< chairman’s letter > Dear Fellow Shareholders: What do growing companies do in slumping markets? They work harder to meet customer needs, increase market share and expand their competitive advantage. They manage costs, while continuing to invest in their business and their people for the future. They respond effectively to short-term challenges without deviating from their long-term plans. Borders Group distinguished itself in all these ways in 2002. borders group 01 < Gregory P.Josefowicz Chairman, President and Chief Executive Officer Despite a struggling economy and lackluster Disappointingly, our sales growth was not as retail environment, Borders Group modestly strong as in past years. This contributed to a increased sales, we improved our earnings, decline in the value of Borders Group stock of and continued to expand our domestic and approximately 19% during calendar year 2002, international presence. While the holiday compared to a drop of just over 24% in the season and fourth quarter fell short of our goals, S&P 500 for the same period. Leveraging our we ended fiscal 2002 in a fundamentally strong cash position, we returned approximately strong position: $75 million to shareholders in the form of stock repurchases, and we intend to use stock > Consolidated sales rose 2.9% to a record repurchases as a core strategy for increasing $3.5 billion. For the year, sales for our shareholder value. Borders and International segments increased 3.8% and 25.1%, respectively, while sales at Waldenbooks declined 5.5%. STRONG MOVES FOR A SOFT MARKET > Consolidated earnings per share increased On a relative basis, Borders Group continued 28.3% to $1.36 per share. to outpace the industry in 2002, increasing our average monthly share of U.S. retail book and > We maintained our strong financial position music sales. In typical growing markets, those by ending 2002 with cash, net of debt, of share gains would have translated into sales $106.4 million, equal to our position one increases. But book and music industry sales year ago. declined in 2002 and our performance suffered as a result. Comparable store sales for our borders group 03 < chairman’s letter > Borders segment declined 1.2% for the year. focused on the four-point business plan that we Waldenbooks’ comparable store sales fell 3.2%. initiated two years ago: It’s not that our customers are spending less when they shop. In fact, the average per-visit 1. BUILDING OUR CORE BUSINESS purchase at our Borders stores increased nearly Investing in stores remains an important part 2% in 2002. But total store visits were down of building our core business. During 2002, during the year, due in part to fewer block- we opened 41 new domestic Borders locations, buster book titles to help drive traffic. from Wilton, Connecticut, to San Diego, While these popularity cycles impact our California, bringing our total at fiscal year-end business, there’s a lot we’ve learned about to 404. how to manage them. Our expansion included 10 new “small market” To help counteract last year’s soft market stores, designed primarily for communities conditions, we continued to rein in costs, that aren’t large enough to support our full-size reducing our expense ratio for the eighth superstore format. These new stores—which consecutive quarter. We improved inventory average about 17,000 square feet compared to management for the second straight year, keep- approximately 23,000 square feet for a typical ing our investment in inventory essentially flat, Borders superstore opened in 2002—exceeded while increasing our total square footage by our initial sales expectations, and we will con- 6.7%. We ended 2002 in a net-cash tinue to explore opportunities for this format. position, and favorably restructured our outstanding loan agreements during the year. New-store growth enabled us to increase sales in 2002. Domestically, Borders stores gener- As a result, our financial position remains solid, ated $2.3 billion in sales in 2002, up 3.8% and we continue to make strategic investments over 2001. While we launched several new to improve our sales and earnings, staying initiatives during the third and fourth quarters 04 borders group < chairman’s letter > to increase sales and further differentiate Category Management plans in six categories, our business—including the launch of a increasing sales, percentage of in-store sales new Express In-Store Pick Up service with and market share. By the fourth quarter of Amazon.com—these programs did not 2003, about 70% of the categories in Borders have much time in 2002 to develop or make stores will have category plans implemented significant contributions to growth, yet we to improve performance. We are committed to look forward to their potential for further accelerating this highly effective initiative. contributions. While books continue to represent the majority Category Management is primary among of our sales, we are also working hard to expand these initiatives. A successful concept in retail other complementary categories. These efforts management for many years, Category helped to drive double-digit comp sales gains Management is: in movies and continued strong growth in gifts and stationery during the fourth quarter. We > a proven business philosophy with the also improved the performance of our cafes, consumer as the focus; and continue to seek attractive third-party > a collaborative business process with our alliances that we believe can help boost both suppliers; and food and beverage profits and incremental sales throughout our stores. > a dynamic business strategy that impacts organizational design and culture. During the year, we intensified our efforts to measure and monitor customer satisfaction, Applying Category Management techniques to which we continue to drive to higher levels. our business, individual categories of our stores According to our research, customers rate prod- are now managed as distinct profit centers, uct availability and personal service among each with its own goals and business plans. our greatest strengths, and two of the attributes In 2002, we completed implementation of that contribute most to customer loyalty. borders group 05 < chairman’s letter > We introduced a number of new training pro- Borders successful in the U.S., while recog- grams in 2002 to constantly improve customer nizing and making adaptations for cultural service and satisfaction. These programs are differences. For the year, International seg- also aimed at enhancing the skills and career ment sales increased 25.1% to $315 million. advancement of our employees, and helping While its net loss increased during 2002, us strengthen our reputation as a great place International generated net income during the to work. fourth quarter, and we aim to achieve breakeven performance by year-end 2003. 2. DRIVING INTERNATIONAL GROWTH Among International’s operating initiatives in 2002, we improved our store model in Borders Group remains the only U.S. retailer Australia, and vastly improved our organization to own and operate a significant number of and infrastructure in the Pacific Rim region. book and music superstores internationally. We also streamlined inventory management During 2002, we expanded our presence by and stocking in the U.K., contributing to opening eight new overseas Borders locations, increased turn and well merchandised, more ending the year with 30 Borders stores productive stores. throughout Australia, England, New Zealand, Puerto Rico, Scotland and Singapore, and 37 Books etc. locations in the U.K. We also 3. LEVERAGING ALLIANCES opened a new distribution center in the U.K., AND TECHNOLOGY doubling our usable square footage. Our successful alliance with Amazon.com, Our success internationally is based in large launched in April 2001, continues to grow part on building on and leveraging our stronger, giving us more ways to sell more company’s core competencies. We work to books to more customers more often. perpetuate the initiatives that have made Launched in October, the new Express 06 borders group < chairman’s letter > In-Store Pick Up service gives Amazon.com Borders store using one of our in-store Title and Borders.com shoppers the option of order- Sleuth computer stations or they can have one ing books, music and movies online for later of our associates place the order for them at an purchase and pick up at a nearby Borders store. information desk. This new service gives us yet Customers who have used the new service love another way to efficiently find and deliver the it, saying it expands access to our products and exact book that a customer is looking for, and provides nearly “instant gratification” when creates a new growth opportunity for us in the they shop. hard-to-find book category. Online purchases made through Borders.com We’re also applying technology to improve continued to grow at an accelerated rate in 2002. our operational efficiency. A good example is Customers can also visit Bordersstores.com our Common Systems program. Common to find the closest Borders location, browse Systems is a long-term project that will enable up-to-date event information and reserve Borders and Waldenbooks businesses to operate titles online for in-store purchase and pick up. on one common technology platform with In November, we teamed with Amazon.com the goal of improving business processes and to launch Waldenbooks.com, providing reducing our costs over the next several years. 24/7 buying and other services to loyal In 2002, the focus of our Common Systems Waldenbooks customers. initiative included the development and testing of new Product Flow-Receiving systems and During the fall, we also launched a new procedures to streamline backroom processes alliance with Alibris, giving our customers and increase inventory accuracy. We also intro- access to more than 15 million used, out-of- duced a new PeopleSoft software system to print and hard-to-find books worldwide.