UNITED STATES
SECURITIES AND EXCHANGE COMMISSIONWashington, D.C. 20549

Form 10-K

For the fiscal year ended July 31, 2007

Zale Corporation

A Delaware Corporation
IRS Employer Identification No. 75-0675400
SEC File Number 1-04129

901 W. Walnut Hill Lane
Irving, Texas 75038-1003
(972) 580-4000

Zale Corporation's common stock, par value $.01 per share, is registered pursuant to Section 12 (b) of the Securities Exchange Act of 1934 (the
"Act") and is listed on the New York Stock Exchange. Zale Corporation does not have any securities registered under Section 12(g) of the Act. Zale Corporation is required to file reports
pursuant to Section 13 of the Act. Zale Corporation (1) has filed all reports required to be filed by Section 13 or 15(d) of the Act during the preceding 12 months, and
(2) has been subject to such filing requirements for the past 90 days.

Disclosure
of the delinquent filers pursuant to Item 405 of Regulation S-K will be contained in our definitive Proxy Statement, portions of which are incorporated by
reference in Part III of this Form 10-K.

The
aggregate market value of Zale Corporation's common stock (based upon the closing sales price quoted on the New York Stock Exchange) held by non-affiliates as of
January 31, 2007 was $1,345,627,745. As of September 17, 2007, 49,058,627 shares of Zale Corporation's common stock were outstanding. For this purpose, directors and officers have been
assumed to be affiliates.

Zale
Corporation is a large accelerated filer and a well-known seasoned issuer.

Zale
Corporation is not a shell company.

DOCUMENTS INCORPORATED BY REFERENCE.

Portions of Zale Corporation's definitive Proxy Statement for the 2007 Annual Meeting of Stockholders to be held on November 14, 2007 are incorporated by
reference into Part III.



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PART I

ITEM 1.    BUSINESS

General

We are, through our wholly owned subsidiaries, a leading specialty retailer of fine jewelry. At July 31, 2007, we operated 1,471 specialty retail jewelry
stores and 793 kiosks located mainly in shopping malls throughout the United States of America ("U.S."), Canada and Puerto Rico.

We
were incorporated in Delaware in 1993. Our principal executive offices are located at 901 W. Walnut Hill Lane, Irving, Texas 75038-1003. Our telephone number at that
address is (972) 580-4000, and our internet address iswww.zalecorp.com.

During
the fiscal year ended July 31, 2007, we generated $2.4 billion of revenues. We believe we are well-positioned to compete in the approximately
$66 billion, combined U.S. and Canadian retail jewelry industry, leveraging our established brand names, economies of scale and geographic and demographic diversity. We have significant brand
name recognition as a result of each brand's long-standing presence in the industry and our national and regional advertising campaigns. We believe that brand name recognition is an
important advantage in jewelry retailing as jewelry products are generally unbranded and consumers must trust in a retailer's reliability, credibility and commitment to customer service.

Business Segments

We report our operations under three business segments: Fine Jewelry, Kiosk Jewelry and All Other. An overview of each business segment follows below. During
fiscal year 2007, our Fine Jewelry segment generated $2.2 billion or approximately 89.0 percent of our revenues. During fiscal year 2007, the Kiosk revenues represented
$263 million or approximately 11.0 percent of our revenues.

Fine Jewelry

Our Fine Jewelry segment is comprised of six brands, predominantly focused on the moderate income consumer as our core customer target. Each brand specializes in
fine jewelry and watches, with merchandise and marketing emphasis focused on diamond products. Additionally, each brand differentiates itself through a customer experience with different points of
emphasis. Our moderate brands, which consist of all brands except Bailey Banks & Biddle, have a centralized merchandising function that creates significant synergies and allows for more teaming
across brands. Zales Jewelers® is our national brand in the U.S. providing moderately priced jewelry to a broad range of customers. We have further leveraged the brand strength through
Zales Outlet, which focuses on a slightly higher-income female self purchaser in outlet malls and neighborhood power centers. Gordon's Jewelers® is a moderately priced regional jeweler
that emphasizes customer relationships. Bailey Banks & Biddle Fine Jewelers® operates jewelry stores that are considered among the finest luxury jewelry stores in their markets,
offering designer jewelry and prestige watches to attract more affluent customers. Peoples Jewellers® and Mappins Jewellers® offer moderately priced jewelry in malls throughout
Canada. The brands in the Fine Jewelry segment have expanded their presence in the retail market through their e-commerce sites,zales.com,
gordonsjewelers.com,andbaileybanksandbiddle.com.



Zales, our national flagship, is a leading brand name in jewelry retailing in the U.S., with 789 stores in 50 states and Puerto Rico, and accounted for
approximately 44 percent of our total revenues in fiscal year 2007. Zales' average store size is 1,681 square feet with an average transaction of $371 in fiscal year 2007.

Zales
is positioned as "The Diamond Store" given its emphasis on diamond jewelry especially in the bridal and fashion segments. The Zales brand complements the merchandise assortments
with a promotional strategy that features "Brilliant Buys" to drive sales during gift-giving occasions and

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throughout
the year. We believe that the prominence of diamond jewelry in our product selection and Zales' reputation for customer service for over 80 years fosters an image of product
expertise, quality and trust among consumers.

Zales,
a multi-channel retailer, serves the internet customer through its e-commerce site,zales.com, which accounted for
approximately two percent of our total revenues in fiscal year 2007.



In Canada, we operate 193 stores in nine provinces and enjoy the largest market share of any specialty jewelry retailer in Canada. Canadian operations consist of
two brands, Peoples Jewellers and Mappins Jewellers. Canadian operations accounted for approximately 11 percent of our total revenues in fiscal year 2007. The average store size is 1,600 square
feet with an average transaction of $299 in fiscal year 2007.

Peoples
Jewellers and Mappins Jewellers are two of the most recognized brand names in Canada. Peoples Jewellers offers jewelry at affordable prices, attracting a wide variety of Canadian
customers. Using the trademark "Peoples, the Diamond Store" in Canada, Peoples emphasizes its diamond business while also offering a wide selection of gold jewelry, gemstone jewelry and watches. Since
2000, the Peoples brand has been building recognition with an aggressive television campaign. Over the past four years, Peoples had the largest television campaign of any Canadian jewelry retailer by
a wide margin. Seasonal newspaper inserts are also a key element in the Peoples marketing campaign. Mappins Jewellers differentiates itself by offering exclusive merchandise primarily in its bridal
assortments. Since 2000, Mappins has utilized newspaper inserts and targeted direct mail offers to reach its customers.



We operated Zales Outlet with stores in 36 states and Puerto Rico which accounted for approximately eight percent of our total revenues in fiscal year 2007. The
average store size is 2,398 square feet, with an average transaction of $414 in fiscal year 2007.

The
outlet concept has evolved into one of the strongest concepts in retail shopping today, featuring items in every major jewelry category including branded watches, gemstones, gold
merchandise, and diamond fashion and solitaire products. The merchandise assortment in a typical Zales Outlet store caters to the higher-income female self purchaser, offering 20 to 70 percent
off traditional retail prices every day. We have grown our Zales Outlet concept over the past nine years from four stores in 1998 to the 137 stores in operation at the end of fiscal year 2007.

Although
Zales Outlet was established as an extension of the Zales brand and capitalizes on Zales' national advertising and brand recognition, Zales Outlet offers its own unique product
assortments and augments this with promotional efforts that are geared specifically to the outlet consumer and consistent with the "off-mall" location.



Gordon's is positioned as our relationship brand in certain regional markets. As of July 31, 2007, Gordon's had 282 stores in 35 states and Puerto Rico and
accounted for approximately 14 percent of our total revenues in fiscal year 2007. Average store size is 1,517 square feet with an average transaction of $411 in fiscal year 2007. Gordon's
distinguishes itself by emphasizing customer service along with its unique marketing and store design.

We
believe the Gordon's customer shares similar demographic characteristics to the Zales customer. Accordingly, we are continuing steps to appropriately position the brand to compete
with our external competitors and leverage our corporate strengths to capture market share across both our Zales and Gordon's brands. We believe our initiatives to centralize and streamline the
merchandising organization will further support strengthening the Gordon's performance. We believe the opportunity is to differentiate Gordon's customer experience based on their strength in building
customer relationships. To

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leverage
our corporate buying power, merchandise will be consistent with Zales in basic merchandise programs such as diamond solitaires and certain bridal categories. However, where appropriate,
products will be differentiated to cater to local demographics. During fiscal year 2007, Gordon's Jewelers launched thegordonsjewelers.come-commerce site to serve its internet customers.



At July 31, 2007, Bailey Banks & Biddle operated 70 upscale jewelry stores in 24 states. We also utilize the trade name Zell Bros® for
one location operated by the Bailey Banks & Biddle brand. Average store size is 4,260 square feet with an average transaction of $1,596 in fiscal year 2007. Total revenue at Bailey
Banks & Biddle accounted for approximately 12 percent of our total revenues in fiscal year 2007.

For
over 170 years, Bailey Banks & Biddle has combined classic jewelry with contemporary designs, offering a compelling shopping environment for the high-end
luxury consumer. Bailey Banks & Biddle locations are among the preeminent stores in their markets. They carry both exclusive and recognized branded and designer merchandise selections to appeal
to the more affluent customer. The Bailey Banks & Biddle merchandise assortments are carefully selected to provide treasures that will be appreciated for generations with a focus on diamonds,
precious gemstones, gold, and branded designer jewelry, complemented by an extensive assortment of prestige watch brands and giftware.

Kiosk Jewelry

The Kiosk Jewelry segment operates primarily under the brand names Piercing Pagoda®, Plumb Gold, and Silver and Gold
Connection® through mall-based kiosks and reaches the opening price point select jewelry customer. At July 31, 2007, Piercing Pagoda operated 793 locations in 42 states
and Puerto Rico. The Kiosk Jewelry segment specializes in gold and silver products that capitalize on the latest fashion trends.

At
the entry-level price point, the Kiosk Jewelry segment targets a young, fashion forward customer. The kiosk segment offers an extensive collection of popularly-priced bracelets,
earrings, charms, rings, and 14 karat and 10 karat gold chains, as well as a selection of silver and diamond jewelry, all in basic styles at moderate prices. In addition, trained associates perform
ear-piercing services on site.

Kiosks
are generally located in high traffic locations that are easily accessible and visible within regional shopping malls. The kiosk locations average 188 square feet in size, with an
average transaction of $39 in fiscal year 2007.

All Other

We provide insurance and reinsurance facilities for various types of insurance coverage, which typically are marketed to our private label credit card customers,
through Zale Indemnity Company, Zale Life Insurance Company and Jewel Re-Insurance Ltd. The three companies are the insurers (either through direct written or reinsurance contracts)
of our customer credit insurance coverage. In addition to providing merchandise replacement coverage for certain perils, credit insurance coverage provides protection to the creditor and cardholder
for losses associated with the disability, involuntary unemployment, leave of absence or death of the cardholder. Zale Life Insurance Company also provides group life insurance coverage for our
eligible employees. Zale Indemnity Company, in addition to writing direct credit insurance contracts, has certain discontinued lines of insurance that it continues to service. Credit insurance
operations are dependent on our retail sales through our private label credit cards. In fiscal year 2007, 35.5 percent of our private label credit card purchasers purchased some form of credit
insurance. Under the current private label arrangement with Citibank U.S.A., N.A. ("Citi"), our insurance affiliates continue to provide insurance to holders of our private label credit cards and
receive payments for such insurance products. In fiscal year 2007, the All Other Segment accounted for less than one percent of our total revenues.

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Industry and Competition

Jewelry retailing is highly fragmented and competitive. We compete with a large number of independent regional and local jewelry retailers, as well as with other
national jewelry chains. We also compete with other types of retailers who sell jewelry and gift items such as department stores, discounters, direct mail suppliers, online retailers and television
home shopping programs. Certain of our competitors are non-specialty retailers, which are larger and have greater financial
resources than we do. The malls where most of our stores are located typically contain competing national chains, independent jewelry stores and/or department store jewelry departments. We believe
that we are also competing for consumers' discretionary spending dollars and, therefore, compete with retailers who offer merchandise other than jewelry or giftware. Therefore, we compete primarily on
the basis of our reputation for high quality products, brand recognition, store location, distinctive and value-priced merchandise, personalized customer service and ability to offer private label
credit card programs to customers wishing to finance their purchases. Our success is also dependent on our ability to both react to and create customer demand for specific merchandise categories.

The
U.S. and Canadian retail jewelry industry accounted for approximately $66 billion of sales in 2006, according to publicly available data. We have a four percent market share
in the combined U.S. and Canadian markets. The largest jewelry retailer in the combined U.S. and Canadian markets is believed to be Wal-Mart Stores, Inc. Other significant segments
of the fine jewelry industry include national chain department stores (such as J.C. Penney Company, Inc. and Sears, Roebuck and Co.), mass merchant discount stores (such as Wal-Mart
Stores, Inc.), other general merchandise stores and apparel and accessory stores. The remainder of the retail jewelry industry is comprised primarily of catalog and mail order houses,
direct-selling establishments, TV shopping networks (such as QVC, Inc.) and online jewelers.

Historically,
retail jewelry store sales have exhibited limited cyclicality. TheUnited States Census Bureauhas recorded only three years
of negative growth in specialty retail jewelry store sales from 1984 to 2006.

We
hold no material patents, licenses, franchises or concessions; however, our established trademarks and trade names are essential to maintaining our competitive position in the retail
jewelry industry.

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Operations by Brand

The following table presents revenues, average sales per location and the number of locations for each of our brands for the periods indicated.

|                                                             |  | Year Ended July 31,
|------------------------------------------------------------ |  | -------------------
|
|
|Zales (includingzales.com)                                   |  | $                  
|Zales Outlet                                                 |  |                    
|Gordon's (includinggordonsjewelers.com)                      |  |                    
|Bailey Banks & Biddle (includingbaileybanksandbiddle.com)(a) |  |                    
|Peoples(b)                                                   |  |                    
|Piercing Pagoda                                              |  |                    
|Peoples II                                                   |  |                    
|Insurance Revenues                                           |  |                    
|                                                             |  |                    
|                                                             |  | $                  
|                                                             |  |                    
|Average Sales Per Location(c):                               |  |                    
|Zales                                                        |  | $                  
|Zales Outlet                                                 |  |                    
|Gordon's                                                     |  |                    
|Bailey Banks & Biddle                                        |  |                    
|Peoples                                                      |  |                    
|Piercing Pagoda                                              |  |                    
|Peoples II                                                   |  |                    

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|                          |  | Locations by Brand
|------------------------- |  | ------------------
|
|Zales                     |  | 21                
|Zales Outlet              |  | 6                 
|Gordon's                  |  | 3                 
|Bailey Banks & Biddle     |  | 2                 
|Peoples                   |  | 19                
|Piercing Pagoda           |  | 14                
|Peoples II                |  |                  
|                          |  |                   
|                          |  | 65                
|                          |  |                   
|Year Ended July 31, 2006: |  |                   
|Zales                     |  | 24                
|Zales Outlet              |  | 7                 
|Gordon's                  |  | 17                
|Bailey Banks & Biddle     |  | 1                 
|Peoples                   |  | 7                 
|Piercing Pagoda           |  | 38                
|Peoples II                |  | 16                
|Master Jewelry Repair     |  | 3                 
|                          |  |                   
|                          |  | 113               
|                          |  |                   
|Year Ended July 31, 2005: |  |                   
|Zales                     |  | 24                
|Zales Outlet              |  | 18                
|Gordon's                  |  | 13                
|Bailey Banks & Biddle     |  |                  
|Peoples                   |  | 6                 
|Piercing Pagoda           |  | 50                
|Peoples II                |  | 71                
|                          |  |                   
|                          |  | 182               
|                          |  |                   

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Business Segment Data

Information concerning sales and segment income attributable to each of our business segments is set forth in Item 6, "Selected Financial Data," in Item 7,
"Management's Discussion and Analysis of Financial Condition and Results of Operations," and in "Notes to Consolidated Financial Statements," all of which are incorporated herein by reference.

Store Operations

Our stores are designed to differentiate our brands, create an attractive environment, make shopping convenient and enjoyable, and maximize operating
efficiencies, all of which enhance the customer

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experience.
We focus on store layout, with particular focus on arrangement of display cases, lighting, and choice of materials to optimize merchandise presentation. Promotional displays are changed
periodically to provide variety or to reflect seasonal events.

Each
of our stores is led by a store manager who is responsible for store-level operations, including overall store sales and personnel matters. Administrative matters, including
purchasing, distribution and payroll, are consolidated at the corporate level in an effort to maintain efficiency and low operating costs at the store level. In addition to selling jewelry, each store
also offers standard warranties and return policies, and provides extended warranty coverage that may be purchased at the customer's option. In order to facilitate sales, stores will hold merchandise
in layaway, generally requiring a deposit of not less than 20 percent of the purchase price at the inception of the layaway transaction.

We
have implemented inventory control systems, extensive security systems and loss prevention procedures to maintain low inventory losses. We screen employment applicants and provide our
store personnel with training in loss prevention. Despite such precautions, we experience losses from theft from time to time, and maintain insurance to cover such external losses.

We
believe it is important to provide knowledgeable and responsive customer service and we maintain a strong focus on connecting with the customer, both through advertising and
in-store communications and service. Our goal is to service the customer from the first sale by maintaining a customer connection through client services. We have a centralized customer
service call center to effectively address customer phone calls at lower aggregate cost.

We
continue to focus on the level and frequency of our employee training programs, particularly with store managers and key sales associates. We also provide training in sales techniques
for new employees, on-the-job training for all store personnel and management training for store managers. Under the banner of Zale Corporation University, we offer training to
employees at every level of the organization.

Purchasing and Inventory

We purchase the majority of our merchandise in finished form from a network of established suppliers and manufacturers located primarily in the United States,
Southeast Asia and Italy. In addition, we procure approximately 34 percent of our merchandise from our internal sourcing organization which consists of both assembled goods and factory direct
goods. All purchasing is done through buying offices at our headquarters. Consignment inventory has historically consisted of test programs, merchandise at higher price points or merchandise that
otherwise does not warrant the risk of ownership. Consignment merchandise can be returned to the vendor at any time or converted to owned inventory if it meets certain productivity thresholds. We had
$159.2 million and $175.1 million of consignment inventory on hand at July 31, 2007 and 2006, respectively. During fiscal years 2007 and 2006, we purchased approximately
18 percent and 22 percent, respectively, of our finished merchandise from our top five vendors, including five percent from one vendor in 2007. If our supply with these top vendors were
disrupted, particularly at certain critical times during the year, our sales could be adversely affected in the short term until alternative supply arrangements could be established. During fiscal
year 2007, our direct sourcing organization accounted for approximately 12 percent of our merchandise requirements.

As
a specialty retail jeweler, we could be affected by industry-wide fluctuations in the prices of diamonds, gold, and other metals and stones. The supply and prices of
diamonds in the principal world markets are significantly influenced by a single entity, the Diamond Trading Company, which has traditionally controlled the marketing of a substantial majority of the
world's supply of diamonds and sells rough diamonds to worldwide diamond cutters at prices determined in its sole discretion. The availability of diamonds to the Diamond Trading Company and our
suppliers is to some extent dependent on the political situation in diamond-producing countries and on continuation of prevailing supply and marketing arrangements for raw diamonds. Until alternate
sources are developed, any sustained interruption in the supply of diamonds could adversely affect us and the retail jewelry industry as a whole. The inverse is true

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with
respect to any oversupply from diamond-producing countries, which could cause diamond prices to fall.

Proprietary Credit

Our private label credit card program helps facilitate the sale of merchandise to customers who wish to finance their purchases rather than use cash or other
payment sources. We offer revolving and interest free credit programs under our private label credit card program. Approximately 39 percent and 41 percent of our U.S. total sales
excluding Piercing Pagoda, which does not offer proprietary credit, were generated by proprietary credit cards in fiscal years 2007 and 2006, respectively. Our Canadian
propriety credit card sales represented approximately 25 percent and 27 percent of Canadian total sales for fiscal years 2007 and 2006, respectively.

In
fiscal year 2007, we continued our proprietary credit offerings of same-as-cash, revolving and interest free programs, all of which allowed our sales personnel
to provide the customer additional financing options.

In
July 2000, we entered into a 10-year agreement with Citi whereby Citi issues private label credit cards branded with appropriate trademarks, and provides financing
for our customers to purchase merchandise in exchange for payment by us of a merchant fee based on a percentage of each credit card sale. The merchant fee varies according to the credit plan that is
chosen by the customer (i.e., revolving, interest free, same-as-cash).

Employees

As of July 31, 2007, we had approximately 17,600 employees, approximately 11 percent of whom were Canadian employees and less than one percent of
whom were represented by unions. Additionally, we usually hire temporary employees during each Holiday season.

Seasonality

As a specialty retailer of fine jewelry, our business is seasonal in nature, with our second quarter, which includes the months of November through January,
typically generating a proportionally greater percentage of annual sales, earnings from operations and cash flow than the other three quarters. We expect such seasonality to continue.

Information Technology

Our technology systems provide information necessary for (i) store operations; (ii) sales and margin management; (iii) inventory control;
(iv) profitability monitoring by many measures (merchandise category, buyer, store); (v) customer care; (vi) expense control programs; and (vii) overall management decision
support. Significant data processing systems include point-of-sale reporting, purchase order management, replenishment, warehouse management, merchandise planning and control,
payroll, general ledger, sales audit, and accounts payable. Bar code ticketing and scanning are used at all point-of-sale terminals to ensure accurate sales and margin
data compilation and to provide for inventory control monitoring. Information is made available online to merchandising staff on a timely basis, thereby increasing the merchants' ability to be
responsive to changes in customer behavior. We are also improving the connectivity between stores and our corporate headquarters to enhance operating efficiencies and speed of transmission.

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Our information technology systems and processes allow management to monitor, review and control operational performance on a daily, monthly, quarterly and annual basis for each store
and each transaction. Senior management can review and analyze activity by store, amount of sale, terms of sale or employees who sell the merchandise.

We
have a data center operations services agreement with a third party for the management of our mainframe processing operations, client server systems, Local Area Network operations,
Wide Area Network management and e-commerce hosting. The agreement requires fixed payments totaling $30.0 million over an 84-month period plus a variable amount based on
usage, and extends through 2012. We believe that by outsourcing our data center operations, we are focusing our resources on developing and enhancing the strategic initiatives discussed in the
Business and Strategy section.

We
have historically upgraded, and expect to continue to upgrade, our information systems to improve operations and support future growth. We estimate we will make capital expenditures
of approximately $20 million in fiscal year 2008 for enhancements to our information systems and infrastructure.

Regulation

Our operations are affected by numerous federal and state laws that impose disclosure and other requirements upon the origination, servicing and enforcement of
credit accounts and limitations on the maximum amount of finance charges that may be charged by a credit provider. In addition to our private label credit cards, credit to our customers is provided
primarily through bank cards such as Visa®, MasterCard®, and Discover®. Any change in the regulation of credit which would materially limit the availability of
credit to our traditional customer base could adversely affect our results of operations or financial condition.

We
are subject to the jurisdiction of various state and other taxing authorities. From time to time, these taxing authorities conduct reviews or audits of the Company.

The
sale of insurance products by us is also highly regulated. State laws currently impose disclosure obligations with respect to our sale of credit and other insurance. In addition, our
sale of insurance products in connection with our private label credit cards appears to be subject to certain disclosure
and other requirements under the Gramm-Leach-Bliley Act of 1999. Our and our competitors' practices are also subject to review in the ordinary course of business by the Federal Trade Commission and
our and other retail companies' credit cards are subject to regulation by state and federal banking regulators. We believe that we are currently in material compliance with all applicable state and
federal regulations.

Merchandise
in the retail jewelry industry is frequently sold at a discount off the "regular" or "original" price. We are subject to federal and state regulations requiring retailers
offering merchandise at promotional prices to offer the merchandise at regular or original prices for stated periods of time. Additionally, we are subject to certain
truth-in-advertising and various other laws, including consumer protection regulations that regulate retailers generally and/or the promotion and sale of jewelry in particular.
We monitor changes in those laws and believe that we are in material compliance with applicable laws with respect to such practices.

Available Information

We provide links to our filings with the Securities and Exchange Commission ("SEC") and to the SEC filings (Forms 3, 4 and 5) of our directors and
executive officers under Section 16 of the Securities Exchange Act of 1934, as amended (the "Exchange Act"), free of charge, on our website at www.zalecorp.com, under the heading "SEC Filings" in
the "Shareholder Information" section. These links are automatically updated, so the filings also
are available immediately after they are made publicly available by the SEC. These filings also are available through the SEC's EDGAR system at www.sec.gov.

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Our
certificate of incorporation and bylaws as well as the charters for the compensation, audit, nominating and corporate governance committees of our Board of Directors and the
corporate governance guidelines are available on our website atwww.zalecorp.com, under the heading "Corporate and Social Responsibility."

We
have a Code of Business Conduct and Ethics (the "Code"). All of our directors, executive officers and employees are subject to the Code. The Code is available on our web site at www.zalecorp.com, under
the heading "Corporate and Social Responsibility-Code of Business Conduct and Ethics." Waivers of the Code for
directors and executive officers will be disclosed in a SEC filing on Form 8-K.

ITEM 1A.    RISK FACTORS

We make forward-looking statements in the Annual Report on Form 10-K and in other reports we file with the SEC. In addition, members of our
senior management make forward-looking statements orally in presentations to analysts, investors, the media and others. Forward-looking statements include statements regarding our objectives and
expectations with respect to our financial plan, sales and earnings, merchandising and marketing strategies, store opening, renovation, remodeling and expansion, inventory management and performance,
liquidity and cash flows, capital structure, capital expenditures, development of our information technology and telecommunications plans and related management information systems,
e-commerce initiatives, human resource initiatives, potential sale of the Bailey Banks & Biddle brand and other statements regarding our plans and objectives. In addition, the words
"plans to," "anticipate," "estimate," "project," "intend," "expect," "believe," "forecast," "can," "could," "should," "will," "may," or similar expressions may identify forward-looking statements, but
some of these statements may use other phrasing. These forward-looking statements are intended to relay our expectations about the future, and speak only as of the date they are made. We disclaim any
obligation to update or revise publicly or otherwise any forward-looking statements to reflect subsequent events, new information or future circumstances.

Forward-looking
statements are not guarantees of future performance and a variety of factors could cause our actual results to differ materially from the anticipated or expected results
expressed in or suggested by these forward-looking statements.

If the general economy performs poorly, discretionary spending on goods that are, or are perceived to be "luxuries" may not grow and may even
decrease.

Jewelry
purchases are discretionary and may be affected by adverse trends in the general economy (and consumer perceptions of those trends). In addition, a number of other factors
affecting consumers such as employment, wages and salaries, business conditions, energy costs, credit availability and taxation policies, for the economy as a whole and in regional and local markets
where we operate, can impact sales and earnings.

The concentration of a substantial portion of our sales in three relatively brief selling periods means that our performance is more susceptible to
disruptions.

A
substantial portion of our sales are derived from three selling periodsHoliday (Christmas), Valentine's Day, and Mother's Day. Because of the briefness of these three
selling periods, the opportunity for sales to recover in the event of a disruption or other difficulty is limited, and the impact of disruptions and difficulties can be significant. For instance,
adverse weather (such as a blizzard or hurricane), a significant interruption in the receipt of products (whether because of vendor
or other product problems), or a sharp decline in mall traffic occurring during one of these selling periods could materially impact sales for the affected period and, because of the importance of
each of these selling periods, commensurately impact overall sales and earnings.

Most of our sales are of products that include diamonds, precious metals and other commodities. Fluctuations in the availability and pricing of commodities could
impact our ability to obtain and produce

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products at favorable prices, and consumer awareness regarding the issue of "conflict diamonds" may affect consumer demand for diamonds.

The
supply and price of diamonds in the principal world market are significantly influenced by a single entity, which has traditionally controlled the marketing of a substantial majority
of the world's supply of diamonds and sells rough diamonds to worldwide diamond cutters at prices determined in its sole discretion. The availability of diamonds also is somewhat dependent on the
political conditions in diamond-producing countries and on the continuing supply of raw diamonds. Any sustained interruption in this supply could have an adverse affect on our business.

We
are also affected by fluctuations in the price of diamonds, gold and other commodities. We historically have engaged in hedging against fluctuations in the cost of gold. A significant
change in prices of key commodities could adversely affect our business by reducing operating margins or decreasing consumer demand if retail prices are increased significantly.

Our sales are dependent upon mall traffic.

Our
stores, kiosks, and carts are located primarily in shopping malls throughout the U.S., Canada and Puerto Rico. Our success is in part dependent upon the continued popularity of malls
as a shopping destination and the ability of malls, their tenants and other mall attractions to generate customer traffic. Accordingly, a significant decline in this popularity, especially if it is
sustained, would substantially harm our sales and earnings.

We operate in a highly competitive and fragmented industry.

The
retail jewelry business is highly competitive and fragmented, and we compete with nationally recognized jewelry chains as well as a large number of independent regional and local
jewelry retailers and other types of retailers who sell jewelry and gift items, such as department stores, mass
merchandisers and catalog showrooms. We also compete with internet sellers of jewelry. Because of the breadth and depth of this competition, we are constantly under competitive pressure that both
constrains pricing and requires extensive merchandising efforts in order for us to remain competitive.

Any failure by us to manage our inventory effectively will negatively impact sales and earnings.

We
purchase much of our inventory well in advance of each selling period. In the event we misjudge consumer preferences or demand, we will experience lower sales than expected and will
have excessive inventory that may need to be written down in value or sold at prices that are less than expected.

Because of our dependence upon a small concentrated number of landlords for a substantial number of our locations, any significant erosion of our relationships
with those landlords would negatively impact our ability to obtain and retain store locations.

We
are significantly dependent on our ability to operate stores in desirable locations with capital investment and lease costs that allow us to earn a reasonable return on our locations.
We depend on the leasing market and our landlords to determine supply, demand, lease cost and operating costs and conditions. We cannot be certain as to when or whether desirable store locations will
become or remain available to us at reasonable lease and operating costs. Further, several large landlords dominate the ownership of prime malls, and we are dependent upon maintaining good relations
with those landlords in order to obtain and retain store locations on optimal terms. From time to time, we do have disagreements with our landlords and a significant disagreement, if not resolved,
could have an adverse impact on our business.

Changes in regulatory requirements relating to the extension of credit may increase the cost of or adversely affect our operations.

Our
operations are affected by numerous U.S. and Canadian federal and state or provincial laws that impose disclosure and other requirements upon the origination, servicing and
enforcement of credit

11

---



accounts
and limitations on the maximum aggregate amount of finance charges that may be charged by a credit provider. Any change in the regulation of credit (including changes in the application of
current laws) which would materially limit the availability of credit to our customer base could adversely affect our sales and earnings.

Any disruption in, or changes to, our private label credit card arrangement with Citi may adversely affect our ability to provide consumer credit and write credit
insurance.

Our
agreement with Citi, through which Citi provides financing for our customers to purchase merchandise through private label credit cards, enhances our ability to provide consumer
credit and write credit insurance. Any disruption in, or change to, this agreement could have an adverse effect on our business, especially to the extent that it materially limits credit availability
to our customer base.

Acquisitions and dispositions involve special risk, including the risk that we may not be able to complete proposed acquisitions or dispositions or that such
transactions may not be beneficial to us.

We
have made significant acquisitions in the past and may in the future make additional acquisitions and dispositions. Difficulty integrating an acquisition into our existing
infrastructure and operations may cause us to fail to realize expected return on investment through revenue increases, cost savings, increases in geographic or product presence and customer reach,
and/or other projected benefits from the acquisition. In addition, we may not achieve anticipated cost savings or may be unable to find attractive investment opportunities for funds received in
connection with a disposition. Additionally, attractive acquisition or disposition opportunities may not be available at the time or pursuant to terms acceptable to us and we may be unable to complete
acquisitions or dispositions.

ITEM 1B.    UNRESOLVED STAFF COMMENTS

Not applicable.

ITEM 2.    PROPERTIES

We lease a 430,000 square foot corporate headquarters facility, which lease extends through 2018. The facility is located in Las Colinas, a planned business
development in Irving, Texas, near the Dallas/Fort Worth International Airport. We lease approximately 40,000 square feet of warehouse space that in June 2003 was subleased to a third party
through the remainder of the lease term, which extends through March 2009. We expanded our Canadian distribution and production operations in July 2005 by leasing a 26,280 square foot
facility in Toronto, Ontario with a lease term through November 2014. We also lease a 20,000 square foot distribution and warehousing facility in Irving, Texas with a lease term through
June 2009 that serves as the Piercing Pagoda distribution center.

We
rent our store retail space under leases that generally range in terms from 5 to 10 years and may contain minimum rent escalation clauses, while kiosk leases generally range
from three to five years. Most of the store leases provide for the payment of base rentals plus real estate taxes, insurance, common area maintenance fees and merchants association dues, as well as
percentage rents based on the stores' gross sales.

We
lease 18.5 percent of our store and kiosk locations from Simon Property Group and 15 percent of our store and kiosk locations from General Growth Management, Inc.
Otherwise, we have no relationship with any lessor relating to 10 percent or more of our store and kiosk locations.

12

---



The
following table indicates the expiration dates of the current terms of our leases as of July 31, 2007:

Term Expires

Stores

Kiosks

Other(1)

Total

Percentage
of Total2008 and prior

280

266

1

547

24.1
%2009

154

167

1

322

14.2
%2010

179

174

1

354

15.6
%2011

179

105



284

12.5
%2012 and thereafter

679

81

4

764

33.6
%1,471

793

7

2,271

100.0
%


---

Management believes substantially all of the store leases expiring in fiscal year 2008 that it wishes to renew (including leases which expired
earlier and are currently being operated under month-to-month extensions) will be renewed. Generally, although rents continue to increase, we otherwise expect leases will be
renewed on terms not materially less favorable to us than the terms of the expiring or expired leases. Management believes our facilities are suitable and adequate for our business as presently
conducted.

ITEM 3.    LEGAL PROCEEDINGS

Information regarding legal proceedings is incorporated by reference from note 12 to our consolidated financial statements set forth in Part IV of
this report.

ITEM 4.    SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

Not applicable.

13

---



ITEM 4A.    EXECUTIVE OFFICERS AND KEY EMPLOYEES OF THE REGISTRANT

The following individuals serve as our executive officers or are other key employees of the Company. Officers are elected by the Board of Directors annually, each
to serve until his or her successor is elected and qualified, or until his or her earlier resignation, removal from office or death.

Name

Age

PositionExecutive Officers:Mary E. Burton

55

President, Chief Executive Officer and DirectorRodney Carter

49

Executive Vice President, Chief Administrative Officer and Chief Financial OfficerCharles Fieramosca

59

Corporate Senior Vice President and President, Bailey Banks & BiddleGilbert P. Hollander

54

Executive Vice President and Chief Sourcing and Supply Chain OfficerStephen R. Lang

39

Group Senior Vice President and Chief Merchandise OfficerKey Employees:Mary Ann Doran

51

Senior Vice President, Human ResourcesCynthia T. Gordon

43

Senior Vice President, ControllerSteven Larkin

49

Senior Vice President, E-CommerceStephen C. Massanelli

51

Senior Vice President, Real EstateSusann C. Mayo

55

Senior Vice President, Supply ChainHilary Molay

53

Senior Vice President, General Counsel and SecretarySterling Pope

52

Senior Vice President, Store OperationsGeorge J. Slicho

58

Senior Vice President, Loss PreventionMark A. Stone

49

Senior Vice President, Chief Information Officer


Executive Officers

The following is a brief description of the business experience of the Company's executive officers for at least the past five years.

Ms. Mary E. Burtonwas appointed President and Chief Executive Officer effective July 2006. Ms. Burton served as
Acting Chief Executive Officer from January 2006 through July 2006. Ms. Burton has served as a director of the Company since August 1, 2003. Prior to being appointed Acting
Chief Executive Officer of the Company, Ms. Burton's principal occupation was serving as Chief Executive Officer of BB Capital, Inc., a retail advisory and management services company.
Ms. Burton was Chief Executive Officer of the Cosmetic Center, Inc., a chain of 250 specialty retail stores, from June 1998 to April 1999.
Prior to occupying that position, she served as Chief Executive Officer of PIP Printing from July 1991 to July 1992, and as Chief Executive Officer of Supercuts, Inc. from
September 1987 to June 1991. She is also a director of Staples, Inc.

Mr. Rodney Carterwas appointed Executive Vice President, Chief Administrative Officer and Chief Financial Officer effective
September 2007. Prior to that appointment, Mr. Carter served as Group Senior Vice President and Chief Financial Officer from October 2006 through September 2007. Prior to
joining the Company, Mr. Carter was the Senior Vice President and Chief Financial Officer of PETCO Animal Supplies, Inc., and prior to that position, was the Executive Vice President and
Chief Financial Officer for CEC Entertainment, Inc. Prior to his position at CEC Entertainment, Inc, Mr. Carter held various positions with J.C. Penney, including Chief Financial Officer
of JCPenney Credit and Chief Financial Officer of JCPenney Direct Marketing Services.

14

---



Mr. Charles E. Fieramoscajoined the Company in April 2001 as Senior Vice President and President of Bailey Banks &
Biddle Fine Jewelers. In the 10 years prior to joining the Company, Mr. Fieramosca founded and served as the CEO of Ascend Consulting, a product and brand development company. Prior to
his role at Ascend Consulting, Mr. Fieramosca held various positions with Jones New York Menswear, BASCO All American Sportswear, and Macy's.

Mr. Gilbert P. Hollanderwas appointed Executive Vice President and Chief Sourcing and Supply Chain Officer in
September 2007. Prior to that appointment, Mr. Hollander served as President, Corporate Sourcing/Piercing Pagoda in May 2006, and was given the additional title of Group Senior
Vice President in August 2006. From January 2005 to August 2006, he served as President, Piercing Pagoda. Prior to and up until that appointment, Mr. Hollander served as
Vice President of Divisional Merchandise for Piercing Pagoda, to which he was appointed in August 2003. Mr. Hollander served as Senior Vice President of Merchandising for Piercing Pagoda
from February 2000 to August 2003. Prior to February 2000, Mr. Hollander held various management positions within Piercing Pagoda beginning in May of 1997.

Mr. Stephen R. Langwas promoted to Group Senior Vice President and Chief Merchandising Officer in August 2007. From
January 2007 until August 2007, Mr. Lang served as Senior Vice President of Gordon's Jeweler's and from August 2004 through December 2006, he served as Vice
President and Division Merchandise Manager of various brands within the Company. Prior to rejoining the Company in 2004, Mr. Lang held various positions with Freidman's Jewelers from 2000
through 2004.

Key Employees

Ms. Mary Ann Doranwas promoted to Senior Vice President of Human Resources in February 2005.
Ms. Doran previously held the position of Vice President of Organizational Development & Recruitment, to which she was appointed in August 1997. Ms. Doran began her career
with the Company in October 1996 as Vice President, Personnel Development & Staffing. Prior to joining the Company, Ms. Doran held positions with Kenzer Corporation, Bombay
Company and the Jordan Marsh Company, where she served as Vice President of Human Resources.

Ms. Cynthia T. Gordonwas promoted to Senior Vice President, Controller in February 2003. From April 2001 to
July 2003, Ms. Gordon served as Vice President of Corporate Planning. From 1998 to 2001, Ms. Gordon served as Senior Director of Investor Relations. Ms. Gordon joined the
Company in October 1994 as the Director of Corporate Planning. Prior to joining the Company in 1994, Ms. Gordon served in various positions, including Director of Investor Relations and
External Reporting for A Pea in the Pod, a maternity wear retailer, and in the audit division of Ernst & Young LLP in Dallas, Texas.

Mr. Steven Larkinjoined the Company in January 2006 as Senior Vice President, E-Commerce. Prior to joining the
Company, Mr. Larkin held positions of Vice President, Merchandising for Benchmark Brands (2003 - 2004) and Shop NBC (2001 - 2002).
Mr. Larkin also held the position of Vice President, E-Commerce for Broadband Sports.com from 2000 through 2001, and Chief Merchandising Officer at The Fingerhut Corporation from
1995 through 2000.

Mr. Stephen C. Massanelliwas appointed Senior Vice President, Real Estate in May 2004. Mr. Massanelli joined the
Company in June 1997 as Senior Vice President, Treasurer. From 1993 to 1997, Mr. Massanelli was a principal and member of the Board of Directors of Treadstone Partners, LLP, a private
merchant banking organization in Dallas. Prior to 1993, Mr. Massanelli served in various financial roles at AMRESCO, Inc. and NationsBank of Texas, predecessor to Bank of America.

Ms. Susann C. Mayojoined the Company in October 2005 as Senior Vice President, Supply Chain. Prior to joining the Company,
Ms. Mayo was the Vice President of Logistics & Distribution for The Bombay Company from 2001 through February 2005. Prior to 2001, Ms. Mayo held various positions at Sears,
Roebuck & Co. from 1973 through 2001.

15

---



Ms. Hilary Molaywas promoted to Senior Vice President, General Counsel and Secretary of the Company in September 2005.
Prior to her most recent promotion, Ms. Molay served as Vice President,
General Counsel and Secretary of the Company from August 2002 through August 2005. Ms. Molay also serves as Secretary to the Zale Board of Directors.

Mr. Sterling Popewas promoted to Senior Vice President, Store Operations in August 2007. From February 2007 through
July 2007, Mr. Pope served as Senior Vice President, Store Operations. From January 2002 through December 2006, Mr. Pope served as Senior Vice President, Store
Operations for Peoples Jewellers, and prior to that appointment, Mr. Pope served in various roles within the Peoples Jewellers organization.

Mr. George J. Slichowas promoted to the position of Senior Vice President, Loss Prevention in November 2000.
Mr. Slicho began his career with the Company in March 1991 as Vice President of Loss Prevention. Prior to joining the Company, Mr. Slicho held various positions in corporate
security, including Vice President of Loss Prevention and Audit for P.A. Bergner & Company. In addition, Mr. Slicho served as a special agent in various field offices of the Federal
Bureau of Investigation.

Mr. Mark A. Stonewas promoted to Senior Vice President, Chief Information Officer in May 2006. From August 2003
through April 2006, Mr. Stone held the position of Vice President, Planning and Analysis. From March 2002 through July 2003, Mr. Stone held the position of Senior
Director, Pagoda Distribution. Mr. Stone joined the Company in January 1995 and held various positions within the Information Technology group until February 2002. Prior to
joining the Company, Mr. Stone was Director of Financial Operations for the Resolution Trust Corporation from January 1990 to January 1995.

16

---





PART II

ITEM 5.    MARKET FOR THE REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

Our common stock is listed on the New York Stock Exchange under the symbol "ZLC." The following table sets forth the high and low sale prices as reported on the
NYSE for the common stock for each fiscal quarter during the two most recent fiscal years.

2007

2006High

Low

High

LowFirst

$
28.88

$
25.34

$
34.42

$
25.62Second

$
31.42

$
26.71

$
29.95

$
24.28Third

$
29.96

$
25.19

$
28.61

$
23.54Fourth

$
28.78

$
21.06

$
27.75

$
21.01


As
of September 17, 2007, the outstanding shares of common stock were held by approximately 685 holders of record. We have not paid dividends on the common stock since its initial
issuance on July 30, 1993. In addition, our long-term debt limits our ability to pay dividends or repurchase our common stock if borrowing availability under our $500 million
U.S. revolving credit facility is less than $75 million. At July 31, 2007, we had borrowing availability under the revolving credit agreement of $278.8 million. See "Management's
Discussion and Analysis of Financial Condition and Results of OperationsLiquidity and Capital Resources" and "Notes to the Consolidated Financial StatementsDebt."

17

---



Corporate Performance Graph

The following graph shows a comparison of cumulative total returns for the Company, the S&P 500 Index, the S&P Smallcap Specialty Store Index and the S&P 600
Smallcap Index for the period from August 1, 2002 to July 31, 2007. The comparison assumes $100 was invested on August 1, 2002 in the Company's common stock and in each of the
three indices and, for the S&P 500 Index, the S&P Smallcap Specialty Store Index and the S&P 600 Smallcap Index, assumes reinvestment of dividends. The Company has not paid any dividends during this
period.

GRAPHIC

|                  |  | 7/31/02 |  | 1/31/03 |  | 7/31/03 |  | 1/31/04 |  | 7/31/04 |  | 1/30/05 |  | 7/30/05 |  | 1/31/06 |  | 7/29/06 |  | 1/31/07 |  | 7/31/07
|----------------- |  | ------- |  | ------- |  | ------- |  | ------- |  | ------- |  | ------- |  | ------- |  | ------- |  | ------- |  | ------- |  | -------
|Zale Corporation  |  | 100     |  | 101.33  |  | 157.97  |  | 179.57  |  | 180.33  |  | 176.48  |  | 225.91  |  | 162.86  |  | 170.17  |  | 182.86  |  | 141.06 
|S&P 500           |  | 100     |  | 94.74   |  | 110.64  |  | 127.47  |  | 125.19  |  | 135.40  |  | 142.78  |  | 149.44  |  | 150.45  |  | 171.11  |  | 174.71 
|S&P Smallcap Spec |  | 100     |  | 96.01   |  | 118.11  |  | 141.94  |  | 143.53  |  | 165.41  |  | 182.66  |  | 197.53  |  | 189.55  |  | 214.14  |  | 216.29 
|S&P 600 Smallcap  |  | 100     |  | 92.75   |  | 126.80  |  | 151.96  |  | 142.06  |  | 142.39  |  | 174.23  |  | 135.83  |  | 115.10  |  | 139.03  |  | 130.24 

The stock price performance depicted in the above graph is not necessarily indicative of future price performance. The Corporate Performance Graph shall not be
deemed "soliciting material" or to be "filed" with the SEC, nor shall such information be incorporated by reference into any future filing by the Company under the Securities Act or the Exchange Act,
except to the extent that the Company specifically incorporates the graph by reference in such filing.

18

---





ITEM 6.    SELECTED FINANCIAL DATA

The following selected financial data is qualified in its entirety by our Consolidated Financial Statements (and the related Notes thereto) contained elsewhere in
this Form 10-K and should be read in conjunction with "Management's Discussion and Analysis of Financial Condition and Results of Operations." The income statement and balance sheet data for each of
the fiscal years ended July 31, 2007, 2006, 2005, 2004, and 2003 has been derived from our audited Consolidated Financial Statements.

|                                                         |                                            | Year Ended July 31, |          
|-------------------------------------------------------- | ------------------------------------------ | ------------------- | ---------
|
|
|Revenues(a)                                              |                                            | $                   | 2,437,075
|                                                         |                                            |                     |          
|Costs and expenses:                                      |                                            |                     |          
|                                                         | Cost of sales(b)                           |                     |          
|                                                         | Selling, general and administrative(c)     |                     |          
|                                                         | Cost of insurance operations               |                     |          
|                                                         | Depreciation and amortization              |                     |          
|                                                         | Impairment of goodwill                     |                     |          
|                                                         | Benefit from settlement of retirement plan |                     |          
|                                                         | Derivatives loss                           |                     |          
|                                                         |                                            |                     |          
|Operating earnings                                       |                                            |                     | 103,127  
|Interest expense                                         |                                            |                     | 18,969   
|Costs of early retirement of debt                        |                                            |                     |         
|                                                         |                                            |                     |          
|Earnings before income taxes                             |                                            |                     | 84,158   
|Income taxes(d)                                          |                                            |                     | 24,906   
|                                                         |                                            |                     |          
|                                                         |                                            | Net earnings (loss) |          
|                                                         |                                            |                     |          
|Earnings (loss) per common share:                        |                                            |                     |          
|                                                         | Basic                                      |                     | $        
|                                                         |                                            |                     |          
|                                                         | Diluted                                    |                     | $        
|                                                         |                                            |                     |          
|Weighted average number of common shares outstanding(e): |                                            |                     |          
|                                                         | Basic                                      |                     |          
|                                                         |                                            |                     |          
|                                                         | Diluted                                    |                     |          
|                                                         |                                            |                     |          
|Balance Sheet Data:                                      |                                            |                     |          
|                                                         | Working capital                            |                     | $        
|                                                         | Total assets                               |                     |          
|                                                         | Long-term debt                             |                     |          
|                                                         | Total stockholders investment              |                     |          

---

19

---



20

---



Segment Data

We report our business under three segments: Fine Jewelry, Kiosk Jewelry and All Other. We group our brands into segments based on the similarities in commodity
characteristics of the merchandise and the product mix. The All Other segment includes insurance and reinsurance operations. Segment revenues are not provided by product type or geographically as we
believe such disclosure is not consistent with the manner in which we make decisions.

Operating
earnings by segment are calculated before unallocated corporate overhead, interest and taxes but include an internal charge for inventory carrying cost to evaluate segment
profitability. Unallocated costs are before income taxes and include corporate employee related costs, administrative costs, information technology costs, corporate facilities costs and depreciation
and amortization.

|                               |                 | Year Ended July 31,                 |  
|------------------------------ | --------------- | ----------------------------------- | -
|
|
|
|Revenues:                      |                 |                                     |  
|                               | Fine Jewelry(a) |                                     | $
|                               | Kiosk(b)        |                                     |  
|                               | All Other       |                                     |  
|                               |                 |                                     |  
|                               |                 | Total revenues                      |  
|                               |                 |                                     |  
|Depreciation and amortization: |                 |                                     |  
|                               | Fine Jewelry    |                                     | $
|                               | Kiosk           |                                     |  
|                               | All Other       |                                     |  
|                               | Unallocated     |                                     |  
|                               |                 |                                     |  
|                               |                 | Total depreciation and amortization |  
|                               |                 |                                     |  
|Operating earnings (loss):     |                 |                                     |  
|                               | Fine Jewelry    |                                     | $
|                               | Kiosk(c)        |                                     |  
|                               | All Other       |                                     |  
|                               | Unallocated(d)  |                                     |  
|                               |                 |                                     |  
|                               |                 | Total operating earnings            |  
|                               |                 |                                     |  
|Assets(e):                     |                 |                                     |  
|                               | Fine Jewelry(f) |                                     | $
|                               | Kiosk(g)        |                                     |  
|                               | All Other       |                                     |  
|                               | Unallocated     |                                     |  
|                               |                 |                                     |  
|                               |                 | Total assets                        |  
|                               |                 |                                     |  
|Capital expenditures:          |                 |                                     |  
|                               | Fine Jewelry    |                                     | $
|                               | Kiosk           |                                     |  
|                               | All Other       |                                     |  
|                               | Unallocated     |                                     |  
|                               |                 |                                     |  
|                               |                 | Total capital expenditures          |  
|                               |                 |                                     |  

---

21

---



The segments are not organized based on product differences or geographic areas and, accordingly, it is not practicable to report revenues based
on such organization.

ITEM 7.    MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

With respect to forward-looking statements made in this Management's Discussion and Analysis of Financial Condition and Results of Operations see "Item
1ARisk Factors."

Overview

We are a leading specialty retailer of fine jewelry in North America. At July 31, 2007, we operated 1,471 fine jewelry stores and 793 kiosk locations
primarily in shopping malls throughout the United States of America, Canada and Puerto Rico. Our operations are divided into three business segments: Fine Jewelry, Kiosk Jewelry and All Other.

The
Fine Jewelry segment focuses primarily on diamond product, but differentiates its six brands through customer service, merchandise assortments, store design and marketing. Zales
Jewelers (includingzales.com), our national brand in the U.S., provides moderately priced jewelry to a broad range of customers. Zales Outlet caters to
the slightly higher-income female self purchaser in malls and neighborhood power centers. Gordon's Jewelers (includinggordonsjewelers.com)is a
moderately priced regional jeweler focusing on customer relationships. Bailey Banks & Biddle Fine Jewelers (includingbaileybanksandbiddle.com)operates jewelry stores that are considered among the finest luxury jewelry stores in their markets, offering designer jewelry and prestige watches to attract more affluent customers. Peoples
Jewellers and Mappins Jewellers are two of the most recognized brand names in Canada, providing moderately priced jewelry to a wide variety of Canadian customers.

The
Kiosk Jewelry segment reaches the opening price point fine jewelry customer primarily through mall-based kiosks under the name Piercing Pagoda.

The
All Other segment consists primarily of our insurance operations, which provide insurance and reinsurance facilities for various types of insurance coverage offered primarily to our
private label credit card customers.

Comparable
store sales exclude revenue recognized from warranty sales, internet sales and insurance premiums related to credit insurance policies sold to customers who purchase
merchandise under our proprietary credit program. The sales results of new stores are included beginning their thirteenth full

22

---



month
of operation. The results of stores that have been relocated, renovated or refurbished are included in the calculation of comparable store sales on the same basis as other stores. However,
stores closed for more than 90 days due to unforeseen events (hurricanes, etc.) are excluded from the calculation of comparable store sales. Beginning in fiscal year 2008, comparable store
sales will include internet sales. This approach is consistent with improving our multi-channel experience and leveraging the best of our real estate footprint with internet sales. The following table
shows comparable store sales as reported and including internet sales for fiscal year 2007:

As Reported

Including
Internet SalesFirst quarter

0.4
%
1.0
%Second quarter

1.4
%
2.3
%Third quarter

(3.4
)%
(2.8
)%Fourth quarter

(0.5
)%
0.1
%Full year

(0.2
)%
0.5
%


During
fiscal year 2007, we focused on several key areas including repositioning of the Zales brand, improving gross margins through direct sourcing, investing in our people and
launching key system initiatives.

The
Zales brand expanded its diamond assortment by investing approximately $100 million in diamond fashion and solitaire jewelry prior to the 2006 calendar Holiday season. These
investments were deemed necessary to position the brand as "The Diamond Store." While Holiday sales were positive, the inventory investments did result in overstock positions of core product that will
be sold in lieu of replenishment of certain styles through fiscal year 2008. Our direct sourcing strategy includes both internal procurement and assembly and importing directly from factories. Direct
sourced goods accounted for 34 percent and 28 percent of purchases in fiscal years 2007 and 2006, respectively. The margin improvements were largely offset by aggressive promotional
discounting in the Holiday selling season that did not result in the desired incremental revenues. We tested investments in payroll to strengthen the team of associates and improve the customer
experience. While the payroll investment in experienced jewelry sales associates appears effective, additional investments in store coverage will be reduced in fiscal year 2008. Additionally, we
launched several key system initiatives to support the needs of the business as well as to facilitate implementation of some of our strategic initiatives. We introduced an online vendor portal that
allows vendors to view and set up new items online. We implemented year one of our three year plan to install the Oracle Merchandise System and we are beginning a three year roll-out of
the new and improved proprietary point-of-sale platform.

In
addition, we introduced a lifetime warranty plan that replaced a two-year product offering. The new lifetime warranty was initially tested in the Zales and Peoples and
Mappins brands during the second quarter of fiscal year 2007. The product was subsequently adopted by Gordon's and Outlet in the third quarter. The plan was well received by customers as the
attachment rate increased from 41.6 percent in fiscal year 2006 to 49.5 percent in fiscal year 2007. Increases in both price and unit sales resulted in an increase of
$33.1 million in warranty sales to $110.7 million in fiscal year 2007 as compared to $77.6 million in fiscal year 2006. However, the introduction of the lifetime warranty plan
required us to change the revenue recognition methodology from recognizing revenues based on the rate services were incurred over a two-year period to recognizing revenues on a straight-line basis
over a period of five years. As a result, recognized revenues decreased $25.9 million from $74.1 million in fiscal year 2006 to $48.2 million in fiscal year 2007. While the
revenue recognized related to warranties negatively impacts revenues in the short-term, the cash from sales of warranties has increased over prior years. For additional information related
to warranties, see note 13 to our consolidated financial statements set forth in Part IV of this report.

23

---



We
have identified several key strategies which are centered on improving our return on capital over time as we move into fiscal year 2008. These strategies include improving the
profitability of our existing core mall business, growth in our Canadian brands and outside of the mall and migrating to a more centralized and streamlined organization.

We
believe improving our core mall business is a significant opportunity to drive shareholder value. We intend to achieve this goal by creating a superior customer experience through
increased emphasis on customer interactions, in-store "comfort" and increased associate training. In addition to focusing on the core business we will continue to invest in our most
profitable brands: the Canadian
mall-based brands and the growth opportunity outside the traditional mall. We intend to build on our success with Zales Outlet that has a proven track record of profitability. We also plan
to continue to build our internet business with a focus on online customer experience and multi-channel execution. The last component of our strategy is to migrate to a more centralized and
streamlined organization. The centralized organization will result in a focus on three core competencies that are consistent to executing our strategic objectives: merchandising, supply chain and
store operations.

The
merchandising organization will be focused on product assortments appropriate to the brands, customer demographics, fashion trends and regional preferences. The supply chain will
focus on procuring the goods through the most effective resource, including internal production or direct import. This organization will allow us to more effectively improve and develop our supply
chain strategy and continuing our focus on margin improvements through direct sourcing. In addition, the supply chain organization will establish a comprehensive vendor strategy and product flow. The
operations organization will be focused on creating and executing a custom experience appropriate to each brand's strengths. In addition, the operations organization will focus on training, recruiting
and retention.

We
believe there are significant synergies and efficiencies to be gained by the elimination of redundancies and more teaming across brands. While we believe there will be significant
savings over time, the near term benefit is an organization that can be more effective by better leveraging our best practices and best people.

From
time to time, we include non-GAAP measurements of financial information in Management's Discussion and Analysis of Financial Condition and Results of Operations,
including information relating to the lifetime warranties we began selling during the second quarter of fiscal year 2007 and charges related to the closing of certain Bailey Banks & Biddle
stores and executive severance in fiscal year 2006. We use these measurements as part of our evaluation of the performance of the Company. In addition, we believe these measures provide useful
information to investors, particularly in evaluating the performance of the Company in fiscal year 2007 as compared to prior periods.

24

---



Results of Operations

The following table sets forth certain financial information from our audited consolidated statements of operations expressed as a percentage of revenues and
should be read in conjunction with our consolidated financial statements and notes thereto included elsewhere in this Form 10-K.

Year Ended July 31,2007

2006

2005Revenues

100.0
%
100.0
%
100.0
%Costs and expenses:Cost of sales

48.7

49.8

48.6Selling, general and administrative

43.9

44.6

41.2Cost of insurance operations

0.3

0.3

0.3Depreciation and amortization

2.5

2.5

2.5Benefit from settlement of retirement plan



(0.6
)
Derivatives loss

0.3

0.1

Operating earnings

4.2

3.3

7.4Interest expense

0.8

0.4

0.3Earnings before income taxes

3.4

2.9

7.1Income taxes

1.0

0.7

2.6Net earnings

2.4
%
2.2
%
4.5
%


Year Ended July 31, 2007 Compared to Year Ended July 31, 2006

Revenues.Revenues for fiscal year 2007 were flat at $2.44 billion, compared to revenues for
the same period in the prior fiscal year. Revenues related to warranty sales decreased $25.9 million primarily due to a change in revenue recognition methodology related to lifetime warranties.
Prior to the second quarter of fiscal year 2007, we offered only a two-year warranty. Revenue from the two-year warranty is recognized over the two-year service period at the
rates the related costs have historically been incurred. During the second quarter of fiscal 2007, certain brands began offering a lifetime warranty. Revenue from the lifetime warranty is recognized
on a straight-line basis over a period of five years. Including the $25.9 million impact of the change in method of amortizing warranty sales and excluding the $15.1 million
impact on revenues of the Bailey Banks & Biddle stores closed in fiscal year 2006, revenues increased 1.6 percent over last year due primarily to new store growth in the Fine Jewelry
segment and a $17 million, or 0.7 percent increase related to internet sales. Comparable store sales decreased $2.8 million, or 0.2 percent as compared to the same period
in the prior year. The decline in comparable store sales was driven primarily by a decrease in the number of customer transactions, partially offset by a 5.4 percent increase in the average
transaction price to $195.

The
Fine Jewelry segment contributed $2.16 billion of revenues in the fiscal year ended July 31, 2007, compared to $2.15 billion for the same period in the prior
year, which represents an increase of 0.5 percent compared to the same period in the prior year. Revenues include $263 million in the Kiosk Jewelry segment compared to
$277 million in the prior year, representing a decrease of 5.0 percent. The All Other segment operations provided $13.6 million in revenues for the fiscal year ended
July 31, 2007 and $13.1 million for the same period in the prior year, which represents an increase of 3.3 percent.

During
the fiscal year ended July 31, 2007, we opened 51 stores in the Fine Jewelry segment and 14 kiosks in the Kiosk Jewelry segment. In addition, we closed 36 stores in the
Fine Jewelry segment and 114 locations, primarily 76 Peoples II carts, in the Kiosk Jewelry segment.

Cost of Sales.Cost of sales includes cost of merchandise sold, as well as receiving and distribution
costs. Cost of sales as a percentage of revenues was 48.7 percent for the year ended July 31, 2007 compared to

25

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49.8 percent
for the same period in the prior year. The decrease relates primarily to the 110 basis point impact of the special charge recorded in fiscal year 2006 intended to accelerate the
clearance of discontinued merchandise and an inventory charge of 10 basis points related to closing certain Bailey Banks & Biddle stores in fiscal year 2006. The decrease also relates to our
continued focus on direct sourcing of product and finished goods across the Company and enhanced markdown control during the last half of fiscal year 2007. The decreases were partially offset by the
50 basis point impact related to the decline in revenue recognized associated with warranties.

Our
LIFO inventory charge was $5.4 million and $5.8 million for the fiscal years ended July 31, 2007 and 2006, respectively.

Selling, General and Administrative.Included in selling, general and administrative ("SG&A") are
store operating, advertising, buying and general corporate overhead expenses. SG&A was 43.9 percent of revenues for the year ended July 31, 2007 compared to 44.6 percent for the
same period in the prior year. The decrease relates primarily to certain charges recorded in fiscal year 2006 including the 120 basis point impact of Bailey Banks & Biddle store closing costs,
executive severance of 50 basis points and asset impairments of 40 basis points. These decreases were partially offset by the 40 basis point decline in revenue recognized associated with warranties, a
50 basis point increase in labor costs as a result of investments in payroll and a 30 basis point increase in occupancy costs.

Depreciation and Amortization.Depreciation and amortization as a percent of revenues for the year
ended July 31, 2007 and 2006 was 2.5 percent.

Derivative Loss.We recognize all derivative instruments measured at fair value, as either assets or
liabilities in the accompanying consolidated balance sheets. Any changes in the fair value of derivative instruments are reported in derivative loss in the consolidated statements of operations. The
fair market value of these instruments is subject to the changes in the underlying commodity. During the fiscal year ended July 31, 2007, we recognized a derivative loss in the amount of
$7.2 million. The loss on derivatives consisted of an increase in fair value of $1.3 million offset by losses on the settlement of contracts in the amount of $8.5 million.

Interest Expense.Interest expense as a percent of revenues for the year ended July 31, 2007
and 2006 was 0.8 percent and 0.4 percent, respectively. The increase in interest expense was a result of an increase in the weighted average effective interest rate from
5.8 percent last year to 6.6 percent this year and increased average borrowings during the year.

Income Tax Expense.The effective tax rate for the year ended July 31, 2007 and 2006 was
29.6 percent and 23.3 percent, respectively. In fiscal year 2006, the rate reflects an $11.9 million tax benefit associated with the repatriation of undistributed Canadian
earnings under the American Jobs Creation Act and the release of certain tax reserves related to state and local audits. In fiscal year 2007, the rate reflects a tax benefit of $8.5 million
associated with our decision to indefinitely reinvest certain undistributed foreign earnings outside the U.S. in accordance with Accounting Principles Board No. 23, "Accounting for Income
Taxes-Special Areas," ("APB 23") which resulted in the release of the deferred tax liability associated with these undistributed earnings.

Year Ended July 31, 2006 Compared to Year Ended July 31, 2005

Revenues.Revenues for fiscal year 2006 were $2.44 billion, an increase of 2.3 percent
over revenues of $2.38 billion for the same period in the prior fiscal year. Revenues include $24.3 million in fiscal year 2006 and $49.8 million in fiscal year 2005 from the 32
Bailey Banks & Biddle stores that we closed during the second quarter of fiscal year 2006. Excluding these stores, revenues were $2.42 billion compared to $2.33 billion in the
prior year, an increase of 3.5 percent. Comparable store sales increased 1.6 percent in the fiscal year ended July 31, 2006 as compared to the same period in the prior year. The
increase in

26

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comparable
store sales was driven primarily by a 2.8 percent increase in the average transaction price to $185, partially offset by a decrease in the number of customer transactions.

The
Fine Jewelry segment contributed $2.15 billion of revenues in the fiscal year ended July 31, 2006, compared to $2.089 billion for the same period in the prior
year, which represents an increase of 2.9 percent. Excluding the revenues from the closed Bailey Banks & Biddle stores, the Fine Jewelry segment contributed $2.13 billion and
$2.04 billion in revenues for fiscal years 2006 and 2005, respectively, an increase of 4.2 percent. Revenues include $277 million in the Kiosk Jewelry segment compared to
$281 million in the prior year, representing a decrease of 1.4 percent. The All Other segment operations provided $13.1 million in revenues for the fiscal year ended
July 31, 2006 and $12.9 million for the same period in the prior year, which represents an increase of 1.6 percent.

During
the fiscal year ended July 31, 2006, we opened 59 stores in the Fine Jewelry segment and 54 kiosks in the Kiosk Jewelry segment. In addition, we closed 67 stores in the
Fine Jewelry segment (including the 32 Bailey Banks & Biddle store closings), and 42 locations in the Kiosk Jewelry segment.

Cost of Sales.Cost of sales includes cost of merchandise sold, as well as receiving and distribution
costs. Cost of sales as a percentage of revenues was 49.8 percent for the year ended July 31, 2006 compared to 48.6 percent for the same period in the prior year. The increase in
cost of sales as a percent of revenues was primarily due to a special charge of 110 basis points intended to accelerate the sell-through of discontinued merchandise and an inventory charge
of 10 basis points related to closing certain Bailey Banks & Biddle stores.

We
also experienced margin improvements driven by directly sourced goods of 40 basis points and more productive use of trade-in product resulting in a 20 basis points
improvement. These improvements were offset by increased promotions in the Bailey Banks & Biddle closed stores and the markdowns to sell through discontinued items in Zales.

We
recorded a LIFO charge of $5.8 million in fiscal year 2006 compared to $3.5 million in fiscal year 2005. We estimate that the portion of the special charge on
approximately $90 million of inventory reduced the LIFO charge by approximately $2 million due to the liquidation of the inventory.

Selling, General and Administrative.Included in SG&A are store operating, advertising, buying and
general corporate overhead expenses. SG&A was 44.6 percent of revenues for the year ended July 31, 2006 compared to 41.2 percent for the same period in the prior year. The
increase in SG&A was primarily the result of the 120 basis point impact of the Bailey Banks & Biddle store closing costs, executive severance of 50 basis points, the 20 basis point impact
related to the adoption of SFAS 123(R), a 20 basis point charge related to the termination of an IT initiative, asset impairment charges of 20 basis points related to certain test stores and
incremental store operating costs offset by a reduction in proprietary credit costs due to a shift to more profitable or less costly credit program offerings.

Depreciation and Amortization.Depreciation and amortization as a percent of revenues for the years
ended July 31, 2006 and 2005 was 2.5 percent.

Derivative Loss.We recognize all derivative instruments measured at fair value, as either assets or
liabilities in the accompanying consolidated balance sheets. Any changes in the fair value of derivative instruments are reported in derivative loss in the consolidated statements of operations. The
fair market value of these instruments is subject to the changes in the underlying commodity. During the fiscal year ended July 31, 2006, we recognized a derivative loss in the amount of
$1.7 million.

Interest Expense.Interest expense as a percent of revenues for the years ended July 31, 2006
and 2005 was 0.5 percent and 0.3 percent, respectively. The increase in interest expense was a result of an increase in the weighted average effective interest rate from
3.8 percent in fiscal year 2005 to 5.8 percent in fiscal year 2006 and increased average borrowings during the year.

27

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Income Tax Expense.The effective tax rate for the fiscal years ended July 31, 2006, and 2005
was 23.3 percent and 37.2 percent, respectively. The decrease in the effective tax rate was due to tax benefits associated with the repatriation under the American Jobs Creation Act (the
"AJCA") (described below), the tax rate on Canadian earnings, and the release of certain tax reserves upon resolution of certain state and local audits.

On
October 22, 2004, the AJCA was signed into law. The AJCA includes, among other provisions, a special one-time deduction for 85 percent of certain foreign
earnings that are repatriated to the U.S. from foreign operations, as defined in the AJCA. We have a Canadian subsidiary for which we elected to apply this provision to qualifying earnings
repatriations in fiscal year 2006. In January 2006, we executed a Domestic Repatriation Plan under the provision and repatriated $47.6 million, realizing an income tax benefit of
$11.9 million, partially offset by a liability of $5.1 million related to management's decision not to elect APB 23 for the fiscal year ended July 31, 2006.

Liquidity and Capital Resources

Our cash requirements consist primarily of funding ongoing operations, including inventory requirements, capital expenditures for new stores, renovations of
existing stores, upgrades to our information technology systems and distribution facilities and debt service. In addition, from time-to-time in the past we have repurchased
shares of our common stock.

Our
business is highly seasonal, with a disproportionate amount of sales (approximately 41 percent) and substantially all of our operating income occurring in November and
December of each year, the
Holiday season. Other important periods include Valentine's Day and Mother's Day. We purchase inventory in anticipation of these periods and, as a result, have higher inventory and inventory financing
needs immediately prior to these periods. Our maximum inventory level typically occurs prior to the Holiday season. Owned inventory at July 31, 2007 was $1.0 billion, an increase of
$117.9 million compared to inventory levels at July 31, 2006. The increase was primarily related to investments in expanded assortments, increased clearance inventory related to the
repositioning in the Fall of fiscal year 2007 and increased inventory in our internal assembly organization.

Net
cash provided by operating activities decreased from $82.1 million for the year ended July 31, 2006 to $40.6 million for the year ended July 31, 2007. The
decrease in cash is primarily due to an increase in inventory of $117.9 million, a $31.9 million decrease in merchandise payables and decreased profitability. The decrease was partially
offset by a $33.1 million increase in cash received related to deferred revenues for warranties and a $22.0 million refund related to fiscal year 2006 income tax overpayments. In fiscal
year 2008, cash provided by operating activities is expected to increase due to a decrease in inventory, an increase in merchandise payables and increased sales of the lifetime warranty plan.

Net
cash provided by operating activities decreased to $82.1 million in fiscal 2006 from $162.6 million in fiscal 2005. The decrease was primarily attributable to an
increase in inventory of $70.5 million excluding the impact of inventory write-downs of $26.9 million. At July 31, 2006, owned inventory was approximately $50 million
higher than at July 31, 2005 primarily due to an increase in directly sourced product for the Fine Jewelry segment which results in earlier receipt of raw materials than finished goods and
increased assortments resulting from the repositioning of the Zales brand. The decrease was also due to decreased profitability, payments totaling $17.7 million related primarily to lease
buyout costs associated with the Bailey Banks & Biddle store closures and a $30.8 million increase in income tax payments associated with fiscal 2005 taxes paid in fiscal 2006 and
overpayments of fiscal 2006 taxes. The decrease was partially offset by an increase in accounts payable as a result of a change in the timing of vendor payments in fiscal 2006 compared to fiscal 2005.

Our
cash requirements are funded through cash flows from operations, funds available under our revolving credit facilities and vendor payment terms. Under our U.S. and Canadian revolving
credit facilities we may borrow up to $500 million and CAD $30 million, respectively. In the third quarter of fiscal

28

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year
2007, we amended our U.S. and Canadian revolving credit facilities to extend the maturity date to August 2011 and reduced the current applicable interest rates from LIBOR (BA in Canada)
plus 1.25 percent to LIBOR plus 1.0 percent. In addition, the amendment to the U.S. Agreement increases our seasonal borrowing capabilities by $100 million and adds an accordion
feature that allows us to permanently increase the facility size in $25 million increments up to another $100 million. Vendor purchase order terms typically require payment within
60 days.

As
of July 31, 2007, we had cash and cash equivalents of $37.6 million and had approximately $300 million available under our revolving credit facilities. We believe
that we have sufficient capacity under our revolving credit facilities to meet our foreseeable financing needs.

During
the fourth quarter of fiscal year 2007, we made the decision to indefinitely reinvest certain of our undistributed foreign earnings outside the U.S. As a result of this decision,
and in accordance with APB 23, we released $8.5 million of deferred tax liabilities associated with the undistributed foreign earnings. We estimate that this decision will result in an annual
benefit of $2 million to $4 million.

In
September 2007, the Company entered into a letter of intent to sell its Bailey Banks & Biddle brand. The decision to sell the brand was a result of our strategy to focus on our
moderately priced business and our continued focus on maximizing return on investments. The net assets to be sold as of July 31, 2007 totaled approximately $193 million and consist
primarily of inventory of approximately $173 million. The brand is included in our Fine Jewelry segment and generated revenues of $284 million during fiscal 2007. The sale is expected to
be completed during the first quarter of fiscal 2008 at an estimated pre-tax loss of up to $5 million, including selling costs.

Capital Growth

During the fiscal year ended July 31, 2007, we invested $86.4 million of capital expenditures with approximately $54.6 million attributed to
our Fine Jewelry segment to open 51 stores and to renovate, relocate or refurbish other locations. In addition, another $3.0 million of capital expenditures were invested in the Kiosk Jewelry
segment to open 14 kiosks, and to renovate, relocate or refurbish other locations. We anticipate investing approximately $105 million of capital expenditures in fiscal year 2008, targeting 37
new stores primarily in the Peoples and Outlet brands and 10 more locations in the Pagoda brand, with approximately $20 million in capital investments related to IT infrastructure and support
operations.

Net Operating Losses

Future liquidity will be enhanced to the extent that we are able to realize the cash benefit from utilization of our past net operating losses ("NOLs") carried
forward against current and future tax liabilities. The cash benefit realized from NOLs in fiscal year 2007 was approximately $6.8 million. As of July 31, 2007, we had NOLs after
limitations of $19.5 million, which represents up to $6.8 million in future tax benefits. The utilization of this asset is subject to limitations. The most restrictive limitation is the
Internal Revenue Code Section 382 annual limitation of $19.5 million. The NOL can be utilized through fiscal year 2008.

29

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Contractual Obligations

Aggregate information about our contractual obligations as of July 31, 2007 is presented in the following table (in millions):

|                                |       | Payments Due by Period
|------------------------------- | ----- | ----------------------
|
|Long-term debt(a)               |       | $                     
|Operating leases(b)             |       |                       
|Operation services agreement(c) |       |                       
|Other long-term liabilities(d)  |       |                       
|                                |       |                       
|                                | Total |                       
|                                |       |                       

---

Not included in the table above as purchase obligations are our obligations under employment agreements and ordinary course purchase orders for
merchandise and obligations, including certain merchandise on memo for which we may have a contingent liability to purchase certain items if they do not sell through.

Recent Accounting Pronouncements

In June 2006, the Financial Accounting Standards Board ("FASB") issued FASB Interpretation No. 48 "Accounting for Uncertainty in Income
Taxesan Interpretation of FASB Statement No. 109" ("FIN 48"). FIN 48 requires companies to determine whether it is more likely than not that a tax position will be sustained upon
examination by the appropriate taxing authorities before any part of the benefit can be recorded in the financial statements. This interpretation also provides guidance on derecognition,
classification, accounting in interim periods and expanded disclosure requirements. FIN 48 is effective for fiscal years beginning after December 15, 2006. We are currently in the
process of assessing the impact that FIN 48 will have on our consolidated financial statements. At this time, we do not anticipate this will result in a material adjustment to the Company's
financial condition, results of operations or liquidity.

In
September 2006, the FASB issued Statement of Financial Accounting Standards ("SFAS") No. 157, "Fair Value Measurements" ("SFAS 157"). This standard defines fair
value, establishes a framework for measuring fair value in generally accepted accounting principles and expands disclosures about fair value measurements. SFAS 157 is effective for fiscal years
beginning after November 15, 2007. The adoption of SFAS 157 is not expected to have a material impact on the Company's financial condition, results of operations or liquidity.

30

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In February 2007, the FASB issued SFAS No. 159, "The Fair Value Option for Financial Assets and Financial LiabilitiesIncluding an Amendment of FASB Statement
No. 115" ("SFAS 159"). This standard permits entities to choose to value certain financial instruments at fair value. Entities shall report unrealized gains and losses on items for which
the fair value option has been elected in earnings at each subsequent reporting date. SFAS 159 is effective for fiscal years beginning after November 15, 2007. The adoption of
SFAS 159 is not expected to have a material impact on the Company's financial condition, results of operations or liquidity.

Inflation

In management's opinion, changes in revenues, net earnings and inventory valuation that have resulted from inflation and changing prices have not been material
during the periods presented. The trends in inflation rates pertaining to merchandise inventories, especially as they relate to gold and diamond costs, are primary components in determining our
last-in, first-out ("LIFO") inventory. Historically, we have hedged a portion of our gold and silver purchases through forward contracts. There is no assurance that inflation
will not materially affect us in the future.

Critical Accounting Policies and Estimates

Our significant accounting policies are disclosed in Note 1 of our consolidated financial statements. The following discussion addresses our most critical
accounting policies, which are those that are both important to the portrayal of our financial condition and results of operations and that require significant judgment or use of complex estimates.

Merchandise Inventories.Merchandise inventories are stated at the lower of cost or market.
Substantially all U.S. inventories represent finished goods which are valued using the LIFO retail inventory method. Merchandise inventory of Peoples Jewellers and Mappins Jewellers of Canada is
valued using the first-in, first-out ("FIFO") retail inventory method. Under the retail method, inventory is segregated into categories of merchandise with similar
characteristics at its current average retail selling value. The determination of inventory at cost and the resulting gross margins are calculated by applying an average
cost-to-retail ratio to the retail value of inventory. At the end of fiscal year 2007, approximately five percent of our total inventory represented raw materials and other
inventory associated with internally sourced product. This inventory is valued at the weighted average cost of the items.

We
are required to determine the LIFO cost on an interim basis by estimating annual inflation trends, annual purchases and ending inventory levels for the fiscal year. Actual annual
inflation rates and inventory balances as of the end of any fiscal year may differ from interim estimates. We apply internally developed indices that we believe accurately and consistently measure
inflation or deflation in the components of our merchandise (i.e., diamonds, gold and other metals and precious stones) and our overall merchandise mix. We believe our internally developed indices
more accurately reflect inflation or deflation in our own prices than the U.S. Bureau of Labor Statistics ("BLS") producer price indices or other published indices.

We
also reduce our inventory valuation for discontinued, slow-moving and damaged inventory. This write-down of inventory is equal to the difference between the
cost of inventory and its estimated market value based upon assumptions of targeted inventory turn rates, future demand, management strategy and market conditions. If actual market conditions are less
favorable than those projected by management or management strategy changes, additional inventory write-downs may be required and, in the case of a major change in strategy or downturn in market
conditions, such write-downs could be significant. For example, in fiscal year 2006, we recorded inventory write-downs of approximately $27 million resulting from the decision to accelerate the
clearance of previously discontinued merchandise assortments and $6 million related to the closure of Bailey Banks & Biddle stores.

31

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Shrinkage
is estimated for the period from the last inventory date to the end of the fiscal year on a store by store basis. Such estimates are based on experience and the shrinkage
results from the last physical inventory. Physical inventories are taken at least once annually for all store locations and for the distribution centers. The shrinkage rate from the most recent
physical inventory, in combination with historical experience and significant changes in physical inventory results could impact our shrinkage reserve.

Impairment of Long-Lived Assets.Long-lived assets are periodically reviewed
for impairment by comparing the carrying value of the assets with their estimated undiscounted future cash flows. If the evaluation indicates that the carrying amount of the asset may not be
recoverable, the potential impairment is measured based on a projected discounted cash flow method using a discount rate that is considered to be commensurate with the risk inherent in our current
business model. Assumptions are made with respect to cash flows expected to be generated by the related assets based upon updated projections. Any changes in key assumptions, particularly store
performance or market conditions, could result in an unanticipated impairment charge. For instance, in the event of a major market downturn or adverse developments within a particular market or
portion of our business, individual stores may become unprofitable, which could result in a write-down of the carrying value of the assets located in those stores. Any impairment would be
recognized in operating results.

Goodwill.In accordance with SFAS No. 142, "Goodwill and Other Intangible Assets," we test
goodwill for impairment annually, at the end of our second quarter, or more frequently if events occur which indicate a potential reduction in the fair value of a reporting unit's net assets below its
carrying value. An impairment is deemed to exist if the estimated fair value is less than the net book value of a reporting unit. We calculate estimated fair value using the present value of future
cash flows expected to be generated using a weighted average cost of capital and updated financial projections. Based upon the amounts currently recorded as goodwill, recent performance and estimated
projections, we believe the likelihood of additional impairment would not be material. However, a significant change in the related brand's performance, such as the closing of a majority of the
brand's stores, could result in additional impairment. As of the second quarter of fiscal year 2007, we performed our annual review for impairment of goodwill related to our Piercing Pagoda, People's
Jewellers and other smaller acquisitions. We concluded that there was no evidence of impairment related to the goodwill of approximately $19.4 million for our Piercing Pagoda acquisition,
$76.3 million recorded for the People's Jewellers acquisition and $5.0 million for other smaller acquisitions.

Revenue Recognition.We recognize revenue in accordance with the Securities and Exchange Commission's
Staff Accounting Bulletin No. 104 "Revenue Recognition." Revenue related to merchandise sales, which is approximately 95 percent of total revenues, is recognized at the time of the sale,
reduced by a provision for sales returns. The provision for sales returns is based on historical evidence of our return rate. Repair revenues are recognized when the service is complete and the
merchandise is delivered to the customers. We offer our customers two-year and lifetime warranties that cover sizing and breakage on certain products and a diamond commitment program
("DCP") that offers a traditional warranty to cover sizing, breakage and theft replacement for a 12-month period. The revenue from the lifetime warranty and DCP is recognized on a
straight-line basis over a five-year and 12-month period, respectively. The revenue from the two-year warranty is recognized over the service period at
the rates the related costs have historically been incurred in performing the services covered under the agreements. Revenues also include premiums from our insurance businesses, principally related
to credit insurance policies sold to customers who purchase our merchandise under the proprietary credit program. Insurance premiums are recognized over the coverage period.

Self-Insurance.We are self-insured for certain losses related to general
liability, workers' compensation and medical claims. Our liability represents an estimate of the ultimate cost of claims incurred as of the balance sheet dates. The estimated liability is not
discounted and is established based

32

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upon
analysis of historical data and actuarial estimates. While we believe these estimates are reasonable based on the information currently available, if actual trends, including the severity or
frequency of claims, medical cost inflation, or fluctuations in premiums differ from our estimates, our results of operations could be impacted.

Other Reserves.We are involved in a number of legal and governmental proceedings as part of the
normal course of business. Reserves are established based on management's best estimates of our
potential liability in these matters. These estimates have been developed in consultation with in-house and outside counsel and are based on a combination of litigation and settlement
strategies.

Income
taxes are estimated for each jurisdiction in which we operate. This involves assessing the current tax exposure together with temporary differences resulting from differing
treatment of items for tax and financial statement accounting purposes. Any resulting deferred tax assets are evaluated for recoverability based on estimated future taxable income. To the extent that
recovery is deemed not likely, a valuation allowance is recorded. We believe that as of July 31, 2007, the realization of our gross deferred tax assets is more likely than not and thus there
was no valuation reserve recorded.

ITEM 7A.    QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

We are exposed to market risk from changes in interest rates, which may adversely affect our financial position, results of operations and cash flows. In seeking
to minimize the risks from interest rate fluctuations, we manage exposures through our regular operating and financing activities. We do not use derivative financial instruments for trading or other
speculative purposes and are not party to any leveraged financial instruments.

The
investments of our insurance subsidiaries, primarily stocks and bonds, had an approximate market value at July 31, 2007 of $25 million.

Based
on our market risk-sensitive instruments (including variable rate debt) outstanding at July 31, 2007, we have determined that there was no material market risk
exposure to our consolidated financial position, results of operations or cash flows as of such date.

Commodity Risk.We principally address commodity risk through retail price point adjustments and
have, from time to time, purchased forward contracts for gold and silver.

The
purpose of purchasing the forward contracts for gold and silver is to minimize the effect of unknown future commodity price movements on planned cash flows and to enable us to
maintain a consistent and predictable pricing strategy. No fees or up front payments are required when using these commodity forwards. These contracts settle on a net basis and have been accounted for
as undesignated derivative instruments. Accounting for our forward contracts as derivatives instead of hedges does not affect the underlying economics of our risk management strategies and has no
impact on the timing or amount of cash flows under any derivative contract. The fair value of our derivative instruments is included in the consolidated balance sheets. These fair values are obtained
from outside counterparties and verified with internal discounted cash flow models. During the term of the contracts,
any changes in the fair value of derivative instruments are reported in derivative losses in the consolidated statements of operations. The fair market value of these instruments is subject to the
changes in the value of the underlying commodity. For the fiscal year ended July 31, 2007, we recognized derivatives losses of $7.2 million. As of July 31, 2007, there were no
outstanding forward contracts.

Foreign Currency Contracts.We are not subject to substantial currency fluctuations because most of
our purchases are U.S. dollar-denominated. However, as a result of our Canadian operations, we are exposed to market risk from currency exchange rate exposure which may adversely affect our financial
position, results of operations and cash flows.

33

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ITEM 8.    FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

We refer you to the Index to Consolidated Financial Statements attached hereto on page 39 for a listing of all financial statements. The consolidated financial
statements are included on pages F-1 through F-26. We incorporate these consolidated financial statements in this document by reference.

ITEM 9.    CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS AND FINANCIAL DISCLOSURE

Not applicable.

ITEM 9A.    CONTROLS AND PROCEDURES

Disclosure Controls and Procedures

Under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, we have evaluated the
effectiveness of our disclosure controls and procedures as of the end of the period covered by this report. Based on that evaluation, the Chief Executive Officer and Chief Financial Officer have
concluded that these disclosure controls and procedures are effective in enabling us to record, process, summarize and report information required to be included in the Company's periodic SEC filings
within the required time period, and that such information is accumulated and communicated to the Company's management, including the Chief Executive Officer and Chief Financial Officer, to allow
timely decisions regarding required disclosure.

Internal Control over Financial Reporting

Our Management's Report on Internal Control Over Financial Reporting is included on page F-1 of this Annual Report on Form 10-K.
The report of KPMG LLP, our independent registered public accounting firm, regarding the effectiveness of our internal control over financial reporting is included on page F-2 of this
Annual Report on Form 10-K.

There
has been no change in our internal control over financial reporting that occurred during our most recent fiscal quarter that has materially affected, or is reasonably likely to
materially affect, our internal control over financial reporting.

ITEM 9B.    OTHER INFORMATION

Not applicable.

PART III

ITEM 10.    DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE

The information set forth under the headings "Proposal No. 1: Election of Directors," "Corporate Governance" and "Section 16(a) Beneficial Ownership
Reporting Compliance" in our definitive Proxy Statement for the 2007 Annual Meeting of Stockholders is incorporated herein by reference.

ITEM 11.    EXECUTIVE COMPENSATION

The information set forth under the headings "Compensation Discussion and Analysis," "Compensation Committee Report," "Compensation Committee Interlocks and
Insider Participation," "Executive Compensation" and "Director Compensation" in our definitive Proxy Statement for the 2007 Annual Meeting of Stockholders is incorporated herein by reference.

34

---



ITEM 12.    SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS

The information set forth under the headings "Outstanding Voting Securities of the Company and Principal Holders Thereof" and "Equity Compensation Plan
Information" in our definitive Proxy Statement for the 2007 Annual Meeting of Stockholders is incorporated herein by reference.

ITEM 13.    CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE

The information set forth under the headings "Independence of Board of Directors" and "Related Party Transactions" in our definitive Proxy Statement for the 2007
Annual Meeting of Stockholders is incorporated herein by reference.

ITEM 14.    PRINCIPAL ACCOUNTANT FEES AND SERVICES

The information set forth under the heading "Independent Auditor Fee Information" in our definitive Proxy Statement for the 2007 Annual Meeting of Stockholders is
incorporated herein by reference.

PART IV

ITEM 15.    EXHIBITS AND FINANCIAL STATEMENTS SCHEDULES

The following documents are filed as part of this report.



We
make reference to the Index to Consolidated Financial Statements attached to this document on page 39 for a listing of all financial statement documents included on pages
F-1 through F-26.



All
other financial statements and financial statement schedules for which provision is made in the applicable accounting regulation of the SEC are not required under the related
instructions, are not material or are not applicable and, therefore, have been omitted or are included in the consolidated financial statements or notes thereto.



Each
management contract or compensation plan required to be filed as an exhibit is identified by an asterisk (*).

|Exhibit
Number |  | Description of Exhibit                                                                |  | The filings referenced for incorporation by reference are Zale Corporation filings (File No. 1-04129) unless otherwise noted
|-------------- |  | ------------------------------------------------------------------------------------- |  | ----------------------------------------------------------------------------------------------------------------------------
|3.1a           |  | Restated Certificate of Incorporation of Zale Corporation                             |  | October 31, 2001 Form 10-Q, Exhibit 3.1                                                                                     
|3.1b           |  | Certificate of Amendment to Restated Certificate of Incorporation of Zale Corporation |  | October 31, 2004 Form 10-Q, Exhibit 3.1                                                                                     
|3.2            |  | Bylaws of Zale Corporation                                                            |  | September 5, 2007 Form 8-K, Exhibit 3.1                                                                                     
|4.1a           |  | Revolving Credit Agreement, dated as of July 23, 2003                                 |  | July 31, 2003 Form 10-K, Exhibit 4.1                                                                                        
|4.1b           |  | Amendment to Revolving Credit Agreement, dated as of December 10, 2004                |  | December 10, 2004 Form 8-K, Exhibit 99.1                                                                                    
|               |  |                                                                                       |  |                                                                                                                             

35

---



|4.1c   |  | Amendment to Revolving Credit Agreement dated as of January 17, 2006                     |  | July 31, 2006 Form 10-K, Exhibit 4.1c      
|------ |  | ---------------------------------------------------------------------------------------- |  | -------------------------------------------
|4.1d   |  | Amendment to Revolving Credit Agreement dated as of April 6, 2007                        |  | April 11, 2007 Form 8-K, Exhibit 99.1      
|10.1   |  | Zale Corporation Savings and Investment Plan, as amended                                 |  | July 31, 2006 Form 10-K, Exhibit 10.1      
|10.2*  |  | Form of Indemnification Agreement between Zale Corporation and its directors             |  | July 31, 1995 Form 10-K Exhibit 10.2       
|10.3*  |  | Zale Corporation Omnibus Stock Incentive Plan                                            |  | July 31, 2000 Form 10-K, Exhibit 10.3a     
|10.4a* |  | Zale Corporation 2003 Stock Incentive Plan, as amended                                   |  | July 31, 2006 Form 10-K, Exhibit 10.4a     
|10.4b* |  | Form of Incentive Stock Option Award Agreement                                           |  | July 31, 2004 Form 10-K, Exhibit 10.4b     
|10.4c* |  | Form of Non-qualified Stock Option Award Agreement                                       |  | August 31, 2006 Form 8-K, Exhibit 10.1     
|10.4d* |  | Form of Restricted Stock Award Agreement                                                 |  | July 31, 2004 Form 10-K, Exhibit 10.4c     
|10.4e* |  | Form of Time-Vesting Restricted Stock Unit Award Agreement                               |  | November 17, 2005 Form 8-K, Exhibit 10.5   
|10.4f* |  | Form of Performance-Based Restricted Stock Unit Award Agreement                          |  | November 17, 2005 Form 8-K, Exhibit 10.6   
|10.5*  |  | Outside Directors' 1995 Stock Option Plan                                                |  | July 31, 2001 Form 10-K, Exhibit 10.3c     
|10.6a* |  | Zale Corporation Outside Directors' 2005 Stock Incentive Plan, as amended                |  | July 31, 2006 Form 10-K, Exhibit 10.6a     
|10.6b* |  | Form of Stock Option Award Agreement                                                     |  | November 17, 2005 Form 8-K, Exhibit 10.2   
|10.6c* |  | Form of Restricted Stock Award Agreement                                                 |  | November 17, 2005 Form 8-K, Exhibit 10.3   
|10.7a* |  | Executive Severance Plan                                                                 |  | Form S-1 (Reg. No. 33-27225), Exhibit 10.23
|10.7b* |  | Amendment to Executive Severance Plan                                                    |  | July 31, 1996 Form 10-K, Exhibit 10.8a     
|10.8a* |  | Supplemental Executive Retirement Plan, as amended                                       |  | July 31, 2006 Form 10-K, Exhibit 10.8      
|10.8b* |  | Supplemental Executive Retirement Plan as amended and restated effective January 1, 2005 |  | April 30, 2007 Form 10-Q, Exhibit 10.4     
|10.8c* |  | Supplemental Executive Retirement Plan as amended and restated effective January 1, 2005 |  | April 30, 2007 Form 10-Q, Exhibit 10.5     
|       |  |                                                                                          |  |                                            

36

---



|10.8d*  |  | Pre-409A Supplemental Executive Retirement Plan as amended and restated effective March 1, 2007                                                 |  | April 30,2007 Form 10-Q, Exhibit 10.6   
|------- |  | ----------------------------------------------------------------------------------------------------------------------------------------------- |  | ----------------------------------------
|10.9a   |  | Lease Agreement for Corporate Headquarters                                                                                                      |  | July 31, 1996 Form 10-K, Exhibit 10.11  
|10.9b   |  | First Amendment to Lease Agreement for Corporate Headquarters                                                                                   |  | July 31, 1996 Form 10-K, Exhibit 10.11a 
|10.9c   |  | Second Amendment to Lease Agreement for Corporate Headquarters                                                                                  |  | July 31, 2004 Form 10-K, Exhibit 10.7c  
|10.10*  |  | Employment Agreement with Mary E. Burton, dated as of October 12, 2006                                                                          |  | July 31, 2006 Form 10-K, Exhibit 10.10  
|10.11*  |  | Terms of Employment Arrangement with George R. Mihalko                                                                                          |  | August 10, 2006 Form 8-K, Exhibit 10.1  
|10.12*  |  | Employment Agreement with John A. Zimmermann, dated as of March 31, 2006                                                                        |  | April 6, 2006 Form 8-K, Exhibit 10.1    
|10.13*  |  | Employment Agreement with Gilbert P. Hollander, dated as of January 5, 2005                                                                     |  | July 31, 2006 Form 10-K, Exhibit 10.13  
|10.14*  |  | Offer Letter to Rodney Carter                                                                                                                   |  | October 31, 2006 Form 10-Q, Exhibit 10.1
|10.15*# |  | Zale Corporation Bonus Plan                                                                                                                     |  | July 31, 2006 Form 10-K, Exhibit 10.18  
|10.16   |  | Amendment to Citibank USA, N.A. Agreement, dated as of April 4, 2003                                                                            |  | April 30, 2003 Form 10-Q, Exhibit 99.2  
|10.17*  |  | Form of Change of Control Agreement of Senior Vice Presidents without separate employment agreements                                            |  | July 31, 2004 Form 10-K, Exhibit 10.14  
|10.18*  |  | Base Salaries of Named Executive Officers                                                                                                       |  | Filed herewith                          
|10.19   |  | Master Agreement for Information Technology Services between Zale Delaware, Inc. and ACS Commercial Solutions, Inc., dated as of August 1, 2005 |  | July 31, 2006 Form 10-K, Exhibit 10.18  
|10.20*  |  | Form of Employment Security Agreement                                                                                                           |  | Filed herewith                          
|14      |  | Code of Ethics                                                                                                                                  |  | July 31, 2003 Form 10-K, Exhibit 14     
|21      |  | Subsidiaries of the Registrant                                                                                                                  |  | Filed herewith                          
|23.1    |  | Consent of KPMG LLP                                                                                                                             |  | Filed herewith                          
|31.1    |  | Rule 13a-14(a) Certification of Chief Executive Officer                                                                                         |  | Filed herewith                          
|31.2    |  | Rule 13a-14(a) Certification of Chief Financial Officer                                                                                         |  | Filed herewith                          
|        |  |                                                                                                                                                 |  |                                         

37

---



|32.1 |  | Section 1350 Certification of Chief Executive Officer |  | Filed herewith                       
|---- |  | ----------------------------------------------------- |  | -------------------------------------
|32.2 |  | Section 1350 Certification of Chief Financial Officer |  | Filed herewith                       
|99.1 |  | Audit Committee Charter                               |  | July 31, 2004 Form 10-K, Exhibit 99.1
|99.2 |  | Compensation Committee Charter                        |  | July 31, 2006 Form 10-K, Exhibit 99.2
|99.3 |  | Nominating/Corporate Governance Committee Charter     |  | July 31, 2004 Form 10-K, Exhibit 99.3

---

38

---





INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

|                                                                 |  | Page
|---------------------------------------------------------------- |  | ----
|Management's Report on Internal Control Over Financial Reporting |  | F-1 
|Reports of Independent Registered Public Accounting Firm         |  | F-2 
|Consolidated Statements of Operations                            |  | F-4 
|Consolidated Balance Sheets                                      |  | F-5 
|Consolidated Statements of Cash Flows                            |  | F-6 
|Consolidated Statements of Stockholders' Investments             |  | F-7 
|Notes to Consolidated Financial Statements                       |  | F-8 

39

---





MANAGEMENT'S REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING

Our management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in
Rule 13a-15(f) promulgated under the Securities Exchange Act of 1934, as amended. Under the supervision and with the participation of our management, including our principal
executive officer and principal financial officer, we conducted an evaluation of the effectiveness of our internal control over financial reporting based on the framework in Internal ControlIntegrated
Frameworkissued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Based on our
evaluation, our management concluded that our internal control over financial reporting was effective as of July 31, 2007. The effectiveness of our internal control over financial reporting was
audited by KPMG LLP, an independent registered public accounting firm, as stated in their report on page F-2.

/s/MARY E. BURTONMary E. Burton President, Chief Executive Officer
October 1, 2007

/s/RODNEY CARTERRodney Carter Executive Vice President, Chief
Administrative Officer and Chief Financial Officer
October 1, 2007


F-1

---





REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

The
Board of Directors and Stockholders
Zale Corporation:

We
have audited Zale Corporation's (the Company) internal control over financial reporting as of July 31, 2007, based on criteria established inInternal
ControlIntegrated Framework, issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO).Zale Corporation's management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial
reporting, included in the accompanying "Management's Report on Internal Control Over Financial Reporting". Our responsibility is to express an opinion on the Company's internal control over financial
reporting based on our audit.

We
conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control
over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our
audit also included performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.

A
company's internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of
financial statements for external purposes in accordance with generally accepted accounting principles. A company's internal control over financial reporting includes those policies and procedures
that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide
reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and
expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide
reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company's assets that could have a material effect on the financial statements.

Because
of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future
periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

In
our opinion, Zale Corporation maintained, in all material respects, effective internal control over financial reporting as of July 31, 2007, based on criteria established in Internal ControlIntegrated
Framework, issued by COSO.

We
also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of Zale Corporation as of
July 31, 2007 and 2006, and the related consolidated statements of operations, stockholders' investment, and cash flows for each of the years in the three-year period ended
July 31, 2007, and our report dated October 1, 2007 expressed an unqualified opinion on those consolidated financial statements.

/s/
KPMG LLP

Dallas,
Texas
October 1, 2007

F-2

---



REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

The
Board of Directors
Zale Corporation:

We
have audited the accompanying consolidated balance sheets of Zale Corporation (the Company) as of July 31, 2007 and 2006, and the related consolidated statements of operations,
stockholders' investment, and cash flows for each of the years in the three-year period ended July 31, 2007. These consolidated financial statements are the responsibility of the
Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.

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

In
our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Zale Corporation as of July 31, 2007
and 2006, and the results of its operations and its cash flows for each of the years in the three-year period ended July 31, 2007, in conformity with U.S. generally accepted
accounting principles. As discussed in Note 1 to the consolidated financial statements, the Company adopted the provisions of Statement of Financial Accounting Standards No. 123 (revised
2004), "Share-Based Payment," in fiscal year 2006.

We
also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), Zale Corporation's internal control over financial reporting as
of July 31, 2007, based on criteria established inInternal ControlIntegrated Framework, issued by the Committee of Sponsoring
Organizations of the Treadway Commission, and our report dated October 1, 2007 expressed an unqualified opinion on the effectiveness of the Company's internal control over financial reporting.

/s/
KPMG LLP

Dallas,
Texas
October 1, 2007

F-3

---





ZALE CORPORATION AND SUBSIDIARIES        CONSOLIDATED STATEMENTS OF OPERATIONS        (in thousands, except per share amounts)

|                                                      |                                            | Year Ended July 31,
|----------------------------------------------------- | ------------------------------------------ | -------------------
|
|Revenues                                              |                                            | $                  
|                                                      |                                            |                    
|Cost and expenses:                                    |                                            |                    
|                                                      | Cost of sales                              |                    
|                                                      | Selling, general and administrative        |                    
|                                                      | Cost of insurance operations               |                    
|                                                      | Depreciation and amortization              |                    
|                                                      | Benefit from settlement of retirement plan |                    
|                                                      | Derivative loss                            |                    
|                                                      |                                            |                    
|Operating earnings                                    |                                            |                    
|Interest expense                                      |                                            |                    
|                                                      |                                            |                    
|Earnings before income taxes                          |                                            |                    
|Income tax expense                                    |                                            |                    
|                                                      |                                            |                    
|                                                      |                                            | Net earnings       
|                                                      |                                            |                    
|Earnings per common share:                            |                                            |                    
|                                                      | Basic earnings per share                   |                    
|                                                      |                                            |                    
|                                                      | Diluted earnings per share                 |                    
|                                                      |                                            |                    
|Weighted average number of common shares outstanding: |                                            |                    
|                                                      | Basic                                      |                    
|                                                      |                                            |                    
|                                                      | Diluted                                    |                    
|                                                      |                                            |                    

See
notes to the consolidated financial statements.

F-4

---



ZALE CORPORATION AND SUBSIDIARIES        CONSOLIDATED BALANCE SHEETS        (in thousands, except per share amounts)

|                                                   |                                                                                                                                                                         | July 31, 2007             |                                                | July 31, 2006 |          
|-------------------------------------------------- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------- | ------------------------- | ---------------------------------------------- | ------------- | ---------
|ASSETS                                             |                                                                                                                                                                         |                           |                                                |               |          
|Current Assets:                                    |                                                                                                                                                                         |                           |                                                |               |          
|                                                   | Cash and cash equivalents                                                                                                                                               |                           | $                                              | 37,643        |          
|                                                   | Merchandise inventories                                                                                                                                                 |                           |                                                | 1,021,164     |          
|                                                   | Other current assets                                                                                                                                                    |                           |                                                | 113,511       |          
|                                                   |                                                                                                                                                                         |                           |                                                |               |          
|                                                   |                                                                                                                                                                         | Total current assets      |                                                |               | 1,172,318
|                                                   |                                                                                                                                                                         |                           |                                                |               |          
|Property and equipment, net                        |                                                                                                                                                                         |                           | 304,396                                        |               |          
|Goodwill                                           |                                                                                                                                                                         |                           | 100,740                                        |               |          
|Other assets                                       |                                                                                                                                                                         |                           | 35,187                                         |               |          
|Deferred tax asset                                 |                                                                                                                                                                         |                           | 1,305                                          |               |          
|                                                   |                                                                                                                                                                         |                           |                                                |               |          
|                                                   |                                                                                                                                                                         |                           | Total assets                                   |               | $        
|                                                   |                                                                                                                                                                         |                           |                                                |               |          
|LIABILITIES AND STOCKHOLDERS' INVESTMENT           |                                                                                                                                                                         |                           |                                                |               |          
|Current liabilities:                               |                                                                                                                                                                         |                           |                                                |               |          
|                                                   | Accounts payable and accrued liabilities                                                                                                                                |                           | $                                              | 300,929       |          
|                                                   | Deferred tax liability                                                                                                                                                  |                           |                                                | 73,529        |          
|                                                   |                                                                                                                                                                         |                           |                                                |               |          
|                                                   |                                                                                                                                                                         | Total current liabilities |                                                |               | 374,458  
|                                                   |                                                                                                                                                                         |                           |                                                |               |          
|Long-term debt                                     |                                                                                                                                                                         |                           | 227,306                                        |               |          
|Deferred tax liability                             |                                                                                                                                                                         |                           |                                               |               |          
|Other liabilities                                  |                                                                                                                                                                         |                           | 109,609                                        |               |          
|Commitments and contingencies (see notes 7 and 12) |                                                                                                                                                                         |                           |                                                |               |          
|Stockholders' Investment:                          |                                                                                                                                                                         |                           |                                                |               |          
|                                                   | Common stock, par value $0.01, 150,000 shares authorized; 54,609 and 53,646 shares issued; 49,053 and 48,134 shares outstanding at July 31, 2007 and 2006, respectively |                           |                                                | 487           |          
|                                                   | Additional paid-in capital                                                                                                                                              |                           |                                                | 138,036       |          
|                                                   | Accumulated other comprehensive income                                                                                                                                  |                           |                                                | 45,939        |          
|                                                   | Accumulated earnings                                                                                                                                                    |                           |                                                | 868,111       |          
|                                                   |                                                                                                                                                                         |                           |                                                |               |          
|                                                   |                                                                                                                                                                         |                           | 1,052,573                                      |               |          
|                                                   | Treasury stock, at cost, 5,556 and 5,551 shares at July 31, 2007 and 2006, respectively                                                                                 |                           |                                                | (150,000      | )        
|                                                   |                                                                                                                                                                         |                           |                                                |               |          
|                                                   |                                                                                                                                                                         |                           | Total stockholders' investment                 |               |          
|                                                   |                                                                                                                                                                         |                           |                                                |               |          
|                                                   |                                                                                                                                                                         |                           | Total liabilities and stockholders' investment |               | $        
|                                                   |                                                                                                                                                                         |                           |                                                |               |          

See
notes to the consolidated financial statements.

F-5

---





ZALE CORPORATION AND SUBSIDIARIES        CONSOLIDATED STATEMENTS OF CASH FLOWS        (in thousands)

|                                                                                    |                                               | Year Ended July 31, |           
|----------------------------------------------------------------------------------- | --------------------------------------------- | ------------------- | ----------
|
|Cash Flows From Operating Activities:                                               |                                               |                     |           
|Net earnings                                                                        |                                               | $                   | 59,252    
|Adjustments to reconcile net earnings to net cash provided by operating activities: |                                               |                     |           
|                                                                                    | Depreciation and amortization                 |                     |           
|                                                                                    | Repatriation on tax provision                 |                     |           
|                                                                                    | Deferred taxes                                |                     |           
|                                                                                    | Loss on disposition of property and equipment |                     |           
|                                                                                    | Impairment of fixed assets                    |                     |           
|                                                                                    | Stock-based compensation                      |                     |           
|                                                                                    | Benefit from settlement of retirement plan    |                     |           
|                                                                                    | Derivative (gain) loss                        |                     |           
|Changes in assets and liabilities:                                                  |                                               |                     |           
|                                                                                    | Merchandise inventories                       |                     |           
|                                                                                    | Other current assets                          |                     |           
|                                                                                    | Other assets                                  |                     |           
|                                                                                    | Accounts payable and accrued liabilities      |                     |           
|                                                                                    | Other liabilities                             |                     |           
|                                                                                    |                                               |                     |           
|Net cash provided by operating activities                                           |                                               |                     | 40,642    
|                                                                                    |                                               |                     |           
|Cash Flows From Investing Activities:                                               |                                               |                     |           
|Payments for property and equipment                                                 |                                               |                     | (86,446   
|Proceeds from sale of property and equipment                                        |                                               |                     |          
|Purchase of available-for-sale investments                                          |                                               |                     | (11,281   
|Proceeds from sales of available-for-sale investments                               |                                               |                     | 8,127     
|                                                                                    |                                               |                     |           
|Net cash used in investing activities                                               |                                               |                     | (89,600   
|                                                                                    |                                               |                     |           
|Cash Flows From Financing Activities:                                               |                                               |                     |           
|Borrowings under revolving credit agreement                                         |                                               |                     | 2,960,693 
|Payments on revolving credit agreement                                              |                                               |                     | (2,936,200
|Proceeds from exercise of stock options                                             |                                               |                     | 17,795    
|Excess tax benefit on stock options exercised                                       |                                               |                     | 1,432     
|Purchase of common stock                                                            |                                               |                     |          
|                                                                                    |                                               |                     |           
|Net cash provided by (used in) financing activities                                 |                                               |                     | 43,720    
|                                                                                    |                                               |                     |           
|Effect of exchange rate changes on cash                                             |                                               |                     | 287       
|Net change in cash and cash equivalents                                             |                                               |                     | (4,951    
|Cash and cash equivalents at beginning of period                                    |                                               |                     | 42,594    
|                                                                                    |                                               |                     |           
|Cash and cash equivalents at end of period                                          |                                               | $                   | 37,643    
|                                                                                    |                                               |                     |           

See
notes to the consolidated financial statements.

F-6

---



ZALE CORPORATION AND SUBSIDIARIES        CONSOLIDATED STATEMENTS OF STOCKHOLDERS' INVESTMENT        (in thousands)

|                                           |                      | Common Stock |   |   |     |   |   |         |  |   |        |   |  
|------------------------------------------ | -------------------- | ------------ | - | - | --- | - | - | ------- |  | - | ------ | - | -
|
|
|Balances at July 31, 2004                  |                      | 52,110       |   | $ | 521 |   | $ | 63,661  |  | $ | 13,470 |   | $
|Net earnings                               |                      |             |   |   |    |   |   |        |  |   |       |   |  
|Unrealized loss on securities              |                      |             |   |   |    |   |   |        |  |   | (474   | ) |  
|Unrealized loss on derivatives             |                      |             |   |   |    |   |   |        |  |   | (338   | ) |  
|Cumulative translation adjustment          |                      |             |   |   |    |   |   |        |  |   | 11,461 |   |  
|                                           |                      |              |   |   |     |   |   |         |  |   |        |   |  
|                                           | Comprehensive income |              |   |   |     |   |   |         |  |   |        |   |  
|                                           |                      |              |   |   |     |   |   |         |  |   |        |   |  
|Exercise of stock options                  |                      | 946          |   |   | 10  |   |   | 18,603  |  |   |       |   |  
|Tax benefit from exercise of stock options |                      |             |   |   |    |   |   | 4,777   |  |   |       |   |  
|Purchase of common stock                   |                      | (1,812       | ) |   | (18 | ) |   | 18      |  |   |       |   |  
|Stock-based compensation                   |                      | (5           | ) |   |    |   |   | 660     |  |   |       |   |  
|                                           |                      |              |   |   |     |   |   |         |  |   |        |   |  
|Balances at July 31, 2005                  |                      | 51,239       |   |   | 513 |   |   | 87,719  |  |   | 24,119 |   |  
|Net earnings                               |                      |             |   |   |    |   |   |        |  |   |       |   |  
|Unrealized loss on securities              |                      |             |   |   |    |   |   |        |  |   | (434   | ) |  
|Unrealized loss on derivatives             |                      |             |   |   |    |   |   |        |  |   | 370    |   |  
|Cumulative translation adjustment          |                      |             |   |   |    |   |   |        |  |   | 9,509  |   |  
|                                           |                      |              |   |   |     |   |   |         |  |   |        |   |  
|                                           | Comprehensive income |              |   |   |     |   |   |         |  |   |        |   |  
|                                           |                      |              |   |   |     |   |   |         |  |   |        |   |  
|Exercise of stock options                  |                      | 579          |   |   | 5   |   |   | 10,665  |  |   |       |   |  
|Tax benefit from exercise of stock options |                      |             |   |   |    |   |   | 876     |  |   |       |   |  
|Purchase of common stock                   |                      | (3,717       | ) |   | (38 | ) |   | 38      |  |   |       |   |  
|Stock-based compensation                   |                      | 33           |   |   | 2   |   |   | 12,150  |  |   |       |   |  
|                                           |                      |              |   |   |     |   |   |         |  |   |        |   |  
|Balances at July 31, 2006                  |                      | 48,134       |   |   | 482 |   |   | 111,448 |  |   | 33,564 |   |  
|Net earnings                               |                      |             |   |   |    |   |   |        |  |   |       |   |  
|Unrealized loss on securities              |                      |             |   |   |    |   |   |        |  |   | (160   | ) |  
|Cumulative translation adjustment          |                      |             |   |   |    |   |   |        |  |   | 12,535 |   |  
|                                           |                      |              |   |   |     |   |   |         |  |   |        |   |  
|                                           | Comprehensive income |              |   |   |     |   |   |         |  |   |        |   |  
|                                           |                      |              |   |   |     |   |   |         |  |   |        |   |  
|Exercise of stock options                  |                      | 893          |   |   | 5   |   |   | 17,790  |  |   |       |   |  
|Tax benefit from exercise of stock options |                      |             |   |   |    |   |   | 2,711   |  |   |       |   |  
|Stock-based compensation                   |                      | 26           |   |   |    |   |   | 6,087   |  |   |       |   |  
|                                           |                      |              |   |   |     |   |   |         |  |   |        |   |  
|Balances at July 31, 2007                  |                      | 49,053       |   | $ | 487 |   | $ | 138,036 |  | $ | 45,939 |   | $
|                                           |                      |              |   |   |     |   |   |         |  |   |        |   |  

See
notes to the consolidated financial statements.

F-7

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ZALE CORPORATION AND SUBSIDIARIES        NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Basis of Presentation.We are, through our wholly owned subsidiaries, a leading specialty retailer of
fine jewelry in North America. At July 31, 2007, we operated 1,471 specialty retail jewelry stores and 793 kiosks located mainly in shopping malls throughout the United States of America,
Canada and Puerto Rico. We report our operations under three segments: Fine Jewelry, Kiosk Jewelry and All Other.

Our
Fine Jewelry segment is comprised of six brands, predominantly focused on the moderate income consumer as our core customer target. Each brand specializes in fine jewelry and
watches, with merchandise and marketing emphasis focused on diamond products. Additionally, each brand differentiates itself through a customer experience with different points of emphasis. Our
moderate brands, which consist of all brands except Bailey Banks & Biddle, have a centralized merchandising function that creates significant synergies and allows for more teaming across
brands. Zales Jewelers® is our national brand in the U.S. providing moderately priced jewelry to a broad range of customers. We have further leveraged the brand strength through Zales
Outlet, which focuses on a slightly higher-income female self purchaser in outlet malls and neighborhood power centers. Gordon's Jewelers® is a moderate regional jeweler that emphasizes
customer relationships. Bailey Banks & Biddle Fine Jewelers® operates jewelry stores that are considered among the finest luxury jewelry stores in their markets, offering designer
jewelry and prestige watches to attract more affluent customers. Peoples Jewellers® and Mappins Jewellers® offer moderately priced jewelry in malls throughout Canada. The
brands in the Fine Jewelry segment have expanded their presence in the retail market through their e-commerce sites,zales.com,
gordonsjewelers.com,andbaileybanksandbiddle.com. During fiscal year 2007, our Fine Jewelry segment generated
$2.2 billion of revenues.

The
Kiosk Jewelry segment operates primarily under the brand names Piercing Pagoda®, Plumb Gold, and Silver and Gold Connection® through
mall-based kiosks and carts and reaches the opening price point select jewelry customer. The Kiosk Jewelry segment specializes in gold and silver products that capitalize on the latest
fashion trends. During fiscal year 2007, our Kiosk Jewelry segment generated $263 million of revenues.

The
accompanying consolidated financial statements and related notes are those of our business as of and for the twelve month periods ended July 31, 2007 and July 31, 2006.
We consolidate substantially all of our U.S. operations into Zale Delaware, Inc. ("ZDel"), a wholly owned subsidiary of Zale Corporation. ZDel is the parent company for several subsidiaries,
including three that are engaged primarily in providing credit insurance to our credit customers. We consolidate our Canadian retail operations into Zale International, Inc., which is a wholly
owned subsidiary of Zale Corporation. All significant intercompany transactions have been eliminated.

Cash and Cash Equivalents.Cash and cash equivalents include cash on hand, deposits in banks and
short-term marketable securities at varying interest rates with original maturities of three months or less. The carrying amount approximates fair value because of the
short-term maturity of those instruments.

Merchandise Inventories.Merchandise inventories are stated at the lower of cost or market.
Substantially all U.S. inventories represent finished goods which are valued using the last-in, first-out ("LIFO") retail inventory method. Merchandise inventory of Peoples
Jewellers and Mappins Jewellers of Canada is valued using the first-in, first-out ("FIFO") retail inventory method. Under the retail method, inventory is segregated into
categories of merchandise with similar characteristics at its current average retail selling value. The determination of inventory at cost and the resulting gross margins are calculated by applying an
average cost-to-retail ratio to the retail value of inventory. At the end of fiscal year 2007, approximately five percent of our total inventory represented raw materials and
other inventory associated

F-8

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with
internally sourced product. This inventory is valued at the weighted average cost of the items. The LIFO charge was $5.4 million, $5.8 million and $3.5 million for the years
ended July 31, 2007, 2006 and 2005, respectively. The cumulative LIFO provision reflected in the accompanying consolidated balance sheets was $37.5 million and $29.1 million at
July 31, 2007 and 2006, respectively. Domestic inventories on a FIFO basis were $953.3 million and $844.4 million at July 31, 2007 and 2006, respectively. Our Canadian
inventory accounted for on the FIFO retail method, net of reserves, was approximately $105.4 million and $88.0 million at July 31, 2007 and 2006, respectively.

Consigned
inventory and related contingent obligations are not reflected in our consolidated financial statements. Consignment inventory has historically consisted of test programs,
merchandise at higher price points, or merchandise that otherwise does not warrant the risk of outright ownership.
Consignment merchandise can be returned to the vendor at any time. At the time consigned inventory is sold, we record the purchase liability in accounts payable and the related cost of merchandise in
cost of sales. We maintained consolidated consigned inventory at our retail locations of approximately $159.2 million and $175.1 million at July 31, 2007 and 2006, respectively.

We
are required to determine the LIFO cost on an interim basis by estimating annual inflation trends, annual purchases and ending inventory levels for the fiscal year. Actual annual
inflation rates and inventory balances as of the end of any fiscal year may differ from interim estimates. We apply internally developed indices that we believe accurately and consistently measure
inflation or deflation in the components of our merchandise (i.e., the proper weighting of diamonds, gold and other metals and precious stones) and our overall merchandise mix. We believe our
internally developed indices more accurately reflect inflation or deflation in our own prices than the U.S. Bureau of Labor Statistics producer price indices or other published indices.

We
also write-down our inventory for discontinued, slow-moving and damaged inventory. This write-down is equal to the difference between the cost of
inventory and its estimated market value based upon assumptions of targeted inventory turn rates, future demand, management strategy, and market conditions. If actual market conditions are less
favorable than those projected by management or management strategy changes, additional inventory write-downs may be required and, in the case of a major change in strategy or downturn in market
conditions, such write-downs could be significant.

Shrinkage
is estimated for the period from the last inventory date to the end of the fiscal year on a store by store basis. Such estimates are based on experience and the shrinkage
results from the last physical inventory. Physical inventories are taken at least once annually for all store locations and for the distribution centers. The shrinkage rate from the most recent
physical inventory, in combination with historical experience and significant changes in physical inventory results could impact our shrinkage reserve.

Impairment of Long-Lived Assets.Long-lived assets are periodically reviewed
for impairment by comparing the carrying value of the assets with their estimated undiscounted future cash flows. If the evaluation indicates that the carrying amount of the asset may not be
recoverable, the potential impairment is measured based on a projected discounted cash flow method, using a discount rate that is considered to be commensurate with the risk inherent in our current
business model. Assumptions are made with respect to cash flows expected to be generated by the related assets based upon updated projections. Any changes in key assumptions, particularly store
performance or market conditions, could result in an unanticipated impairment charge. For instance, in the event of a major market downturn or adverse developments within a particular market or
portion of our business, individual stores may become unprofitable, which could result in a write-down of the carrying value of the assets located in those stores.

Goodwill.In accordance with Statement of Financial Accounting Standards ("SFAS") No. 142,
"Goodwill and Other Intangible Assets," we test goodwill for impairment annually, at the end of our second quarter, or more frequently if events occur which indicate a potential reduction in the fair
value of a reporting unit's net assets below its carrying value. An impairment is deemed to exist if the estimated fair

F-9

---



value
of a reporting unit is less than its net book value. We calculate estimated fair value using the present value of future cash flows expected to be generated using a weighted average cost of
capital and updated financial projections. As of the second quarter of fiscal year 2007, we performed our annual review for impairment of goodwill related to our Piercing Pagoda, People's Jewellers
and other smaller acquisitions. We concluded that there was no evidence of impairment related to the goodwill of approximately $19.4 million for the Piercing Pagoda acquisition,
$76.3 million recorded for the People's Jewellers acquisition and $5.0 million for other smaller acquisitions.

Revenue Recognition.We recognize revenue in accordance with the Securities and Exchange Commission's
Staff Accounting Bulletin No. 104 "Revenue Recognition." Revenue related to merchandise sales, which is approximately 95 percent of total revenues, is recognized at the time of the sale,
reduced by a provision for sales returns. The provision for sales returns is based on historical evidence of our return rate. Repair revenues are recognized when the service is complete and the
merchandise is delivered to the customers. We offer our customers two-year and lifetime warranties that cover sizing and breakage on certain products and a diamond commitment program
("DCP") that offers a traditional warranty to cover sizing, breakage and theft replacement for a 12-month period. The revenue from the lifetime warranty and DCP is recognized on a
straight-line basis over a five-year and 12-month period, respectively. The revenue from the two-year warranty is recognized over the two-year service
period at the rates the related costs have historically been incurred in performing the services covered under the agreements. Revenues also include premiums from our insurance businesses, principally
related to credit insurance policies sold to customers who purchase our merchandise under the proprietary credit program. Insurance premiums are recognized over the coverage period.

In
connection with the sale of our customer receivables in fiscal year 2000, we entered into a 10 year merchant services agreement whereby Citibank U.S.A., NA ("Citi") will issue
private label credit cards branded with appropriate Company trademarks. We received a $41.8 million incentive for entering into the agreement which is being recognized ratably over
10 years. The deferred revenue as of July 31, 2007 and 2006 totaled $12.5 million and $16.7 million, respectively.

Cost of Sales.Cost of sales includes cost of merchandise sold, as well as receiving and distribution
costs.

Selling, General and Administrative.Included in selling, general and administrative ("SG&A") are
store operating, advertising, buying and general corporate overhead expenses.

Operating Leases.Rent expense is recognized on a straight-line basis, including
consideration of rent holidays, tenant improvement allowances received from the landlords and applicable rent escalations over the term of the lease. The commencement date of the rent expense is the
earlier of the date when we become legally obligated for the rent payments or the date when we take possession of the building for construction purposes.

Depreciation and Amortization.Buildings and leasehold improvements are amortized using the
straight-line method over the estimated useful lives of the assets or remaining lease life, whichever is shorter, which generally range from 5 to 10 years. Fixtures and equipment
are amortized using the straight-line method over the estimated useful lives of the assets, which range from 3 to 15 years. Original cost and related accumulated depreciation or
amortization is removed from the accounts in the year assets are retired. Gains or losses on dispositions of property and equipment are included in operations in the year of disposal.

Stock-Based Compensation.Prior to fiscal year 2006, we accounted for stock-based compensation under
the recognition and measurement principles of Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees" ("APB 25") and related interpretations, Statement of
Financial Accounting Standards Board ("SFAS") No. 123, "Accounting for Stock-Based Compensation,"

F-10

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("SFAS 123"),
and complied with the disclosure provisions of SFAS No. 148, "Accounting for Stock-Based CompensationTransition and Disclosure, an Amendment of SFAS
No. 123."

Effective
August 1, 2005, we adopted SFAS No. 123 (Revised 2004), "Share-Based Payment" ("SFAS 123(R)"), which requires the use of the fair value method of
accounting for all stock-based compensation, including stock options. SFAS 123(R) was adopted using the modified prospective method. Under this method, in addition to reflecting compensation
expense for new share-based awards, expense is also recognized for those awards vesting in the current period based on the value that had been included in pro forma disclosures in prior periods.
Results from prior periods have not been restated.

Prior
to the adoption of SFAS 123(R), we presented all benefits of tax deductions resulting from the exercise of stock-based compensation as operating cash flows in the statements
of cash flows. SFAS 123(R) requires the benefits of tax deductions in excess of the compensation cost recognized for those options (excess tax benefits) to be classified as financing cash
flows.

Had
stock-based compensation expense been determined based upon the fair values at the grant dates for awards under our stock incentive plans in accordance SFAS No. 123(R) for the
year ended July 31,
2005, our pro forma net earnings, basic and diluted earnings per common share would have been as follows (amounts in thousands, except per share data):

Net earnings, as reported

$
106,775Add: Reported stock-based compensation expense, net of taxes


414Deduct: Fair value based compensation expense, net of taxes


(6,509
)Net earnings, pro forma

$
100,680Earnings per common share:Basic, as reported

$
2.08Basic, pro forma

$
1.96Diluted, as reported

$
2.05Diluted, pro forma

$
1.94


Preferred Stock.At July 31, 2007 and 2006, 5,000,000 shares of preferred stock, par value of
$0.01, were authorized. None was issued or outstanding.

Credit Insurance Operations.Insurance premium revenue from credit insurance subsidiaries was
$13.6 million, $13.1 million and $12.9 million for the fiscal years ended July 31, 2007, 2006 and 2005, respectively. These insurance premiums are included in revenues in
the accompanying consolidated statements of operations.

Advertising Expenses.Advertising is generally expensed when incurred and is a component of SG&A. All
related production costs are expensed upon the first occurrence of the advertisement. Advertising expenses were $104.5 million, $106.2 million and $93.2 million for the fiscal
years ended July 31, 2007, 2006 and 2005, respectively, net of amounts contributed by vendors. The amounts of prepaid advertising at July 31, 2007, 2006 and 2005 were
$17.7 million, $16.5 million and $9.8 million, respectively,
and are classified as components of other current assets in the accompanying consolidated balance sheets.

Vendor Allowances.We receive cash or allowances from merchandise vendors primarily in connection
with cooperative advertising programs and reimbursements for markdowns taken to sell the vendor's products. We have agreements in place with each vendor setting forth the specific conditions for each
allowance or payment. The majority of these agreements are entered into or renewed annually at the beginning of each fiscal year. Qualifying vendor reimbursements of costs incurred to specifically
advertise

F-11

---



vendors'
products are recorded as a reduction of advertising expense. All other allowances or cash payments received are recorded as a reduction to the cost of merchandise.

Income Taxes.Income taxes are accounted for under the asset and liability method prescribed by SFAS
No. 109, "Accounting for Income Taxes." Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying
amounts of existing assets and liabilities and their respective tax bases and operating loss and tax credit carryforwards. Deferred tax assets and liabilities are measured using enacted tax rates
expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax
rates is recognized in income in the period that includes the enactment date. A valuation allowance is recorded to reduce the carrying amounts of deferred tax assets unless it is more likely than not
such assets will be realized.

Sales Tax.The Company presents revenues net of taxes collected and records the taxes as a liability
in the consolidated balance sheets until the taxes are remitted to the appropriate taxing authority.

Foreign Currency.Translation adjustments result from translating foreign subsidiaries' financial
statements into U.S. dollars. Balance sheet accounts are translated at exchange rates in effect at the balance sheet date. Income statement accounts are translated at average exchange rates during the
year. Resulting translation adjustments are included as a component of comprehensive income in the accompanying consolidated statements of stockholders' investment.

Earnings Per Common Share.Basic earnings per share is computed by dividing net earnings available to
common stockholders by the weighted average number of common shares outstanding for the reporting period. Diluted earnings per share of common stock reflect the potential dilution that could occur if
securities or other contracts to issue common stock were exercised or converted into common stock. Outstanding stock options issued by us represent the only dilutive effect reflected in diluted
weighted average shares. There were antidilutive common stock equivalents of 2,172,460, 1,911,563 and 27,119 as of July 31, 2007, 2006 and 2005, respectively.

Financial Instruments.As cash and short-term cash investments, trade payables and
certain other short-term financial instruments are all short-term in nature, their carrying amount approximates fair value.

We
principally address commodity risk through retail price point adjustments and have, from time to time, purchased forward contracts for gold and silver. Any changes in the fair value
of derivative instruments are reported in derivative loss in the accompanying consolidated statements of operations. We do not utilize derivative financial instruments for trading or speculative
purposes.

The
purpose of purchasing the forward contracts for gold and silver is to minimize the effect of unknown future commodity price movements on planned cash flows and to enable us to
maintain a consistent and predictable pricing strategy. No fees or up front payments are required when using these commodity forwards. These contracts settle on a net basis. We have accounted for
these forward contracts as undesignated derivative instruments. Accounting for our forward contracts as derivatives instead of hedges does not affect the underlying economics of our risk management
strategies and has no impact on the timing or amount of cash flows under any derivative contract. The fair value of our derivative instruments is included in the consolidated balance sheets. These
fair values are obtained from outside counterparties and verified with internal discounted cash flow models. During the term of the contracts, any changes in the fair value of derivative instruments
are reported in derivative losses in the consolidated statements of operations. The fair market value of these instruments is subject to the changes in the value of the underlying commodity. For the
fiscal year ended July 31, 2007, we recognized derivatives losses of $7.2 million. As of July 31, 2007, there were no outstanding forward contracts. We have classified cash
activity associated with derivatives as an operating activity in the consolidated statements of cash flows.

F-12

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For
fiscal year 2007, the carrying amount of $227.3 million related to the revolving credit agreements approximates fair value due to the variable interest rate on the debt.

The
investments of our insurance subsidiaries, primarily stocks and bonds, are accounted for as available-for-sale securities and are reflected in other assets in
the accompanying consolidated balance sheets. The fair value of these instruments as of July 31, 2007 and 2006 were approximately $25 million and $22 million, respectively.

Concentrations of Business and Credit Risk.During fiscal year 2007, we purchased approximately
18 percent of our finished merchandise from our top five vendors, including five percent from one vendor, compared to approximately 22 percent in the same period of the prior year. In
fiscal years 2007 and 2006, approximately 12 percent and six percent, respectively, of our merchandise requirements were provided by our internal sourcing organization. If supply between us and
these top vendors were
disrupted, particularly at certain critical times during the year, our sales could be adversely affected in the short term until alternative supply arrangements could be established. As of
July 31, 2007 and 2006, we had no significant concentrations of credit risk.

Use of Estimates.Our accounting and financial reporting policies are in conformity with U.S.
generally accepted accounting principles. The preparation of financial statements in conformity with U.S. generally accepted accounting principles requires management to make estimates and assumptions
that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues and
expenses during the reporting period. Actual results could differ from those estimates. For example, unexpected changes in market conditions or a downturn in the economy could adversely affect actual
results. Estimates are used in accounting for, among other things, inventory valuation, goodwill and long-lived asset valuation, last-in, LIFO inventory retail method, legal
liability, credit insurance liability, product warranty, depreciation, employee benefits, workers' compensation, tax and contingencies. Estimates and assumptions are reviewed periodically and the
effects of revisions are reflected in the consolidated financial statements in the period they are determined to be necessary.

Reclassifications.The classifications in use at July 31, 2007 have been applied to the
financial statements for July 31, 2006 and 2005.

F-13

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2. INVESTMENTS

Investments in debt and equity securities are reported as other assets in the accompanying consolidated balance sheets. Investments are recorded at fair value
based on quoted market prices. All long-term debt securities outstanding at July 31, 2007 will contractually mature within 1 to 29 years.

Investments,
principally related to our insurance subsidiaries as of July 31, 2007 and 2006 were as follows (in thousands):

July 31, 2007

July 31, 2006Cost

Fair Value

Cost

Fair ValueU.S. government obligations

$
16,563

$
16,180

$
14,249

$
13,770Corporate bonds and notes


7,818


7,698


4,153


4,076Corporate equity securities


1,025


1,089


3,826


4,102$
25,406

$
24,967

$
22,228

$
21,948


All
investments are classified as available-for-sale. At July 31, 2007 and 2006, the carrying value of investments included net unrealized losses of
approximately $439,000 and $279,000, respectively, which are included in accumulated other comprehensive income. The net realized gain on investments totaled $230,176, $91,000 and $400,000 in fiscal
years 2007, 2006 and 2005, respectively, as determined on the specific identification basis. Investments with a carrying value of $7.8 million and $6.2 million were on deposit with
various state insurance departments at July 31, 2007 and 2006, respectively, as required by law.

3. PROPERTY AND EQUIPMENT, NET

Our property and equipment consists of the following (in thousands):

Year Ended July 31,2007

2006Building and leasehold improvements

$
266,424

$
245,343Furniture and fixtures


465,195


414,833Construction in progress


12,013


18,108743,632


678,284Less: Accumulated amortization and depreciation


(439,236
)

(394,563
)$
304,396

$
283,721


We
recorded impairment charges of $2.8 million, $19.1 million and $1.5 million for the fiscal years ended July 31, 2007, 2006 and 2005, respectively. The
fiscal year 2006 impairment consists primarily of a $3.6 million charge related to certain test stores, a $5.2 million charge related to a terminated information technology initiative
and an $8.4 million charge related to Bailey Banks & Biddle store closures. These impairment charges, primarily in the Fine Jewelry segment, are included in SG&A and resulted from our
ongoing process to evaluate the productivity of our asset base.

F-14

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4. ACCOUNTS PAYABLE AND ACCRUED LIABILITIES

Our accounts payable and accrued liabilities consist of the following (in thousands):

Year Ended July 31,2007

2006Accounts payable

$
142,640

$
174,581Accrued payroll


45,284


41,507Accrued taxes


29,688


26,549Warranty deferred revenue


29,501


28,136Accrued rent


15,533


17,713Other


38,283


49,592$
300,929

$
338,078


5. OTHER LIABILITIES

Our other liabilities consist of the following (in thousands):

Year Ended July 31,2007

2006Long-term accrued rent

$
32,994

$
31,504Long-term warranty deferred revenue


61,131


Long-term deferred servicing fee revenue


8,360


12,540Insurance reserves


7,124


7,433Other





132$
109,609

$
51,609


6. DEBT

U.S. Revolving Credit Agreement.Our U.S. revolving credit agreement (the "U.S. Agreement") bears
interest at a floating rate at either (i) LIBOR plus the applicable margin (as defined in the U.S. Agreement), or (ii) the base rate (as defined in the U.S. Agreement) plus the
applicable margin. The margin applicable to LIBOR based loans and standby letter of credit commission rates will be automatically reduced or increased from time to time based upon excess borrowing
availability under the U.S. Agreement. We pay a quarterly commitment fee of 0.20 percent to 0.25 percent on the preceding month's unused commitment. We may repay the revolving credit
loans at any time without penalty prior to the maturity date of August 2011. For the years ended July 31, 2007 and 2006, the weighted average effective interest rate was
6.7 percent and 5.80 percent, respectively. The applicable margin for LIBOR based loans was 1.0 percent and 1.25 percent at July 31, 2007 and 2006, respectively; and
the applicable margin for Base Rate loans was zero percent at July 31, 2007 and 2006. At July 31, 2007 and 2006, $221.2 and $186.1 million, respectively, was outstanding under the
U.S. Agreement. We had approximately $278.8 million and $313.9 million in available borrowings at July 31, 2007 and 2006, respectively. In addition, the U.S. Agreement provides
for seasonal borrowing capabilities of up to $100 million and an accordion feature that allows us to permanently increase the facility size in $25 million increments up to another
$100 million. The maximum amount outstanding under the U.S. Agreement during fiscal years 2007 and 2006 was $462.9 million and $315.0 million, respectively.

At
any time, if remaining borrowing availability falls below $75 million, we will be restricted in our ability to repurchase stock or pay dividends. If remaining borrowing
availability falls below $50 million, we will be required to meet a minimum fixed charge coverage ratio. The U.S. Agreement requires us to comply with certain restrictive covenants including,
among other things, limitations on indebtedness,

F-15

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investments,
liens, acquisitions and asset sales. We are currently in compliance with all of our obligations under the U.S. Agreement.

Canadian Revolving Credit Agreement.Our Canadian revolving credit agreement (the "Canadian
Agreement") bears interest at a floating rate of either (i) the BA rate (as defined in the Canadian Agreement) plus the applicable margin (as defined in the U.S. Agreement), or (ii) the
Base Rate (as defined in the Canadian Agreement) plus the applicable margin. The margin applicable to BA based loans is equivalent to the margin for LIBOR based loans as defined in the U.S. Agreement.
We pay a quarterly commitment fee of 0.20 percent to 0.25 percent on the preceding month's unused commitment. We may repay the revolving credit loans outstanding at any time without
penalty prior to the maturity date of August 2011. The Canadian Agreement provides up $30 million CAD in commitments by Bank of America (acting through its Canadian branch). The Canadian
Agreement is secured by a guaranty from certain U.S. affiliates.

At
July 31, 2007 and 2006, CAD $6.5 million and CAD $18.9 million, respectively, was outstanding under the Canadian Agreement. For the years ended July 31,
2007 and 2006, the weighted average effective interest rate was 5.74 percent and 5.49 percent, respectively. The applicable margin for BA based loans was 1.25 percent at
July 31, 2007 and 2006 and the applicable margin for Base Rate loans was zero percent at July 31, 2007 and 2006. We had approximately CAD $23.5 million and $11.1 million in
available borrowings at July 31, 2007 and 2006, respectively.

Interest
paid during fiscal years 2007, 2006 and 2005 was $19.2 million, $10.7 million and $6.6 million, respectively.

7. LEASES

We rent most of our retail space under leases that generally range from 5 to 10 years and may contain minimum rent escalations, while kiosk leases
generally range from three to five years. Our headquarters lease extends to 2018. We recognize the minimum rent payments on a straight-line basis over the term of the lease, including the
construction period. Contingent rentals paid to lessors of certain store facilities are determined principally on the basis of a percentage of sales in excess of contractual limits. All existing real
estate leases are treated as operating leases. Rent expense is included in SG&A.

Year Ended July 31,2007

2006

2005(amounts in thousands)Retail space:Minimum rentals

$
215,840

$
228,363

$
196,647Rentals based on sales


8,458


13,359


11,589224,298


241,722


208,236Equipment and corporate headquarters


3,732


3,576


1,773$
228,030

$
245,298

$
210,009


F-16

---



Future
minimum lease payments as of July 31, 2007, for all non-cancelable leases were as follows (in thousands):

Year Ended

Minimum Rent
Commitments2008

$
203,1802009


177,3922010


155,0042011


127,3582012


101,394Thereafter


299,148$
1,063,476


8. INCOME TAXES

Currently, we file a consolidated income tax return. The effective income tax rate varies from the federal statutory rate of 35 percent as follows
(in thousands):

Year Ended July 31,2007

2006

2005Federal income tax expense at statutory rate

$
29,456

$
24,483

$
59,527State income taxes, net of federal benefit


2,979


1,666


2,634APB 23 representation(1)


(8,496
)




Tax on repatriation of foreign items(2)





(6,762
)

Canadian rate changes(3)


438


(1,908
)

Foreign tax credits


(367
)

(1,400
)

Other


896


249


1,142$
24,906

$
16,328

$
63,303Effective income tax rate


29.6
%

23.3
%

37.2
%


---

F-17

---



The provision for income taxes consists of the following (in thousands):

Year Ended July 31,2007

2006

2005Current income tax expense:Federal

$
2,315

$
10,598

$
36,771Foreign


12,430


9,283


9,015State


2,579


3,535


4,524Total current income tax expense


17,324


23,416


50,310Deferred income tax expense:Federal


9,603


(3,550
)

14,154Foreign


(3,662
)

(2,178
)

(286
)State


1,641


(1,360
)

(875
)Total deferred income tax expense


7,582


(7,088
)

12,993$
24,906

$
16,328

$
63,303


As
of July 31, 2007, we have a tax net operating loss carryforward ("NOL") after limitations of $19.5 million which represents up to $6.8 million in
future tax benefits. The utilization of this asset is subject to limitations. The most restrictive is the Internal Revenue Code Section 382 annual limitation of $19.5 million. The NOL
carryforward can be utilized through fiscal year 2008.

Deferred
tax assets and liabilities are determined based on estimated future tax effects of the difference between the financial statement and tax basis of assets and liabilities using
enacted tax rates. Tax

F-18

---



effects
of temporary differences that give rise to significant components of the deferred tax assets and deferred tax liabilities at July 31, 2007 and 2006, respectively, are as follows (in
thousands):

Year Ended July 31,2007

2006Current deferred taxes:AssetsCustomer receivables

$
117

$
292Accrued liabilities


20,795


26,087Net operating loss carryforward


6,821


6,821Inventory reserves


16,298


20,738Other


1,502


1,377Current deferred tax assets


45,533


55,315LiabilitiesMerchandise inventories, principally due to LIFO reserve


(109,344
)

(107,431
)Accrued liabilities


(9,718
)

(9,831
)Current deferred tax liabilities, net

$
(73,529
)
$
(61,947
)Non-current deferred taxes:AssetsNet operating loss carryforward

$


$
7,176Postretirement benefits


2,794


875Accrued liabilities


18,480


15,416State and local taxes


7,413


8,420Investments


3,329


3,286Other


1,717


2,104Non-current deferred tax assets


33,733


37,277LiabilitiesProperty and equipment


(16,148
)

(20,020
)Undistributed Earnings


(39
)

(6,106
)Goodwill


(13,967
)

(12,408
)Other


(2,274
)

(2,511
)Non-current deferred tax assets (liabilities), net

$
1,305

$
(3,768
)


A
valuation allowance must be provided when it is more likely than not that the deferred income tax asset will not be realized. We believe that, as of July 31, 2007 and 2006, the
realization of our gross deferred income tax assets is more likely than not, and thus, there was no valuation reserve recorded.

No
provision has been made for income taxes which may become payable upon distribution of the Company's Canadian subsidiaries' earnings. It is not practicable to estimate the amount of
tax that
might be payable because management's intent is to permanently reinvest these earnings or to repatriate earnings when it is tax effective to do so.

Income
taxes paid, net of refunds, for fiscal years 2007, 2006 and 2005 were $13.1 million, $61.9 million and $31.1 million, respectively.

F-19

---



9. STOCK-BASED COMPENSATION

We currently provide grants of options to purchase our common stock, restricted stock, restricted stock units and performance-based restricted stock units under
the Zale Corporation 2003 Stock Incentive Plan and the Zale Corporation Outside Directors' 2005 Stock Incentive Plan (collectively, the "Plans"). We are authorized to issue up to 3.7 million
shares of our common stock to employees and non-employee directors under the Plans. Stock options and restricted share awards are issued as new shares of common stock. Stock-based
compensation expense is included in SG&A in the consolidated statements of operations and totaled $6.1 million, $6.4 million and $0.7 million for the fiscal years ended
July 31, 2007, 2006 and 2005, respectively. As of July 31, 2007, there was $11.4 million of unrecognized compensation cost related to stock-based awards that is expected to be
recognized over a weighted-average period of 2.5 years. The income tax benefit recognized in the consolidated statements of operations related to stock-based compensation totaled
$1.8 million, $1.3 million and $0.3 during fiscal 2007, 2006 and 2005, respectively.

Stock Options.Stock options are granted at an exercise price equal to the market value of the shares of our common stock at
the date of grant, generally vest ratably over a four-year vesting period and generally expire ten years from the date of grant. Expense related to stock options is recognized using a
graded-vesting schedule over the vesting period.

Stock
option transactions during fiscal year 2007 are summarized as follows:

Number of
Options

Weighted Average
Exercise Price

Weighted Average
Remaining
Contractual Life
(Years)

Aggregate
Intrinsic ValueOutstanding, beginning of year

3,121,742

$
23.81Granted

714,700


27.51Exercised

892,880


19.91Forfeited

221,007


26.49Outstanding, end of year

2,722,555

$
25.82

7.59

$
1,000,335Options exercisable, end of year

1,425,116

$
23.97

6.35

$
1,793,703


For
the years ended July 31, 2007, 2006 and 2005, the total intrinsic value of stock options exercised was $7.0 million, $4.7 million and $10.5 million,
respectively. The weighted average fair values of option grants were $9.56, $9.37 and $10.74 during fiscal years 2007, 2006 and 2005, respectively. The fair value of stock options that vested during
fiscal year 2007, 2006 and 2005 was $4.0 million, $7.2 million and $6.9 million, respectively.

The
fair value of each stock option grant is estimated on the date of grant using the Black-Scholes option pricing model. The following table presents the weighted-average assumptions
used in the option pricing model for stock option grants in fiscal years 2007, 2006 and 2005:

2007

2006

2005Expected volatility

29.1
%
33.2
%
37.8
%Risk-free interest rate

4.8
%
4.3
%
3.7
%Expected lives in years

5.0

5.0

5.0Dividend yield

0.0
%
0.0
%
0.0
%


Expected
volatility and the expected life of the stock options are based on historical experience. The risk-free rate is based on the yield of a five-year
Treasury Note.

F-20

---



Restricted Share Awards.Restricted share awards consist of restricted stock, restricted stock units and performance-based
restricted stock units. Restricted stock and restricted stock units granted to employees generally vest on the third anniversary of the grant date and are subject to restrictions on sale or transfer.
Restricted stock granted to non-employee directors vest on the first anniversary of the grant date and are subject to restrictions on sale or transfer. The fair value of restricted stock
and restricted stock units is based on our stock price on the date of grant. Performance-based restricted stock units entitle the holder to receive a specified number of shares of our common stock
based on our achievement of performance targets established by the Compensation Committee. If we fail to meet the specified performance targets, the holder will not receive any shares of common stock,
or, if we substantially exceed the targets, the holder may receive up to two hundred percent of the performance-based restricted stock units granted. At the sole discretion of the Compensation
Committee, the holder of a restricted stock unit or performance-based restricted stock
unit may receive a cash payment in lieu of a payout of shares of common stock equal to the fair market value of the number of shares of common stock the holder otherwise would have received.

Restricted
share award transactions during fiscal year 2007 are summarized as follows:

Number of
Restricted
Share Awards

Weighted
Average
Fair Value
Per AwardRestricted share awards, beginning of year

155,000

$
24.18Granted

89,641


27.64Vested

(29,141
)

26.57Forfeited

(26,000
)

27.32Restricted share awards, end of year

189,500

$
26.52


10. COMPREHENSIVE INCOME

Comprehensive income represents the change in equity during a period from transactions and other events, except those resulting from investments by and
distributions to stockholders. Income taxes are generally not provided for foreign currency translation adjustments, as such adjustments relate to permanent investments in international subsidiaries.

F-21

---



The
following table gives further detail regarding changes in the composition of accumulated other comprehensive income (in thousands):

|                                  |  | Cumulative translation adjustment |        | Unrealized gain (loss) on securities |   | Unrealized loss on derivatives |   | Total accumulated other comprehensive income |     
|--------------------------------- |  | --------------------------------- | ------ | ------------------------------------ | - | ------------------------------ | - | -------------------------------------------- | ----
|Balance at July 31, 2004          |  | $                                 | 12,873 |                                      | $ | 629                            |   | $                                            | (32 
|Cumulative translation adjustment |  |                                   | 11,461 |                                      |   |                               |   |                                              |    
|Unrealized loss on securities     |  |                                   |       |                                      |   | (874                           | ) |                                              |    
|Unrealized loss on derivatives    |  |                                   |       |                                      |   |                               |   |                                              | (789
|Reclassification to earnings      |  |                                   |       |                                      |   | 400                            |   |                                              | 451 
|                                  |  |                                   |        |                                      |   |                                |   |                                              |     
|Balance at July 31, 2005          |  |                                   | 24,334 |                                      |   | 155                            |   |                                              | (370
|Cumulative translation adjustment |  |                                   | 9,509  |                                      |   |                               |   |                                              |    
|Unrealized loss on securities     |  |                                   |       |                                      |   | (525                           | ) |                                              |    
|Reclassification to earnings      |  |                                   |       |                                      |   | 91                             |   |                                              | 370 
|                                  |  |                                   |        |                                      |   |                                |   |                                              |     
|Balance at July 31, 2006          |  |                                   | 33,843 |                                      |   | (279                           | ) |                                              |    
|Cumulative translation adjustment |  |                                   | 12,535 |                                      |   |                               |   |                                              |    
|Unrealized loss on securities     |  |                                   |       |                                      |   | (390                           | ) |                                              |    
|Reclassification to earnings      |  |                                   |       |                                      |   | 230                            |   |                                              |    
|                                  |  |                                   |        |                                      |   |                                |   |                                              |     
|Balance at July 31, 2007          |  | $                                 | 46,378 |                                      | $ | (439                           | ) | $                                            |    
|                                  |  |                                   |        |                                      |   |                                |   |                                              |     

11. SEGMENTS

We report our operations under three business segments: Fine Jewelry, Kiosk Jewelry, and All Other. All corresponding items of segment information in prior
periods have been presented consistently.

The
Fine Jewelry segment consists of six principal brands, which sell diamonds, gemstone, gold jewelry and watches. These six brands have been aggregated into one reportable segment. The
Kiosk Jewelry segment operates primarily under the brand names Piercing Pagoda®, Plumb Gold, and Silver and Gold Connection® through mall-based kiosks
and reaches the opening price point select jewelry customer. The Kiosk Jewelry segment specializes in gold and silver products that capitalize on the latest fashion trends. The All Other segment
includes credit insurance operations, which provide offerings of insurance coverage primarily to our private label credit card customers. Management's expectation is that overall economics of each of
our major concepts within each reportable segment will be similar over time.

The
reportable segments are groups of brands that offer merchandise with similar commodity characteristics and merchandise mix. Segment revenues are not provided by product type or
geographically as we believe such disclosure would not add meaningful value and is not consistent with the manner in which we make decisions.

We
use earnings before unallocated corporate overhead, interest and taxes but include an internal charge for inventory carrying cost to evaluate segment profitability. Unallocated costs
before income taxes include corporate employee related costs, administrative costs, information technology costs, corporate facilities and depreciation expense.

F-22

---



Income tax information by segment has not been included as taxes are calculated at a company-wide level and not allocated to each segment.

Year Ended July 31,Selected Financial Data by Segment2007

2006

2005(amounts in thousands)Revenues:Fine Jewelry(a)

$
2,160,870

$
2,149,217

$
2,089,261Kiosk(b)


262,627


276,619


280,897All Other


13,578


13,141


12,908Total revenues

$
2,437,075

$
2,438,977

$
2,383,066Depreciation and amortization:Fine Jewelry

$
45,224

$
43,273

$
44,410Kiosk


5,625


5,571


4,708All Other








Unallocated


11,038


10,927


10,722Total depreciation and amortization

$
61,887

$
59,771

$
59,840Operating earnings (loss):Fine Jewelry

$
109,110

$
108,082

$
147,414Kiosk


6,646


20,402


29,030All Other


6,780


6,443


6,824Unallocated(c)


(19,409
)

(53,792
)

(5,465
)Total operating earnings

$
103,127

$
81,135

$
177,803Assets(d):Fine Jewelry(e)

$
1,256,501

$
1,119,679

$
1,103,142Kiosk(f)


125,148


124,415


117,125All Other


49,099


39,261


35,670Unallocated


183,198


179,213


124,963Total assets

$
1,613,946

$
1,462,568

$
1,380,900Capital expenditures:Fine Jewelry

$
54,619

$
54,942

$
59,587Kiosk


3,036


7,750


8,650All Other








Unallocated


28,791


20,026


14,887Total capital expenditures

$
86,446

$
82,718

$
83,124


---

F-23

---



12. CONTINGENCIES

We are named as a defendant in two lawsuits arising, in general, from matters that were the subject of a Securities and Exchange Commission investigation that was
terminated, as we announced on September 24, 2006, with no enforcement action being recommended:In re Zale Corporation Securities LitigationNo. 3:06-CV-01470-K, filed January 29, 2007, U.S. District Court for the Northern District of Texas; andSalvato v. Zale
Corp.,No. 3:06-CV-1124 (SAF), filed March 5, 2007, U.S. District Court for the Northern District of Texas, originally filed
June 26, 2006 and consolidated withConnell v. Zale Corp.,originally filed August 7, 2006, U.S. District Court for the Southern District
of New York and transferred to the U.S. District Court for the Northern District of Texas. These lawsuits are the product of the consolidation of six lawsuits that were initially filed in New York and
Texas. Various current and former officers and directors also are defendants.

Both
lawsuits are purported class actions. InIn re Zale Corporation Securities Litigation,the plaintiffs allege various violations of
securities laws based upon our public disclosures. InSalvato,the plaintiffs allege various violations of the Employee Retirement Income Security Act
of 1974 based upon the investment by the Zale Corporation Savings and Investment Plan in Company stock.

On
September 19, 2007, the parties inIn re Zale Corporation Securities Litigationjointly notified the court that they have
reached a settlement in principle on the plaintiffs' claims. On September 24, 2007, counsel for the parties inSalvatonotified the court that
they have reached a settlement in principle on
the plaintiffs' claims, subject to approval by their clients. In each case, the proposed settlement involves payment to the plaintiffs of an amount that is within the limits of the applicable
insurance policy and that will be paid by the Company's insurance carrier. Both agreements in principle are subject to negotiation of formal settlement documents and court approval. There can be no
assurance at this time that the proposed settlements will be completed or approved. If the proposed settlements are not completed and approved, we will continue to vigorously contest the cases. We do
not believe that the cases will ultimately have a material effect on the Company.

In
June 2007, we agreed to settle a California wage and hour dispute that was filed against us in Sacramento County Superior Court as a purported class action by certain current
and former employees. The settlement totals $3.8 million and requires us to make payments on a claims-made basis, subject to a minimum payout. The settlement is subject to court
approval. As a result of the settlement, we recorded an additional charge of $1.5 million in SG&A during fiscal year 2007.

We
are involved in a number of other legal and governmental proceedings as part of the normal course of our business. Reserves have been established based on management's best estimates
of our potential liability in these matters. These estimates have been developed in consultation with internal and external counsel and are based on a combination of litigation and settlement
strategies. Management believes that such litigation and claims will be resolved without material effect on our financial position or results of operations.

F-24

---



13. GUARANTEES

Credit Programs.Citibank U.S.A., N.A. ("Citi"), a subsidiary of CitiGroup, provides financing to our
customers through our private label credit card program in exchange for payment by us of a merchant fee (subject to periodic adjustment) based on a percentage of each credit card sale. The receivables
established through the issuance of credit by Citi are originated and owned by Citi. Losses related to a "standard credit account" (an account within the credit limit approved under the original
merchant agreement between us and Citi) are assumed entirely by Citi without recourse to us, except where a Company employee violates the credit procedures agreed to in the merchant agreement.

In
an effort to better service customers, we and Citi developed a program that extends credit to qualifying customers above the approved credit amount (the "Shared Risk Program"). The
extension of
incremental credit is at our discretion to accommodate larger sales transactions. We bear the responsibility of customer default losses related to the Shared Risk Program, as defined in the agreement
with Citi.

Under
the Shared Risk Program, we incurred approximately $205,000 in losses for fiscal year 2007 compared to losses of $107,000 for the previous fiscal year. We believe that future
losses will not have a material impact on our financial position or results of operations.

Product Warranty Programs.We offer our customers two-year and lifetime warranties that
cover sizing and breakage on certain products and a diamond commitment program ("DCP") that offers a traditional warranty to cover sizing, breakage and theft replacement for a 12-month
period. The revenue from the lifetime warranty and DCP is recognized on a straight-line basis over a five-year and 12-month period, respectively. The revenue from
the two-year warranty is recognized over the service period at the rates the related costs have historically been incurred in performing the services covered under the agreements.

The
change in deferred revenue associated with the sale of warranties is as follows (in thousands):

Year Ended July 31,2007

2006

2005Deferred revenue, beginning of period

$
28,136

$
24,616

$
28,146Warranties sold


110,705


77,586


59,415Revenue recognized


(48,209
)

(74,066
)

(62,945
)Deferred revenue, end of period

$
90,632

$
28,136

$
24,616


14. BENEFIT AND RETIREMENT PLANS

We maintain the Zale Corporation Savings & Investment Plan (the "Investment Plan"). As amended and restated in fiscal year 2006, it allows all employees
who are at least age 21 to participate in the Investment Plan, although new employees are required to complete one year of continuous service with us to be eligible to participate. Each employee can
contribute from one percent to 60 percent of his or her annual salary subject to IRS limitations, (30 percent for highly-compensated employees). Employees who have not otherwise elected
will be automatically enrolled in the Investment Plan at a contribution rate of two percent upon satisfying all eligibility requirements. Through February 2002, we matched one dollar in common
stock for every dollar an employee contributes to the plan up to four percent of annual compensation, subject to Internal Revenue Service ("IRS") limitations. Effective March 1, 2002, we match
$0.50 in common stock or cash for every dollar an employee contributes to the plan up to four percent of annual compensation subject to IRS limitations. Matching contributions are made on an annual
basis, and employees must be employed with us on the last day of the plan year to receive our matching contributions. Employees vest in our matched contributions immediately. Our provisions for
matching contributions were $2.9 million, $2.1 million and $2.1 million for fiscal years 2007, 2006 and 2005, respectively.

F-25

---



Prior
to March 2006, we provided medical, dental and vision insurance benefits for all eligible retirees and spouses who retired prior to April 1, 2002 with benefits for
spouses continuing after the death of the retiree. Effective March 31, 2006, we terminated the plan and recognized a benefit of $13.4 million. The net periodic benefit including interest
costs and amortization of prior gains totaled $13.7 million and $0.4 million for the years ended July 31, 2006 and 2005, respectively. In addition, all accrued balances and
obligations associated with the plan were eliminated as a result of the termination.

15. QUARTERLY RESULTS OF OPERATIONS (UNAUDITED)

Unaudited quarterly results of operations for the fiscal years ended July 31, 2007 and 2006 were as follows (in thousands, except per share data):

Fiscal Year 2007
For the Three Months EndedJuly 31, 2007

April 30, 2007

January 31, 2007

October 31, 2006Revenues

$
488,226

$
511,866

$
1,004,495

$
432,488Cost of sales


234,051


250,935


495,151


207,464Net earnings (loss)


1,537


(3,950
)

88,060


(26,395
)Net earnings (loss) per diluted share


0.03


(0.08
)

1.80


(0.55
)


Fiscal Year 2006
For the Three Months EndedJuly 31, 2006

April 30, 2006

January 31, 2006

October 31, 2005Revenues

$
490,695

$
526,895

$
993,749

$
427,639Cost of sales


257,370


254,361


495,094


208,812Net (loss) earnings


(27,362
)

16,831


87,815


(23,661
)Net (loss) earnings per diluted share


(0.57
)

0.35


1.78


(0.47
)


16. SUBSEQUENT EVENT

In September 2007, the Company entered into a letter of intent to sell its Bailey Banks & Biddle brand. The decision to sell the brand was a result of our
strategy to focus on our moderately priced business and our continued focus on maximizing return on investments. The net assets to be sold as of July 31, 2007 totaled approximately
$193 million and consist primarily of inventory of approximately $173 million. The brand is included in our Fine Jewelry segment and generated revenues of $284 million during
fiscal 2007. The sale is expected to be completed during the first quarter of fiscal 2008 at an estimated pre-tax loss of up to $5 million, including selling costs.

F-26

---



SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its
behalf by the undersigned, thereunto duly authorized, as of the 1st day of October, 2007.

| |  | ZALE CORPORATION
| |  | ----------------
| |  | By:             

KNOW
ALL MEN BY THESE PRESENTS, that each person whose signature appears below constitutes and appoints Mary E. Burton and Rodney Carter, and each of them, as his or her true and lawful
attorneys-in-fact and agents, with full powers and substitution and resubstitution for him or her, in his or her name place and stead, in any and all capacities, to sign any
and all amendments to this Annual Report on Form 10-K, and to file the same, with all exhibits thereto, and other documents in connection therewith, with the Securities and Exchange
Commission, granting unto said attorneys-in-fact and agents full power and authority to do perform each and every act and thing requisite and necessary to be done in and about
the premises as fully and to all intents and purposes as he or she might or could do in person, hereby ratifying and confirming all that said attorneys-in-fact and agents may
lawfully do or cause to be done by virtue hereof.

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

|Signature                             |  | Title                                                                                                                              |  | Date           
|------------------------------------- |  | ---------------------------------------------------------------------------------------------------------------------------------- |  | ---------------
|                                      |  |                                                                                                                                    |  |                
|/s/MARY E. BURTONMary E. Burton       |  | President, Chief Executive Officer (principal executive officer of the registrant)                                                 |  | October 1, 2007
|/s/RODNEY CARTERRodney Carter         |  | Executive Vice President, Chief Administrative Officer and Chief Financial Officer (principal financial officer of the registrant) |  | October 1, 2007
|/s/CYNTHIA T. GORDONCynthia T. Gordon |  | Senior Vice President, Controller (principal accounting officer of the registrant)                                                 |  | October 1, 2007
|/s/JOHN B. LOWE, JR.John B. Lowe, Jr. |  | Chairman of the Board                                                                                                              |  | October 1, 2007
|/s/J. GLEN ADAMSJ. Glen Adams         |  | Director                                                                                                                           |  | October 1, 2007
|                                      |  |                                                                                                                                    |  |                

---



|/s/RICHARD C. MARCUSRichard C. Marcus           |  | Director |  | October 1, 2007
|----------------------------------------------- |  | -------- |  | ---------------
|/s/THOMAS C. SHULLThomas C. Shull               |  | Director |  | October 1, 2007
|/s/DAVID M. SZYMANSKIDavid M. Szymanski         |  | Director |  | October 1, 2007
|/s/GEORGE R. MIHALKO, JR.George R. Mihalko, Jr. |  | Director |  | October 1, 2007
|/s/CHARLES M. SONSTEBYCharles M. Sonsteby       |  | Director |  | October 1, 2007

---



|Exhibit
Number |  | Description of Exhibit                                 
|-------------- |  | -------------------------------------------------------
|10.18          |  | Base Salaries of Named Executive Officers              
|10.20          |  | Form of Employment Security Agreement                  
|21             |  | Subsidiaries of the Registrant                         
|23.1           |  | Consent of KPMG LLP                                    
|31.1           |  | Rule 13a-14(a) Certification of Chief Executive Officer
|31.2           |  | Rule 13a-14(a) Certification of Chief Financial Officer
|32.1           |  | Section 1350 Certification of Chief Executive Officer  
|32.2           |  | Section 1350 Certification of Chief Financial Officer  

The
above list reflects all exhibits filed herewith. See Item 15 for a complete list of our exhibits, including exhibits incorporated by reference from previous filings.

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