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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10 - Q

[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE
SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended April 25, 2004

OR

[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE
SECURITIES EXCHANGE ACT OF 1934

For the transition period from          to         

Commission file number 1-13740

BORDERS GROUP, INC.

(Exact name of registrant as specified in its charter)

100 Phoenix Drive, Ann Arbor, Michigan 48108
(Address of principal executive offices with zip code)

(734) 477-1100
(Registrant's telephone number, including area code)

Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes   X            No     

BORDERS GROUP, INC.

INDEX

ii

BORDERS GROUP, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(dollars in millions except per share data)
(UNAUDITED)

See accompanying Notes to Unaudited Condensed Consolidated Financial Statements.

1

BORDERS GROUP, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(dollars in millions except per share data)
(UNAUDITED)

See accompanying Notes to Unaudited Condensed Consolidated Financial Statements.

2

BORDERS GROUP, INC.
CONDENSED CONSOLIDATED STATEMENT OF STOCKHOLDERS’ EQUITY
FOR THE 13 WEEKS ENDED APRIL 25, 2004
(dollars in millions except share amounts)
(UNAUDITED)

See accompanying Notes to Unaudited Condensed Consolidated Financial Statements.

3

BORDERS GROUP, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(dollars in millions)
(UNAUDITED)

See accompanying Notes to Unaudited Condensed Consolidated Financial Statements.

4

BORDERS GROUP, INC.
NOTES TO UNAUDITED CONDENSED
CONSOLIDATED FINANCIAL STATEMENTS
(dollars in millions except per share data)

NOTE 1 - BASIS OF PRESENTATION

The accompanying unaudited condensed consolidated financial statements of Borders Group, Inc. (the Company) have been prepared in accordance with Rule 10-01 of Regulation S-X and do not include all the information and notes required by accounting principles generally accepted in the United States for complete financial statements. All adjustments, consisting only of normal recurring adjustments, have been made which, in the opinion of management, are necessary for a fair presentation of the results of the interim periods. The results of operations for such interim periods are not necessarily indicative of results of operations for a full year. The unaudited condensed consolidated financial statements should be read in conjunction with the Company’s consolidated financial statements and notes thereto, included in its Annual Report on Form 10-K for the fiscal year ended January 25, 2004.

The Company’s fiscal year ends on the Sunday immediately preceding the last Wednesday in January. At April 25, 2004, the Company operated 485 superstores primarily under the Borders name, including 24 in the United Kingdom, nine in Australia, two in Puerto Rico, and one each in Singapore and New Zealand. The Company also operated 712 mall-based and other bookstores primarily under the Waldenbooks name, and 36 bookstores under the Books etc. name in the United Kingdom.

NOTE 2 - COMMITMENTS AND CONTINGENCIES

Litigation: Two former employees, individually and on behalf of a purported class consisting of all current and former employees who worked as assistant managers in Borders stores in the state of California at any time between April 10, 1996, and the present, have filed an action against the Company in the Superior Court of California for the County of San Francisco. The action alleges that the individual plaintiffs and the purported class members worked hours for which they were entitled to receive, but did not receive, overtime compensation under California law, and that they were classified as exempt store management employees but were forced to work more than 50% of their time in non-exempt tasks. The Amended Complaint, which names two additional plaintiffs, alleges violations of the California Labor Code and the California Business and Professions Code. The relief sought includes compensatory and punitive damages, penalties, preliminary and permanent injunctions requiring Borders to pay overtime compensation as required under California and Federal law, prejudgment interest, costs, and attorneys’ fees and such other relief as the court deems proper. On July 29, 2002, the Superior Court of California granted the plaintiffs’ motion for class certification in the action. The class certified consists of all individuals who worked as Assistant Managers in a Borders superstore in California at any time between April 10, 1996 and March 18, 2001. The class was further certified by the Court into the following subclasses: Assistant Manager-Merchandising; Assistant Manager-Inventory; Assistant Manager-Human Resources; Assistant Manager-Music; Assistant Manager-Training; Assistant Manager-Café. On January 28, 2004, a tentative settlement, subject to court approval, was reached pursuant to which the Company has agreed to pay $3.5 to resolve all claims asserted in the litigation. The Company classified this charge as “Legal settlement expense” in the consolidated statements of operations in 2003.

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

5

BORDERS GROUP, INC.
NOTES TO UNAUDITED CONDENSED
CONSOLIDATED FINANCIAL STATEMENTS
(dollars in millions except per share data)

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

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

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

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

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

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

Lease Guaranty Agreement: Borders’ leases for 13 of its retail stores and its distribution center in Harrisburg, Pennsylvania have been guaranteed by Kmart. Under the terms of a lease guaranty, indemnification and reimbursement agreement entered into upon completion of the IPO, as amended, (Lease Guaranty Agreement), the underlying leases will be transferable by Borders, subject to a right of first refusal in favor of Kmart with respect to sites within a three-mile radius of a Kmart store and, with respect to all other sites, a right of first offer in favor of Kmart. The Company and Borders are required to indemnify Kmart with respect to (i) any liabilities Kmart may incur under the lease guarantees, except those liabilities arising from the gross negligence or willful misconduct

6

BORDERS GROUP, INC.
NOTES TO UNAUDITED CONDENSED
CONSOLIDATED FINANCIAL STATEMENTS
(dollars in millions except per share data)

of Kmart, and (ii) any losses incurred by Kmart after taking possession of any particular premises, except to the extent such losses arise solely from the acts or omissions of Kmart. Under the terms of the Lease Guaranty Agreement, in the event of (i) the Company’s or Borders’ failure to provide any required indemnity, (ii) a knowing and material violation of the limitations on transfers of guaranteed leases set forth in the agreement, or (iii) certain events of bankruptcy, Kmart will have the right to assume any or all of the guaranteed leases and to take possession of all of the premises underlying such guaranteed leases; provided, that in the event of a failure or failures to provide required indemnities, the remedy of taking possession of all of the premises underlying the guaranteed leases may be exercised only if such failures relate to an aggregate liability of $10.0 or more and only if Kmart has provided 100 days’ prior written notice. In the event of a failure to provide required indemnities resulting in losses of more than the equivalent of two months rent under a particular lease but less than $10.0, Kmart may exercise such remedy of possession as to the premises underlying the guaranteed lease or leases to which the failure to provide the indemnity relates and one additional premise for each such premises to which the failure relates, up to a maximum, in any event, of five additional premises, and thereafter, with respect to such additional premises, Kmart remedies and indemnification rights shall terminate. In the event of a failure to provide required indemnities resulting in liabilities of less than the equivalent of two months rent under a particular lease, Kmart may exercise such remedy of possession only as to the premises underlying the guaranteed lease or leases to which the failure to provide the indemnity relates. The Lease Guaranty Agreement will remain in effect until the expiration of all lease guarantees, which the Company believes will be in January 2020.

NOTE 3 - FINANCING

Credit Facility: The Company has a Multicurrency Revolving Credit Agreement (the “Credit Agreement”), which will expire in June 2005. The Credit Agreement provides for borrowings of up to $450.0. Borrowings under the Credit Agreement bear interest at a variable base rate plus an increment or LIBOR plus an increment at the Company’s option. The Credit Agreement contains covenants which limit, among other things, the Company’s ability to incur indebtedness, grant liens, make investments, consolidate or merge, declare dividends, dispose of assets, repurchase its common stock in excess of $225.0 over the term of the Agreement (plus any proceeds and tax benefits resulting from stock option exercises and tax benefits resulting from restricted shares purchased by employees from the Company), and requires the Company to meet certain financial measures regarding fixed coverage, leverage, tangible net worth and capital expenditures. The Company had borrowings outstanding under the Credit Agreement (or a prior agreement) of $116.3 at April 25, 2004, $116.3 at April 27, 2003 and $126.9 at January 25, 2004.

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

Lease Financing Facilities. The Company has two lease financing facilities (collectively, the “Lease Financing Facilities”) to finance new stores and other property owned by unaffiliated entities and leased to the Company or its subsidiaries. The original facility (the “Original Lease Facility”) will expire in June 2006. In June of 2002, the Company established a new facility (the “New Lease Facility”), which will expire in 2007. The aggregate amount available under the Lease Financing Facilities is $25.0. Properties to be financed after the effective date of the New Lease Facility will be financed under that Facility, and no additional properties will be financed under the Original Lease Facility. The Lease Financing Facilities provide financing to lessors of properties leased to the Company or its subsidiaries through loans from lenders for up to 95% of a project’s cost. Additionally, under the New Lease Facility, the unaffiliated lessor will make equity contributions approximating 5% of the cost of each project. The lessors under the Original Lease Facility have made similar contributions.

7

BORDERS GROUP, INC.
NOTES TO UNAUDITED CONDENSED
CONSOLIDATED FINANCIAL STATEMENTS
(dollars in millions except per share data)

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

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

There were two, four and two properties financed through the Original Lease Facility at April 25, 2004, April 27, 2003 and January 25, 2004, respectively, with financed values of $13.8, $22.6 and $13.8. The two properties financed through the Original Lease Facility at April 25, 2004 and January 25, 2004 were consolidated by the Company, pursuant to the provisions of Financial Accounting Standards Board (FASB) issued Interpretation No. 46, “Consolidation of Variable Interest Entities” (FIN 46), as discussed below. Of the amount financed under the Original Lease Facility at April 27, 2003, the Company had recorded $19.0 as capitalized leases, under “Other assets” (for the capital lease assets) and “Long-term capital lease obligations” (for the capital lease liabilities) on the consolidated balance sheets at April 27, 2004. These amounts were treated as non-cash items on the consolidated statements of cash flows. There were no borrowings under the New Lease Facility as of April 25, 2004, April 27, 2003 or January 25, 2004.

Consolidated VIEs: Pursuant to the requirements of FIN 46, the Company is the primary beneficiary of the two variable interest entities (VIEs) that own the two properties financed under the Original Lease Facility at April 25, 2004. As a result, the Company consolidates these VIEs and has recorded land, property and equipment, net of accumulated depreciation, of $12.0, short-term borrowings of $13.8, and minority interest of $1.3 at April 25, 2004. These amounts have been treated as non-cash items on the consolidated statements of cash flows.

The Company also is the primary beneficiary of two additional VIEs, due to the Company’s guarantee of the debt of these entities. As a result, the Company consolidates these VIEs and has recorded property and equipment, net of accumulated depreciation, of $5.5, long-term debt of $5.8, and minority interest of $0.4 at April 25, 2004. These amounts have been treated as non-cash items on the consolidated statements of cash flows.

Mortgage Notes: During 1994, the Company entered into agreements in which leases with respect to four Borders locations served as collateral for certain mortgage pass-through certificates. These mortgage pass-through certificates included a provision requiring the Company to repurchase the underlying mortgage notes in certain events. In the fourth quarter of 2001, the Company was obligated to purchase the notes for $33.5, due to Kmart Corporation’s (the former guarantor of the leases) failure to maintain investment grade credit ratings. As a result, the Company has categorized this prepaid rent amount as part of “Other assets” in the consolidated balance sheets and is amortizing the balance over each property’s remaining lease term. The remaining balance at April 25, 2004 was approximately $28.3.

8

BORDERS GROUP, INC.
NOTES TO UNAUDITED CONDENSED
CONSOLIDATED FINANCIAL STATEMENTS
(dollars in millions except per share data)

NOTE 4 – STOCK-BASED BENEFIT PLANS

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

NOTE 5- SEGMENT INFORMATION

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

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

Total assets for the Corporate segment include certain corporate headquarters property and equipment, net of accumulated depreciation, of $67.2 and $73.3 at April 25, 2004 and April 27, 2003, respectively, whose related depreciation expense has been allocated to the Borders, Waldenbooks and International segments. Depreciation expense allocated to the Borders segment totaled $2.4 and $2.8 for the 13 weeks ended April 25, 2004 and April 27, 2003, respectively. Depreciation expense allocated to the Waldenbooks segment totaled $1.1 and $1.5 for the 13 weeks ended April 25, 2004 and April 27, 2003, respectively. Depreciation expense allocated to the International segment totaled $0.1 and $0.0 for the 13 weeks ended April 25, 2004 and April 27, 2003, respectively.

9

BORDERS GROUP, INC.
NOTES TO UNAUDITED CONDENSED
CONSOLIDATED FINANCIAL STATEMENTS
(dollars in millions except per share data)

NOTE 6 - SALE-LEASEBACK TRANSACTIONS

In March 2004, the Company entered into an agreement with GE Pension Limited to sell and subsequently leaseback the Company-owned property at 120 Charing Cross Road, London U.K. WC2J 0JR, owned by its Books, Etc. subsidiary. There were no future commitments, obligations, provisions, or circumstances included in either the sale contract or the lease contract that would result in the Company’s continuing involvement, therefore, the assets associated with the property were removed from the Company’s condensed consolidated balance sheets.

The transaction was recorded in the International segment. The sale proceeds were $32.3 and the net book value of the property upon the completion date of the sale was $28.4. Direct costs associated with the transaction were $0.4. A deferred gain of $3.5 was recorded on the consolidated balance sheets in “Other long-term liabilities” and will be amortized over the 20-year term of the operating lease.

10

ITEM 2. Management's Discussion and Analysis of Financial Condition and Results of Operations

General

Borders Group, Inc., through its subsidiaries, Borders, Inc. (Borders), Walden Book Company, Inc. (Waldenbooks), Borders U.K. Limited, Borders Australia Pty Limited and others (individually and collectively, “the Company”), is the second largest operator of book, music and movie superstores and the largest operator of mall-based bookstores in the world based upon both sales and number of stores. At April 25, 2004, the Company operated 485 superstores under the Borders name, including 24 in the United Kingdom, nine in Australia, two in Puerto Rico, and one each in Singapore and New Zealand. The Company also operated 712 mall-based and other bookstores primarily under the Waldenbooks name in the United States and 36 bookstores under the Books etc. name in the United Kingdom.

The Company’s business strategy is to continue its growth and increase its profitability through (i) expanding and refining its core domestic superstore business, (ii) driving International growth by expanding established markets and leveraging infrastructure investments, (iii) leveraging strategic alliances and in-store Web-based commerce technologies which enhance the customer experience, and (iv) maximizing cash flow and profitability at Waldenbooks through a combination of selective growth and profit initiatives. Specifically, the Company expects to open 18 to 20 domestic Borders stores and will undertake an expanded remodel program, through which the Company expects to complete major remodels of 40 to 50 existing stores in 2004. International store growth over the next several years will primarily focus on existing markets with approximately six to eight International store openings annually. The International segment achieved full year profitability for the first time in 2003 and full year profit growth is expected going forward. The Waldenbooks segment has experienced negative comparable store sales percentages for the past several years primarily due to the overall decrease in mall traffic and the impact of superstore openings; however, as a result of the successful plan to optimize the Waldenbooks store base, the comparable store sales percentages are generally improving. The Company is continuing to implement this plan in order to continue improving sales, net income and free cash flow. This plan could result in further store closing costs or asset impairments over the next few years, but at a lesser rate going forward. In addition, Waldenbooks manages the Company’s kiosks and small format stores, including those in airports and outlet malls and selective growth in these small format stores is expected in 2004. The Company’s objectives with respect to these initiatives are to continue to grow consolidated sales and earnings in 2004. In addition, subject to Board approval, the Company plans to provide returns to stockholders through quarterly cash dividends and share repurchases by utilizing free cash flow generated by the business. In March 2004, the Board of Directors declared a quarterly cash dividend of $0.08 per share on the Company’s common stock, payable April 28, 2004 to stockholders of record at the close of business April 7, 2004, and in May 2004, the Board of Directors declared a quarterly cash dividend of $0.08 per share on the Company’s common stock, payable July 28, 2004 to stockholders of record at the close of business July 7, 2004. In May 2003, the Board of Directors authorized an increase in the amount of share repurchases to $150 million (plus any proceeds and tax benefits resulting from stock option exercises and tax benefits resulting from restricted shares purchased by employees from the Company).

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

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

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

11

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

The Company’s first quarters of 2004 and 2003 consisted of the 13 weeks ended April 25, 2004 and April 27, 2003, respectively.

Results of Operations

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

Consolidated Results - Comparison of the 13 weeks ended April 25, 2004 to the 13 weeks ended April 27, 2003

Sales

Consolidated sales increased $79.4 million, or 10.6%, to $830.8 million in 2004 from $751.4 million in 2003. This resulted primarily from increased sales in the Borders, International segments, along with a slight increase in sales from the Waldenbooks segment.

Comparable store sales for all Borders superstores increased 4.3% in 2004. Comparable store sales measures for all Borders superstores, which are based upon a 52-week year, include all stores open more than one year except those not offering music (of which there are 10, representing approximately 2% of total sales). New stores are included in the calculation of comparable store sales measures upon the 13th month of operation. The comparable store sales increase for 2004 was due primarily to the book, movie and gifts and stationery categories, which experienced strong positive comparable store sales, partially offset by negative comparable store sales in the music category. Comparable store sales of books increased due to continued strength in bestsellers. Sales of movies improved on a comparable store basis primarily as the result of increased sales of digital videodiscs (DVDs). Sales of the gifts and stationery category also increased, principally the result of category management initiatives resulting in product enhancements, improved placements, and a slight increase in space allocation. The impact of price changes on comparable store sales was not significant.

Waldenbooks’ comparable store sales increased 5.6% in 2004. Waldenbooks’ comparable store sales measures, which are based upon a 52-week year, include all stores open more than one year. New stores are included in the calculation of comparable store sales measures upon the 13th month of operation. The Company’s seasonal mall-based kiosks are also included in Waldenbooks’ comparable store sales measures. The comparable store sales increase for 2004 was primarily due to improved conversion of mall traffic. The impact of price changes on comparable store sales was not significant.

Other revenue

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

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

12

income as “Other revenue” in the Company’s consolidated statements of operations. Discounts on purchases are netted against “Sales” in the Company’s consolidated statements of operations.

Gross margin

Consolidated gross margin increased $21.8 million, or 11.5%, to $210.8 million in 2004 from $189.0 million in 2003. As a percentage of sales, consolidated gross margin increased to 25.4% in 2004 from 25.2% in 2003. This was primarily due to the Waldenbooks and International segments’ gross margin as a percentage of sales increasing, while the Borders segment remained flat. In the Waldenbooks segment, the improvement was primarily due to occupancy costs for stores open more than one year remaining essentially flat while comparable store sales improved. The International segment improvement was due to higher third party vendor income from café operations and lower costs related to shrink and distribution as a percentage of sales, offset by an increase in occupancy costs as a percentage of sales.

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

Selling, general and administrative expenses

Consolidated selling, general and administrative expenses (SG&A) increased $10.0 million, or 5.2%, to $203.0 million in 2004 from $193.0 million in 2003. As a percentage of sales, SG&A decreased to 24.5% in 2004 from 25.7% in 2003. This decrease primarily resulted from reduced corporate non-payroll costs as percentage of sales for the Borders, Waldenbooks and International segments.

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

Interest expense

Consolidated interest expense decreased $0.3 million, or 13.6%, to $1.9 million in 2004 from $2.2 million in 2003. This was primarily due to lower average debt levels in 2004 as compared to 2003, which primarily resulted from increased cash flow generated by the Borders segment.

Taxes

The effective tax rate for the years presented differed from the federal statutory rate primarily as a result of state income taxes. The Company’s effective tax rate used was 37.0% in 2004 compared to 38.0% in 2003.

Net income (loss)

Due to the factors mentioned above, net income as a percentage of sales increased to net income of 0.4% in 2004 from a net loss of 0.6% in 2003, and net income dollars increased to net income of $3.0 million in 2004 from a net loss of $4.8 million in 2003.

Segment Results

The Company is organized based upon the following operating segments: domestic Borders stores, Waldenbooks stores, International Borders and Books etc. stores, and Corporate (consisting of the unallocated portion of interest expense, certain corporate governance costs and corporate incentive costs). See “Note 5 - Segment Information” in the notes to consolidated financial statements for further information relating to these segments.

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

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Borders

Borders - Comparison of the 13 weeks ended April 25, 2004 to the 13 weeks ended April 27, 2003

Sales

Borders’ sales increased $55.8 million, or 10.7%, to $577.3 million in 2004 from $521.5 million in 2003. This increase was comprised of comparable store sales increases of $19.7 million and non-comparable sales increases of $36.1 million primarily associated with 2004 and 2003 store openings.

Gross margin

Gross margin as a percentage of sales remained flat at 26.5% in 2004 as compared to 2003. Store occupancy costs as a percentage of sales decreased 0.2% as a result of the stores’ rent expense representing a lower percentage of sales, primarily due to rent expense for stores open more than one year remaining essentially flat while comparable store sales improved. This was offset by an increase in markdowns, freight and product costs of 0.2% as a percentage of sales.

Gross margin dollars increased $14.7 million, or 10.6%, to $153.1 million in 2004 from $138.4 million in 2003, which was primarily due to the increase in comparable store sales and the increase in the gross margin percentage.

Selling, general and administrative expenses

SG&A as a percentage of sales decreased to 23.7% in 2004 from 25.0% in 2003. This was primarily due to an decrease of 0.8% in corporate non-payroll costs as a percentage of sales, due to disciplined costs controls at the corporate level, a decrease of 0.5% in store operating expenses as a percentage of sales, a decrease of 0.3% in corporate payroll costs as a percentage of sales and a decrease of 0.1% in store payroll as a percentage of sales, partially offset by a 0.4% increase in advertising expenses as a percentage of sales.

SG&A dollars increased $6.6 million, or 5.1%, to $137.0 million in 2004 from $130.4 million in 2003 primarily due to increased store payroll expenses resulting from new store openings.

Effect of terrorist attacks on September 11, 2001

As a result of the terrorist attacks on September 11, 2001, a Borders store that operated in the World Trade Center in New York City was destroyed. The loss of that store’s sales and net income was not material to the consolidated 2003, 2002 or 2001 results as a whole. The Company was insured for the replacement value of the assets destroyed at the store and up to 24 months of lost income from business interruption coverage and has recognized a total recovery of $19.9 million to date.

In the first quarter of 2004, Borders recognized as income an insurance reimbursement of $1.2 million related to the September 11, 2001 loss. Of this, $0.9 million was categorized as an offset to “Selling, general and administrative expenses”. This amount primarily represented the excess of lost assets’ replacement value over their net book value. It is the Company’s policy to record gains and losses on asset disposals as a part of “Selling, general and administrative expenses”. The remaining $0.3 million was related to pre-opening expenses incurred in the opening of replacement stores in New York City. This was categorized as an offset to “Pre-opening expense” on the consolidated statements of operations.

The Company does not expect to recover additional insurance amounts related to its loss.

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Depreciation expense

Depreciation expense remained flat at $17.3 million in 2004 as compared to 2003.

Interest income

Interest income increased $0.9 million, or 100.0%, to $1.8 million in 2004 from $0.9 million in 2003. This was the result of Border’s continued positive cash flow at fixed internal interest rates.

Net income

Due to the factors mentioned above, net income as a percentage of sales increased to 1.8% in 2004 from 0.9% in 2003, and net income dollars increased $5.7 million, or 118.8%, to $10.5 million in 2004 from $4.8 million in 2003.

Waldenbooks

Waldenbooks - Comparison of the 13 weeks ended April 25, 2004 to the 13 weeks ended April 27, 2003

Sales

Waldenbooks’ sales increased $0.5 million, or 0.3%, to $150.8 million in 2004 from $150.3 million in 2003. This increase was comprised of increased comparable store sales of $8.1 million and decreased non-comparable sales associated with 2004 and 2003 store closings of $7.6 million.

Other revenue

Waldenbooks’ other revenue, which consists of membership income from the Preferred Reader Program, was largely consistent in 2004 with 2003.

Other revenue dollars were $5.4 million in 2004 and $6.0 million in 2003.

Gross margin

Gross margin as a percentage of sales increased to 24.5% in 2004 from 23.1% in 2003. This was primarily due to a 1.3% decrease in store occupancy expenses as a percentage of sales, as a result of rent expense for stores remaining open more than one year remaining essentially flat while comparable stores sales improved. In addition, distribution and other costs improved 0.6% as a percentage of sales. This was partially offset by a decrease of 0.4% in other revenue as a percentage of sales and an increase in markdowns and product costs of 0.1% as a percentage of sales.

Gross margin dollars increased $2.3 million, or 6.6%, to $37.0 million in 2004 from $34.7 million in 2003, primarily due to the increase in comparable store sales and the increase in gross margin percentage.

Selling, general and administrative expenses

SG&A as a percentage of sales decreased to 28.1% in 2004 from 28.7% in 2003. This was primarily due decreased corporate non-payroll expenses of 0.5% as a percentage of sales due to disciplined costs controls at the corporate level and decreased advertising

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expenses of 0.1% as a percentage of sales.

SG&A dollars decreased $0.8 million, or 1.9%, to $42.4 million in 2004 from $43.2 million in 2003 primarily due to store closings.

Depreciation expense

Depreciation expense decreased $0.6 million, or 14.6%, to $3.5 million in 2004 from $4.1 million in 2003. This was primarily due to a lower fixed asset base resulting from prior year asset impairments and store closings.

Interest income

Interest income increased $1.2 million, or 12.9%, to $10.5 million in 2004 from $9.3 million in 2003. This was the result of Waldenbooks’ continued positive cash flow at fixed internal interest rates.

Net income

Due to the factors mentioned above, net income as a percentage of sales increased to 1.9% in 2004 from 0.3% in 2003, while net income dollars increased $2.4 million, to $2.9 million in 2004 from $0.5 million in 2003.

International

International - Comparison of the 13 weeks ended April 25, 2004 to the 13 weeks ended April 27, 2003

Sales

International sales increased $23.1 million, or 29.0%, to $102.7 million in 2003 from $79.6 million in 2002. Of this increase in sales, 17.0% was due to the translation of foreign currencies to U.S. dollars. The remaining 12% was the result of new superstore openings and comparable store sales increases. The impact of price changes on comparable store sales was not significant.

Gross margin

Gross margin as a percentage of sales increased to 20.2% in 2004 from 20.0% in 2003. The International segment experienced a 0.2% increase in third party vendor income from café operations as a percentage of sales, due to its agreement with Starbucks Coffee Company (U.K.) Limited. In addition, gross margin as a percentage of sales was impacted by decreases of 0.2% in shrink and 0.2% in distribution costs as a percentage of sales, primarily due to the annualization of superstores opened in fiscal 2003. Offsetting these factors was a 0.4% increase in occupancy costs as a percentage of sales, which resulted from currency fluctuations and the annualization of superstores opened in fiscal 2003.

Gross margin dollars increased $4.8 million, or 30.2%, to $20.7 million in 2004 from $15.9 million in 2003, primarily due to new superstore openings.

Selling, general and administrative expenses

SG&A as a percentage of sales decreased to 20.8% in 2004 from 22.5% in 2003. This improvement was primarily the result of decreases, as a percentage of sales, in store payroll costs of 1.3% due to changes in the store management structure and store operating expenses of 0.4% due to disciplined cost controls at the store level. Although these expenses increased in dollars, they increased at

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rates less than sales growth. In addition corporate non-payroll costs decreased 0.3%, due to increased income from the Company’s gift certificate program based on favorable redemption trends. Offsetting those improvements was an increase in advertising costs of 0.3% as a percentage of sales, due to increased spending targeted at driving sales.

SG&A dollars increased $3.5 million, or 19.6%, to $21.4 million in 2004 from $17.9 million in 2003, primarily due to currency fluctuations, as well as 2003 superstore openings and the increased store payroll and operating expenses required.

Depreciation expense

Depreciation expense increased $0.6 million, or 21.4%, to $3.4 million in 2004 from $2.8 million in 2003. This was primarily due to depreciation expense recognized on new stores’ capital expenditures.

Interest expense

Interest expense increased $0.1 million, or 2.2%, to $4.7 million in 2004 from $4.6 million in 2003.

Net loss

Due to the factors mentioned above, net loss as a percentage of sales decreased to 3.1% in 2004 as compared to 5.3% in 2003, and net loss dollars decreased $1.0 million, or 23.8%, to $3.2 million in 2004 from $4.2 million in 2003.

Corporate

Corporate - Comparison of the 13 weeks ended April 25, 2004 to the 13 weeks ended April 27, 2003

The Corporate segment includes the unallocated portion of interest expense, certain corporate governance costs and corporate incentive costs.

Net loss dollars increased $1.3 million, or 22.0%, to $7.2 million in 2004 from $5.9 million in 2003. This was primarily due to increased interest expense for this segment primarily resulting from increased borrowings to fund corporate stock repurchases in 2004, partially offset by a reduction in various governance costs as compared to the prior year. Interest expense represents corporate-level interest costs not charged to the Company’s other segments.

Liquidity and Capital Resources

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

Net cash used for operations was $117.3 million and $111.9 million for the 13 weeks ended April 25, 2004 and April 27, 2003, respectively. Operating cash outflows for the period resulted from decreases in taxes payable, expenses payable and accrued liabilities and accounts payable, as well as increases in inventories, prepaid expenses and other long-term assets. The most significant of these was the decrease in taxes payable, which resulted from payment of the Company’s estimated fiscal 2003 taxes. The current year operating cash inflows primarily reflect operating results net of non-cash charges for depreciation, as well as a decrease in accounts receivable and an increase in other long-term liabilities.

Net cash provided by investing was $18.8 million, which primarily resulted from proceeds received from the sale-leaseback of a Company-owned store and office building in the United Kingdom. The proceeds from the sale, totaling $32.3 million were offset against assets with a net book value of $28.4 million. Direct costs associated with the transaction were $0.4 million. A deferred gain of $3.5 million was recorded on the consolidated balance sheets in “Other long-term liabilities” and will be amortized over the 20 year term of the operating lease.

In fiscal 2004, capital expenditures were $13.5 million, which reflects the opening of three new superstores and one new airport store,

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operated by the Waldenbooks segment. In fiscal 2003, capital expenditures were $16.4 million, which primarily funded new stores and the refurbishment of existing stores. Capital expenditures in 2003 reflected the opening of 11 new superstores and two new airport stores, operated by the Waldenbooks segment. Additional capital spending in 2003 reflected the development and installation of in-store web-based technology and spending on corporate information technology streamlining.

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

Net cash used for financing was $43.2 million, resulting from the repurchase of common stock totaling $50.1 million, the repayment of the credit facility of $7.2 million, the payment of the Company’s January cash dividend of $6.2 million and the repayment of long-term capital lease obligations of $0.4 million, offset by $20.7 million of proceeds from stock option exercises. Net cash used for financing in 2003 was $4.0 million, resulting primarily from the repurchase of common stock, partially offset by funding from the credit facility and the issuance of common stock.

The Company currently has a share repurchase program in place with remaining authorization to repurchase approximately $113.5 million. During the 13 weeks ended April 25, 2004 and April 27, 2003, $50.1 million and $13.8 million of common stock was repurchased, respectively. The Company plans to continue the repurchase of its common stock throughout fiscal 2004, subject to the Company’s share price and capital needs.

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

At the Annual Stockholders Meeting in May of 2004, the shareholders approved the Borders Group, Inc. 2004 Long-Term Incentive Plan as detailed in the Company’s Proxy Statement dated April 14, 2004. This plan will replace the existing stock option and restricted stock plans on a going-forward basis, which will allow the Company to reduce its annual stock grants as a percentage of outstanding shares by implementing a greater use of restricted stock while reducing the number of stock options issued.

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

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

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

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

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

The Company has two lease financing facilities (collectively, the “Lease Financing Facilities”) to finance new stores and other property owned by unaffiliated entities and leased to the Company or its subsidiaries. The original facility (the “Original Lease Facility”) will expire in June 2006. In June of 2002, the Company established a new facility (the “New Lease Facility”), which will expire in 2007. The aggregate amount available under the Lease Financing Facilities is $25.0 million. Properties to be financed after the effective date of the New Lease Facility will be financed under that Facility, and no additional properties will be financed under the Original Lease Facility. The Lease Financing Facilities provide financing to lessors of properties leased to the Company or its subsidiaries through loans from lenders for up to 95% of a project’s cost. Additionally, under the New Lease Facility, the unaffiliated lessor will make equity contributions approximating 5% of the cost of each project. The lessors under the Original Lease Facility have made similar contributions.

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

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

There were two, four and two properties financed through the Original Lease Facility at April 25, 2004, April 27, 2003 and January 25, 2004, respectively, with financed values of $13.8 million, $22.6 million and $13.8 million. The two properties financed through the Original Lease Facility at April 25, 2004 and January 25, 2004 were consolidated by the Company, pursuant to the provisions of Financial Accounting Standards Board (FASB) issued Interpretation No. 46, “Consolidation of Variable Interest Entities” (FIN 46), as discussed below. Of the amount financed under the Original Lease Facility at April 27, 2003, the Company had recorded $19.0 million as capitalized leases, under “Other assets” (for the capital lease assets) and “Long-term capital lease obligations” (for the capital lease liabilities) on the consolidated balance sheets at April 27, 2003. These amounts were treated as non-cash items on the consolidated statements of cash flows. There were no borrowings under the New Lease Facility as of April 25, 2004, April 27, 2003 or January 25, 2004.

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Consolidated VIEs: Pursuant to the requirements of FIN 46, the Company is the primary beneficiary of the two variable interest entities (VIEs) that own the two properties financed under the Original Lease Facility at April 25, 2004. As a result, the Company consolidates these VIEs and has recorded land, property and equipment, net of accumulated depreciation, of $12.0 million, short-term borrowings of $13.8 million, and minority interest of $1.3 million at April 25, 2004. These amounts have been treated as non-cash items on the consolidated statements of cash flows.

The Company also is the primary beneficiary of two additional VIEs, due to the Company’s guarantee of the debt of these entities. As a result, the Company consolidates these VIEs and has recorded property and equipment, net of accumulated depreciation, of $5.5 million, long-term debt of $5.8 million, and minority interest of $0.4 million at April 25, 2004. These amounts have been treated as non-cash items on the consolidated statements of cash flows.

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

The following table summarizes the Company's significant financing and lease obligations at April 25, 2004:

(1) Included as debt of consolidated VIE’s

Seasonality

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

Critical Accounting Policies and Estimates

In the ordinary course of business, the Company has made a number of estimates and assumptions relating to the reporting of results of operations and financial condition in the preparation of its financial statements in conformity with accounting principles generally accepted in the United States. Actual results could differ from those estimates under different assumptions and conditions. Such estimates have been disclosed in the Company’s last Annual Report on Form 10-K for the fiscal year ended January 25, 2004. There have been no significant changes in these estimates during the first quarter of fiscal 2004.

Related Party Transactions

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

Forward Looking Statements

This Quarterly Report on Form 10-Q contains forward-looking statements as defined in the Private Securities Litigation Reform Act of 1995. Forward-looking statements reflect management’s current expectations and are inherently uncertain. The Company’s actual

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results may differ significantly from management’s expectations. Exhibit 99.1 to this report, “Cautionary Statement under the Private Securities Litigation Reform Act of 1995", identifies the forward-looking statements and describes some, but not all, of the factors that could cause these differences.

Item 3. Quantitative and Qualitative Disclosures About Market Risk

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

There have been no material changes in this Item since the Company’s last Annual Report on Form 10-K for the fiscal year ended January 25, 2004.

Item 4. Controls and Procedures

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

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

Part II – Other Information

Item 1. Legal Proceedings

The Company’s Form 10-K Annual Report for the fiscal year ended January 25, 2004, describes pending lawsuits and claims against the Company. The status of such litigation and claims has not changed in any significant respect.

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

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Item 2. Changes in Securities and Use of Proceeds

ITEM 6. Exhibits and Reports on Form 8-K

Exhibits:

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SIGNATURES

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

BORDERS GROUP, INC.
(Registrant)

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EXHIBIT INDEX

DESCRIPTION OF EXHIBITS