Company's planned acquisition of
              Ingram. The Company's application before the Federal Trade
              Commission for the purchase was formally withdrawn. As a result,
              other income reflects a one-time charge of $5,000 for acquisition
              costs relating primarily to legal, accounting and other
              transaction related costs.

7.  Barnes & Noble.com

         On November 12, 1998, the Company and Bertelsmann AG (Bertelsmann)
completed the formation of a limited liability company to operate the online
retail bookselling operations of the Company's wholly owned subsidiary,
barnesandnoble.com inc. (Barnes & Noble.com Inc.). The new entity, Barnes &
Noble.com, was structured as a limited liability company. Under the terms of the
relevant agreements, effective as of October 31, 1998, the Company and
Bertelsmann each retained a 50 percent membership interest in Barnes &
Noble.com. The Company contributed substantially all of the assets and
liabilities of its online operations to the joint venture and Bertelsmann paid
$75,000 to the Company and made a $150,000 cash contribution to the joint
venture. Bertelsmann also agreed to contribute an additional $50,000 to the
joint venture for future working capital requirements. The Company recognized a
pre-tax gain during fiscal 1998 in the amount of $126,435, of which $63,759 was

                                       31
<PAGE>

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS CONTINUED

recognized in earnings based on the $75,000 received directly and $62,676
($36,351 after taxes) was reflected in additional paid-in capital based on the
Company's share of the incremental equity of the joint venture resulting from
the $150,000 Bertelsmann contribution.

         On May 25, 1999, Barnes & Noble.com Inc. completed an initial public
offering (IPO) of 28.75 million shares of Class A Common Stock and used the
proceeds to purchase a 20 percent interest in Barnes & Noble.com. As a result,
the Company and Bertelsmann each retained a 40 percent interest in Barnes &
Noble.com. The Company recorded an increase in additional paid-in capital of
$116,158 after taxes representing the Company's incremental share in the equity
of Barnes & Noble.com. The Company will continue to account for its investment
under the equity method.

        Under the terms of the November 12, 1998 joint venture agreement between
the Company and Bertelsmann, the Company received a $25,000 payment from
Bertelsmann in connection with the IPO. The Company recognized the $25,000
pre-tax gain in the second quarter of 1999. The estimated fair market value of
Barnes & Noble.com at January 29, 2000 was $742,000.

         Summarized financial information for Barnes & Noble.com follows:

                                              12 months ended
                                                December 31,
                                         -------------------------
                                            1999            1998
                                         ---------       ----------

Net sales                               $  202,567          61,834
Gross profit                            $   42,630          14,265
Loss before taxes                       $ (102,405)        (83,148)

Cash and cash equivalents               $  478,047          96,940
Other current assets                        27,567          14,736
Noncurrent assets                          173,904          90,468
Current liabilities                         75,940          32,995
                                        ----------       ---------
Net assets                              $  603,578         169,149
                                        ==========       =========

8.  Employees' Retirement and Defined Contribution Plans

        As of December 31, 1999, substantially all employees of the Company were
covered under a noncontributory defined benefit pension plan (the Pension Plan).
As of January 1, 2000, the Pension Plan was amended and frozen so that employees
no longer earn benefits for subsequent service. Subsequent service continues to
be the basis for vesting of benefits not yet vested at December 31, 1999 and the
Pension Plan will continue to hold assets and pay benefits. The amendment was
treated as a curtailment in fiscal 1999 resulting in a pre-tax gain of $14,142
which is included as a reduction of selling and administrative expenses.

        The Company maintains defined contribution plans (the Savings Plans) for
the benefit of substantially all employees. In addition, the Company provides
certain health care and life insurance benefits (the Postretirement Plan) to
retired employees, limited to those receiving benefits or retired as of April 1,
1993.

                                       32
<PAGE>

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS CONTINUED

         A summary of the components of net periodic cost for the Pension Plan
and the Postretirement Plan follows:

<TABLE>
<CAPTION>
                                                     Pension Plan                    Postretirement Plan
                                           ---------------------------------- ----------------------------------
Fiscal Year                                   1999        1998        1997        1999        1998       1997
-----------                                ---------- ----------- ----------- ----------- ----------- ----------
<S>                                        <C>        <C>         <C>         <C>         <C>          <C>
Service cost                                  $4,535       4,157       3,294          --          --         --
Interest cost                                  2,349       2,039       1,666         151         149        315
Expected return on plan assets                (2,494)     (2,208)     (1,803)         --          --         --
Net amortization and deferral                     32          36          36        (123)       (135)        --
                                           ---------  ----------  ----------       -----       -----      -----
   Net periodic cost                          $4,422       4,024       3,193          28          14        315
                                           =========  ==========  ==========       =====       =====      =====
</TABLE>

         Total Company contributions charged to employee benefit expenses for
the Savings Plans were $3,374, $3,090 and $2,545 during fiscal 1999, 1998 and
1997, respectively.

         Weighted-average actuarial assumptions used in determining the net
periodic costs of the Pension Plan and the Postretirement Plan are as follows:

<TABLE>
<CAPTION>
                                                     Pension Plan                    Postretirement Plan
                                           ---------------------------------- ----------------------------------
Fiscal Year                                   1999        1998        1997        1999        1998       1997
-----------                                ---------- ----------- ----------- ----------- ----------- ----------
<S>                                        <C>        <C>         <C>         <C>         <C>         <C>
Discount rate                                 7.8%        7.3%       7.3%           7.8%       7.3%       7.3%
Expected return on plan assets                9.5%        9.5%       9.5%             --         --         --
Assumed rate of compensation
    increase                                  4.8%        4.3%       4.3%             --         --         --
</TABLE>

         As a result of the formation of Barnes & Noble.com, as more fully
described in Note 7, certain assets of the Pension Plan and a portion of the
benefit obligation, were transferred to Barnes & Noble.com's defined benefit
pension plan as of the date of the formation.

                                       33
<PAGE>

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS CONTINUED

        The following table provides a reconciliation of benefit obligations,
plan assets and funded status of the Pension Plan and the Postretirement Plan:

<TABLE>
<CAPTION>
                                                      Pension Plan                        Postretirement Plan
                                           -----------------------------------    -----------------------------------
Fiscal Year                                      1999              1998                 1999              1998
-----------                                ----------------- -----------------    ----------------- -----------------
<S>                                        <C>               <C>                  <C>               <C>
Change in benefit obligation:
Benefit obligation at beginning of
    year                                            $33,064            30,734                2,145             1,975
Service cost                                          4,535             4,157                   --                --
Interest cost                                         2,349             2,039                  151               149
Transfer to Barnes & Noble.com                           --              (642)                  --                --
Actuarial (gain) loss                                (1,707)           (2,427)                 272               136
Benefits paid                                        (1,062)             (797)                (515)             (115)
Curtailment                                         (14,142)               --                   --                --
                                                   --------           -------              -------           -------
Benefit obligation at end of year                   $23,037            33,064                2,053             2,145
                                                   --------           -------              -------           -------

Change in plan assets:
Fair value of plan assets at
    beginning of year                               $25,331            22,909                   --                --
Actual return on assets                               1,393             2,255                   --                --
Employer contributions                                3,374             1,395                   --                --
Benefits paid                                        (1,062)             (797)                  --                --
Transfer to Barnes & Noble.com                           --              (431)                  --                --
                                                   --------           -------              -------           -------
Fair value of plan assets at end of
    year                                            $29,036            25,331                   --                --
                                                   --------           -------              -------           -------

Funded status                                        $5,999            (7,733)              (2,053)           (2,145)
Unrecognized net actuarial (gain)
    loss                                                200               805               (1,741)           (2,136)
Unrecognized prior service cost                          --              (183)                  --                --
Unrecognized net obligation
    remaining                                            --               166                   --                --
                                                   --------           -------              -------           -------
Prepaid (accrued) benefit cost                       $6,199            (6,945)              (3,794)           (4,281)
                                                   ========           =======              =======           =======
</TABLE>

         The health care cost trend rate used to measure the expected cost of
the Postretirement Plan benefits is assumed to be seven percent in 2000,
declining at one-half percent decrements each year through 2004 to five percent
in 2004 and each year thereafter. The health care cost trend assumption has a
significant effect on the amounts reported. For example, a one percent increase
or decrease in the health care cost trend rate would change the accumulated
postretirement benefit obligation by approximately $193 and $171, respectively,
as of January 29, 2000, and would change the net periodic cost by approximately
$15 and $13, respectively, during fiscal 1999.

                                       34
<PAGE>

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS CONTINUED

9.  Income Taxes

        The Company files a consolidated federal return. Federal and state
income tax provisions for fiscal 1999, 1998 and 1997 are as follows:

Fiscal Year                   1999              1998              1997
-----------                  -------           ------            ------

Current:
   Federal                   $64,454           39,286            26,324
   State                      15,306           10,146             7,013
                             -------           ------            ------

                              79,760           49,432            33,337
                             -------           ------            ------

Deferred:
   Federal                     7,193           11,697             9,575
   State                       2,684            3,064             2,023
                             -------           ------            ------

                               9,877           14,761            11,598
                             -------           ------            ------

   Total                     $89,637           64,193            44,935
                             =======           ======            ======

         A reconciliation between the provision for income taxes and the
expected provision for income taxes at the federal statutory rate of 35 percent
during fiscal 1999, 1998 and 1997, is as follows:

<TABLE>
<CAPTION>
Fiscal Year                                                 1999         1998          1997
-----------                                                ------       ------        ------
<S>                                                       <C>           <C>           <C>
Expected  provision  for income taxes at federal
  statutory rate                                          $76,522       54,799        38,361
Amortization  of  non-deductible   goodwill  and
  trade names                                               1,342        1,251         1,140
State income  taxes,  net of federal  income tax
  benefit                                                  11,694        8,596         5,873
Other, net                                                     79         (453)         (439)
                                                          -------       ------        ------

Provision for income taxes                                $89,637       64,193        44,935
                                                          =======       ======        ======
</TABLE>

                                       35
<PAGE>

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS CONTINUED

        The tax effects of temporary differences that give rise to significant
components of the Company's deferred tax assets and liabilities as of January
29, 2000 and January 30, 1999 are as follows:

                                              January 29,     January 30,
                                                 2000            1999
                                              -----------     -----------

Deferred tax liabilities:
   Operating expenses                          $(15,437)         (12,528)
   Depreciation                                 (31,289)         (29,829)
   Gain on equity  increase  in Barnes &
     Noble.com                                 (110,439)         (26,325)
                                              ---------        ---------

     Total deferred tax liabilities            (157,165)         (68,682)
                                              ---------        ---------
Deferred tax assets:
   Inventory                                      4,312            4,043
   Lease transactions                            18,664           15,025
   Reversal of estimated accruals                 4,246            5,692
   Restructuring charge                          14,537           16,931
   Insurance liability                            2,673            2,502
   Deferred income                                4,015           11,411
   Unrealized holding losses on
        available-for-sale securities               839               --
   Other                                          7,278            5,632
                                              ---------        ---------

     Total deferred tax assets                   56,564           61,236
                                              ---------        ---------

       Net deferred tax liabilities           $(100,601)          (7,446)
                                              =========        =========

         Deferred tax liabilities are recorded on the deferred income tax line
and deferred tax assets are recorded as a component of prepaid and other current
assets on the accompanying balance sheet.

10. Acquisition of Babbage's Etc.

         On October 28, 1999, the Company acquired Babbage's Etc., one of the
nation's largest operators of video game and entertainment software stores, for
$208,670 (including assumed liabilities). If financial performance targets are
met over the next two fiscal years, the Company will make additional payments of
approximately $10,000 in 2001 and approximately $10,000 in 2002. The acquisition
was accounted for under the purchase method of accounting and, accordingly, the
results of operations for the period subsequent to the acquisition are included
in the consolidated financial statements. The excess of purchase price over the
net assets acquired, in the amount of $202,386, has been recorded as goodwill
and is being amortized using the straight-line method over an estimated useful
life of 30 years.

                                       36
<PAGE>

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS CONTINUED

         The following table summarizes pro forma results as if the Company had
entered into the agreement on the first day of fiscal year 1998:

Fiscal Year                                          1999           1998
-----------------------------------------------  -------------- --------------

Sales                                              $3,815,435      3,470,774

Earnings before cumulative effect of a change
     in accounting principle                         $125,011         93,298

Net earnings                                         $120,511         93,298

Net earnings per common share:
     Basic                                              $1.75           1.36
     Diluted                                            $1.69           1.30

         The pro forma results of operations include adjustments to give effect
to amortization of goodwill and interest expense on debt related to the
acquisition, together with related income tax effects. The information has been
prepared for comparative purposes only and does not purport to be indicative of
the results of operations which actually would have resulted had the acquisition
occurred on the date indicated, or which may result in the future.

11. Segment Information

         Historically, the Company operated as a single segment. As a result of
the acquisition of Babbage's Etc. in 1999, the Company is currently operating
under two segments and accordingly, is required to disclose information in
accordance with Statement of Financial Accounting Standards No. 131,
"Disclosures about Segments of an Enterprise and Related Information" (SFAS
131). The Company's reportable segments are strategic groups that offer
different products. These groups have been aggregated into two segments:
bookstores and video game and entertainment software stores.

         Bookstores

         This segment includes 542 book "super" stores under the Barnes & Noble
Booksellers, Bookstop and Bookstar names which generally offer a comprehensive
title base, a cafe, a children's section, a music department, a magazine section
and a calendar of ongoing events, including author appearances and children's
activities. Additionally, this segment includes 400 small format mall-based
stores under the B. Dalton Bookseller, Doubleday Book Shops and Scribner's
Bookstore trade names.

         Video Game and Entertainment Software Stores

         This segment includes 526 video game and entertainment software stores
under the Babbage's, Software Etc. and GameStop names, and a Web site,
gamestop.com. The principal products of these stores are comprised of video game
hardware and software and PC entertainment software. The Company's consolidated
financial statements reflect the results of Babbage's Etc. for the fourth
quarter of 1999 only.

         The accounting policies of the segments are the same as those described
in the summary of significant accounting policies. Segment operating profit
includes corporate expenses in each operating segment. Barnes & Noble evaluates
the performance of its segments and allocates resources to them

                                       37
<PAGE>

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS CONTINUED

based on operating profit.

         Summarized financial information concerning the Company's reportable
segments is presented below:

<TABLE>
<CAPTION>
                                                         Sales                           Depreciation and Amortization
                                       -------------------------------------------    -----------------------------------
Fiscal Year                                1999           1998           1997            1999        1998        1997
-----------                            -------------- -------------- -------------    ------------ ---------- -----------
<S>                                    <C>            <C>            <C>              <C>          <C>         <C>
Bookstores                                $3,262,295      3,005,608     2,796,852        $108,691     88,345      76,951
Video game & entertainment
      software stores                        223,748             --            --           3,613         --          --
                                       -------------- -------------- -------------    ------------ ---------- -----------
          Total                           $3,486,043      3,005,608     2,796,852        $112,304     88,345      76,951
                                       ============== ============== =============    ============ ========== ===========
<CAPTION>
                                                                                             Equity Investment in
                                                    Operating Profit                          Barnes & Noble.com
                                       -------------- -------------- -------------    ------------ ---------- -----------
Fiscal Year                                1999           1998           1997            1999        1998        1997
-----------                            -------------- -------------- -------------    ------------ ---------- -----------
<S>                                    <C>            <C>            <C>              <C>          <C>         <C>
Bookstores                                  $216,678        185,142       145,356        $240,531     82,307          --
      Operating margin                          6.64%          6.16%         5.20%
Video game & entertainment
       software stores                        15,432             --            --              --         --          --
      Operating margin                          6.90%            NA            NA
                                       -------------- -------------- -------------    ------------ ---------- -----------
          Total                             $232,110        185,142       145,356        $240,531     82,307          --
                                       ============== ============== =============    ============ ========== ===========

<CAPTION>
                                              Capital Expenditures                            Total Assets
                                       ------------ ----------- -----------     -------------- ------------- -------------
Fiscal Year                               1999         1998        1997             1999           1998          1997
-----------                            ------------ ----------- -----------     -------------- ------------- -------------
<S>                                    <C>            <C>            <C>              <C>          <C>         <C>
Bookstores                                $142,005     141,378     121,903         $2,076,795     1,807,597     1,591,171
Video game & entertainment
       software stores                       4,289          --          --            336,996            --            --
                                       ------------ ----------- -----------     -------------- ------------- -------------

          Total                           $146,294     141,378     121,903         $2,413,791     1,807,597     1,591,171
                                       ============ =========== ===========     ============== ============= =============
</TABLE>

         A reconciliation of operating profit reported by reportable segments to
earnings before income taxes, extraordinary charge and cumulative effect of a
change in accounting principle in the consolidated financial statements is as
follows:

<TABLE>
<CAPTION>
Fiscal Year                                                          1999          1998            1997
-----------                                                    -------------- -------------- ---------------
<S>                                                            <C>            <C>            <C>
Reportable segments operating profit                                $232,110        185,142         145,356
Interest, net                                                        (23,765)       (24,412)        (37,666)
Equity in net loss of Barnes & Noble.com                             (42,047)       (71,334)             --
Gain on formation of Barnes & Noble.com                               25,000         63,759              --
Other income                                                          27,337          3,414           1,913
                                                               -------------- -------------- ---------------
 Consolidated earnings before income taxes, extraordinary
 charge and cumulative effect of a change in accounting
 principle                                                          $218,635        156,569         109,603
                                                               ============== ============== ===============

</TABLE>

                                       38
<PAGE>

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS CONTINUED

12. Comprehensive Earnings

         In 1999, as a result of the Company's investment activities (see Note
5), the Company adopted Statement of Financial Accounting Standards No. 130,
"Reporting Comprehensive Income" which establishes standards for reporting and
display of comprehensive earnings and its components in the financial
statements. Comprehensive earnings are net earnings, plus certain other items
that are recorded directly to shareholders' equity. The only such item currently
applicable to the Company is the unrealized loss on available-for-sale
securities, as follows:

<TABLE>
<CAPTION>
Fiscal Year                                                          1999             1998            1997
-----------                                                     -------------     ------------    ------------
<S>                                                             <C>               <C>             <C>
Net earnings                                                        $124,498           92,376          53,169
Other comprehensive loss:
    Unrealized loss on available-for-sale  securities,  net of
    deferred income tax benefit of $839                               (1,198)              --              --
                                                                -------------     ------------    ------------
Total comprehensive earnings                                        $123,300           92,376          53,169
                                                                =============     ============    ============
</TABLE>

13. Shareholders' Equity

         In fiscal 1999, the Board of Directors authorized a common stock
repurchase program for the purchase of up to $250,000 of the Company's common
shares. As of January 29, 2000, the Company has repurchased 4,025,900 shares at
a cost of approximately $86,797 under this program. The repurchased shares are
held in treasury.

         As discussed more fully in Note 7, shareholders' equity as of January
29, 2000 includes an increase in additional paid-in capital of $116,158
representing the Company's incremental share in the equity of Barnes & Noble.com
as a result of the IPO. Shareholders' equity as of January 30, 1999 includes an
increase in additional paid-in capital of $36,351 as a result of the formation
of Barnes & Noble.com.

         On July 10, 1998, the Board of Directors of the Company declared a
dividend of one Preferred Share Purchase Right (a Right) for each outstanding
share of the Company's common stock (Common Stock). The distribution of the
Rights was made on July 21, 1998 to stockholders of record on that date. Each
Right entitles the holder to purchase from the Company one four-hundredth of a
share of a new series of preferred stock, designated as Series H Preferred
Stock, at a price of $225 per one four-hundredth of a share. The Rights will be
exercisable only if a person or group acquires 15 percent or more of the
Company's outstanding Common Stock or announces a tender offer or exchange
offer, the consummation of which would result in such person or group owning 15
percent or more of the Company's outstanding Common Stock.

         If a person or group acquires 15 percent or more of the Company's
outstanding Common Stock, each Right will entitle a holder (other than such
person or any member of such group) to purchase, at the Right's then current
exercise price, a number of shares of Common Stock having a market value of
twice the exercise price of the Right. In addition, if the Company is acquired
in a merger or other business combination transaction or 50 percent or more of
its consolidated assets or earning power are sold at any time after the Rights
have become exercisable, each Right will entitle its holder to purchase, at the
Right's then current exercise price, a number of the acquiring company's common
shares having a market value at

                                       39
<PAGE>

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS CONTINUED

that time of twice the exercise price of the Right. Furthermore, at any time
after a person or group acquires 15 percent or more of the outstanding Common
Stock of the Company but prior to the acquisition of 50 percent of such stock,
the Board of Directors may, at its option, exchange part or all of the Rights
(other than Rights held by the acquiring person or group) at an exchange rate of
one four-hundredth of a share of Series H Preferred Stock or one share of the
Company's Common Stock for each Right.

         The Company will be entitled to redeem the Rights at any time prior to
the acquisition by a person or group of 15 percent or more of the outstanding
Common Stock of the Company, at a price of $.01 per Right. The Rights will
expire on July 20, 2008.

         The Company has 5,000,000 shares of $.001 par value preferred stock
authorized for issuance, of which 250,000 shares have been designated by the
Board of Directors as Series H Preferred Stock and reserved for issuance upon
exercise of the Rights. Each such share of Series H Preferred Stock will be
nonredeemable and junior to any other series of preferred stock the Company may
issue (unless otherwise provided in the terms of such stock) and will be
entitled to a preferred dividend equal to the greater of $2.00 per share or 400
times any dividend declared on the Company's Common Stock. In the event of
liquidation, the holders of Series H Preferred Stock will receive a preferred
liquidation payment of $1,000 per share, plus an amount equal to accrued and
unpaid dividends and distributions thereon. Each share of Series H Preferred
Stock will have 400 votes, voting together with the Company's Common Stock.
However, in the event that dividends on the Series H Preferred Stock shall be in
arrears in an amount equal to six quarterly dividends thereon, holders of the
Series H Preferred Stock shall have the right, voting as a class, to elect two
of the Company's Directors, whose terms shall extend until such time when all
accrued and unpaid dividends for all previous quarterly dividend periods and for
the current quarterly dividend period on all shares of Series H Preferred Stock
then outstanding shall have been declared and paid or set apart for payment. In
the event of any merger, consolidation or other transaction in which the
Company's Common Stock is exchanged, each share of Series H Preferred Stock will
be entitled to receive 400 times the amount and type of consideration received
per share of the Company's Common Stock. As of January 29, 2000, there were no
shares of Series H Preferred Stock outstanding.

14. Restructuring Charge

        From 1989 through 1995, the Company closed, on average, between 40 and
60 mall bookstores per year primarily due to increasing competition from
superstores and declining mall traffic. During the fourth quarter of fiscal
1995, the Company accelerated its mall bookstore closing program with the aim of
forming a core of more profitable B. Dalton stores, and provided for these
closing costs and asset valuation adjustments through a non-cash restructuring
charge, and early adoption of Statement of Financial Accounting Standards No.
121, "Accounting for Impairment of Long-Lived Assets and Assets to be Disposed
Of" (SFAS 121). In the fourth quarter of fiscal 1995, the Company recorded a
non-cash charge to operating earnings of $123,768 ($87,303 after tax or $1.32
per share) to reflect the aggregate impact of its restructuring plan and change
in accounting policy. The charge to earnings included a $33,000 write-down of
goodwill, and $45,862 related to the write-down of fixed assets and other
long-term assets. The Company has completed this store closing program. Costs
incurred in excess of the amount provided by the restructuring charge were
immaterial and have been included in selling and administrative expenses.

                                       40
<PAGE>

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS CONTINUED

        The following table sets forth the restructuring liability activity:

<TABLE>
<CAPTION>
                                                                    Lease
                                        Provision for         Termination
                                        Store Closing               Costs            Other           Total
                                  --------------------------------------------------------------------------
<S>                               <C>                        <C>               <C>             <C>
Balance at February 1, 1997                   $1,532              30,462            1,602           33,596
Fiscal 1997 payments                           1,532               9,026            1,602           12,160
                                             -------             -------           ------           ------
Balance at January 31, 1998                       --              21,436               --           21,436
Fiscal 1998 payments                              --              12,968               --           12,968
                                             -------             -------           ------           ------
Balance at January 30, 1999                       --               8,468               --            8,468
Fiscal 1999 payments                              --               8,468               --            8,468
                                             -------             -------           ------           ------
Balance at January 29, 2000                   $   --                  --               --               --
                                             =======             =======           ======           ======
</TABLE>

15. Stock Option Plans

         The Company currently has two incentive plans under which stock options
have been or may be granted to officers, directors and key employees of the
Company - the 1991 Employee Incentive Plan (the 1991 Plan) and the 1996
Incentive Plan (the 1996 Plan). The options to purchase common shares generally
are issued at fair market value on the date of the grant, begin vesting after
one year in 33-1/3 percent or 25 percent increments per year, expire 10 years
from issuance and are conditioned upon continual employment during the vesting
period.

         The Company increased the number of shares available for issuance under
the 1996 Plan from 6,000,000 to 11,000,000. The 1996 Plan and the 1991 Plan
allow the Company to grant options to purchase up to 11,000,000 and 4,732,704
shares of common stock, respectively.

         In addition to the two incentive plans, the Company has granted stock
options to certain key executives and directors. The vesting terms and
contractual lives of these grants are similar to that of the incentive plans.

         In accordance with the Statement of Financial Accounting Standards No.
123, "Accounting for Stock-Based Compensation" (SFAS 123), the Company discloses
the pro forma impact of recording compensation expense utilizing the
Black-Scholes model. The Black-Scholes option valuation model was developed for
use in estimating the fair value of traded options which have no vesting
restrictions and are fully transferable. In addition, option valuation models
require the input of highly subjective assumptions including the expected stock
price volatility. Because the Company's stock options have characteristics
significantly different from those of traded options, and because changes in the
subjective input assumptions can materially affect the fair value estimate, in
management's opinion, the Black-Scholes model does not necessarily provide a
reliable measure of the fair value of its stock options.

         Had compensation cost for the Company's stock option grants been
determined based on the fair value at the stock option grant dates consistent
with the pro forma method of SFAS 123, the Company's net earnings and diluted
earnings per share for fiscal 1999, 1998 and 1997, would have been reduced by
approximately $6,298 or $0.09 per share, $6,188 or $0.09 per share, and $3,863
or $0.06 per share, respectively.

         Because the application of the pro forma disclosure provision of SFAS
123 are required only to

                                       41
<PAGE>

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS CONTINUED

be applied to grants of options made by the Company during fiscal 1995 and
after, the above pro forma amounts may not be representative of the effects of
applying SFAS 123 to future years.

         The weighted -average fair value of the options granted during fiscal
1999, 1998 and 1997 were estimated at $10.00, $12.96 and $8.05 respectively,
using the Black-Scholes option-pricing model with the following assumptions:
volatility of 35 percent for fiscal 1999 and fiscal 1998 grants, 28 percent for
fiscal 1997 grants, risk-free interest rate of 5.90 percent in fiscal 1999, 5.33
percent in fiscal 1998, and 6.54 percent in fiscal 1997, and an expected life of
6.0 years for fiscal 1999, 5.4 years for fiscal 1998 and 6.0 years for fiscal
1997.

         A summary of the status of the Company's stock options is presented
below:

                                                              Weighted-Average
(Thousands of shares)                           Shares         Exercise Price
--------------------------------------------------------------------------------

Balance, February 1, 1997                        9,142             $   11.07
Granted                                          2,254                 19.31
Exercised                                       (1,546)                 9.28
Forfeited                                         (186)                16.25
                                                ------

Balance, January 31, 1998                        9,664                 13.17
Granted                                          1,841                 31.12
Exercised                                         (837)                11.11
Forfeited                                         (390)                22.35
                                                ------

Balance, January 30, 1999                       10,278                 16.22
Granted                                          2,148                 22.31
Exercised                                         (795)                11.39
Forfeited                                         (488)                26.91
                                                ------

Balance, January 29, 2000                       11,143             $   17.27
                                                ======

         Options exercisable as of January 29, 2000, January 30, 1999 and
January 31, 1998 were 7,133,000, 6,780,000 and 6,558,000, respectively. Options
available for grant under the plans were 4,243,000, 5,902,000 and 2,354,000 at
January 29, 2000, January 30, 1999 and January 31, 1998, respectively.

                                       42
<PAGE>

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS CONTINUED

         The following table summarizes information as of January 29, 2000
concerning outstanding and exercisable options:

<TABLE>
<CAPTION>
                                            Options Outstanding                             Options Exercisable
                                               Weighted-
                                               Average            Weighted-
Range of                   Number              Remaining          Average          Number             Weighted-
Exercise                   Outstanding         Contractual        Exercise         Exercisable        Average
Prices                     (000s)              Life               Price            (000s)             Exercise Price
-----------------------    -------------    --------------     -------------    ---------------    -----------------
<S>                        <C>              <C>                <C>              <C>                <C>
$3.21 - $3.77                      556                3.36        $    3.59                556        $     3.59
$10.00 - $15.00                  5,068                3.89        $   12.06              5,068        $    12.06
$17.13 - $24.25                  3,729                8.27        $   19.92              1,230        $    19.29
$26.50 - $34.75                  1,790                8.52        $   30.73                279        $    33.90
                                ------                                                  ------
$3.21 - $34.75                  11,143                6.07        $   17.27              7,133        $    13.50
                                ======                                                  ======
</TABLE>

16. Leases

        The Company leases retail stores, warehouse facilities, office space and
equipment. Substantially all of the retail stores are leased under noncancelable
agreements which expire at various dates through 2036 with various renewal
options for additional periods. The agreements, which have been classified as
operating leases, generally provide for both minimum and percentage rentals and
require the Company to pay all insurance, taxes and other maintenance costs.
Percentage rentals are based on sales performance in excess of specified
minimums at various stores.

        Rental expense under operating leases are as follows:

Fiscal Year                       1999              1998              1997
-----------                       ----              ----              ----

Minimum rentals                $291,964           271,201           253,472
Percentage rentals                7,502             3,183             3,216
                                  -----             -----             -----
                               $299,466           274,384           256,688
                               ========           =======           =======

         Future minimum annual rentals, excluding percentage rentals, required
under leases that had initial, noncancelable lease terms greater than one year,
as of January 29, 2000 are:

Fiscal Year
-----------

2000                        $301,622
2001                         294,336
2002                         279,017
2003                         257,289
2004                         236,072
After 2004                 1,541,439
                           ---------
                          $2,909,775
                          ==========

                                       43
<PAGE>

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS CONTINUED

17. Litigation

         In March 1998, the American Booksellers Association (ABA) and 26
independent bookstores filed a lawsuit in the United States District Court for
the Northern District of California against the Company and Borders Group, Inc.
(Borders) alleging violations of the Robinson-Patman Act, the California Unfair
Trade Practice Act and the California Unfair Competition Law. The Complaint
seeks injunctive and declaratory relief; treble damages on behalf of each of the
bookstore plaintiffs, and, with respect to the California bookstore plaintiffs,
any other damages permitted by California law; disgorgement of money, property
and gains wrongfully obtained in connection with the purchase of books for
resale, or offered for resale, in California from March 18, 1994 until the
action is completed and pre-judgment interest on any amounts awarded in the
action, as well as attorney fees and costs. In October 1999, Barnes & Noble.com
was added as a defendant in the action. The Company intends to vigorously defend
this action.

         In August 1998, The Intimate Bookshop, Inc. and its owner, Wallace
Kuralt, filed a lawsuit in the United States District Court for the Southern
District of New York against the Company, Borders, Amazon.com, Inc., certain
publishers and others alleging violation of the Robinson-Patman Act and other
federal law, New York statutes governing trade practices and common law. The
Complaint sought certification of a class consisting of all retail booksellers
in the United States, whether or not currently in business, which were in
business and were members of the ABA at any time during the four year period
preceding the filing of the Complaint. The Complaint alleged that the named
plaintiffs have suffered damages of $11,250 or more and requested treble damages
on behalf of the named plaintiffs and each of the purported class members, as
well as of injunctive and declaratory relief (including an injunction requiring
the closure of all of defendants' stores within 10 miles of any location where
plaintiff either has or had a retail bookstore during the four years preceding
the filing of the Complaint, and prohibiting the opening by defendants of any
bookstore in such areas for the next 10 years), disgorgement of alleged
discriminatory discounts, rebates, deductions and payments, punitive damages,
interest, costs, attorneys fees and other relief. The plaintiffs subsequently
amended their complaint to allege eight causes of action on behalf of the
Intimate Bookshop and Wallace Kuralt, accusing the Company and the other
defendants of: (i) violating Section 2(f) the Robinson-Patman Act; (ii)
violating Section 2(c) of the Robinson-Patman Act; (iii) violating Section
13(a)of the Clayton Act; (iv) inducing every publisher in the United States to
breach contracts with the plaintiffs; (v) interfering with the plaintiff's
advantageous business relationships; (vi) engaging in unfair competition; (vii)
violating Sections 349 and 350 of the New York General Business Law; and (viii)
being unjustly enriched. The class action allegations have been removed and the
plaintiffs voluntarily dismissed defendants Harper Collins Publishers, Inc. and
Amazon.com, Inc. from the case.

         On April 13, 1999, the Company and the other defendants filed a motion
to dismiss the second through eighth causes of action in their entireties and
for a more definite statement of the remaining allegations of the first cause of
action. As a result, the plaintiffs' third through eighth causes of action were
dismissed with prejudice, as were all claims asserted by Wallace Kuralt in his
individual capacity. The Company served an Answer on April 5, 2000 denying the
material allegations of the Complaint and asserting various affirmative
defenses. The Company intends to continue to vigorously defend this action.

         In addition to the above actions, various claims and lawsuits arising
in the normal course of business are pending against the Company. The subject
matter of these proceedings primarily includes

                                       44
<PAGE>

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS CONTINUED

commercial disputes and employment issues. The results of these proceedings are
not expected to have a material adverse effect on the Company's consolidated
financial position or results of operations.

18. Certain Relationships and Related Transactions

         The Company leases space for its executive offices in properties in
which Leonard Riggio, chairman, chief executive officer and principal
stockholder of Barnes & Noble, has a minority interest. The space was rented at
an aggregate annual rent including real estate taxes of approximately $2,753,
$1,316 and $1,309 in fiscal years 1999, 1998 and 1997, respectively.

         The Company leases a 75,000 square foot office/warehouse from a
partnership in which Leonard Riggio has a 50 percent interest, pursuant to a
lease expiring in 2023. Pursuant to such lease, the Company paid $573, $737 and
$743 in fiscal years 1999, 1998 and 1997, respectively.

         The Company is provided with certain package shipping services by the
LTA Group, Inc. (LTA), a company in which a brother of Leonard Riggio owns a 20
percent interest. The Company paid LTA $13,118, $12,571 and $11,528 for such
services during fiscal years 1999, 1998 and 1997, respectively.

         The Company leases retail space in a building in which Barnes & Noble
College Bookstores, Inc. (B&N College), a company owned by Leonard Riggio,
subleases space for its executive offices. Occupancy costs allocated by the
Company to B&N College for this space totaled $686, $725 and $634 for fiscal
years 1999, 1998 and 1997, respectively. In connection with the space, the
Company reimbursed B&N College during fiscal 1997, for a landmark tax credit
totaling $726.

         B&N College allocated to the Company certain operating costs it
incurred on its behalf. These charges are included in the accompanying
consolidated statements of operations and approximated $193, $48 and $75 for
fiscal 1999, 1998 and 1997, respectively. The Company charged B&N College $1,042
and $972 for fiscal years 1999 and 1998, respectively, for capital expenditures,
business insurance and other operating costs incurred on its behalf.

         The Company uses a jet aircraft owned by B&N College and pays for the
costs and expenses of operating the aircraft based upon the Company's usage.
Such costs which include fuel, insurance, personnel and other costs approximate
$2,205, $1,760 and $1,910 during fiscal 1999, 1998 and 1997, respectively, and
are included in the accompanying consolidated statements of operations.

        On October 28, 1999, the Company acquired Babbage's Etc., one of the
nation's largest operators of video game and entertainment software stores, a
company majority owned by Leonard Riggio, for $208,670. If financial performance
targets are met over the next two fiscal years, the Company will make additional
payments of approximately $10,000 in 2001 and approximately $10,000 in 2002.

         Barnes & Noble.com purchased $74,682 and $33,444 of merchandise from
the Company during fiscal 1999 and 1998, respectively, and Barnes & Noble.com
expects to source purchases through the Company in the future. The Company has
entered into an agreement (the Supply Agreement) with Barnes & Noble.com whereby
the Company charges Barnes & Noble.com the costs associated with such purchases
plus incremental overhead incurred by the Company in connection with providing
such inventory. The Supply Agreement is subject to certain termination
provisions.

         The Company has entered into agreements (the Service Agreements)
whereby Barnes &

                                       45
<PAGE>

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS CONTINUED

Noble.com receives various services from the Company, including, among others,
services for payroll processing, benefits administration, insurance (property
and casualty, medical, dental and life), tax, traffic, fulfillment and
telecommunications. In accordance with the terms of such agreements the Company
has received, and expects to continue to receive, fees in an amount equal to the
direct costs plus incremental expenses associated with providing such services.
The Company received $2,037, $856 and $250 for such services during fiscal 1999,
1998 and 1997, respectively.

         The Company subleases to Barnes & Noble.com approximately one-third of
a 300,000 square foot warehouse facility located in New Jersey. The Company has
received from Barnes & Noble.com $473 and $310 for such subleased space during
fiscal 1999 and 1998, respectively.

         Since 1993, the Company has used the music distributor AEC One Stop
Group, Inc. (AEC) as its primary music and video supplier and to provide a music
and video database. In 1999, AEC's parent corporation was acquired by an
investor group in which Leonard Riggio was a significant minority investor. The
Company paid AEC $126,241 in connection with this agreement during fiscal 1999.

19. Selected Quarterly Financial Information (Unaudited)

        A summary of quarterly financial information for each of the last two
fiscal years is as follows:

<TABLE>
<CAPTION>
                                                                                                              Total
Fiscal 1999 Quarter End                                   April             July     October      January     Fiscal
On or About                                               1999              1999       1999        2000      Year 1999
--------------------------------------------------        ----              ----       ----        ----      ---------
<S>                                                       <C>             <C>        <C>        <C>          <C>
Sales                                                     $ 718,336       727,165    715,903    1,324,639    3,486,043
Gross profit                                              $ 192,371       199,275    200,490      410,178    1,002,314
Equity in net loss of Barnes & Noble.com  (a)             $ (11,544)       (6,532)    (8,736)     (15,235)     (42,047)
   Earnings (loss) before cumulative effect of a
     change in accounting principle                       $  (1,444)       23,543      3,387      103,512      128,998
   Net earnings (loss)   (b) (c)                          $  (5,944)       23,543      3,387      103,512      124,498
Basic earnings (loss) per common share
   Earnings (loss) before cumulative effect of a
     change in accounting principle                       $   (0.02)         0.34       0.05         1.52         1.87
   Net earnings (loss)                                    $   (0.09)         0.34       0.05         1.52         1.80
Diluted earnings (loss) per common share
   Earnings (loss) before cumulative effect of a
     change in accounting principle                       $   (0.02)         0.33       0.05         1.48         1.81
   Net earnings (loss)                                    $   (0.09)         0.33       0.05         1.48         1.75

<CAPTION>
                                                                                                              Total
Fiscal 1998 Quarter End                                   April             July     October      January     Fiscal
On or About                                               1998              1998       1998        1999      Year 1998
--------------------------------------------------        ----              ----       ----        ----      ---------
<S>                                                      <C>             <C>         <C>        <C>          <C>
Sales                                                    $ 656,976       662,507     656,837    1,029,288     3,005,608
Gross profit                                             $ 172,387       179,844     182,967      327,693       862,891
Equity in net loss of Barnes & Noble.com (d)             $ (13,603)      (23,003)    (20,472)     (14,256)      (71,334)
   Net earnings (loss) (e)                               $  (3,335)       (5,709)     (4,596)     106,016        92,376
Basic earnings (loss) per common share                   $   (0.05)        (0.08)      (0.07)        1.54          1.35
Diluted earnings (loss) per common share                 $   (0.05)        (0.08)      (0.07)        1.47          1.29
</TABLE>

(a)  As a result of the Barnes & Noble.com Inc. initial public offering on May
     25, 1999, the Company retained a 40 percent interest in Barnes

                                       46
<PAGE>

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS CONTINUED

     & Noble.com. Accordingly, fiscal 1999 reflects the Company's 50 percent
     interest in the net losses of Barnes & Noble.com through the date of the
     IPO and 40 percent thereafter.

(b)  Included in net earnings for the second quarter of fiscal 1999 is a pre-tax
     gain of $25,000 ($14,750 after tax) or $0.21 per diluted share from the
     receipt of $25,000 from Bertelsmann as a result of the Barnes & Noble.com
     initial public offering, as well as a pre-tax gain of $10,975 ($6,475 after
     tax) or $0.09 per basic and diluted common share resulting from the partial
     sale of the Company's investment in Chapters.

(c)  Included in net earnings for the fourth quarter of fiscal 1999 is a pre-tax
     gain of $22,356 ($13,190 net of tax) or $0.18 per diluted share in
     connection with the sale of the Company's investment in NuvoMedia as more
     fully discussed in Note 6 of the Notes to Consolidated Financial
     Statements. In addition, the fourth quarter of fiscal 1999 includes the
     results of the Company's acquisition of Babbage's Etc. as more fully
     discussed in Note 10 of the Notes to Consolidated Financial Statements.

(d)  As a result of the formation of Barnes & Noble.com on October 31, 1998,
     each quarter of fiscal 1998 presents the Company's equity in net loss of
     Barnes & Noble.com as a separate line item in accordance with the equity
     method of accounting. Accordingly, the first three quarters of fiscal 1998
     reflect the Company's 100 percent equity in net losses of Barnes &
     Noble.com and the fourth quarter reflects the Company's 50 percent interest
     in the net losses of Barnes & Noble.com.

(e)  Included in net earnings for the fourth quarter of fiscal 1998 is a pre-tax
     gain on the formation of Barnes & Noble.com of $63,759 ($37,618 after tax)
     or $0.52 per diluted share.

                                       47
<PAGE>

               REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS

The Board of Directors
Barnes & Noble, Inc.

        We have audited the accompanying consolidated balance sheets of Barnes &
Noble, Inc. and subsidiaries as of January 29, 2000 and January 30, 1999 and the
related consolidated statements of operations, changes in shareholders' equity
and cash flows for each of the three fiscal years in the period ended January
29, 2000. These financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statements based on our audits.

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

        In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of Barnes &
Noble, Inc. and its subsidiaries as of January 29, 2000 and January 30, 1999 and
the results of their operations and their cash flows for each of the three
fiscal years in the period ended January 29, 2000, in conformity with generally
accepted accounting principles.

         As discussed in Note 1 to the Consolidated Financial Statements,
effective January 31, 1999, the Company changed its method of accounting for
pre-opening expenses.

New York, New York
March 16, 2000

BDO Seidman, LLP

                                       48<PAGE>

                                                                     Exhibit 4.1

                            RSL COMMUNICATIONS, LTD.

                    CERTIFICATE OF DESIGNATION OF THE POWERS,
                PREFERENCES AND RELATIVE, PARTICIPATING, OPTIONAL
             AND OTHER SPECIAL RIGHTS OF 7-1/2% SERIES A CONVERTIBLE
              PREFERRED SHARES AND QUALIFICATIONS, LIMITATIONS AND
                              RESTRICTIONS THEREOF

                  RSL Communications, Ltd., an exempted company organized under
the laws of Bermuda (the "Issuer"), certifies that pursuant to the authority
contained in its Memorandum of Association (the "Memorandum of Association") and
its Bye-Laws (the "Bye-Laws"), and in accordance with Bermuda law, the Board of
Directors (or a duly authorized committee thereof) of the Issuer on February 10,
2000, and February 14, 2000 duly approved and adopted the following resolution,
which resolution remains in full force and effect on the date hereof:

                  RESOLVED, on this 14th day of February, 2000, that pursuant to
the authority vested in the Board of Directors by the Memorandum of Association
and Bye-Laws, the Board of Directors does hereby designate, create, authorize
and provide for the issue of a series of preferred shares having the following
designation, voting powers, preferences and relative, participating, optional
and other special rights:

                  Certain capitalized terms used herein are defined in Section
16.

                  1. Number and Designation. The Issuer shall have a class of
preferred shares, which shall be designated as its 7 1/2% Series A Convertible
Preferred Shares (the "Series A Preferred Shares"), par value U.S. $0.00457 per
share, with 7,000,000 shares initially authorized and, subject to the
limitations set forth herein, such number of additional shares as are authorized
from time to time by resolution of the Board of Directors of the Issuer and as
set forth in the Bye-Laws of the Issuer. Unless otherwise specified, references
herein to any "Section" refer to the Section number specified in this
Certificate of Designation (this "Certificate").

                  2. Issuance; Registered Form; Registrar. The Issuer may issue
Series A Preferred Shares from time to time up to the aggregate number of shares
at the time authorized to be outstanding by action of the Board of Directors (or
any committee thereof) of the Issuer. Certificates for Series A Preferred Shares
shall be issuable only in registered form. The Issuer hereby appoints American
Stock

<PAGE>

Transfer & Trust Company as its initial Registrar and Transfer Agent (the
"Transfer Agent") for the Series A Preferred Shares.

                  3. Liquidation Preference. Upon any liquidation, winding up or
dissolution of the Issuer, each Series A Preferred Share shall be entitled to a
liquidation preference of U.S.$50 per share (the "liquidation preference") plus,
without duplication, an amount equal to all accrued and unpaid dividends
("Accumulated Dividends"). Such amount shall be payable as and to the extent
provided in Section 9.

                  4. Registration Under Securities Act; Transfer. (a) The Series
A Preferred Shares have not been registered under the United States Securities
Act of 1933 (the "Securities Act") and may not be resold, pledged or otherwise
transferred prior to the date when they no longer constitute "restricted
securities" for purposes of Rule 144 under the Securities Act other than (i) to
"qualified institutional buyers" ("QIBs") pursuant to and in compliance with
Rule 144A ("Rule 144A") under the Securities Act, (ii) to institutional
"accredited investors" as defined in Rule 501(a) under the Securities Act, (iii)
pursuant to an exemption from registration under the Securities Act provided by
Rule 144 thereunder (if available), or (iv) pursuant to an effective
registration statement under the Securities Act, in each case in accordance with
any applicable securities laws of the states of the United States and other
jurisdictions. Until such time as determined by the Issuer and the Registrar,
certificates evidencing the Series A Preferred Shares shall contain a legend
(the "Restricted Shares Legend") evidencing the foregoing restrictions in
substantially the form set forth on the form of Series A Preferred Share
attached hereto as Exhibit A.

                  (b) Series A Preferred Shares will initially be represented by
one or more global certificates with the global legend (the "Global Shares
Legend") and the Restricted Shares Legend (each, a "Global Certificate") each as
set forth on the form of Series A Preferred Share attached hereto as Exhibit A
which will be deposited with, or on behalf of, the Depository Trust Company
("DTC" or the "Depositary") and registered in the name of Cede & Co., as nominee
of DTC (the "Global Certificate Holder"). Except as set forth below, record
ownership of the Global Certificate may be transferred, in whole or in part,
only to another nominee of DTC or to a successor of DTC or its nominee.

                                       2
<PAGE>

                  (c) Owners of a beneficial interest in the Global Certificate
may hold their interest in the Global Certificate directly through DTC if such
holder is a participant in DTC (a "Participant") or indirectly through
organizations that are Participants. Persons who are not Participants may
beneficially own interests in the Global Certificate held by DTC only through
Participants or certain banks, brokers, dealers, trust companies and other
parties that clear through or maintain a custodial relationship with a
Participant, either directly or indirectly.

                  (d) Global Certificates are exchangeable for certificates in
definitive form (the "Definitive Securities") of like tenor as such Global
Certificates if DTC notifies the Issuer that it is unwilling or unable to
continue as depositary for the Global Certificates or ceases to be a clearing
agency under the United States Securities Exchange Act of 1934 (the "Exchange
Act") and, in either case, a successor depositary registered as a clearing
agency under the Exchange Act is not appointed by the Issuer within 90 days or
at any time if the Issuer determines not to have all of the Series A Preferred
Shares represented by Global Certificates. Any Definitive Securities that are
issued in exchange for Global Certificates will be issued in authorized
denominations and will be registered in such names as DTC shall direct. Subject
to the foregoing, Global Certificates are not exchangeable, except for Global
Certificates of the same aggregate denomination to be registered in the name of
DTC or its nominee or in the name of a successor of DTC or its nominee. In
addition, such certificates will bear the Restricted Shares Legend (unless the
Issuer determines otherwise in accordance with applicable law) subject, with
respect to such Series A Preferred Shares, to the provisions of such legend.

                  (e) No certificate evidencing Series A Preferred Shares shall
be valid unless it bears the countersignature of the Transfer Agent.

                  5. Paying Agent and Conversion Agent; Transfer Restrictions.
(a) The Issuer shall maintain in the Borough of Manhattan, City of New York,
State of New York (i) an office or agency where Series A Preferred Shares may be
presented for payment (the "Paying Agent") and (ii) an office or agency where
Series A Preferred Shares may be presented for conversion (the "Conversion
Agent"). The Issuer may appoint the Transfer Agent, the Paying Agent and the
Conversion Agent and may appoint one or more additional paying agents and one or
more additional conversion agents in such other locations as it shall determine.
The term "Paying Agent" includes any additional paying agent and,

                                       3
<PAGE>

with respect to payments hereunder by delivery of Class A Common Shares, may
include the Common Share Transfer Agent, and the term "Conversion Agent"
includes any additional conversion agent. The Issuer may change any Paying Agent
or Conversion Agent without prior notice to any holder. The Issuer shall notify
the Registrar of the name and address of any Paying Agent or Conversion Agent
appointed by the Issuer. If the Issuer fails to appoint or maintain another
entity as Paying Agent or Conversion Agent, the Transfer Agent shall act as
such. The Issuer or any of its Affiliates may act as Paying Agent, Transfer
Agent, or Conversion Agent.

                  (b) Notwithstanding any provision to the contrary herein, so
long as a Global Certificate remains outstanding and is held by or on behalf of
the Depositary or a successor of the Depositary, transfers of a Global
Certificate, in whole or in part, or of any beneficial interest therein, shall
only be made in accordance with Section 4 and this Section 5; provided, however,
that beneficial interests in a Global Certificate may be transferred to persons
who take delivery thereof in the form of a beneficial interest in the same
Global Certificate in accordance with the transfer restrictions set forth in the
Restricted Shares Legend:

                  (i) Except for transfers or exchanges made in accordance with
         clause (b)(ii) of this Section 5, transfers of a Global Certificate
         shall be limited to transfers of such Global Certificate in whole, but
         not in part, to nominees of the Depositary or to a successor of the
         Depositary or such successor's nominee.

                  (ii) If Definitive Securities are issued and a holder of
         Definitive Securities bearing a Restricted Shares Legend ("Restricted
         Definitive Securities") wishes at any time to transfer all or part of
         the Series A Preferred Shares represented by such Restricted Definitive
         Securities to a person who is required to take delivery thereof in the
         form of Restricted Definitive Securities, such holder may, subject to
         the restrictions on transfer set forth herein and in the certificate
         representing such Series A Preferred Shares, cause the exchange of the
         certificate representing such Series A Preferred Shares for one or more
         Restricted Definitive Securities evidencing such Series A Preferred
         Shares. Upon receipt by the Transfer Agent, at its office in The City
         of New York of (A) the certificate representing such Series A Preferred
         Shares, duly endorsed as provided herein, (B) instructions from such
         holder

                                       4
<PAGE>

         directing the Transfer Agent to authenticate and deliver one or more
         Restricted Definitive Securities evidencing such Series A Preferred
         Shares, such instructions to contain the name of the transferee and the
         number of such Series A Preferred Shares to be represented by the
         Restricted Definitive Securities so issued to such transferee and
         appropriate delivery instructions, (C) a certificate from the holder of
         the Restricted Definitive Securities to be exchanged in the form of
         Exhibit B and, if applicable, Exhibit C attached hereto given by the
         transferor, to the effect set forth therein and (D) such other
         certifications, legal opinions or other information as the Issuer or
         the Transfer Agent may reasonably require to confirm that such transfer
         is being made pursuant to an exemption from, or in a transaction not
         subject to, the registration requirements of the Securities Act, then
         the Transfer Agent shall cancel or cause to be canceled such Restricted
         Definitive Securities and concurrently therewith, in accordance with
         the instructions referred to above, the Issuer shall execute, and the
         Transfer Agent shall countersign and deliver, one or more Restricted
         Definitive Securities representing in the aggregate the number of
         Series A Preferred Shares represented by the Definitive Restricted
         Securities so exchanged.

                  (c) In the case of (x) certificates representing Class A
Common Shares issued (A) as dividends on Series A Preferred Shares, (B) on
conversion of Series A Preferred Shares or (C) in redemption of Series A
Preferred Shares, and any securities into which such Series A Preferred Shares
or Class A Common Shares shall be converted or into which they shall be changed
by operation of law or otherwise, (y) certificates representing Series A
Preferred Shares issued upon the transfer, exchange or replacement of Series A
Preferred Shares bearing the Restricted Shares Legend, or (z) if a request is
made to remove such Restricted Shares Legend on certificates representing Series
A Preferred Shares, certificates representing the Class A Common Shares or
Series A Preferred Shares so issued shall bear the Restricted Shares Legend, or
the Restricted Shares Legend shall not be removed, as the case may be, unless
there is delivered to the Issuer and the Transfer Agent such satisfactory
evidence, which may include an opinion of counsel licensed to practice law in
the State of New York, as may be reasonably required by the Issuer or the
Transfer Agent, that neither the legend nor the restrictions on transfer set
forth therein are required to ensure that transfers of the Class A Common Shares
or Series A Preferred Shares represented by such certificates comply with the

                                       5
<PAGE>

provisions of Rule 144A or Rule 144 or, with respect to Restricted Series A
Preferred Shares, that such Series A Preferred Shares are not "restricted
securities" within the meaning of Rule 144 under the Securities Act or that such
transfer is covered by an effective registration statement under the Securities
Act. Upon provision of such satisfactory evidence, the Transfer Agent, at the
direction of the Issuer, shall countersign and deliver certificates representing
Series A Preferred Shares that do not bear the Restricted Shares Legend.

                  (d) The Transfer Agent shall have no responsibility for any
actions taken or not taken by the Depositary.

                  (e) Each holder of a Series A Preferred Share agrees to
indemnify the Issuer and the Transfer Agent against any liability that may
result from the transfer, exchange or assignment of such holder's Series A
Preferred Share in violation of any provision of this Certificate and/or
applicable U.S. Federal or State securities law; provided, however, that such
indemnity shall not apply to acts of wilful misconduct or gross negligence on
the part of the Issuer or the Transfer Agent, as the case may be.

                  (f) Payments (whether in cash or, as permitted by Section 11,
in Class A Common Shares) due on the Series A Preferred Shares shall be payable
at the office or agency of the Issuer maintained for such purpose in The City of
New York and at any other office or agency maintained by the Issuer for such
purpose. If any such payment is in cash, it shall be payable by United States
dollar check drawn on, or wire transfer (provided that appropriate wire
instructions have been received by the Transfer Agent at least 15 days prior to
the applicable date of payment) to a United States dollar account maintained by
the holder with, a bank located in New York City; provided, however, that any
cash payments in respect of any dividends on and any redemption payment with
respect to any Global Certificate will be made to the Global Certificate Holder
or its nominee, as registered owner of the Global Certificate, by wire transfer
of immediately available funds on each Dividend Payment Date or Redemption
Effective Date, as applicable. Neither the Issuer nor the Transfer Agent will
have any responsibility or liability for any aspect of the records relating to
or payments made on account of beneficial ownership interests in any Global
Certificate or for maintaining, supervising or reviewing any records relating to
such beneficial ownership interest.

                                       6
<PAGE>

                  6. Dividend Rights. (a) The Issuer shall pay, and the holders
of the Series A Preferred Shares shall be entitled to receive, cumulative
dividends from the date of initial issuance of such Series A Preferred Shares at
a rate of 7-1/2% per annum on the amount of the liquidation preference of the
Series A Preferred Shares. Dividends will be computed on the basis of a 360-day
year consisting of twelve 30-day months and are deemed to accrue on a daily
basis. Dividends are payable quarterly in arrears, subject to Section 11, on
February 1, May 1, August 1 and November 1 of each year (each a "Dividend
Payment Date"), commencing August 1, 2000, until the liquidation preference
thereof is paid or made available for payment; provided, however, that if such
date is not a Business Day, then the Dividend Payment Date shall be the next
Business Day. The Issuer may elect not to declare dividend payments on any
Dividend Payment Date; provided, however, that dividends on the Series A
Preferred Shares will accrue whether or not the Issuer has earnings or profits,
whether or not there are funds legally available for the payment of such
dividends and whether or not dividends are declared. Dividends will accumulate
to the extent they are not paid on the Dividend Payment Date for the period to
which they relate. Arrearages of Accumulated Dividends will not themselves bear
interest or be added to the liquidation preference of the Series A Preferred
Shares.

                  (b) Pursuant to the terms of the Registration Rights
Agreement, if (i) the Shelf Registration Statement has not been filed within 90
days of the Closing Date or has not been declared effective by the Commission
within 180 days after the Closing Date or (ii) the Shelf Registration Statement
has been filed and declared effective by the Commission but, prior to the time
it is no longer required to be effective under the Registration Rights
Agreement, is not available for the resale of any Transfer Restricted
Securities, because (x) the Shelf Registration Statement is withdrawn by the
Issuer or becomes subject to an effective stop order issued pursuant to Section
8(d) of the Securities Act suspending the effectiveness of the Shelf
Registration Statement (without being succeeded immediately by an additional
registration statement filed and declared effective or (y) the availability of
the Shelf Registration Statement is suspended by the Issuer pursuant to the
Registration Rights Agreement (each of the foregoing clauses (i) and (ii), a
"Registration Default"), the Issuer shall pay special dividends ("Special
Dividends") to each holder of Transfer Restricted Securities at a per annum rate
of 0.5% of the liquidation preference for any Registration Default Period.
Following the cure of all Registration Defaults relating to any Transfer
Restricted Securities, the

                                       7
<PAGE>

accrual of Special Dividends with respect to such Transfer Restricted Securities
shall cease (without in any way limiting the effect of any subsequent
Registration Default). A Registration Default shall be cured on the date that
the Shelf Registration Statement is declared effective by the SEC or on the date
the Shelf Registration Statement is declared effective or becomes usable and
holders of Transfer Restricted Securities are provided notice thereof.

                  (c) The Issuer will be required to pay additional amounts
("Additional Amounts") to the holders of Series A Preferred Shares as additional
dividends to make up for any deduction or withholding for any present or future
taxes, assessments or other governmental charges imposed by (i) Bermuda, (ii)
any jurisdiction (excluding the United States or any political subdivision
thereof) from or through which the Issuer, or its paying agent, is making
payments on the Series A Preferred Shares or (iii) any other jurisdiction
(excluding the United States or any political subdivision thereof) in which the
Issuer, or a successor corporation, is organized or any political subdivision or
governmental authority of or in that jurisdiction with the power to tax (each an
"Applicable Jurisdiction"), in respect of any amounts that the Issuer or a
successor corporation must pay with respect to the Series A Preferred Shares, so
that the net amounts paid to the holders of the Series A Preferred Shares, after
that deduction or withholding, will be not less than the amount specified as
payable with respect to those shares. However, the Issuer will not be obligated
to pay additional amounts to any holder of Series A Preferred Shares that: (i)
resides in or is a citizen of an Applicable Jurisdiction; or (ii) is a
fiduciary, partnership or limited liability company if, and to the extent that,
the payment of Additional Amounts would not have been required if the Series A
Preferred Shares were held directly by a beneficiary or settlor with respect to
that fiduciary or a member of that partnership or limited liability company. In
addition, the Issuer will not be obligated to pay any Additional Amounts to a
holder of Series A Preferred Shares on account of: (i) any tax, assessment or
other governmental charge that would not have been imposed but for (a) the
existence of any present or former connection between such holder, or certain
other persons, and the Applicable Jurisdiction, (b) the presentation of Series A
Preferred Shares for payment more than 60 days after the relevant payment is due
or (c) the presentation of Series A Preferred Shares for payment in Bermuda or
any political subdivision of or in Bermuda, unless those shares could not have
been presented for payment elsewhere; (ii) any estate, inheritance, gift, sales,
transfer, excise, personal property or similar tax,

                                       8
<PAGE>

assessment or other governmental charge; (iii) any tax, assessment or other
governmental charge that is payable otherwise than by withholding from payment
of the liquidation preference of or any dividends or redemption premium on the
Series A Preferred Shares; (iv) any tax, assessment or other governmental charge
that is imposed or withheld by reason of the failure by the holder or the
beneficial owner of the Series A Preferred Shares to comply with a request by
the Issuer to (a) provide information, documents or other evidence concerning
the nationality, residence, identity or connection with the Applicable
Jurisdiction of the holder or beneficial owner or (b) make and deliver any
declaration or other similar claim, other than a claim for refund of a tax,
assessment or other government charge withheld by the Issuer, or satisfy any
information or reporting requirements, which, in the case of clause (a) or (b),
is required or imposed by a statute, treaty, regulation or administrative
practice of the taxing jurisdiction as a precondition to exemption from all or
part of that tax, assessment or other governmental charge; or (v) any
combination of the items above.

                  7. Payment of Dividends; Mechanics of Payment; Dividend Rights
Preserved. (a) Dividends on any Series A Preferred Share which are payable, and
are punctually paid or duly provided for, on any Dividend Payment Date shall be
paid in arrears to the person in whose name such Series A Preferred Share (or
one or more predecessor Series A Preferred Shares) is registered at the close of
business on the next preceding January 15, April 15, July 15 and October 15
(each, together with any record date established for the payment of Accumulated
Dividends, a "Dividend Record Date").

                  (b) No dividend whatsoever shall be declared or paid upon, or
any sum set apart for the payment of dividends upon, any outstanding share of
the Series A Preferred Shares with respect to any dividend period unless all
dividends for all preceding dividend periods have been declared and paid, or
declared and a sufficient sum set apart for the payment of such dividends, upon
all outstanding Series A Preferred Shares. Unless full cumulative dividends on
all outstanding Series A Preferred Shares for all past dividend periods shall
have been declared and paid, or declared and a sufficient sum for the payment
thereof set apart, then:

                  (i) no dividend (other than a dividend payable solely in any
         Junior Shares or Parity Shares or partial cash or property dividend on
         Parity Shares that is paid pro rata on the Series A Preferred Shares)
         shall be declared or paid upon, or any sum set apart for the

                                       9
<PAGE>

         payment of dividends upon, any Junior Shares or Parity Shares,
         respectively;

                  (ii) no other distribution shall be declared or made upon, or
         any sum set apart for the payment of any distribution upon, any Junior
         Shares or Parity Shares, other than a distribution consisting solely of
         Junior Shares or Parity Shares, respectively;

                  (iii) no Junior Shares or Parity Shares or any warrants,
         rights, calls or options exercisable for or convertible into any Parity
         Share or Junior Share shall be purchased, redeemed or otherwise
         acquired (other than in exchange for other Junior Shares or Parity
         Shares, respectively) by the Issuer or any of its subsidiaries; and

                  (iv) no monies shall be paid into or set apart or made
         available for a sinking or other like fund for the purchase, redemption
         or other acquisition of any Junior Shares or Parity Shares or any
         warrants, rights, calls or options exercisable for or convertible into
         any Parity Share or Junior Share by the Issuer or any of its
         subsidiaries.

                  (c) Holders of the Series A Preferred Shares will not be
entitled to any dividends, whether payable in cash, property or stock, in excess
of the full cumulative dividends as herein described. In the event that the
Issuer fails to pay the dividends due for an aggregate of six quarterly payments
(whether or not consecutive), the holders will have the rights and remedies set
forth in Section 8.

                  (d) Subject to the requirements of Section 11, any Accumulated
Dividends on any Series A Preferred Share may be paid, subject to Section 11, by
the Issuer in any lawful manner (which shall include the establishment of a
record date not more then 45 days prior to the payment thereof) not inconsistent
with the requirements of any securities exchange on which the Series A Preferred
Shares may be listed, and upon such notice (which shall precede the record date
by at least ten Business Days) as may be required by such exchange, if, after
notice given by the Issuer to the Transfer Agent of the proposed payment
pursuant to this clause (d), such manner of payment shall be deemed practicable
by the Transfer Agent.

                  (e) Subject to the foregoing provisions of this Section 7,
each Series A Preferred Share delivered under this Certificate upon registration
of transfer of or in exchange for or in lieu of any other Series A Preferred

                                       10
<PAGE>

Share shall carry the rights to dividends accumulated and unpaid, and to accrue,
which were carried by such other Series A Preferred Share.

                  (f) The holder of record of a Series A Preferred Share at the
close of business on a Dividend Record Date with respect to the payment of
dividends on the Series A Preferred Shares will be entitled to receive such
dividends with respect to such Series A Preferred Share on the corresponding
Dividend Payment Date, notwithstanding the conversion of such shares after such
Dividend Record Date and prior to such Dividend Payment Date. A Series A
Preferred Share surrendered for conversion during the period from the close of
business on any Dividend Record Date to the opening of business of the
corresponding Dividend Payment Date must be accompanied by a payment in cash,
Class A Common Shares or a combination thereof, depending on the method of
payment that the Issuer has chosen to pay such dividend, in an amount equal to
such dividend payable on such Dividend Payment Date, unless such Series A
Preferred Shares have been called for redemption on a redemption date occurring
during the period from the close of business on any Dividend Record Date to the
close of business on the corresponding Dividend Payment Date. The dividend
payment with respect to a Series A Preferred Share called for redemption on a
date during the period from the close of business on any Dividend Record Date to
the close of business on the corresponding Dividend Payment Date will be payable
on such Dividend Payment Date to the record holder of such share on such
Dividend Record Date if such share has been converted after such Dividend Record
Date and prior to such Dividend Payment Date. Notwithstanding the immediately
preceding three sentences of this Section 7(f), no payment shall be owed or
payable to or by any converting holder if the Board of Directors of the Issuer
shall have elected to defer the dividend payment to be made on such Dividend
Payment Date pursuant to Section 6(a). Fractional Class A Common Shares will not
be issued upon conversion, but in lieu thereof the Transfer Agent will pay a
cash adjustment in the manner set forth in Section 11(c).

                  (g) No payment or adjustment will be made upon conversion of
Series A Preferred Shares for accumulated and unpaid dividends or for dividends
with respect to the Class A Common Shares issued upon such conversion.

                  8. Voting Rights. (a) Holders of Series A Preferred Shares
will not be entitled to any voting rights (i) except as required by law and (ii)
except as follows: If at any time the equivalent of six quarterly dividends on
the Series A Preferred Shares are accrued and unpaid, then

                                       11
<PAGE>

the total number of Directors constituting the entire Board of Directors of the
Issuer shall be increased by two and, whether or not consecutive and whether or
not declared, the holders of a majority of the Series A Preferred Shares shall
have the right to elect two Directors. This right will continue until all
dividends in arrears on the Series A Preferred Shares are paid in full, at which
time the term of office of any such members of the Board of Directors so elected
shall terminate and such directors shall be deemed to have resigned. At any time
after voting power to elect Directors shall have become vested and be continuing
in the holders of the Series A Preferred Shares pursuant to the second preceding
sentence, or if a vacancy shall exist in the offices of Series A Preferred Share
Directors, the Board of Directors may, and upon written request of the holders
of record of at least 25% of the Outstanding Series A Preferred Shares addressed
to the Board of Directors of the Issuer, shall, call a special meeting of the
holders of the Series A Preferred Shares for the purpose of electing the Series
A Preferred Share Directors that such holders are entitled to elect. At any
meeting held for the purpose of electing Series A Preferred Share Directors, the
presence in person or by proxy of the holders of at least a majority of the
Outstanding Series A Preferred Shares shall be required to constitute a quorum
of such Series A Preferred Shares. Any vacancy occurring in the office of a
Series A Preferred Share Director may be filled by the remaining Series A
Preferred Share Director unless and until such vacancy shall be filled by the
holders of the Series A Preferred Shares.

                  (b) In addition to the voting rights set forth above, the
approval of the holders of at least 66-2/3% of the then-Outstanding Series A
Preferred Shares voting or consenting, as the case may be, as one class, will be
required for the Issuer to amend this Certificate, so as to affect adversely the
specified rights, preferences, privileges or voting rights of holders of the
Series A Preferred Shares; provided, however, that no such modification or
amendment may, without the consent of the holders of each Outstanding Series A
Preferred Share affected thereby, (i) change the Mandatory Redemption Date, the
dates on which payments are to be made pursuant to Optional Redemption, or any
Dividend Payment Date, (ii) reduce the liquidation preference, the rate of
dividends, the redemption prices or the purchase price thereof pursuant to
Section 13, (iii) change the place of payment where, or the coin or currency in
which, any Series A Preferred Share or any payment thereon is payable, (iv)
adversely affect the rights to convert any Series A Preferred Share as provided
in Section 12, (v) alter the voting rights with respect to the Series A
Preferred Shares

                                       12
<PAGE>

or reduce the percentage of the Outstanding Series A Preferred Shares the
consent of whose holders is required for any such modification, or the consent
of whose holders is required for any waiver of compliance with provisions of
this Certificate or (vi) modify any of the provisions of this Section 8 except
to increase any such percentage or to provide that certain other provisions of
this Certificate cannot be modified or waived without the consent of the holder
of each Outstanding Series A Preferred Share affected thereby.

                  (c) The Issuer will not authorize any new class of Senior
Shares or any obligation or security convertible or exchangeable into or
evidencing a right to purchase shares of any class or series of Senior Shares,
without the approval of the holders of at least 66-2/3% of the then-Outstanding
Series A Preferred Shares, voting or consenting, as the case may be, as one
class.

                  (d) Except as set forth in Section 8(c) with respect to Senior
Shares, neither (i) the creation, authorization or issuance of any Junior
Shares, Parity Shares or Senior Shares or (ii) the increase or decrease in the
amount of authorized capital stock of any class, including any Series A
Preferred Shares, shall require the consent of the holders of the Series A
Preferred Shares or shall be deemed to affect adversely the rights, preferences,
privileges, special rights or voting rights of holders of Series A Preferred
Shares. Furthermore, the consent of the holders of Series A Preferred Shares
will not be required for the Issuer to authorize, create (by way of
reclassification or otherwise) or issue any Parity Shares or Junior Shares or
any obligation or security convertible or exchangeable into, or evidencing a
right to purchase, shares of any class or series of Parity Shares or Junior
Shares.

                  9. Ranking. (a) The Series A Preferred Shares will, with
respect to dividend rights and rights on liquidation, winding-up and
dissolution, rank (i) junior to all of the Issuer's existing and future
indebtedness and other obligations; (ii) junior to each class of capital stock
or series of preferred shares that the Issuer establishes after February 22,
2000 the terms of which expressly provide that such class or series will rank
senior to the Series A Preferred Shares as to dividend distributions and
distributions upon the Issuer's liquidation, winding-up and dissolution ("Senior
Shares"); (iii) on parity with each other class of capital stock or series of
preferred shares that the Issuer establishes after February 22, 2000 the terms
of which expressly provide that

                                       13
<PAGE>

such class or series will rank on a parity with the Series A Preferred Stock as
to dividend distributions and distributions upon the Issuer's liquidation,
winding-up and dissolution ("Parity Shares"); and (iv) senior to all classes of
the Issuer's Class A Common Shares and to each other class of capital stock or
series of the Issuer's preferred shares established after February 22, 2000 the
terms of which do not expressly provide that it ranks senior to or on a parity
with the Series A Preferred Shares as to dividend distributions and
distributions upon the Issuer's liquidation, winding-up and dissolution
(together with the Issuer's Class A Common Shares,"Junior Shares").

                  (b) No dividend whatsoever shall be declared or paid upon, or
any sum set apart for the payment of dividends upon, any outstanding Series A
Preferred Share with respect to any dividend period unless all dividends for all
preceding dividend periods have been declared and paid, or declared and a
sufficient sum set apart for the payment of such dividends, upon all outstanding
Senior Shares.

                  (c) In the event of any liquidation, dissolution or winding-up
of the Issuer, whether voluntary or involuntary, the holders of the Series A
Preferred Shares then Outstanding shall be entitled to receive, prior and in
preference to any distribution of any of the assets of the Issuer to the holders
of Class A Common Shares or Junior Shares by reason of their ownership thereof,
the liquidation preference of $50 per share for each Outstanding Series A
Preferred Share, plus, without duplication, an amount equal to all Accumulated
Dividends (including Special Dividends and Additional Amounts, if any) thereon
to the date fixed for liquidation, dissolution or winding-up (including an
amount equal to a pro rata dividend for the period from the last Dividend
Payment Date to the date fixed for liquidation, dissolution or winding-up). If
upon the occurrence of such event the assets thus distributed among the holders
of Series A Preferred Shares shall be insufficient to permit the payment to such
holders of the full preferential amount, the entire assets of the Issuer legally
available for distribution shall be distributed ratably based upon their
respective liquidation preference among the holders of the Series A Preferred
Shares pari passu with the holders of all Parity Shares. Except as provided in
Section 9(d), all amounts payable in respect of the Series A Preferred Shares in
the event of any liquidation, dissolution or winding up of the Issuer shall be
paid in cash. After payment of the full preferential amount (and, if applicable,
an amount equal to a pro rata dividend to the holders of Outstanding Series A
Preferred

                                       14
<PAGE>

Shares), such holders shall not be entitled to any further participation in any
distribution of assets of the Issuer.

                  (d) Notwithstanding the foregoing, in the case of liquidation,
dissolution or winding-up in connection with any transaction that is treated as
a sale, assignment, transfer, lease, conveyance or other disposition of all or
substantially all of the Issuer's assets under Section 14 in which the Issuer
receives in exchange for such assets, among other things, Replacement Preferred
Shares, the liquidation preference of each Series A Preferred Share, and any
other entitlement in respect of a Series A Preferred Share to receive any
distribution in connection with such liquidation, dissolution or winding-up,
shall be satisfied and discharged in full, upon distribution to the holders of
Series A Preferred Shares of such Replacement Preferred Shares, provided that
each holder of Series A Preferred Shares receives Replacement Preferred Shares
that, among other things, are convertible into the kind and amount securities,
cash and other property that such holder would have received had such holder
converted such holder's Series A Preferred Shares into Class A Common Shares
immediately prior to such transaction.

                  10. Redemption. (a) The Series A Preferred Shares may be
redeemed at any time commencing on or after February 1, 2005, in whole or from
time to time in part, at the election of the Issuer (the "Optional Redemption"),
at the redemption price per share set forth below plus accumulated and unpaid
dividends (including an amount equal to a prorated dividend for any partial
dividend period) and Additional Amounts and Special Dividends, if any, to the
Business Day specified as the date of redemption in the notice to the holders of
Series A Preferred Shares described below (the "Redemption Effective Date"), if
redeemed in the 12-month period commencing on the dates set forth below (unless
such date is not a Business Day in which case such period will commence on the
next succeeding Business Day):

Date                                                Redemption Price
----                                                ----------------
February 1, 2005                                         $51.875
February 1, 2006                                         $51.500
February 1, 2007                                         $51.125
February 1, 2008                                         $50.750
February 1, 2009                                         $50.375
February 1, 2010 and thereafter                          $50.000

                                       15
<PAGE>

         (b) The Series A Preferred Shares may be redeemed at any time in whole
or from time to time in part, at the election of the Issuer (the "Tax
Redemption"), at 100% of the liquidation preference per share plus accumulated
and unpaid dividends (including an amount equal to a prorated dividend for any
partial dividend period) and Additional Amounts and Special Dividends, if any,
to the Redemption Effective Date, if after the issue date of the Series A
Preferred Shares there is (i) a change in or amendment to laws, regulations or
rulings of any Applicable Jurisdiction, (ii) a change in the official
application or interpretation of those laws, regulations or rulings or (iii) any
execution of or amendment to any treaty affecting taxation to which any
Applicable Jurisdiction is party, in each case that would require the Issuer or
any successor corporation to pay Additional Amounts with respect to any shares
of Series A Preferred Shares on the next succeeding Dividend Payment Date, and
the payment of those Additional Amounts cannot be avoided by the use of any
reasonable measures available to the Issuer or any successor corporation.

         (c) With regards to the Optional Redemption and the Tax Redemption, on
the Redemption Effective Date (i) all cash to be paid as part of the redemption
price will become payable, (ii) all dividends on the Series A Preferred Shares
to be redeemed will cease to accrue, and (iii) the right to convert the Series A
Preferred Shares to be redeemed will cease at the close of business.

         If any Class A Common Shares are to be delivered as part of the
redemption price, (x) the number of Class A Common Shares to be delivered will
be determined on the basis of the average of the closing market prices of those
shares for the 10 Trading Days following the Redemption Effective Date and (y)
those shares will be deliverable on the 12th Trading Day following the
Redemption Effective Date.

         In the case of any partial redemption, the Issuer will select the
Series A Preferred Shares to be redeemed on a pro rata basis, by lot or any
other method that the Issuer, in its sole discretion, deems fair and
appropriate; provided that the Issuer may redeem all shares held by holders of
fewer than 100 Series A Preferred Shares (or by holders that would hold fewer
than 100 Series A Preferred Shares following such redemption) prior to the
Issuer's redemption of other Series A Preferred Shares.

         If the Redemption Effective Date falls after a Dividend Record Date and
before the related Dividend Payment Date, the holders of Series A Preferred
Shares at the close

                                       16
<PAGE>

of business on that Dividend Record Date will be entitled to receive the
dividend payable on those shares on the corresponding Dividend Payment Date,
even if those shares are redeemed after that Dividend Record Date.

         (d) The Series A Preferred Shares (if not earlier redeemed or
converted) shall be mandatorily redeemed (the "Mandatory Redemption") by the
Issuer on February 1, 2012, 2012 (the "Mandatory Redemption Date") (unless such
date is not a Business Day, in which case the Mandatory Redemption Date shall be
the next Business Day), at a redemption price of 100% of the liquidation
preference per share plus accumulated and unpaid dividends and Special
Dividends, if any, to the Mandatory Redemption Date.

         (e) No Optional Redemption may be authorized or made unless, prior to
giving the applicable redemption notice, all Accumulated Dividends and unpaid
dividends for periods ended prior to the date of such redemption notice shall
have been paid in cash or, subject to Section 11, in Class A Common Shares.

         (f) In the event the Issuer elects to effect an Optional Redemption or
a Tax Redemption, the Issuer shall give a redemption notice (the "Redemption
Notice") to the holders of Series A Preferred Shares not fewer than 30 days nor
more than 60 days before the Redemption Effective Date. Whenever a Redemption
Notice is required to be delivered to the holders, such notice shall provide the
information set forth below and be given by first class mail, postage prepaid to
each holder of Series A Preferred Shares to be redeemed, at such holder's
address appearing in the Series A Preferred Share Register. All Redemption
Notices shall identify the Series A Preferred Shares to be redeemed (including
CUSIP number) and shall state:

                  (i) the Redemption Effective Date;

                  (ii) the redemption price (the "Redemption Price");

                  (iii) the form of consideration the Issuer will use to satisfy
         the Redemption Price;

                  (iv) if any portion of the redemption price is to be paid by
         the delivery of Class A Common Shares, the method for determining the
         applicable Average Market Value and the date on which the Class A
         Common Shares will be deliverable;

                                       17
<PAGE>

                           (v) if fewer than all the outstanding Series A
                  Preferred Shares are to be redeemed, the identification (and,
                  in the case of partial redemption, the certificate number, the
                  total number of shares represented thereby and the number of
                  such shares being redeemed on the Redemption Date) of the
                  particular Series A Preferred Shares to be redeemed;

                           (vi) that on the Redemption Date the Redemption
                  Price, together with (subject to Section 10(j)) dividends
                  accumulated and unpaid to the Redemption Date (including an
                  amount equal to a prorated dividend for any partial dividend
                  period), will become due and payable upon each such Series A
                  Preferred Share to be redeemed and that dividends thereon will
                  cease to accrue on and after said date;

                           (vii) the conversion price (and, if applicable, the
                  amount of cash payable on conversion pursuant to Section
                  12(d)(x)), the date on which the right to convert Series A
                  Preferred Shares to be redeemed will terminate and the place
                  or places where such Series A Preferred Shares may be
                  surrendered for conversion; and

                           (viii) the place or places where such Series A
                  Preferred Shares are to be surrendered for payment of the
                  Redemption Price.

         The Redemption Notice shall be given by the Issuer or, at the Issuer's
request, by the Transfer Agent in the name and at the expense of the Issuer;
provided that if the Issuer so requests, it shall provide the Transfer Agent
adequate time, as reasonably determined by the Transfer Agent, to deliver such
notices in a timely fashion.

         (g) Prior to any Redemption Date, the Issuer shall deposit with the
Transfer Agent or with a Paying Agent (or, if the Issuer is acting as its own
Paying Agent, segregate and hold in trust) an amount of consideration sufficient
to pay the Redemption Price of and (except to the extent payable to a holder of
Series A Preferred Shares on a Dividend Record Date prior to the Redemption
Effective Date) accrued but unpaid dividends (including an amount equal to a
prorated dividend for any partial dividend period) on all the Series A Preferred
Shares which are to be redeemed on that date other than any Series A Preferred
Shares called for redemption on that date which have been converted into Class A
Common Shares prior to the date of such deposit. If

                                       18
<PAGE>

any Series A Preferred Share called for redemption is converted, any
consideration deposited with the Transfer Agent or with any Paying Agent or so
segregated and held in trust for the redemption of such Series A Preferred Share
shall (subject to any right of the holder of such Series A Preferred Share or
any predecessor Series A Preferred Share to receive accrued but unpaid dividends
thereon as provided in Section 7(f)) be paid or delivered to the Issuer upon
Issuer Order or, if then held by the Issuer, shall be discharged from such
trust.

         (h) Notice of redemption having been given as aforesaid, the Series A
Preferred Shares so to be redeemed shall, on the Redemption Effective Date,
become due and payable at the Redemption Price therein specified, and from and
after such date (unless the Issuer shall default in the payment of the
Redemption Price and accrued but unpaid dividends) dividends on such Series A
Preferred Shares shall cease to accrue and such shares shall cease to be
convertible into Class A Common Shares. Upon surrender of any such Series A
Preferred Shares for redemption in accordance with said notice, such Series A
Preferred Shares shall be redeemed, subject to Section 7(f), by the Issuer at
the Redemption Price, together with (except to the extent payable to a holder of
Series A Preferred Shares on a Dividend Record Date prior to the Redemption
Effective Date) accrued but unpaid dividends and Special Dividends, if any, to
the Redemption Date. If any Series A Preferred Share called for redemption shall
not be so paid upon surrender thereof for redemption, the Redemption Price
thereof, exclusive of accrued but unpaid dividends, shall, until paid, bear
interest from the Redemption Date at the dividend rate payable on the Series A
Preferred Shares.

         (i) Any certificate that represents more than one Series A Preferred
Share and is to be redeemed only in part shall be surrendered at any office or
agency of the Issuer designated for that purpose (with, if the Issuer or the
Transfer Agent so requires, due endorsement by, or a written instrument of
transfer in form satisfactory to the Issuer and the Transfer Agent duly executed
by, the holder thereof or his attorney duly authorized in writing), and the
Issuer shall execute, and the Transfer Agent shall countersign and deliver to
the holder of such Series A Preferred Share without service charge, a new Series
A Preferred Share certificate or certificates, representing any number of Series
A Preferred Shares as requested by such holder, in aggregate amount equal to and
in exchange for the number of shares not redeemed and represented by the Series
A Preferred Share certificate so surrendered.

                                       19
<PAGE>

         (j) If a Series A Preferred Share is redeemed subsequent to a Dividend
Record Date with respect to any Dividend Payment Date specified above and on or
prior to such Dividend Payment Date, then any accumulated but unpaid dividends
will be paid to the person in whose name such Series A Preferred Share is
registered at the close of business on such Dividend Record Date.

         11. Method of Payments and Public Announcement. (a) The Issuer may make
any payments due on the Series A Preferred Shares (other than, except as
provided in Section 9(d), payments of the liquidation preference and any
Accumulated Dividends pursuant to Section 9, which shall be made in cash),
including each regular dividend payment, Special Dividend payment, if any,
Additional Amount payment, if any, Optional Redemption payment, Tax Redemption
payment and Mandatory Redemption payment and any payments due under Section 13
as a result of a Change of Control, (i) in cash, (ii) by delivery of Class A
Common Shares or (iii) a combination thereof, as provided in this Section 11.
The Issuer will take all actions required or permitted under The Companies Act
1981 of Bermuda (the "Companies Act") to permit the payments on the Series A
Preferred Shares provided in this Certificate.

         (b) The Issuer will make each regular dividend payment, Special
Dividend payment, if any, Additional Amount payment, if any, Optional Redemption
payment, Tax Redemption payment and Mandatory Redemption payment on the Series A
Preferred Shares and any payment due under Section 13 as a result of a Change of
Control, in cash, except to the extent it has elected to make all or any portion
of such payment in Class A Common Shares. If the Issuer elects to make any such
payment, or any portion thereof, by delivery of Class A Common Shares, such
shares shall be valued for such purpose at 95% of the Average Market Value.
However, in the event that in any of the foregoing situations on the date of
such payment a Shelf Registration Statement is required to be effective under
the Registration Rights Agreement and is not effective the Class A Common Shares
shall be valued for such purpose at 80% of the Average Market Value.

         If the Issuer is prevented by Bermuda law from making any such payment
in cash or by issuing Class A Common Shares, the Issuer will issue from the
share premium attributable to the Series A Preferred Shares that number of
additional Series A Preferred Shares that is convertible at the then effective
Conversion Rate into the number of Class A Common Shares deliverable to holders
on such payment date ("Bonus Shares"). Upon delivery of Class A Common Shares
(including any Class A Common Shares issued upon

                                       20
<PAGE>

conversion by the Issuer of Bonus Shares) in respect of any such payments,
including any regular dividend, Special Dividend, if any, Additional Amount
payment, if any, Optional Redemption payment, Tax Redemption payment or
Mandatory Redemption payment or any payment due under Section 13 as a result of
a Change of Control, such payment shall be deemed to have been paid and
discharged to the extent of the value (determined as provided above) of the
Class A Common Shares so delivered.

         (c) No fractional Class A Common Shares will be delivered to the
holders of Series A Preferred Shares, but the Transfer Agent will instead
deliver a cash adjustment to each holder of Series A Preferred Shares that would
otherwise be entitled to a fraction of a Class A Common Share. The amount of
such cash adjustment will be determined based on, and such adjustments will be
paid from, the proceeds received by the Transfer Agent from the sale of that
number of Class A Common Shares, which the Issuer will deliver to the Transfer
Agent for such purpose, equal to the aggregate of all such fractions (round up
to the nearest whole share). The Transfer Agent is authorized and directed to
sell such shares at the best available prices and distribute the proceeds to the
holders in proportion to their respective interests therein. The Issuer will pay
the expenses of the Transfer Agent with respect to such sale, including
brokerage commissions.

         (d) Any portion of any payment on or in respect of the Series A
Preferred Shares that is declared and not paid through the delivery of Class A
Common Shares will be paid in cash.

         (e) The Issuer will notify the Transfer Agent and make a public
announcement (i) no later than the close of business on the tenth Business Day
prior to the Dividend Record Date for each regular dividend or Special Dividend
as to whether the Issuer will make the required payment on the related Dividend
Payment Date, and, if so, whether the Issuer will make such payment in cash, by
delivery of Class A Common Shares or a combination thereof, (ii) no later than
the close of business on the fifteenth Business Day prior to the Mandatory
Redemption Date, whether the Issuer will make the payment required on the
Mandatory Redemption Date in cash, by delivery of Class A Common Shares or a
combination thereof, (iii) no later than the close of business on the 30th day
prior to any Redemption Effective Date, whether the Issuer will make the
required payment in cash, by delivery of Class A Common Shares or a combination
thereof. The Issuer will make any public announcement required by this Section
by a press release

                                       21
<PAGE>

issued to Dow Jones News Service and Bloomberg News Service or their respective
successors. The Issuer will also deliver or mail a copy of each announcement to
each record holder of Series A Preferred Shares.

         (f) Prior to the issuance of any Class A Common Shares pursuant to this
Section 11, the Issuer shall have provided for the listing or quotation of such
Class A Common Shares on the Nasdaq National Market or any other securities
exchange in the United States upon which the Class A Common Shares are then
listed or quoted.

         12. Conversion. (a) Subject to and upon compliance with the provisions
of this Certificate, at the option of the holder thereof, any Series A Preferred
Share may be converted at any time prior to the close of business on the
Mandatory Redemption Date, unless previously redeemed, at the option of the
holder thereof, into fully paid and non-assessable Class A Common Shares at the
then effective Conversion Rate per Series A Preferred Share. A holder's right to
convert Series A Preferred Shares called for redemption will terminate at the
close of business on the applicable Redemption Effective Date and will be lost
if not exercised prior to that time, unless the Issuer defaults in making the
payment due upon redemption under Section 10(d).

         Subject to and upon compliance with the provisions of this Certificate,
each Series Preferred Share will be convertible at the Issuer's option at any
time within 24 hours of issuance, unless the Issuer waives its conversion right
in writing, into fully paid and non-assessable Class A Common Shares at the then
effective conversion rate. The Issuer may waive or exercise its conversion right
with respect to any Series A Preferred Share in advance of their issuance by
written notice to the transfer agent. Any such waiver or notice will be
irrevocable.

         The "Conversion Rate" shall be equal to $50 per Series A Preferred
Share divided by the Conversion Price. The "Conversion Price" shall be initially
$22.14 per share. The Conversion Price shall be adjusted in certain instances as
provided in Section 12(d) and Section 12(e).

         (b) In order to exercise the conversion privilege, the holder of any
Series A Preferred Share to be converted shall surrender the certificate for
such share, duly endorsed or assigned to the Issuer or in blank, at any office
or agency of the Issuer maintained for that purpose, accompanied by written
notice to the Issuer at such office

                                       22
<PAGE>

or agency that the holder elects to convert such share or, if fewer than all the
Series A Preferred Shares represented by a single share certificate are to be
converted, the number of shares represented thereby to be converted. Except as
provided in Section 10(a) or 7(f), no payment or adjustment shall be made upon
any conversion on account of any dividends accrued on the Series A Preferred
Shares surrendered for conversion or on account of any dividends on the Class A
Common Shares issued upon conversion. In no event shall the Issuer be obligated
to pay any converting holder any unpaid Accumulated Dividends upon conversion.

         Series A Preferred Shares shall be deemed to have been converted
immediately prior to the close of business on the day of surrender of such
shares for conversion in accordance with the foregoing provisions, and at such
time the rights of the holders of such shares as holders shall cease, and the
person or persons entitled to receive the Class A Common Shares issuable upon
conversion shall be treated for all purposes as the record holder or holders of
such Class A Common Shares at such time. As promptly as practicable on or after
the conversion date, the Issuer shall issue and shall deliver at such office or
agency a certificate or certificates for the number of full Class A Common
Shares issuable upon conversion, together with payment in lieu of any fraction
of a share, as provided in Section 12(c).

         In the case of any conversion of fewer than all the Series A Preferred
Shares evidenced by a certificate, upon such conversion the Issuer shall execute
and the Transfer Agent shall countersign and deliver to the holder thereof, at
the expense of the Issuer, a new certificate or certificates representing the
number of unconverted Series A Preferred Shares.

         (c) No fractional Class A Common Shares shall be issued upon the
conversion of a Series A Preferred Share; in lieu thereof, the Transfer Agent
will deliver a cash adjustment based upon the Closing Price of the Class A
Common Shares on the Business Day prior to the conversion date. The amount of
such cash adjustment will be determined based on and paid from the proceeds
received by the Transfer Agent from the sale of that number of Class A Common
Shares, which the Issuer will deliver to the Transfer Agent for such purpose,
equal to the aggregate of all such fractions (rounded up to the nearest whole
share).

                                       23
<PAGE>

         (d) The conversion price shall be adjusted from time to time by the
Issuer as follows:

                  (i) if the Issuer shall hereafter pay a dividend or make a
         distribution to holders of any class of its capital stock in Class A
         Common Shares, the Conversion Price in effect at the opening of
         business on the date following the date fixed for the determination of
         shareholders entitled to receive such dividend or other distribution
         shall be reduced by multiplying such Conversion Price by a fraction of
         which the numerator shall be the number of Class A Common Shares
         outstanding at the close of business on the Common Share Record Date
         (as defined in Section 12(d)(vi)) fixed for such determination and the
         denominator shall be the sum of such number of shares and the total
         number of shares constituting such dividend or other distribution, such
         reduction to become effective immediately after the opening of business
         on the day following the Common Share Record Date. If any dividend or
         distribution of the type described in this Section 12(d)(i) is declared
         but not so paid or made, the Conversion Price shall again be adjusted
         to the Conversion Price which would then be in effect if such dividend
         or distribution had not been declared. Not- withstanding the foregoing,
         no adjustment shall be made for the payment in Class A Common Shares
         (or the issuance of any Bonus Shares in connection therewith) in
         respect of the Series A Preferred Shares or in any other series of
         preferred shares with payment provisions that are substantially the
         same as the payment provisions of the Series A Preferred Shares.

                  (ii) if the Issuer shall offer or issue rights or warrants to
         holders of its outstanding Class A Common Shares entitling them to
         subscribe for or purchase Class A Common Shares at a price per share
         less than the Current Market Price (as defined in Section 12(d)(vi)) on
         the Common Share Record Date fixed for the determination of
         shareholders entitled to receive such rights or warrants, the
         Conversion Price shall be adjusted so that the same shall equal the
         price determined by multiplying the Conversion Price in effect at the
         opening of business on the date after such Common Share Record Date by
         a fraction of which the numerator shall be the number of Class A Common
         Shares outstanding at the close of business on the Common Share Record
         Date plus the number of Class A Common Shares which the aggregate
         offering price of the total number of Class A Common Shares subject to
         such rights or warrants would purchase at such Current

                                       24
<PAGE>

         Market Price and of which the denominator shall be the number of Class
         A Common Shares outstanding at the close of business on the Common
         Share Record Date plus the total number of additional Class A Common
         Shares subject to such rights or warrants for subscription or purchase.
         Such adjustment shall become effective immediately after the opening of
         business on the day following the Common Share Record Date fixed for
         determination of shareholders entitled to purchase or receive such
         rights or warrants. To the extent that Class A Common Shares are not
         delivered pursuant to such rights or warrants, upon the expiration or
         termination of such rights or warrants the Conversion Price shall again
         be adjusted to be the Conversion Price which would then be in effect
         had the adjustments made upon the issuance of such rights or warrants
         been made on the basis of delivery of only the number of Class A Common
         Shares actually delivered. If such rights or warrants are not so
         issued, the Conversion Price shall again be adjusted to be the
         Conversion Price which would then be in effect if such date fixed for
         the determination of shareholders entitled to receive such rights or
         warrants had not been fixed. In determining whether any rights or
         warrants entitle the holders to subscribe for or purchase Class A
         Common Shares at less than such Current Market Price, and in
         determining the aggregate offering price of such Class A Common Shares,
         there shall be taken into account any consideration received for such
         rights or warrants, with the value of such consideration, if other than
         cash, to be determined by the Board of Directors;

                  (iii) if the outstanding Class A Common Shares shall be
         subdivided into a greater number of Class A Common Shares, the
         Conversion Price in effect at the opening of business on the day
         following the day upon which such subdivision becomes effective shall
         be proportionately reduced, and, conversely, if the outstanding Class A
         Common Shares shall be combined into a smaller number of Class A Common
         Shares, the Conversion Price in effect at the opening of business on
         the day following the day upon which such combination becomes effective
         shall be proportionately increased, such reduction or increase, as the
         case may be, to become effective immediately after the opening of
         business on the day following the day upon which such subdivision or
         combination becomes effective;

                  (iv) if the Issuer shall, by dividend or otherwise, distribute
         to holders of its Class A Common Shares any

                                       25
<PAGE>

         class of capital stock of the Issuer (other than any dividends or
         distributions to which Section 12(d)(i) applies) or evidences of its
         indebtedness, cash or other assets (including securities, but excluding
         any rights or warrants of a type referred to in Section 12(d)(ii) and
         dividends and distributions paid exclusively in cash and excluding any
         capital stock, evidences of indebtedness, cash or assets distributed
         upon a merger or consolidation to which Section 12(e) applies) (the
         foregoing hereinafter in this Section 12(d)(iv) called the "Distributed
         Securities"), then, in each such case, the Conversion Price shall be
         reduced so that the same shall be equal to the price determined by
         multiplying the Conversion Price in effect immediately prior to the
         close of business on the Common Share Record Date (as defined in
         Section 12(d)(vi)) with respect to such distribution by a fraction of
         which the numerator shall be the Current Market Price (determined as
         provided in Section 12(d)(vi)) on such date less the fair market value
         (as determined by the Board of Directors, whose determination shall be
         conclusive and described in a resolution of the Board of Directors) on
         such date of the portion of the Distributed Securities so distributed
         applicable to one Class A Common Share and the denominator shall be
         such Current Market Price, such reduction to become effective
         immediately prior to the opening of business on the day following the
         Common Share Record Date; provided, however, that, in the event the
         then fair market value (as so determined) of the portion of the
         Distributed Securities so distributed applicable to one Class A Common
         Share is equal to or greater than the Current Market Price on the
         Common Share Record Date, in lieu of the foregoing adjustment, adequate
         provision shall be made so that each holder of Series A Preferred
         Shares shall have the right to receive upon conversion of a Series A
         Preferred Share (or any portion thereof) the amount of Distributed
         Securities such holder would have received had such holder converted
         such Series A Preferred Share (or portion thereof) immediately prior to
         such Common Share Record Date. If such dividend or distribution is not
         so paid or made, the Conversion Price shall again be adjusted to be the
         Conversion Price which would then be in effect if such dividend or
         distribution had not been declared. If the Board of Directors
         determines the fair market value of any distribution for purposes of
         this Section 12(d)(iv) by reference to the actual or when issued
         trading market for any securities constituting all or part of such
         distribution, it must in doing so consider the prices in such market
         over the

                                       26
<PAGE>

         same period used in computing the Current Market Price pursuant to
         Section 12(d)(vi) to the extent possible.

                  Rights or warrants distributed by the Issuer to holders of
         Class A Common Shares entitling the holders thereof to subscribe for or
         purchase shares of the Issuer's capital stock (either initially or
         under certain circumstances), which rights or warrants, until the
         occurrence of a specified event or events ("Dilution Trigger Event"):
         (A) are deemed to be transferred with such Class A Common Shares; (B)
         are not exercisable; and (C) are also issued in respect of future
         issuances of Class A Common Shares, shall be deemed not to have been
         distributed for purposes of this Section 12(d)(iv) (and no adjustment
         to the Conversion Price under this Section 12(d)(iv) shall be required)
         until the occurrence of the earliest Dilution Trigger Event, whereupon
         such rights and warrants shall be deemed to have been distributed and
         an appropriate adjustment to the Conversion Price under this Section
         12(d)(iv) shall be made. If any such rights or warrants, including any
         such existing rights or warrants distributed prior to the first
         issuance of Series A Preferred Shares, are subject to subsequent
         events, upon the occurrence of each of which such rights or warrants
         shall become exercisable to purchase different securities, evidences of
         indebtedness or other assets, then the occurrence of each such event
         shall be deemed to be such date of issuance and record date with
         respect to new rights or warrants (and a termination or expiration of
         the existing rights or warrants, without exercise by the holder
         thereof). In addition, in the event of any distribution (or deemed
         distribution) of rights or warrants, or any Dilution Trigger Event with
         respect thereto, that was counted for purposes of calculating a
         distribution amount for which an adjustment to the Conversion Price
         under this Section 12(d) was made, (1) in the case of any such rights
         or warrants which shall all have been redeemed or repurchased without
         exercise by any holders thereof, the Conversion Price shall be
         readjusted upon such final redemption or repurchase to give effect to
         such distribution or Dilution Trigger Event, as the case may be, as
         though it were a cash distribution, equal to the per share redemption
         or repurchase price received by a holder or holders of Class A Common
         Shares with respect to such rights or warrants (assuming such holder
         had retained such rights or warrants), made to all holders of Class A
         Common Shares as of the date of such redemption or repurchase, and (2)
         in the case of such rights or warrants which shall have expired or been

                                       27
<PAGE>

         terminated without exercise by any holders thereof, the Conversion
         Price shall be readjusted as if such rights and warrants had not been
         issued.

                  Notwithstanding any other provision of this Section 12(d)(iv)
         to the contrary, rights, warrants, evidences of indebtedness, other
         securities, cash or other assets (including, without limitation, any
         rights distributed pursuant to any shareholder rights plan) shall be
         deemed not to have been distributed for purposes of this Section
         12(d)(iv) if the Issuer makes proper provision so that each holder of
         Series A Preferred Shares who converts a Series A Preferred Share (or
         any portion thereof) after the date fixed for determination of
         shareholders entitled to receive such distribution shall be entitled to
         receive upon such conversion, in addition to the Class A Common Shares
         issuable upon such conversion, the amount and kind of such
         distributions that such holder would have been entitled to receive if
         such holder had, immediately prior to such determination date,
         converted such Series A Preferred Share (or portion thereof).

                  For purposes of this Section 12(d)(iv) and Sections 12(d)(i)
         and (ii), any dividend or distribution to which this Section 12(d)(iv)
         is applicable that also includes Class A Common Shares, or rights or
         warrants to subscribe for or purchase Class A Common Shares to which
         Section 12(d)(ii) applies (or both), shall be deemed instead to be (A)
         a dividend or distribution of the evidences of indebtedness, assets,
         shares of capital stock, rights or warrants other than such Class A
         Common Shares or rights or warrants to which Section 12(d)(ii) applies
         (and any Conversion Price reduction required by this Section 12(d)(iv)
         with respect to such dividend or distribution shall then be made)
         immediately followed by (B) a dividend or distribution of such Class A
         Common Shares or such rights or warrants (and any further Conversion
         Price reduction required by Sections 12(d)(i) or 12(d)(ii) with respect
         to such dividend or distribution shall then be made), except that (1)
         the Common Share Record Date of such dividend or distribution shall be
         substituted as "the date fixed for the determination of stockholders
         entitled to receive such dividend or other distribution", "the Common
         Share Record Date fixed for such determination" and "the Common Share
         Record Date" within the meaning of Section 12(d)(i) and as "the date
         fixed for the determination of shareholders entitled to receive such
         rights or warrants", "the Common Share Record Date fixed for the
         determination of the

                                       28
<PAGE>

         shareholders entitled to receive such rights or warrants" and "such
         Common Share Record Date" for purposes of Section 12(d)(ii), and (2)
         any Class A Common Shares included in such dividend or distribution
         shall not be deemed "outstanding at the close of business on the date
         fixed for such determination" for the purposes of Section 12(d)(i).

                  (v) If the Issuer shall, by dividend, repurchase or otherwise,
         distribute to holders of its Class A Common Shares cash (excluding any
         cash that is distributed upon a merger or consolidation to which
         Section 12(e) applies or as part of a distribution referred to in
         Section 12(d)(iv)) in an aggregate amount that, combined together with
         (A) the aggregate amount of any other such distributions to holders of
         its Class A Common Shares made exclusively in cash within the 12 months
         preceding the date of payment of such distribution, and in respect of
         which no adjustment pursuant to this Section 12(d)(v) has been made,
         and (B) the aggregate of any cash plus the fair market value (as
         determined by the Board of Directors, whose determination shall be
         conclusive and described in a resolution of the Board of Directors) of
         consideration payable in respect of any repurchases by the Issuer for
         all or any portion of the Class A Common Shares concluded within the 12
         months preceding the date of payment of such distribution, and in
         respect of which no adjustment pursuant to this Section 12(d)(v) has
         been made, exceeds 10% of the product of the Current Market Price
         (determined as provided in Section 12(d)(v)) times the number of Class
         A Common Shares outstanding on such date, then, and in each such case,
         immediately after the close of business on such date, the Conversion
         Price shall be reduced so that the same shall equal the price
         determined by multiplying the Conversion Price in effect immediately
         prior to the close of business on such date by a fraction (1) the
         numerator of which shall be equal to the Current Market Price on the
         Common Share Record Date for such distribution less an amount equal to
         the quotient of (x) the excess of such combined amount over such 10%
         and (y) the number of Class A Common Shares outstanding on such Common
         Share Record Date and (2) the denominator of which shall be equal to
         the Current Market Price on such Common Share Record Date; provided,
         however, that, if the portion of the cash so distributed applicable to
         one Class A Common Share is equal to or greater than the Current Market
         Price of the Class A Common Shares on such Common Share Record Date, in
         lieu of the foregoing adjustment, adequate

                                       29

<PAGE>

         provision shall be made so that each holder of Series A Preferred
         Shares shall have the right to receive upon conversion of a Series A
         Preferred Share (or any portion thereof) the amount of cash such holder
         would have received had such holder converted such Series A Preferred
         Share (or portion thereof) immediately prior to such Common Share
         Record Date. If such dividend or distribution is not so paid or made,
         the Conversion Price shall again be adjusted to be the Conversion Price
         which would then be in effect if such dividend or distribution had not
         been declared. Any cash distribution to holders of Class A Common
         Shares as to which the Issuer makes the election permitted by Section
         12(d)(x) and as to which the Issuer has complied with the requirements
         of such Section 12(d)(x) shall be treated as not having been made for
         all purposes of this Section 12(d)(v).

                  (vi) For purposes of this Section 12(d), the following terms
         shall have the meaning indicated:

                           "Closing Price" with respect to any securities on any
                  day means the closing price on such day or, if no such sale
                  takes place on such day, the average of the reported high and
                  low prices on such day, in each case on the Nasdaq National
                  Market or the New York Stock Exchange, as applicable, or, if
                  such security is not listed or admitted to trading on such
                  national market or exchange, on the principal national
                  securities exchange or quotation system in the United States
                  on which such security is quoted or listed or admitted to
                  trading, or, if not quoted or listed or admitted to trading on
                  any national securities exchange or quotation system in the
                  United States, the average of the high and low prices of such
                  security on the over-the-counter market on the day in question
                  as reported by the National Quotation Bureau Incorporated or a
                  similar generally accepted reporting service in the United
                  States, or, if not so available, in such manner as furnished
                  by any New York Stock Exchange member firm selected from time
                  to time by the Board of Directors for that purpose, or a price
                  determined in good faith by the Board of Directors, whose
                  determination shall be conclusive and described in a
                  resolution of the Board of Directors.

                           "Common Share Record Date" shall mean, with respect
                  to any dividend, distribution or other transaction or event in
                  which the holders of

                                       30
<PAGE>

                  Class A Common Shares have the right to receive any cash,
                  securities or other property or in which the Class A Common
                  Shares (or other applicable security) is exchanged for or
                  converted into any combination of cash, securities or other
                  property, the date fixed for determination of shareholders
                  entitled to receive such cash, securities or other property
                  (whether such date is fixed by the Board of Directors or by
                  statute, contract or otherwise).

                           "Current Market Price" means, as of any date, the
                  arithmetic average of the Current Market Value of the Class A
                  Common Shares for the ten Trading Days ending on the second
                  Business Day prior to such date. Notwithstanding the
                  foregoing, whenever successive adjustments to the Conversion
                  Price are called for pursuant to this Section 12(d), such
                  adjustments shall be made to the Current Market Price as may
                  be necessary or appropriate to effectuate the intent of this
                  Section 12(d) and to avoid unjust or inequitable results,
                  including such adjustments as may be necessary as a result of
                  the occurrence of one or more "ex" dates during such 10
                  Trading Day period, as determined in good faith by the Board
                  of Directors.

                           "fair market value" shall mean the amount which a
                  willing buyer would pay a willing seller in an arm's-length
                  transaction.

                  (vii) No adjustment in the Conversion Price shall be required
         unless such adjustment would require an increase or decrease of at
         least 1% in such price; provided, however, that any adjustments which
         by reason of this Section 12(d)(vii) are not required to be made shall
         be carried forward and taken into account in any subsequent adjustment.
         All calculations under this Section 12 shall be made by the Issuer and
         shall be made to the nearest cent. No adjustment need be made for a
         change in the par value or no par value of the Class A Common Shares.

                  (viii) Whenever the Conversion Price is adjusted as herein
         provided, the Issuer shall promptly file with the Transfer Agent an
         Officers' Certificate setting forth the Conversion Price after such
         adjustment and setting forth a brief statement of the facts requiring
         such adjustment. Promptly after delivery of such certificate, the
         Issuer shall prepare a notice of such

                                       31
<PAGE>

         adjustment of the Conversion Price setting forth the adjusted
         Conversion Price and the date on which each adjustment becomes
         effective and shall mail such notice of such adjustment of the
         Conversion Price to each holder of Series A Preferred Shares at such
         holder's last address appearing on the register of holders maintained
         for that purpose within 20 days of the effective date of such
         adjustment. Failure to deliver such notice shall not affect the
         legality or validity of any such adjustment.

                  (ix) In any case in which this Section 12(d) provides that an
         adjustment shall become effective immediately after a Common Share
         Record Date for an event, the Issuer may defer until the occurrence of
         such event issuing to the holder of any Series A Preferred Share
         converted after such Common Share Record Date and before the occurrence
         of such event the additional Class A Common Shares issuable upon such
         conversion by reason of the adjustment required by such event over and
         above the Class A Common Shares issuable upon such conversion before
         giving effect to such adjustment.

                  (x) In lieu of making any adjustment to the Conversion Price
         pursuant to Section 12(d)(v), the Issuer may elect to reserve an amount
         of cash for distribution to the holders of Series A Preferred Shares
         upon the conversion of the Series A Preferred Shares so that any such
         holder converting Series A Preferred Shares will receive upon such
         conversion, in addition to the Class A Common Shares and other items to
         which such holder is entitled, the full amount of cash which such
         holder would have received if such holder had, immediately prior to the
         Common Share Record Date for such distribution of cash, converted its
         Series A Preferred Shares into Class A Common Shares, together with any
         interest accrued with respect to such amount, in accordance with this
         Section 12(d)(x). The Issuer may make such election by providing an
         Officers' Certificate to the Transfer Agent to such effect on or prior
         to the payment date for any such distribution and depositing with the
         Transfer Agent on or prior to such date an amount of cash equal to the
         aggregate amount that the holders of Series A Preferred Shares would
         have received if such holders had, immediately prior to the Common
         Share Record Date for such distribution, converted all the Series A
         Preferred Shares into Class A Common Shares. Any such funds so
         deposited by the Issuer with the Transfer Agent shall be invested by
         the Transfer Agent

                                       32
<PAGE>

         in unconditional U.S. Government obligations with a maturity not more
         than three months from the date of issuance. Upon conversion of Series
         A Preferred Shares by a holder thereof, such holder shall be entitled
         to receive, in addition to the Class A Common Shares issuable upon
         conversion, an amount of cash equal to the amount such holder would
         have received if such holder had, immediately prior to the Common Share
         Record Date for such distribution, converted its Series A Preferred
         Shares into Class A Common Shares, along with such holder's pro rata
         share of any accrued interest earned as a consequence of the investment
         of such funds. Promptly after making an election pursuant to this
         Section 12(d)(xi), the Issuer shall give or shall cause to be given
         notice to all holders of Series A Preferred Shares of such election,
         which notice shall state the amount of cash per Series A Preferred
         Share such holders shall be entitled to receive (excluding interest)
         upon conversion of the Series A Preferred Shares as a consequence of
         the Issuer having made such election.

         (e) Subject to Section 13, in case of any consolidation of the Issuer
with, or merger of the Issuer into, any other corporation, or in case of any
merger of another corporation into the Issuer (other than a merger which does
not result in any reclassification, conversion, exchange or cancelation of
outstanding shares of Class A Common Shares of the Issuer), or in case of any
sale, conveyance or transfer of all or substantially all the assets of the
Issuer, the holder of each Series A Preferred Share then outstanding shall have
the right thereafter, during the period such Series A Preferred Share shall be
convertible as specified in Section 12(a), to convert such Series A Preferred
Share only into the kind and amount of securities, cash and other property
receivable upon such consolidation, merger, conveyance or transfer by a holder
of the number of shares of Class A Common Shares of the Issuer into which such
Series A Preferred Share might have been converted immediately prior to such
consolidation, merger, conveyance or transfer, assuming such holder of Class A
Common Shares of the Issuer failed to exercise his rights of election, if any,
as to the kind or amount of securities, cash and other property receivable upon
such consolidation, merger, conveyance or transfer (provided that, if the kind
or amount of securities, cash and other property receivable upon such
consolidation, merger, conveyance or transfer is not the same for each Class A
Common Share of the Issuer in respect of which such rights of election shall not
have been exercised ("Nonelecting Share"), then for the purpose of this Section
12 the kind and amount of securities, cash and

                                       33
<PAGE>

other property receivable upon such consolidation, merger, conveyance or
transfer by each Nonelecting Share shall be deemed to be the kind and amount so
receivable per share by a plurality of the Nonelecting Shares). Such securities
shall provide for adjustments which, for events subsequent to the effective date
of the triggering event, shall be as nearly equivalent as may be practicable to
the adjustments provided for in this Section 12. The above provisions of this
Section 12 shall similarly apply to successive consolidations, mergers,
conveyances or transfers.

         (f)  In case:

                           (i) the Issuer shall declare a dividend (or any other
                  distribution) on its Class A Common Shares payable otherwise
                  than in cash out of its earned surplus; or

                           (ii) the Issuer shall authorize the granting to all
                  holders of its Class A Common Shares of rights or warrants to
                  subscribe for or purchase any shares of capital stock of any
                  class or of any other rights; or

                           (iii) of any reclassification of the Class A Common
                  Shares of the Issuer (other than a subdivision or combination
                  of its outstanding Class A Common Shares), or of any
                  consolidation or merger to which the Issuer is a party and for
                  which approval of any shareholders of the Issuer is required,
                  or the sale, conveyance or transfer of all or substantially
                  all the assets of the Issuer; or

                           (iv) of the voluntary or involuntary dissolution,
                  liquidation or winding-up of the Issuer (other than in
                  connection with a sale of all or substantially all of the
                  assets of the Issuer governed by Section 14);

then the Issuer shall cause to be filed with the Transfer Agent and at each
office or agency maintained for the purpose of conversion of Series A Preferred
Shares, and shall cause to be mailed to all holders at their last addresses as
they shall appear in the Series A Preferred Shares Register, at least 20
Business Days (or 10 Business Days in any case specified in clause (i) or (ii)
above) prior to the applicable date hereinafter specified, a notice stating (x)
the date on which a record is to be taken for the purpose of such dividend,
distribution, rights or warrants, or, if a record is not to be taken, the date
as of

                                       34
<PAGE>

which the holders of Class A Common Shares of record to be entitled to
such dividend, distribution, rights or warrants are to be determined or (y) the
date on which such reclassification, consolidation, merger, sale, transfer,
dissolution, liquidation or winding-up is expected to become effective, and the
date as of which it is expected that holders of Class A Common Shares of record
shall be entitled to exchange their Class A Common Shares for securities, cash
or other property deliverable upon such reclassification, consolidation, merger,
sale, transfer, dissolution, liquidation or winding-up. Failure to give the
notice required by this Section 12(f) or any defect therein shall not affect the
legality or validity of any dividend, distribution, right, warrant,
reclassification, consolidation, merger, sale, transfer, dissolution,
liquidation or winding-up, or the vote upon any such action.

         (g) In addition to the conversion right specified in Section 12(a),
subject to and upon compliance with the provisions of this Certificate, at the
option of the holder thereof a Series A Preferred share may be converted into
Class A Common Shares on the Change of Control Conversion Date specified below
in the circumstances described in the next two paragraphs.

         If the Issuer is prevented under the terms of any applicable debt
instrument from effecting a Change of Control Purchase Offer pursuant to Section
13, the Issuer shall within 30 days following any Change of Control, mail a
notice to each holder of Series A Preferred Shares describing the transaction or
transactions that constitute the Change of Control and offering to convert that
holder's Series A Preferred Shares on the date (the "Change of Control
Conversion Date") specified in that notice (the "Change of Control Conversion
Notice"), which date will be no earlier than 60 days from the date the Change of
Control Conversion Notice is mailed.

         On the Change of Control Conversion Date, the Issuer will convert each
Series A Preferred Share submitted for conversion into that number of Class A
Common Shares which is equal to the number of Class A Common Shares that would
have been payable had a Change of Control Purchase been effected using entirely
Class A Common Shares. To the extent applicable the Issuer will comply with Rule
14e-1 under the Exchange Act and any other applicable securities laws. The
requirements of such laws shall supersede any inconsistent provisions of this
Section 12(g).

         (h) The Issuer shall at all times reserve and keep available, free from
preemptive rights, out of its

                                       35
<PAGE>

authorized but unissued Class A Common Shares, for the purpose of effecting the
conversion of Series A Preferred Shares, the full number of Class A Common
Shares then issuable upon the conversion of all outstanding Series A Preferred
Shares.

         13. Change of Control. (a) If the Issuer experiences a Change of
Control, each holder of Series A Preferred Shares will have the right to require
the Issuer to purchase (a "Change of Control Purchase") all or any part of that
holder's Series A Preferred Shares at a purchase price equal to 100% of the
liquidation preference of those shares, plus all Accumulated Dividends and
unpaid dividends on those shares to the date of purchase. Within 30 days
following any Change of Control, the Issuer will mail a notice to each holder of
Series A Preferred Shares describing the transaction or transactions that
constitute the Change of Control and offer to purchase that holder's Series A
Preferred Shares on the date (the "Change of Control Purchase Date") specified
in that notice (the "Change of Control Offer to Purchase Notice"), which date
will be no earlier than 60 days from the date the Change of Control Purchase
Notice is mailed. The Issuer will also advise holders in each notice of whether
it will pay the change of control purchase price in the form of cash, Class A
Common Shares or a combination thereof.

         The Issuer will comply with the requirements of Rule 14e-1 under the
Exchange Act and any other securities laws and regulations to the extent those
laws and regulations are applicable in connection with the purchase of preferred
stock as a result of a Change of Control. To the extent that the provisions of
any securities laws or regulations conflict with any of the provisions of this
Section, the Issuer will comply with the applicable securities laws and
regulations and will be deemed not to have breached its obligations under this
section.

         (b) On the date scheduled for payment for the purchase of the Series A
Preferred Shares under this Section, the Issuer will, to the extent lawful, (a)
accept for payment all Series A Preferred Shares properly tendered, (b) deposit
with the Transfer Agent the purchase price of the Series A Preferred Shares so
tendered and (c) deliver or cause to be delivered to the Transfer Agent Series A
Preferred Shares so accepted together with an Officers' Certificate stating the
aggregate liquidation preference of the Series A Preferred Shares being
purchased by the Issuer. The Transfer Agent will promptly mail or deliver to
each holder of Series A Preferred Shares so tendered the applicable payment for
those Series A Preferred Shares, and

                                       36
<PAGE>

the Transfer Agent will promptly countersign and mail or deliver, or cause to be
transferred by book-entry, to each such holder new Series A Preferred Shares
equal in liquidation preference to any unpurchased portion of the Series A
Preferred Shares surrendered, if any. The Issuer will publicly announce the
results of this offer on or as soon as practicable after the payment date for
the purchase of Series A Preferred Shares in connection with a Change of
Control.

         (c) Notwithstanding the foregoing, the Issuer shall not be required to
repurchase any Series A Preferred Shares in connection with a Change of Control
until it has repurchased any and all indebtedness and senior securities that are
required by their terms to be repurchased in connection with such Change of
Control. In addition, the Issuer will not be required to make an offer to
purchase any Series A Preferred Shares upon the occurrence of a Change of
Control if a third party makes that offer in the manner, at the times and
otherwise in compliance with the requirements described in this Section 13 and
purchases all Series A Preferred Shares validly tendered and not withdrawn.

         (d) If the Issuer is prohibited from paying cash upon a Change of
Control under any applicable debt instrument, then, notwithstanding the
provisions of this Section 13, the Issuer shall not be required to effect a
Change of Control Purchase Offer pursuant to this Section 13, but instead shall
be required to offer to effect a Change of Control conversion after pursuant to
Section 12g.

         (e) For purposes of this Section 13, the following terms shall have the
meaning indicated:

         A "Change of Control" means: (i) a "person" or "group" (within the
meaning of Sections 13(d) and 14(d)(2) of the Exchange Act) becomes the ultimate
"beneficial owner" (as defined in Rule 13-d under the Exchange Act) of more than
35% of the total voting power of the Issuer's Voting Stock on a fully diluted
basis and such ownership is greater than the amount of voting power of the
Issuer's Voting Stock, on a fully diluted basis, held by the Existing
Stockholders and their Affiliates on such date; (ii) individuals who on the
Closing Date constitute the Board of Directors (together with any new directors
whose election by the Board of Directors or whose nomination for election by
stockholders was approved by a vote of at least two-thirds of the members of the
Board of Directors then in office who either were members of the Board of
Directors on the Closing Date or whose election or nomination for

                                       37
<PAGE>

election was previously so approved) cease for any reason to constitute a
majority of the members of the Board of Directors then in office; (iii) all the
common stock of RSL Communications PLC is not beneficially owned by the Issuer
(other than directors' qualifying shares) or the Issuer's successor in a
transaction governed by the provisions described in Section 14 or (iv) the
Existing Stockholders as a group acquire, on a cumulative basis after the
Closing Date, directly or indirectly, beneficial ownership of more than (x)
three million additional Class A Common Shares plus (y) 50% of the number of
Class A Common Shares issued by the Issuer in underwritten public offerings
occurring after the Closing Date to persons other than the existing
stockholders, plus (z) the number of Class A Common Shares sold by the Existing
Stockholders in the public markets after the date hereof; this calculation shall
exclude acquisitions from the Issuer or from other Existing Stockholders or from
other officers and directors or Metro Holdings AG of Class A Common Shares owned
by them on the date hereof, including as a result of the conversion of
securities held by the Existing Stockholders on the date hereof; the share
threshold will be appropriately adjusted for stock splits, combinations,
reclassifications and similar transactions.

         "Voting Stock" means Capital Stock which ordinarily has voting power
for the election of directors (or persons performing similar functions), whether
at all times or only so long as no senior class of securities has such voting
power by reason of any contingency.

         "Capital Stock" means any and all shares, interests, participants or
other equivalents (however designated) or corporate stock or other equity
participants, including partnership interests, whether general or limited.

         "Existing Stockholders" means (i) R.S. Lauder, Gaspar & Co., L.P.,
("RSLAG"), (ii) partners in RSLAG and Lauder Gaspar Ventures LLC and their
affiliates, in each case as of the closing of this offering, (iii) Itzhak
Fisher, Ronald S. Lauder, Leonard A. Lauder, Jacob Z. Schuster, Nir Tarlovsky,
Nesim N. Bildirici, and Eugene Sekulow, (iv) family members of any of the
foregoing, (v) trusts, the only beneficiaries of which are persons or entities
described in clauses (i) through (iv) above and (vi) partnerships which are
controlled by the persons or entities described in clauses (i) through (iv)
above.

         "Affiliate" means any persons directly or indirectly controlling or
controlled by or under direct or indirect common control with such person. For
the purposes

                                       38
<PAGE>

of this definition, "control" when used with respect to any person means to
direct the management and policies of such person, directly or indirectly,
whether through the ownership of voting securities, by contract or otherwise,
and the terms "controlling" and "controlled" have meanings correlative to the
foregoing.

         14. Consolidation, Merger, Conveyance or Transfer. Without the vote or
consent of the holders of a majority of the then Outstanding Series A Preferred
Shares, the Issuer may not consolidate or merge with or into, or sell, assign,
transfer, lease, convey or otherwise dispose of all or substantially all of its
assets to, any person unless (a) the entity formed by such consolidation or
merger (if other than the Issuer) or to which such sale, assignment, transfer,
lease, conveyance or other disposition shall have been made (in any such case,
the "resulting entity") is a corporation organized and existing under the laws
of Bermuda, the United Kingdom, the United States or any State thereof or the
District of Columbia, the British Virgin Islands, Cayman Islands, the
Netherlands, Ireland or Jersey; (b) if the Issuer is not the resulting entity,
the Series A Preferred Shares are converted into or exchanged for and become
shares of such resulting entity ("Replacement Preferred Shares"), having in
respect of such resulting entity the same (or more favorable) powers,
preferences and relative, participating, optional or other special rights that
the Series A Preferred Shares had immediately prior to such transaction; (c)
immediately after giving effect to such transaction, no Voting Rights Triggering
Event has occurred and is continuing and (d) the Issuer shall have delivered to
the Transfer Agent an Officers' Certificate and an opinion of counsel, each
stating that such consolidation, merger, conveyance or transfer complies with
this Section 13 and that all conditions precedent herein provided for relating
to such transaction have been complied with.

         The resulting entity of such transaction shall thereafter be deemed to
be the "Issuer" for all purposes of this Certificate and the predecessor shall
be relieved of all obligations with respect to the Series A Preferred Shares.

         15. SEC Reports; Reports by Issuer. So long as any Series A Preferred
Shares are outstanding, the Issuer shall file with the SEC and, within 15 days
after it files them with the SEC, with the Transfer Agent and, if requested,
furnish to the holders of Series A Preferred Shares all annual and quarterly
reports and the information, documents, and other reports that the Issuer is
required to file with the SEC pursuant to Section 13(a) or 15(d) of the

                                       39
<PAGE>

Exchange Act ("SEC Reports"). In the event the Issuer is not required or shall
cease to be required to file SEC Reports, pursuant to the Exchange Act, the
Issuer will nevertheless file such reports with the SEC (unless the SEC will not
accept such a filing). Whether or not required by the Exchange Act to file SEC
Reports with the SEC, so long as any Series A Preferred Shares are Outstanding,
the Issuer will furnish or cause to be furnished copies of the SEC Reports to
the Transfer Agent at the time the Issuer is required to make such information
available to the Transfer Agent, to holders of Series A Preferred Shares and to
prospective investors who request it in writing. In addition, the Issuer has
agreed that, for so long as any Series A Preferred Shares remain outstanding, if
the Issuer is required pursuant to Rule 144A(d)(4) under the Securities Act, it
will furnish to the holders and to securities analysts and prospective
investors, upon their reasonable request, the information required to be
delivered pursuant to Rule 144A(d)(4) under Securities Act.

                                       40
<PAGE>

         16. Definitions. For purposes of this Certificate, the following terms
shall have the meaning set forth below:

         "Accumulated Dividends" has the meaning set forth in Section 3.

         "Additional Amounts" has the meaning set forth in Section 6(c).

         "Agent Members" has the meaning set forth in Section 4(c).

         "Applicable Jurisdiction" has the meaning set forth in Section 6(c).

         "Affiliate" has the meaning set forth in Section 13(d).

         "Average Market Value" of the Class A Common Shares means (a) with
respect to the payment of any dividends, including regular dividends, Special
Dividends and Additional Amounts, the arithmetic average of the Current Market
Value (as defined below) of the Class A Common Shares for the five Trading Days
ending on the second Business Day prior to the Dividend Record Date for such
dividend, (b) with respect to any Optional Redemption or Tax Redemption, the
arithmetic average of the Current Market Value of the Class A Common Shares for
the ten Trading Days beginning on the Trading Day following the Redemption
Effective Date and (c) with respect to Mandatory Redemption, offers to purchase
pursuant to Section 13 or any other payment, the arithmetic average of the
Current Market Value of the Class A Common Shares for the ten Trading Days
ending on the second Business Day prior to the date of such payment.

         "Bonus Shares" has the meaning set forth in Section 11.

         "Business Day" means each Monday, Tuesday, Wednesday, Thursday and
Friday which is not a day on which banking institutions in The City of New York
are authorized or obligated by law or executive order to be closed.

         "Bye-Laws" has the meaning set forth in the Recitals.

         "Capital Stock" has the meaning set forth in 13(d).

                                       41
<PAGE>

         "Change of Control" has the meaning set forth in Section 13(d).

         "Change of Control Conversion Date" has the meaning set forth in
Section 12(g).

         "Change of Control Conversion Notice" has the meaning set forth in
Section 12(g).

         "Change of Control Purchase" has the meaning set forth in Section
13(a).

         "Change of Control Purchase Date" has the meaning set forth in Section
13(a).

         "Change of Control Offer to Purchase Notice" has the meaning set forth
in Section 13(a).

         "Class A Common Shares" means the Class A Common shares, par value
U.S.$.00457 per share.

         "Closing Date" means any Closing Date under the Purchase Agreement.

         "Closing Price" has the meaning set forth in Section 12(d)(vi).

         "Common Share Record Date" has the meaning set forth in Section
12(d)(vi).

         "Companies Act" has the meaning set forth in Section 11(a).

         "Conversion Agent" has the meaning set forth in Section 5(a).

         "Conversion Price" has the meaning set forth in Section 12(a).

         "Conversion Rate" has the meaning set forth in Section 12(a).

         "Current Market Value" of the Class A Common Shares means (a) if the
shares are traded on the Nasdaq Stock Market, or its successor, the last sale
price, or if there is no last sale price, the average of the last reported bid
and asked prices, as reported by the Nasdaq Stock Market, or its successor, as
of the close of regular trading for that Trading Day and (b) if the shares are
traded on the New York Stock Exchange or another national securities exchange,
the Closing Price as reported on the

                                       42
<PAGE>

NYSE Composite Transactions Tape, or any comparable exchange reporting service,
as of the close of regular trading on such exchange for that Trading Day.

         "Current Market Price" has the meaning set forth in Section 12(d)(vii).

         "Depositary" has the meaning set forth in Section 4(b).

         "Dilution Trigger Event" has the meaning set forth in Section
12(d)(iv).

         "Distributed Securities" has the meaning set forth in Section
12(d)(iv).

         "Dividend Payment Date" means each February 1, May 1, August 1 and
November 1; provided, however, that if such date shall not be a Business Day,
then such date shall be the next Business Day.

         "Dividend Record Date" has the meaning set forth in Section 7(a).

         "DTC" has the meaning set forth in Section 4(b).

         "Exchange Act" has the meaning set forth in Section 4(d).

         "Existing Stockholders" has the meaning set forth in Section 13(d).

         "Expiration Time" has the meaning set forth in Section 12(d)(vi).

         "fair market value" has the meaning set forth in Section 12(d)(vii).

         "Global Series A Preferred Share" has the meaning set forth in Section
4(b).

         "Global Shares Legend" has the meaning set forth in Section 4(b).

         "Initial Purchasers" means Goldman, Sachs & Co.; Lehman Brothers Inc.;
Merrill Lynch, Pierce, Fenner & Smith; and Morgan Stanley & Co. Incorporated.

         "Issuer" means the Person named as the "Issuer" in the Recitals until a
successor Person shall have become such

                                       43
<PAGE>

pursuant to Section 14 and thereafter "Issuer" shall mean such successor Person.

         "Issuer Order" means a written request or order signed in the name of
the Issuer by its Chairman of the Board, its President or a Vice President and
by its Treasurer, an Assistant Treasurer, its Secretary or an Assistant
Secretary.

         "Junior Shares" has the meaning set forth in Section 9(a).

         "liquidation preference" has the meaning set forth in Section 3.

         "Mandatory Redemption Date" has the meaning set forth in Section 10(d);
provided, however, that if such date shall not be a Business Day, then such date
shall be the next Business Day.

         "Memorandum of Association" has the meaning set forth in the Recitals.

         "Nonelecting Share" has the meaning set forth in Section 12(e).

         "Officers' Certificate" means a certificate of the Issuer signed in the
name of the Issuer by its Chairman of the Board, its Chief Executive Officer,
its President, its Chief Operating Officer, its Chief Financial Officer or a
Vice President and by its Treasurer, an Assistant Treasurer, its Secretary or an
Assistant Secretary.

         "Optional Redemption" has the meaning set forth in Section 10(a).

         "Optional Redemption Date" has the meaning set forth in Section 10(a).

         "Outstanding" means when used with respect to Series A Preferred Shares
means, as of the date of determination, all Series A Preferred Shares
theretofore authenticated and delivered under this Certificate, except (a)
Series A Preferred Shares theretofore converted into Class A Common Shares in
accordance with Section 12 and Series A Preferred Shares theretofore canceled by
the Transfer Agent or delivered to the Transfer Agent for cancelation; (b)
Series A Preferred Shares for whose payment or redemption money in the necessary
amount has been theretofore deposited with the Transfer Agent or any Paying
Agent (other than the Issuer) in trust or set aside and

                                       44
<PAGE>

segregated in trust by the Issuer (if the Issuer shall act as its own Paying
Agent) for the holders of such Series A Preferred Shares; provided that, if such
Series A Preferred Shares are to be redeemed, notice of such redemption has been
duly given pursuant to this Certificate or provision therefor satisfactory to
the Transfer Agent has been made; and (c) Series A Preferred Shares (x) that are
mutilated, destroyed, lost or stolen which the Issuer has decided to pay or (y)
in exchange for or in lieu of which other Series A Preferred Shares have been
authenticated and delivered pursuant to this Certificate; provided, however,
that, in determining whether the holders of the Series A Preferred Shares have
given any request, demand, authorization, direction, notice, consent or waiver
or taken any other action hereunder, Series A Preferred Shares owned by the
Issuer or any other obligor upon the Series A Preferred Shares or any Affiliate
of the Issuer or of such other obligor shall be disregarded and deemed not to be
Outstanding, except that, in determining whether the Transfer Agent shall be
protected in relying upon any such request, demand, authorization, direction,
notice, consent, waiver or other action, only Series A Preferred Shares which
the Transfer Agent has actual knowledge of being so owned shall be so
disregarded. Series A Preferred Shares so owned which have been pledged in good
faith may be regarded as Outstanding if the pledgee establishes to the
satisfaction of the Transfer Agent the pledgee's right so to act with respect to
such Series A Preferred Shares and that the pledgee is not the Issuer or any
other obligor upon the Series A Preferred Shares or any Affiliate of the Issuer
or of such other obligor.

         "Parity Shares" has the meaning set forth in Section 9(a).

         "Paying Agent" has the meaning set forth in Section 5(a).

         "Persons" means, etc.

         "Purchase Agreement" means the Purchase Agreement dated February 14,
2000, between the Issuer, and the Initial Purchasers.

         "Purchased Shares" has the meaning set forth in Section 12(d)(vi).

         "QIBs" has the meaning set forth in Section 4(a).

         "Redemption Date" means (a) with respect to any Mandatory Redemption,
the Mandatory Redemption Date,

                                       45
<PAGE>

(b) with respect to any Optional Redemption or Tax Redemptions, (x) to the
extent the Redemption Price is to be paid in cash, the Redemption Effective Date
with respect thereto, and (y) to the extent the Redemption Price is to be paid
in Class A Common Shares, the 12th Trading Day after such Redemption Effective
Date.

         "Redemption Effective Date" has the meaning set forth in Section 10(a).

         "Redemption Notice" has the meaning set forth in Section 10(g).

         "Redemption Price" has the meaning set forth in Section 10(g).

         "Registrable Securities" has the meaning set forth in Section 5(c).

         "Registration Default" has the meaning set forth in Section 6(b).

         "Registration Rights Agreement" means the Registration Rights Agreement
dated as of February 22, 2000, between the Issuer and the Initial Purchasers.

         "Replacement Preferred Shares" has the meaning set forth in Section 14.

         "Restricted Definitive Securities" has the meaning set forth in Section
4(f).

         "Restricted Shares Legend" has the meaning set forth in Section 4(a).

         "resulting entity" has the meaning set forth in Section 14.

         "Rule 144A" has the meaning set forth in Section 4(a).

         "SEC" means the Securities and Exchange Commission, as from time to
time constituted, created under the Securities Exchange Act of 1934, or, if at
any time after the adoption of this Certificate such commission is not existing
and performing the duties now assigned to it, then the body performing such
duties at such time.

         "SEC Reports" has the meaning set forth in Section 15.

                                       46
<PAGE>

         "Securities Act" has the meaning set forth in Section 4(a).

         "Senior Shares" has the meaning set forth in Section 9(a).

         "Series A Preferred Share Directors" has the meaning set forth in
Section 8(a).

         "Series A Preferred Shares" has the meaning set forth in Section 1.

         "Shelf Registration Statement" means the shelf registration statement
in respect of the Transfer Restricted Securities required pursuant to the
Registration Rights Agreement to be filed with the SEC with respect to resales
of the Transfer Restricted Securities.

         "Special Dividends" has the meaning set forth in Section 6(b).

         "Tax Redemption" has the meaning set forth in Section 10(b).

         "Trading Day" means a day when the principal securities market on which
the relevant securities trade is open for business.

         "Transfer Agent" has the meaning set forth in Section 3.

         "Transfer Restricted Securities" means each Series A Preferred Share
and Class A Common Share issuable upon conversion of Series A Preferred Shares
or in satisfaction of any dividend or other payment on Series A Preferred Shares
until (a) the date on which such security has been effectively registered under
the Securities Act and disposed of in accordance with the Shelf Registration
Statement or (b) the date on which such security is distributed to the public
pursuant to Rule 144 under the Securities Act or may be distributed to the
public pursuant to Rule 144(k) under the Securities Act.

         "Voting Stock" has the meaning set forth in Section 13(d).

                                       47
<PAGE>

                                                    [CERTIFICATE OF DESIGNATION]

         IN WITNESS WHEREOF, the Issuer has caused this Certificate to be duly
executed as of the date hereof.

                                              RSL COMMUNICATIONS, LTD.

                                              by: /s/ Itzhak Fisher
                                                 -------------------------------
                                                  Name:
                                                  Title:

ATTEST:

by: /s/ Avery S.Fischer
   ----------------------------
   Name:
   Title:

<PAGE>

                                                                       EXHIBIT A

                                FACE OF SECURITY

[Restricted Shares Legend (include if Security is not registered under the U.S.
Securities Act of 1933): THE SERIES A PREFERRED SHARES EVIDENCED HEREBY (AND (1)
THE CLASS A COMMON SHARES ISSUABLE UPON CONVERSION OF THE SERIES A PREFERRED
SHARES AND (2) THE CLASS A COMMON SHARES ISSUABLE IN PAYMENT OF DIVIDENDS OR OF
THE REDEMPTION OR PURCHASE PRICE) HAVE NOT BEEN REGISTERED UNDER THE UNITED
STATES SECURITIES ACT OF 1933 (THE "SECURITIES ACT") AND MAY NOT BE OFFERED,
SOLD, PLEDGED OR OTHERWISE TRANSFERRED EXCEPT (A) (1) IN THE CASE OF THE SERIES
A PREFERRED SHARES, TO A PERSON WHO THE SELLER REASONABLY BELIEVES IS A
QUALIFIED INSTITUTIONAL BUYER WITHIN THE MEANING OF RULE 144A UNDER THE
SECURITIES ACT PURCHASING FOR ITS OWN ACCOUNT OR FOR THE ACCOUNT OF A QUALIFIED
INSTITUTIONAL BUYER IN A TRANSACTION MEETING THE REQUIREMENTS OF RULE 144A, (2)
TO AN INSTITUTIONAL ACCREDITED INVESTOR IN A TRANSACTION EXEMPT FROM THE
REGISTRATION REQUIREMENTS OF THE SECURITIES ACT, (3) PURSUANT TO AN EXEMPTION
FROM REGISTRATION UNDER THE SECURITIES ACT PROVIDED BY RULE 144 THEREUNDER (IF
AVAILABLE) OR (4) PURSUANT TO AN EFFECTIVE REGISTRATION STATEMENT UNDER THE
SECURITIES ACT AND (B) IN ACCORDANCE WITH ALL APPLICABLE SECURITIES LAWS OF THE
STATES OF THE UNITED STATES AND OTHER JURISDICTIONS. THE HOLDER WILL, AND EACH
SUBSEQUENT HOLDER IS REQUIRED TO, NOTIFY ANY PURCHASER FROM IT OF THE SECURITY
EVIDENCED HEREBY OF THE RESALE RESTRICTIONS SET FORTH ABOVE.

[Global Shares Legend (include if Security is issued as a global certificate):
UNLESS THIS CERTIFICATE IS PRESENTED BY AN AUTHORIZED REPRESENTATIVE OF THE
DEPOSITORY TRUST COMPANY, A NEW YORK CORPORATION ("DTC"), NEW YORK, NEW YORK, TO
THE COMPANY OR ITS AGENT FOR REGISTRATION OF TRANSFER, EXCHANGE OR PAYMENT, AND
ANY CERTIFICATE ISSUED IS REGISTERED IN THE NAME OF CEDE & CO. OR SUCH OTHER
NAME AS IS REQUESTED BY AN AUTHORIZED REPRESENTATIVE OF DTC (AND ANY PAYMENT IS
MADE TO CEDE & CO., OR TO SUCH OTHER ENTITY AS IS REQUESTED BY AN AUTHORIZED
REPRESENTATIVE OF DTC) ANY TRANSFER, PLEDGE OR OTHER USE HEREOF FOR VALUE OR
OTHERWISE BY OR TO ANY PERSON IS WRONGFUL INASMUCH AS THE REGISTERED OWNER
HEREOF, CEDE & CO. HAS AN INTEREST HEREIN.

                  TRANSFERS OF THIS GLOBAL SECURITY SHALL BE LIMITED TO
TRANSFERS IN WHOLE, BUT NOT IN PART, TO NOMINEES OF DTC OR TO A SUCCESSOR
THEREOF OR SUCH SUCCESSOR'S NOMINEE AND TRANSFERS OF PORTIONS OF THIS GLOBAL
SECURITY SHALL BE LIMITED TO TRANSFERS MADE IN ACCORDANCE WITH THE RESTRICTIONS
SET FORTH IN THE CERTIFICATE OF DESIGNATION REFERRED TO BELOW.

      IN CONNECTION WITH ANY TRANSFER, THE HOLDER WILL DELIVER TO THE REGISTRAR
AND TRANSFER AGENT SUCH CERTIFICATES AND OTHER INFORMATION AS SUCH REGISTRAR AND
TRANSFER AGENT MAY

<PAGE>

REASONABLY REQUIRE TO CONFIRM THAT THE TRANSFER COMPLIES WITH THE FOREGOING
RESTRICTIONS.]

                                       2
<PAGE>

                                                                Number of Shares
Number: ____                                                         ____ Shares

                                                     144A CUSIP NO.:
                                                      IAI CUSIP NO.:

                  Series A 7-1/2% Convertible Preferred Shares

                                       of

                            RSL COMMUNICATIONS, LTD.

                  RSL COMMUNICATIONS, LTD., an exempted company organized under
the laws of Bermuda (the "Issuer", which term includes any successor Person
under the Certificate of Designation hereinafter referred to) hereby certifies
that [HOLDER] (the "Holder") is the registered owner of fully paid and
non-assessable preferred securities of the Issuer designated the Series A 7 1/2%
Convertible Preferred Shares, par value U.S.$0.00457 and liquidation preference
U.S.$50.00 per share (the "Preferred Shares"). The Preferred Shares are
transferable on the books and records of the Transfer Agent, in person or by a
duly authorized attorney, upon surrender of this certificate duly endorsed and
in proper form for transfer. The designation, rights, privileges, restrictions,
preferences and other terms and provisions of the Preferred Shares represented
hereby are issued and shall in all respects be subject to the provisions of the
Certificate of Designation dated February 14, 2000, as the same may be amended
from time to time in accordance with its terms (the "Certificate of
Designation"). Capitalized terms used herein but not defined shall have the
meaning given them in the Certificate of Designation. The Issuer will provide a
copy of the Certificate of Designation to a Holder without charge upon written
request to the Issuer at its principal place of business.

                  Reference is hereby made to select provisions of the Preferred
Shares set forth on the reverse hereof, and to the Certificate of Designation,
which select provisions and the Certificate of Designation shall for all
purposes have the same effect as if set forth at this place.

                  Upon receipt of this certificate, the Holder is bound by the
Certificate of Designation and is entitled to the benefits thereunder.

                                       3
<PAGE>

                  Unless the Transfer Agent's valid countersignature appears
hereon, the Preferred Shares evidenced hereby shall not be entitled to any
benefit under the Certificate of Designation or be valid or obligatory for any
purpose.

                                       4
<PAGE>

                  IN WITNESS WHEREOF, the Issuer has executed this certificate
as of the date set forth below.

                                    RSL COMMUNICATIONS, LTD.,

                                    By:_____________________________
                                       Name:
                                       Title:

[Seal]

                                    By:______________________________
                                       Name:
                                       Title:

                                    Dated:

COUNTERSIGNED AND REGISTERED

AMERICAN STOCK TRANSFER & TRUST COMPANY
as Registrar and Transfer Agent,

By:  ________________________________
     Authorized Signatory

Dated:

                                       5
<PAGE>

                               REVERSE OF SECURITY

                            RSL COMMUNICATIONS, LTD.

                  Series A 7-1/2% Convertible Preferred Shares

                  Dividends on each Preferred Share shall be payable at a rate
per annum set forth in the face hereof or as provided in the Certificate of
Designation (including Special Dividends). Dividends may be paid, at the option
of the Issuer, in cash, or, subject to certain limitations, in Class A Common
Shares of the Issuer or a combination of cash and Class A Common Shares of the
Issuer.

                  The Preferred Shares shall be redeemable as provided in the
Certificate of Designation. The Preferred Shares shall be convertible into the
Issuer's Class A Common Shares in the manner and according to the terms set
forth in the Certificate of Designation.

                  Generally, when a successor Person issues replacement
preferred shares upon conversion of, or in exchange for, the Series A Preferred
Shares in a transaction governed by Section 14 of the Certificate of
Designation, the predecessor Person will be released from any obligation on the
Series A Preferred Shares, except as provided in Section 9(d) of the Certificate
of Designation.

                                       6
<PAGE>

                                   ASSIGNMENT

         FOR VALUE RECEIVED, the undersigned assigns and transfers the Preferred
Shares evidenced hereby to:-----------------------------------------------------

--------------------------------------------------------------------------------
--------------------------------------------------------------------------------

--------------------------------------------------------------------------------
(Insert assignee's social security or tax identification number)

--------------------------------------------------------------------------------
--------------------------------------------------------------------------------
--------------------------------------------------------------------------------
--------------------------------------------------------------------------------
--------------------------------------------------------------------------------
(Insert address and zip code of assignee)

and irrevocably appoints:
--------------------------------------------------------------------------------
--------------------------------------------------------------------------------
--------------------------------------------------------------------------------
agent to transfer the Preferred Shares evidenced hereby on the books of the
Registrar and Transfer Agent. The agent may substitute another to act for him or
her.

Date:---------------------------------------------------------------------------

Signature: ______________________________
(Sign exactly as your name appears on the other side of this Convertible
Preferred Share Certificate)

Signature Guarantee:______________________________

--------
*Signature must be guaranteed by an "eligible guarantor institution" (i.e., a
bank, stockbroker, savings and loan association or credit union) meeting the
requirements of the Registrar, which requirements include membership or
participation in the Securities Transfer Agents Medallion Program ("STAMP") or
such other "signature guarantee program" as may be determined by the Registrar
in addition to, or in substitution for, STAMP, all in accordance with the
Securities Exchange Act of 1934.

                                       7
<PAGE>

                              NOTICE OF CONVERSION]

                    (To be Executed by the Registered Holder
                    in order to Convert the Preferred Stock)

The undersigned hereby irrevocably elects to convert (the "Conversion")
_________ Series A 7-1/2% Convertible Preferred Shares (the "Preferred Shares"),
represented by stock certificate No(s). (the "Preferred Share Certificates")
into shares of common stock, par value U.S.$0.00457 per share ("Class A Common
Shares"), of RSL Communications, Ltd. (the "Issuer") according to the conditions
of the Certificate of Designation establishing the terms of the Preferred Stock
(the "Certificate of Designation"). If shares are to be issued in the name of a
person other than the undersigned, the undersigned will pay all transfer taxes
payable with respect thereto and is delivering herewith such certificates. No
fee will be charged to the holder for any conversion, except for transfer taxes,
if any. Each Preferred Share Certificate is attached hereto (or evidence of
loss, theft or destruction thereof).*

The undersigned represents and warrants that all offers and sales by the
undersigned of Class A Common Shares issuable to the undersigned upon conversion
of the Preferred Shares shall be made pursuant to registration of the Class A
Common Shares under the Securities Act of 1933 (the "Act"), or pursuant to any
exemption from registration under the Act.

Any holder, upon the exercise of its conversion rights in accordance with the
terms of the Certificate of Designation and the Preferred Shares, agrees to be
bound by the terms of the Registration Rights Agreement.

Capitalized terms used but not defined herein shall have the meanings ascribed
thereto in or pursuant to the Certificate of Designation.

                              Date:___________________________________

                              Applicable Conversion Price:____________

                              Number of Preferred Shares
                              to be Converted:________________________

                              Number of Class A Common Shares
                              to be Issued:___________________________

<PAGE>

                              Signature:______________________________

                              Name:___________________________________

                              Address:**______________________________

                              Fax No.:________________________________

*The Issuer is not required to issue Class A Common Shares until the original
Preferred Share Certificate(s) (or evidence of loss, theft or destruction
thereof) to be converted are received by the Issuer or its Transfer Agent. The
Issuer shall issue and deliver Class A Common Shares to an overnight courier not
later than three Business Days following receipt of the original Preferred Share
Certificate(s) to be converted.

**Address where Class A Common Shares and any other payments or certificates
shall be sent by the Issuer.

                                       2
<PAGE>

[Global Share Schedule: (include if Security is issued as a global certificate)]

                                                                      SCHEDULE A

                    SCHEDULE OF EXCHANGES FOR GLOBAL SECURITY

                  The initial number of Series A Preferred Shares represented by
this Global Series A Preferred Share shall be _______. The following exchanges
of a part of this Global Series A Preferred Share have been made:

<TABLE>
<CAPTION>

----------------------- -------------------- -------------------- -------------------- --------------------
                                                                    Number of shares
                         Amount of decrease    Amount of increase   represented by
                             in number of          in number of    this Global Series
                          shares represented   shares represented   A Preferred Share
                           by this Global        by this Global      following such          Signature of
                         Series A Preferred    Series A Preferred      decrease or        authorized officer
   Date of Exchange            Share                 Share              increase             of Registrar
----------------------- -------------------- -------------------- -------------------- --------------------
<S>                     <C>                  <C>                  <C>                  <C>
----------------------- -------------------- -------------------- -------------------- --------------------

----------------------- -------------------- -------------------- -------------------- --------------------

----------------------- -------------------- -------------------- -------------------- --------------------

----------------------- -------------------- -------------------- -------------------- --------------------

----------------------- -------------------- -------------------- -------------------- --------------------

----------------------- -------------------- -------------------- -------------------- --------------------

----------------------- -------------------- -------------------- -------------------- --------------------

----------------------- -------------------- -------------------- -------------------- --------------------

----------------------- -------------------- -------------------- -------------------- --------------------

----------------------- -------------------- -------------------- -------------------- --------------------

----------------------- -------------------- -------------------- -------------------- --------------------

----------------------- -------------------- -------------------- -------------------- --------------------

----------------------- -------------------- -------------------- -------------------- --------------------
</TABLE>

                                       3

<PAGE>

                                                                       EXHIBIT B

                          FORM OF TRANSFER CERTIFICATE

            (Transfers pursuant toss. 5(b)(ii) of the Certificate of
                  Designation of the Series A Preferred Shares)

American Stock Transfer & Trust Company, as Transfer Agent
40 Wall Street
New York, New York 10005

Att: Stock Transfer
     Administration

Re:  RSL Communications, Ltd.
     7-1/2% Series A Convertible Preferred Shares due 2012 (the
     "Series A Preferred Shares")

                  Reference is hereby made to the Certificate of Designation of
the Series A Preferred Shares. Capitalized terms used but not defined herein
shall have the meanings given them in the Schedule.

                  This letter relates to __________ Series A Preferred Shares
(the "Securities") which are represented by Restricted Definitive Securities
(CUSIP No. __) held in the name of [name of transferor] (the "Transferor") to
effect the transfer of the Securities.

                  In connection with such request, and in respect of the
Securities, the Transferor does hereby certify the Securities are being
transferred (i) in accordance with applicable securities laws of any state of
the United States or any other jurisdiction and (ii) in accordance with their
terms:

CHECK ONE BOX BELOW:

         (1) [ ]  to a transferee that the Transferor reasonably believes is a
                  qualified institutional buyer within the meaning of Rule 144A
                  under the Securities Act purchasing for its own account or for
                  the account of a qualified institutional buyer in a
                  transaction meeting the requirements of Rule 144A;

         (2) [ ]  to a transferee that the Transferor reasonably believes is
                  an institutional "accredited investor" as defined in Rule
                  501(a)(1), (2), (3) or (7) under the Securities Act that is
                  acquiring such Securities for investment purposes and not for
                  distribution and is acquiring at least $250,000 aggregate
                  liquidation preference of

<PAGE>

                  Series A Preferred Shares for its own account or for one or
                  more accounts (each of which is acquiring at least $250,000
                  aggregate liquidation preference) as to which the transferee
                  exercises sole investment discretion; or

         (3) [ ]  pursuant to an exemption from registration under the
                  Securities Act provided by Rule 144 thereunder (if available).

                                       [Name of Transferor]

                                        by: ________________________
                                            Name:
                                            Title:

Dated:

cc:  RSL Communications, Ltd.
     767 Fifth Avenue
     Suite 4300
     New York, NY 10153

                                       2

<PAGE>

                                                                       EXHIBIT C

               FORM OF ACCREDITED INVESTOR TRANSFEREE CERTIFICATE

             (Transfers pursuant toss. 5(b)(ii) of the Certificate)

American Stock Transfer & Trust Company, as Transfer Agent
40 Wall Street
New York, NY 10005

Att: Stock Transfer
     Administration

Re:  RSL Communications, Ltd.
     7-1/2% Series A Convertible Preferred Shares due 2012
     (the "Series A Preferred Shares")

                  Reference is hereby made to the Certificate of Designation of
the Series A Preferred Shares. Capitalized terms used but not defined herein
shall have the meanings given them in the Certificate.

                  This letter relates to ________ Series A Preferred Shares (the
"Securities") which are represented by the Restricted Definitive Securities
(CUSIP No. ___) held in the name of [name of transferor] (the "Transferor"), and
is given in connection with the transfer of the Securities to the undersigned.

                  In connection with such request, and in respect of the
Securities, we confirm that:

                  1. We understand that the Securities have not been registered
under the U.S. Securities Act of 1933 (the "Securities Act"), and are being sold
to us in a transaction that is exempt from the registration requirements of the
Securities Act.

                  2. We are a corporation, partnership or other entity (other
than a natural person) having such knowledge and experience in financial and
business matters as to be capable of evaluating the merits and risks of an
investment in the Securities, and we are (or any account for which we are
purchasing under paragraph 4 below is) an accredited investor as defined in Rule
501(a) under the Securities Act, able to bear the economic risk of the proposed
investment in the Securities.

<PAGE>

                  3. We are acquiring the Securities for our own account (or for
accounts as to which we exercise sole investment discretion and have authority
to make, and do make, the statements contained in this letter) and not with a
view to any distribution of the Securities, subject, nevertheless, to the
understanding that the disposition of our property shall at all times be and
remain within our control.

                  4. We are, and each account (if any) for which we are
purchasing Securities is, purchasing Securities having an aggregate liquidation
preference of not less than $250,000.

                  5. We understand that (a) the Securities will be delivered to
us in registered form only and that the certificate delivered with respect to
the Securities will bear a legend substantially to the following effect:

         THE SERIES A PREFERRED SHARES EVIDENCED HEREBY (AND (1) THE CLASS A
         COMMON SHARES ISSUABLE UPON CONVERSION OF THE SERIES A PREFERRED SHARES
         AND (2) THE CLASS A COMMON SHARES ISSUABLE IN PAYMENT OF DIVIDENDS OR
         OF THE REDEMPTION OR PURCHASE PRICE) HAVE NOT BEEN REGISTERED UNDER THE
         UNITED STATES SECURITIES ACT OF 1933 (THE "SECURITIES ACT") AND MAY NOT
         BE OFFERED, SOLD, PLEDGED OR OTHERWISE TRANSFERRED EXCEPT (A) (1) IN
         THE CASE OF THE SERIES A PREFERRED SHARES, TO A PERSON WHO THE SELLER
         REASONABLY BELIEVES IS A QUALIFIED INSTITUTIONAL BUYER WITHIN THE
         MEANING OF RULE 144A UNDER THE SECURITIES ACT PURCHASING FOR ITS OWN
         ACCOUNT OR FOR THE ACCOUNT OF A QUALIFIED INSTITUTIONAL BUYER IN A
         TRANSACTION MEETING THE REQUIREMENTS OF RULE 144A, (2) TO AN
         INSTITUTIONAL ACCREDITED INVESTOR IN A TRANSACTION EXEMPT FROM THE
         REGISTRATION REQUIREMENTS OF THE SECURITIES ACT, (3) PURSUANT TO AN
         EXEMPTION FROM REGISTRATION UNDER THE SECURITIES ACT PROVIDED BY RULE
         144 THEREUNDER (IF AVAILABLE) OR (4) PURSUANT TO AN EFFECTIVE
         REGISTRATION STATEMENT UNDER THE SECURITIES ACT AND (B) IN ACCORDANCE
         WITH ALL APPLICABLE SECURITIES LAWS OF THE STATES OF THE UNITED STATES
         AND OTHER JURISDICTIONS. THE HOLDER WILL, AND EACH SUBSEQUENT HOLDER IS
         REQUIRED TO, NOTIFY ANY PURCHASER FROM IT OF THE SECURITY EVIDENCED
         HEREBY OF THE RESALE RESTRICTIONS SET FORTH ABOVE. THE HOLDER WILL, AND
         EACH SUBSEQUENT HOLDER IS REQUIRED TO, NOTIFY ANY PURCHASER FROM IT OF
         THE SECURITY EVIDENCED HEREBY OF THE RESALE RESTRICTIONS SET FORTH
         ABOVE.

                                       2
<PAGE>

                  and (b) such certificates will be reissued without the
foregoing legend only in accordance with the terms of the Certificate.

                  6. We agree that in the event that at some future time we wish
to dispose of any of the Securities, we will not do so unless:

                  (a) the Securities are sold to the Issuer;

                  (b) the Securities are sold to a qualified institutional buyer
in compliance with Rule 144A under the Securities Act;

                  (c) the Securities are sold to an institutional accredited
         investor, as defined in Rule 501(a) under the Securities Act, acquiring
         at least $250,000 liquidation preference of the Securities that, prior
         to such transfer, furnishes to the Transfer Agent a signed letter
         containing certain representations and agreements relating to the
         restrictions on transfer of the Securities (the form of which letter
         can be obtained from such Transfer Agent);

                  (d) the Securities are sold by us pursuant to Rule 144 under
the Securities Act; or

                                       3

<PAGE>

                  (e) the Securities are sold pursuant to an effective
registration statement under the Securities Act.

                                   Very truly yours,

                                   [PURCHASER]

                                   by: __________________________
                                       Name:
                                       Title:

Dated:

cc:  RSL Communications, Ltd.
     767 Fifth Avenue
     Suite 4300
     New York, NY 10153

                                       4

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