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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

Form 10-K

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

For the fiscal year ended July 31, 2001
OR
[   ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from  to

Commission file no. 1-04129

Zale Corporation
(Exact name of registrant as specified in its charter)

|                                                                               |  |                                                
|------------------------------------------------------------------------------ |  | -----------------------------------------------
|Delaware
(State or other jurisdiction of
incorporation or organization)        |  | 75-0675400
(I.R.S. Employer
Identification No.)
|                                                                               |  |                                                
|901 W. Walnut Hill Lane
Irving, Texas
(Address of principal executive offices) |  | 75038-1003
(Zip code)                          

Registrants telephone number, including area code: (972) 580-4000

Securities registered pursuant to Section 12(b) of the Act:

|                                       |  |                                          
|-------------------------------------- |  | -----------------------------------------
|Title of each class                    |  | Name of each exchange
on which registered
|                                       |  |                                          
|Common Stock, $.01 par value per share |  | New York Stock Exchange                  

Securities registered pursuant to Section 12(g) of the Act:
None

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

Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to
the best of registrants knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [X]

As of September 5, 2001 the aggregate market value of the registrants
voting stock held by non-affiliates of the registrant was approximately
$1,131,382,176.

As of September 5, 2001, the registrant had outstanding 34,825,378 shares of
its common stock, $.01 par value per share.

DOCUMENTS INCORPORATED BY REFERENCE.

Part III of this report incorporates information from the registrants
definitive Proxy Statement relating to the registrants annual meeting of
stockholders to be held on November 2, 2001.



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TABLE OF CONTENTS



|                                                 |                                                                                               |  |  |  |  |  |  | 
|------------------------------------------------ | --------------------------------------------------------------------------------------------- |  |  |  |  |  |  | 
|PART I                                          
|                                                 | ITEM 1. BUSINESS                                                                             
|                                                 | ITEM 2. PRINCIPAL PROPERTIES                                                                 
|                                                 | ITEM 3. LEGAL PROCEEDINGS                                                                    
|                                                 | ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS                                  
|PART II                                         
|                                                 | ITEM 5. MARKET FOR THE REGISTRANTS COMMON EQUITY AND RELATED STOCKHOLDERS EQUITY           
|                                                 | ITEM 6. SELECTED FINANCIAL DATA                                                              
|                                                 | ITEM 7. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
|                                                 | ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK                          
|                                                 | ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA                                          
|                                                 | ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE 
|PART III                                        
|                                                 | ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS                                                    
|                                                 | ITEM 11. EXECUTIVE COMPENSATION                                                              
|                                                 | ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT                      
|                                                 | ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.                                     
|PART IV                                         
|                                                 | ITEM 14. EXHIBITS, FINANCIAL STATEMENTS SCHEDULES AND REPORTS ON FORM 8-K                    
|SIGNATURES                                      
|Amended and Restated Omnibus Stock Option Plan  
|Outside Directors 1995 Stock Option Plan        
|EX-10.11D Employement Agreement-Robert DiNicola 
|EX-10.13 Employment Agreement-Alan Shor         
|EX-10.14 Employment Agreement-Mary Forte        
|EX-10.15 Employment Agreement-Sue Gove          
|EX-10.21 Amendment to Real Estate Lien Note     
|EX-10.22 Amendment/Extension to Real Estate Note
|EX-21 Subsidiaries of the Registrant            
|EX-23 Consent of Independent Public Accountants 



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PART I




ITEM 1. BUSINESS

General

Zale Corporation and its wholly owned subsidiaries (the Company) is the
largest specialty retailer of fine jewelry in North America. At July 31, 2001,
the Company operated 2,344 specialty retail jewelry stores and kiosks located
primarily in shopping malls throughout the United States, Canada and Puerto
Rico. The Company principally operates under six brand names: Zales Jewelers®,
Zales the Diamond Store Outlet®, Gordons Jewelers®, Bailey Banks & Biddle Fine
Jewelers®, Peoples Jewellers®, and Piercing Pagoda®. Zales Jewelers provides
traditional, moderately priced jewelry to a broad range of customers. Zales
the Diamond Store Outlet® focuses on the brand conscious, value oriented
shopper, offering discounts off retail prices everyday in outlet malls.
Gordons Jewelers offers contemporary merchandise designed to attract slightly
higher purchases. Bailey Banks & Biddle Fine Jewelers operates upscale jewelry
stores which are considered among the finest jewelry stores in their markets.
Peoples Jewellers offers traditional moderately priced jewelry to customers
across Canada. With the acquisition of Piercing Pagoda, Inc. in September
2000, the Company broadened its market base to include the opening price point
customer, principally through kiosks throughout the United States and Puerto
Rico. During the fiscal year ended July 31, 2001, the Company generated $2.1
billion of net sales.

The Company believes it is well-positioned to compete in the approximately
$40 billion, highly fragmented retail jewelry industry, leveraging its
established brand names, economies of scale and geographic and demographic
diversity. The Company enjoys significant brand name recognition as a result of
its long-standing presence in the industry and its national and regional
advertising campaigns. The Company believes that name recognition is an
important advantage in jewelry retailing as products are generally unbranded
and consumers must trust in a retailers reliability and credibility. In
addition, as the largest specialty retailer of fine jewelry in North America,
the Company believes it realizes economies of scale in purchasing and
distribution, real estate, advertising and administrative costs. The Company
also believes that the geographic diversity of its retail distribution network
through all 50 states, Puerto Rico and Canada and the demographic breadth of
its target customer groups may serve to mitigate earnings volatility typically
associated with local or regional conditions.

The Company is incorporated in Delaware. Its principal executive offices
are located at 901 W. Walnut Hill Lane, Irving, Texas 75038-1003, its telephone
number at that address is (972) 580-4000, and its internet address is
www.zalecorp.com.

Business Initiatives and Strategy

During the second half of fiscal year 2001, the Company focused on
repositioning its business in a declining external environment. Management
plans to continue the rebuilding in fiscal year 2002.

The Company relies on the disciplined merchandising and marketing
strategies it has developed and implemented in order to promote its brand
identities. Beginning in the spring of fiscal 2001 and looking into the next
year, the Company has refocused on clearly differentiating its brands to target
specific customers, and addressing the quality of its merchandise. This effort
should continue to differentiate the target customer segments that have been
emphasized for Zales, Zales Outlet, Gordons, Bailey Banks & Biddle, Peoples,
and Piercing Pagoda. Product assortments capitalize on year round gift giving,
fashion and special occasions, and there is a renewed focus on the bridal
category.

Management has developed a key item strategy as the foundation for
merchandising and marketing initiatives. Items have been identified from among
the best selling products in the retail jewelry industry, such as diamond
solitaires, diamond stud earrings, certain semi-precious stones, exclusive
signature diamonds for each of the brands, certified diamonds, white metals,
such as platinum and white gold, and the three stone anniversary band.
Certified diamonds are sold with an independent evaluation as to the cut,
clarity, color and carat weight. The Company has worked to ensure that these
key items are available in a variety of styles and sizes to offer a range of
competitive price points. At the same time, the Companys goal is to execute an
aggressive approach to inventory management to keep key items in stock and
inventories current. This goal is achieved through using a merchandise system
which
provides regular reporting to the Companys merchandise buyers on in-stock
and slow-moving merchandise. The





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Company employs a consistent methodology
which provides inventory turnover and profitability information to identify
slow-moving merchandise and take appropriate merchandising actions on a timely
basis. In fiscal 2001, the Company conducted a strategic review of inventories
to determine the quality of its diamond inventory as well as its level of
promotional quality merchandise. As a result of that review, the Company
recorded a non-recurring charge in cost of sales of $25.2 million to adjust the
valuation of inventory not of a quality consistent with the strategic direction
for the Companys brands.

The Companys marketing efforts are designed to enhance brand identity
through product and event-focused promotional activities. The Company features
selected key items at various price points through its advertising on
television and radio and in nationally distributed newspapers and magazines,
local newspaper inserts, and direct mail. The Companys marketing efforts
extend beyond the Christmas season to tie in with other gift-giving holidays,
such as Valentines Day and Mothers Day. Over the past year, the Company has
included continuous year round advertising campaigns, such as the Today show
television campaign, to enhance brand awareness. For the past two years, the
Company has taken steps to enhance brand awareness through special marketing
efforts such as supporting the Rockefeller Center Christmas Tree Lighting, a
sponsorship which the Company plans to continue in fiscal 2002. In addition,
the Company launched special programs, such as the spring introduction of the
signature Zales Diamond, a patented 82 faceted diamond exclusive to Zales.
In addition, advertising and in-store promotions are synchronized with mall
marketing efforts to take advantage of other periods of high mall traffic, such
as Labor Day, which are typically not considered jewelry-oriented holidays. In
early fiscal year 2001, the Company ran a campaign promoting a mix of
promotional and gift items such as the holiday box. Also, the Company currently
has over 19 million customer names available to direct promotional material in
its target marketing programs. The current advertising strategy is focused on
raising the amount of the average sale in the anticipation of fewer
transactions in a slower economy and on placing a significant emphasis on the
wedding categories in store marketing, taking advantage of that stronger,
seasonless category. The Companys business strategy as a whole has been
restructured to attain more appropriate returns on investment, with a special
focus on the marketing efforts.

The Company implemented a buyer training program to develop and train new
buyers on merchandise and Company standards. The Company also has centralized
purchasing for each brand to ensure consistency of quality and cost. In
addition, the Company leverages its size to achieve better prices, payment
terms, return privileges and cooperative advertising arrangements with product
suppliers.

The Company believes it has enhanced its image as a provider of fine
jewelry at competitive prices by establishing price points for merchandise that
should be perceived by customers as good values. Certain items are labeled
Brilliant Buys, Premier Values and Baileys Classic Values in Zales and
Peoples, Gordons and Bailey Banks & Biddle stores, respectively. These items,
along with their prices, are prominently displayed throughout the store, a
practice uncommon in the U.S. jewelry retailing industry, and one that the
Company believes enhances its reputation for pricing integrity. Also, the
Company carries items whose designs are exclusive to the Company. The
introduction of certified diamonds and signature diamonds, such as the
Zales Diamond, and Gordons Ariella Diamond in each division adds
credibility and further enhance the Companys brands.

The Companys strategy is to continue to increase store productivity and
profitability by: (i) focusing on the core category of bridal, while
maintaining a presence in the fashion and watch categories; (ii) using key item
merchandise to drive volume; (iii) slowing remodeling and renovation activity
to target key stores that should provide a better return on investment; (iv)
enhancing merchandising systems to assist buyer decision making; (v) executing
tailored staffing and training programs for store personnel; (vi) refocusing
advertising on brand recognition and product distinction to address individual
customer segments; (vii) providing exclusive products to develop brand
distinction; (viii) focusing more on improving quality of all merchandise and
increasing the average sale amounts, rather than emphasizing the volume of
promotional merchandise and; (ix) reducing the volume and visibility of
clearance merchandise to an appropriate level.

The Company plans to open approximately 60 new locations, principally
under the brand names Zales, Zales Outlet, Peoples Jewellers, and Piercing
Pagoda for which it will incur approximately $13 million in capital
expenditures during the fiscal year 2002. The Company is attempting to identify
strategic locations where the Company is underrepresented to solidify the
Companys core mall business, and expand into new outlet malls. The
Company targets premier regional mall locations throughout the country and
selects sites based on a variety of well-defined demographic and store
profitability characteristics. The Company has identified the specific malls
for this
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planned expansion which satisfy the Companys real estate strategy.
The Company also plans to refurbish, remodel or relocate approximately 180
stores and kiosks at a cost of approximately $21 million during fiscal year
2002. As a result of current business conditions, the Company has slowed store
growth and postponed both the rollout of the new store development program in
the New York City metropolitan area and the construction of a new distribution
center.

For the next year, the Company is refocused on an effort to reduce
selling, general and administrative expenses where appropriate by streamlining
processes and leveraging technology where possible. Initiatives include: (i)
streamlining corporate operations through review and improvement of current
processes and application of new technology in areas such as merchandising and
financial systems and (ii) managing advertising expense for a better return on
investment.

Current Year Events

Stock Repurchase Plan.On August 7, 2001, the Company announced that its
Board of Directors had approved a stock repurchase program pursuant to which
the Company, from time to time and at managements discretion, may purchase
throughout the fiscal year, up to an aggregate of $50 million of Zale common
stock on the open market. This action represents the Companys fifth
consecutive fiscal year of commitment to a repurchase program.

In July 2001, the Company completed its fiscal year 2001 stock repurchase
program, which was authorized in July 2000. Under this $50 million program,
the Company repurchased 1.3 million shares at an aggregate cost of $38.7
million in fiscal 2001.

Sale of Private Label Credit Card Business.Effective July 31, 2000, the
Company sold its private label credit card operations and its outstanding
accounts receivable, without recourse, to Associates Credit Card Services, Inc.
(Associates), a Delaware corporation, and wholly owned subsidiary of
Associates First Capital Corporation (AFCC). The total purchase price for the
accounts receivable was approximately $542 million. With a portion of the
proceeds from such sale, the Company paid off all of its credit card related
indebtedness and the Companys receivables securitization facility was
terminated.

In connection with the sale of its customer receivables, the Company
entered into a ten-year merchant services agreement whereby Hurley State Bank
(Hurley), a wholly owned subsidiary of AFCC, issues private label credit
cards branded with appropriate Company trademarks and provides financing for
the Companys customers to purchase merchandise in exchange for payment by the
Company of a merchant fee based upon a percentage of each credit card sale.
The merchant fee is a flat percentage per credit sale for standard revolving
accounts and varies for certain special interest-free or deferred payment
credit sales, depending on the credit program. The Company received a $41.8
million incentive for entering into the agreement. Portions of this payment
are subject to refund for early termination of the agreement. This incentive
payment will be recognized ratably over the term of the agreement.

In connection with the sale of its customer receivables, the Company
agreed pursuant to an Agreement and Plan of Merger, dated as of July 10, 2000,
to merge Jewelers National Bank (JNB), a wholly owned subsidiary of the
Company, with and into Hurley. The closing of the transactions contemplated
under the Agreement and Plan of Merger took place on March 8, 2001. Prior to
the merger of JNB and Hurley, the Company sold without recourse its credit card
receivables to Associates on a daily basis pursuant to an interim purchase and
servicing arrangement. Following consummation of the merger, AFCC and its
affiliates assumed responsibility for JNBs previously owned credit operations.

As a result of the sale of the Companys customer receivables to AFCC and
the merger, the Companys previous credit processing service agreement with a
third party servicer was terminated upon conversion to AFCCs systems.

Acquisition of Piercing Pagoda, Inc.On September 20, 2000, the Company
completed the acquisition of Piercing Pagoda, Inc. (Piercing Pagoda), the
largest retailer of gold jewelry through kiosk stores in the United
States, for approximately $203 million, plus approximately $45 million to
pay down existing debt and the assumption of certain bank debt and liabilities.

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The excess of the purchase price over the fair value of the net assets
acquired, approximately $155 million, is classified as goodwill, and is being
amortized on a straight line basis over twenty years. However, the Company will
adopt Statement of Financial Accounting Standards No. 142 Goodwill and Other
Intangible Assets in the first quarter of fiscal year 2002. As a result,
goodwill related to the Companys acquisitions will no longer be amortized, and
instead will be reviewed for impairment. Assets acquired and liabilities
assumed have been recorded at their estimated fair values and are subject to
adjustment when additional information concerning the alignment of operations
is finalized. These adjustments will relate to the cost of relocating the
Piercing Pagoda head office functions to Dallas. The Company believes these
adjustments will be immaterial to the financial statements.

The acquisition described above was accounted for by the purchase method
of accounting for business combinations. Accordingly, the accompanying
Consolidated Statements of Operations do not include any revenues or expenses
related to Piercing Pagoda prior to September 20, 2000. The entire cost of the
acquisition was funded through the Companys available cash and from working
capital.

Executive Transactions.Effective September 6, 2000, Robert J. DiNicola
retired as Chairman of the Board but remained as a non-employee member of the
Board. In connection with his severance arrangement, the Company agreed to pay
certain benefits of approximately $1.9 million consisting principally of an
amount equivalent to one year of salary and bonus and other severance related
benefits including the accelerated vesting of certain options held by Mr.
DiNicola. Additionally, the Board approved the provision to Mr. DiNicola by
the Company of a full recourse, $2.2 million interest-bearing loan at 8.74
percent for the sole purpose of exercising 125,000 stock options prior to their
expiration. The Company also extended the exercise period on an additional
500,000 stock options set to expire on September 6, 2002 to the earlier of the
original 10 year term (to expire July 9, 2007), the maximum term pursuant to
the Companys stock option plan, or two years after Mr. DiNicola leaves the
Board of Directors. Based on the intrinsic value of these stock options on the
modification date, no compensation charge was recorded by the Company.

Effective February 12, 2001, Beryl B. Raff resigned from the Company as
Chairman of the Board and Chief Executive Officer. In connection with her
resignation, the Company agreed to pay certain benefits of approximately $2.5
million consisting principally of an amount equivalent to three years of salary
and other severance related benefits including accelerated vesting of certain
options and restricted stock.

Robert J. DiNicola was re-appointed as Chairman of the Board and Chief
Executive Officer, effective February 21, 2001, under a three year contract
with terms substantially consistent with his previous contract when he held the
same position. In August 2001, the Company entered into a five year employment
agreement with Mr. DiNicola effective upon Mr. DiNicolas reelection as
Chairman of the Board and Chief Executive Officer, replacing the earlier
employment agreement. In April 2001, the Company extended a $2.1 million,
three year interest bearing loan at 7.25 percent to Mr. DiNicola for the
purpose of purchasing a home. In August 2001, the loan was modified and
extended with the entire principal amount to be repaid in August 2006.

Non-recurring Charge.Upon the return of Robert J. DiNicola as Chairman
and Chief Executive Officer, the Company performed an in depth merchandising
review to determine the inventory that was not of a quality consistent with the
strategic direction of the Companys brands. As a result of that review, the
Company recorded a non-recurring charge in Cost of Sales of $25.2 million to
adjust the valuation of such inventory and provide for markdowns to liquidate
or sell-through the inventory.

Industry

The U.S. retail jewelry industrys sales were approximately $40 billion in
2000. Specialty jewelry stores (such as the Company) account for over half of
the industry, according to publicly available data. Historically, retail
jewelry store sales have exhibited only limited effects of cyclicality.
According to the United States Census Bureau, retail jewelry store sales have
increased every year for the past 17 years with the exception of 1991, which
included both the Persian Gulf War and the introduction of the luxury tax.
Other significant segments of the 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 composed primarily of catalog and mail order houses, direct-selling
establishments, TV home shopping (such as QVC, Inc.) and computer on-line
shopping.

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The U.S. retail jewelry industry is highly fragmented with the seven
largest companies accounting for less than 25 percent of the market. The
largest jewelry retailer is believed to be Wal-Mart Stores, Inc., followed by
the Company. The Company is the largest specialty jewelry retail chain in North
America, with approximately eight percent of market share based on the United
States Census Bureauestimate of 2000 U.S. Retail Jewelry and Watch Sales.
Only three other specialty jewelry retailers had greater than three percent
market share.

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Operations

The Company operates principally under six brand names. The following
table presents net sales, average sales per store and the number of stores for
Zales, Zales Outlet, Gordons, Bailey Banks & Biddle, Peoples (including
Mappins stores), and Piercing Pagoda for the periods indicated.

|                                   |                            |   |                     |           |      |   |           |           |  |   |           |           | 
|---------------------------------- | -------------------------- | - | ------------------- | --------- | ---- | - | --------- | --------- |  | - | --------- | --------- | 
|                                   |                            |   | Year Ended July 31,
|                                   |                            |   |                    
|                                   |                            |   | 2001                |           | 2000 |   | 1999     
|                                   |                            |   |                     |           |      |   |          
|Net Sales (In Thousands)(a)        |                            |   |                     |           |      |   |           |           |  |   |           |          
|                                  
|                                  
|                                  
|                                  
|                                   | Zales (including Zale.com) |   | $                   | 918,725   |      |   | $         | 934,064   |  |   | $         | 821,910   | 
|                                  
|                                  
|                                  
|                                  
|                                   | Zales Outlet               |   |                     | 96,075    |      |   |           | 57,605    |  |   |           | 21,346    | 
|                                  
|                                  
|                                  
|                                  
|                                   | Gordons                   |   |                     | 324,199   |      |   |           | 347,148   |  |   |           | 316,374   | 
|                                  
|                                  
|                                  
|                                  
|                                   | Bailey Banks & Biddle      |   |                     | 323,744   |      |   |           | 319,938   |  |   |           | 264,767   | 
|                                  
|                                  
|                                  
|                                  
|                                   | Peoples(b)                 |   |                     | 150,989   |      |   |           | 155,607   |  |   |           | 21,237    | 
|                                  
|                                  
|                                  
|                                  
|                                   | Piercing Pagoda(c)         |   |                     | 254,510   |      |   |           |          |  |   |           |          | 
|                                   |                            |   |                     |           |      |   |           |           |  |   |           |          
|                                   |                            | $ | 2,068,242           |           |      | $ | 1,814,362 |           |  | $ | 1,445,634 |          
|                                   |                            |   |                     |           |      |   |           |           |  |   |           |          
|Average sales per store/kiosk(d)   |                            |   |                     |           |      |   |           |           |  |   |           |          
|                                  
|                                  
|                                  
|                                  
|                                   | Zales                      |   | $                   | 1,210,000 |      |   | $         | 1,280,000 |  |   | $         | 1,162,000 | 
|                                  
|                                  
|                                  
|                                  
|                                   | Zales Outlet               |   |                     | 1,266,000 |      |   |           | 1,374,000 |  |   |           | 1,602,000 | 
|                                  
|                                  
|                                  
|                                  
|                                   | Gordons                   |   |                     | 1,050,000 |      |   |           | 1,105,000 |  |   |           | 994,000   | 
|                                  
|                                  
|                                  
|                                  
|                                   | Bailey Banks & Biddle      |   |                     | 2,825,000 |      |   |           | 2,984,000 |  |   |           | 2,497,000 | 
|                                  
|                                  
|                                  
|                                  
|                                   | Peoples(b)                 |   |                     | 878,000   |      |   |           | 869,000   |  |   |           | N/A       | 
|                                  
|                                  
|                                  
|                                  
|                                   | Piercing Pagoda(c)         |   |                     | N/A       |      |   |           | N/A       |  |   |           | N/A       | 
|                                  
|                                  
|                                  
|                                  
|Stores/kiosks opened during period |                            |   |                     |           |      |   |           |           |  |   |           |          
|                                  
|                                  
|                                  
|                                  
|                                   | Zales                      |   |                     | 27        |      |   |           | 35        |  |   |           | 29        | 
|                                  
|                                  
|                                  
|                                  
|                                   | Zales Outlet               |   |                     | 16        |      |   |           | 37        |  |   |           | 25        | 
|                                  
|                                  
|                                  
|                                  
|                                   | Gordons                   |   |                     | 5         |      |   |           | 3         |  |   |           | 4         | 
|                                  
|                                  
|                                  
|                                  
|                                   | Bailey Banks & Biddle      |   |                     | 11        |      |   |           | 9         |  |   |           | 6         | 
|                                  
|                                  
|                                  
|                                  
|                                   | Peoples(b)                 |   |                     | 5         |      |   |           |          |  |   |           |          | 
|                                  
|                                  
|                                  
|                                  
|                                   | Piercing Pagoda(c)         |   |                     | 21        |      |   |           |          |  |   |           |          | 
|                                   |                            |   |                     |           |      |   |           |           |  |   |           |          
|                                   |                            |   | 85                  |           |      |   | 84        |           |  |   | 64        |          
|                                   |                            |   |                     |           |      |   |           |           |  |   |           |          
|Stores/kiosks closed during period |                            |   |                     |           |      |   |           |           |  |   |           |          
|                                  
|                                  
|                                  
|                                  
|                                   | Zales                      |   |                     | 13        |      |   |           | 7         |  |   |           | 16        | 
|                                  
|                                  
|                                  
|                                  
|                                   | Zales Outlet               |   |                     | 1         |      |   |           |          |  |   |           |          | 
|                                  
|                                  
|                                  
|                                  
|                                   | Gordons                   |   |                     | 9         |      |   |           | 9         |  |   |           | 9         | 
|                                  
|                                  
|                                  
|                                  
|                                   | Bailey Banks & Biddle      |   |                     | 2         |      |   |           | 4         |  |   |           | 7         | 
|                                  
|                                  
|                                  
|                                  
|                                   | Peoples(b)                 |   |                     | 1         |      |   |           | 8         |  |   |           |          | 
|                                  
|                                  
|                                  
|                                  
|                                   | Piercing Pagoda(c)         |   |                     | 41        |      |   |           |          |  |   |           |          | 
|                                   |                            |   |                     |           |      |   |           |           |  |   |           |          
|                                   |                            |   | 67                  |           |      |   | 28        |           |  |   | 32        |          
|                                   |                            |   |                     |           |      |   |           |           |  |   |           |          
|Total stores/kiosks                |                            |   |                     |           |      |   |           |           |  |   |           |          
|                                  
|                                  
|                                  
|                                  
|                                   | Zales                      |   |                     | 750       |      |   |           | 736       |  |   |           | 708       | 
|                                  
|                                  
|                                  
|                                  
|                                   | Zales Outlet               |   |                     | 83        |      |   |           | 68        |  |   |           | 31        | 
|                                  
|                                  
|                                  
|                                  
|                                   | Gordons                   |   |                     | 302       |      |   |           | 306       |  |   |           | 312       | 
|                                  
|                                  
|                                  
|                                  
|                                   | Bailey Banks & Biddle      |   |                     | 120       |      |   |           | 111       |  |   |           | 106       | 
|                                  
|                                  
|                                  
|                                  
|                                   | Peoples(b)                 |   |                     | 172       |      |   |           | 168       |  |   |           | 176       | 
|                                  
|                                  
|                                  
|                                  
|                                   | Piercing Pagoda(c)         |   |                     | 917       |      |   |           |          |  |   |           |          | 
|                                   |                            |   |                     |           |      |   |           |           |  |   |           |          
|                                   |                            |   | 2,344               |           |      |   | 1,389     |           |  |   | 1,333     |          
|                                   |                            |   |                     |           |      |   |           |           |  |   |           |          



---

|(a) |  | Data includes amortized revenue from extended service agreements,
previously included in selling, general and administrative expense. All
periods have been restated to reflect the change.                          
|--- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|   
|   
|   
|   
|(b) |  | Data from Peoples Jewellers in 1999 includes results from May 23, 1999,
the date the Company acquired substantially all assets and certain
operational liabilities of Peoples Jewellers Corp., through July 31, 1999.
|   
|   
|   
|   
|(c) |  | Data from Piercing Pagoda includes results from September 20, 2000, the
date the Company acquired Piercing Pagoda, Inc.                                                                                              
|   
|   
|   
|   
|(d) |  | Based on merchandise sales per store open a full twelve months during the
respective year.                                                                                                                           

6



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##### Table of Contents



Zales Jewelers

Zales is positioned as the Companys national flagship and is a leading
brand name in jewelry retailing in the United States. At July 31, 2001, Zales
had 750 stores in 50 states and Puerto Rico. Average store size is
approximately 1,500 square feet, and the average selling price per unit sold is
$264. The Zales brand accounted for approximately 44 percent of the Companys
sales in fiscal year 2001.

Zales merchandise selection is generally standardized across the nation
and targeted at customers representing a cross-section of mainstream America.
In fiscal year 2001, bridal merchandise represented 33 percent of merchandise
sales, while fashion jewelry and watches comprised the remaining 67 percent.
The bridal merchandise category consists of engagement rings, bridal sets and
diamond anniversary bands. Fashion jewelry consists generally of diamond
fashion rings, certain semi-precious stones, earrings, gold chains, watches and
various other items. The Company believes that the prominence of diamond
jewelry in its product selection fosters an image of quality and trust among
consumers. While placing added emphasis on the bridal segment of the business,
Zales maintains a balance with non-bridal merchandise such as fashion jewelry
and gift-giving events. Zales also introduces innovative items and capitalizes
on emerging trends, including platinum engagement rings, and diamond fashion
jewelry. Certified diamond jewelry was introduced in fiscal year 2000, and
expanded in fiscal 2001. In Spring 2001, Zales introduced the Companys first
branded diamond, the Zales Diamond. In fiscal 2001, Zales launched its
featured Brilliant Buys and promoted them for the fiscal 2001 holiday. The
combination of Zales national presence and centralized merchandise selection
allow it to use television advertising across the nation as its primary
advertising medium, supplemented by newspaper inserts and direct mail. Zales
broadened its television advertising presence in fiscal years 2000 and 2001 to
include brand awareness marketing, such as support of the Rockefeller Center
Christmas Tree Lighting, and will continue this support in fiscal 2002. Zales
is in the direct fulfillment business through its Internet web site, which
accounted for less than one percent of the Companys net sales in fiscal year
2001.

Zales Outlet

Zales Outlet builds on the Zales brand recognition and national
advertising programs. At July 31, 2001, the Company operated 83 Zales Outlet
stores in 30 states and Puerto Rico, including 16 stores opened in fiscal 2001.
The average store size is approximately 2,200 square feet, and the average
selling price per unit sold is $265. Zales Outlet accounted for less than 5
percent of the Companys net sales in fiscal 2001.

The Company has expanded its Zales Outlet concept during the past three
years and plans to continue its growth over the next several years. The
merchandise assortment in a Zales Outlet store caters to the brand conscious
and value-oriented female shopper, offering 20-70% off traditional retail
prices everyday.

Although Zales Outlet was established as an extension of the Zales brand
to benefit from Zales national advertising and brand recognition, Zales Outlet
offers its own product line and promotional effort geared specifically to the
outlet consumer who is both value and name brand driven. In addition to
fashion forward looks in diamonds, gemstones, gold and name brand watches,
Zales Outlet has been successful with certified and exclusive products. The
Lilla Diamond, a diamond cut exclusive to Zales Outlet is a 98 faceted
diamond set in platinum accompanied with a certification. Also, the Zales
Outlets special collection of Exceptional Values has performed well,
offering good value on best selling items in each merchandise category.

Gordons Jewelers

Gordons is positioned as the Companys major regional brand. As of July
31, 2001, Gordons had 302 stores in 34 states and Puerto Rico. Average store
size is approximately 1,400 square feet and the average selling price per unit
sold is $275. Gordons accounted for 16 percent of the Companys net sales in
fiscal year 2001.

The Company has taken steps to upgrade Gordons image, including store
remodeling and improved merchandise and marketing, with a focus on exclusive
and certified diamond merchandise.

7



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##### Table of Contents



Gordons distinguishes itself from Zales by providing a more upscale,
contemporary product mix and tailoring a portion of the store inventory to
regional tastes. Gordons has selections for both the entry price point
customer as well as the more discerning, established jewelry customer.
Gordons offers a broad range of merchandise, such as diamond solitaires, bold
gold, platinum and semi-precious gems. Gordons has also introduced two very
successful exclusive diamonds the Ariella and the Oriana. Available
exclusively at Gordons, these diamonds are certified and set in platinum.
Gordons is expanding these two proprietary stones into other categories beyond
bridal.

Gordons utilizes an advertising media mix consisting primarily of radio,
newspaper inserts and direct mail. As the Gordons customer database continues
to grow, direct mail will likely become a greater part of the mix.

Bailey Banks & Biddle Fine Jewelers

Established in 1832, Bailey Banks & Biddle offers high-end merchandise,
exclusive designs and a prestigious shopping environment for the upscale
customer. The stores are among the pre-eminent stores in their markets and
carry both exclusive and recognized designer merchandise selections to appeal
to the more affluent customer, while maintaining a fine jewelry selection for
the mall based customer. The Bailey Banks & Biddle merchandise assortments
emphasize the classic and traditional look and focus on diamonds, precious
stones and gold jewelry, as well as watches and giftware. At July 31, 2001,
Bailey Banks & Biddle operated 120 upscale jewelry stores in 31 states and
Puerto Rico. The Company also utilizes the trade name Zell Bros.® for one of
its stores. The stores have an average selling price per unit sold of $775,
have an average store size of approximately 3,600 square feet and accounted for
approximately 16 percent of the Companys net sales in fiscal year 2001.
Bailey Banks & Biddle plans to focus on inventory selections within each
merchandise category, creating the proper breadth of assortment. Additionally,
it plans on enhancing the visual impact of its stores in the coming year.

Bailey Banks & Biddle stores rely heavily on upscale direct-mail catalogs,
enabling the stores to focus on specific products for specific customers.
During the next year, Bailey Banks & Biddle will utilize an increased database
to reach 20 percent more customers through direct mail. In fiscal year 2001,
Bailey Banks & Biddle continued to expand its advertising reach with a
repetitive presence in nationally distributed newspapers such as The New York
Timesand The Wall Street Journaland high profile magazines such as Town &
Country, Architectural Digest, House and Garden, In Style, Vogue, Vanity Fair,
and Bon Appetit. During the next year, Bailey Banks & Biddle will expand its
merchandise assortments with additional prestige brand watch lines while it
will upgrade diamond quality in Bailey Banks & Biddle distinctive style and
settings.

Peoples Jewellers

In May, 1999, Zale Corporation acquired the Peoples Jewellers Corporation,
a privately owned chain of jewelery retail outlets in Canada, operating under
the banners of Peoples Jewellers and Mappins Jewellers. This operation now has
172 stores in 9 provinces across Canada and enjoys the largest market share of
any jewelry retailer in Canada. The stores have an average selling price per
unit of $120, an average store size of approximately 1,600 square feet and
accounted for approximately 7 percent of the Companys net sales in fiscal year
2001.

The primary banner, Peoples Jewellers, is one of the most recognized brand
names in Canada. Peoples offers traditional jewelery at moderate prices,
attracting a wide variety of Canadian customers, with a focus on the consumer
in the mall environment. Using the identification Peoples, the Diamond Store
in Canada, Peoples emphasizes its diamond business, while also offering a wide
selection of other classic jewelry and watch products.

From 2000, Peoples has been building its brand using television and
newspaper inserts. In 2000 and 2001, Peoples had the largest television
campaign of any Canadian jewelry retailer by a wide margin. Seasonal newspaper
insertions and advertising the Brilliant Buy products also assisted the growth
of the business in these years. Peoples plans to continue this emphasis in
2002.

In 2001, Peoples successfully launched a 128 facet brilliant cut diamond
as the Peoples Diamond. With the growth of this solitaire product, an
anniversary band and other line extensions were launched in spring 2001 with
great success. For 2002, Peoples intends to add additional products to
increase the penetration of this branded product.

8



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Piercing Pagoda

Effective September 20, 2000, the Company acquired Piercing Pagoda, Inc.,
the largest retailer of gold jewelry through kiosk stores in the United States.
At July 31, 2001, Piercing Pagoda operated 917 locations in 46 states and
Puerto Rico, under the names Piercing Pagoda, Plum Gold, Silver and Gold
Connection and Diamond Isle. Piercing Pagoda offers an extensive collection of
popularly priced 14 karat and 10 karat gold chains, bracelets, earrings, charms
and rings, as well as a selection of silver and diamond jewelry, all basic
styles at everyday low prices. The Piercing Pagoda stores are generally located
in high traffic concourses of regional shopping malls.

The kiosk locations average approximately 170 square feet in size, can be
opened quickly and are easily accessible and visible within malls. In fiscal
2001, the average price per unit was $26. The kiosks focus on the opening price
point customer.

Store Operations

The Companys stores are designed to create an attractive environment, to
maximize operating efficiencies and to make shopping convenient and enjoyable.
The Company pays careful attention to store layout, particularly in areas such
as lighting, choice of materials and arrangement of display cases to maximize
merchandise presentation. Promotional displays are changed periodically to
provide variety, to reflect seasonal events or to complement a particular
malls promotions.

Each of the Companys stores is led by a store manager who is responsible
for certain store-level operations, including sales and certain personnel
matters. Non-sales administrative matters, including purchasing, credit
operations and payroll are consolidated at the corporate level in an effort to
maintain low operating costs at the store level. Each store also offers
standard warranties and return policies and provides extended warranty coverage
which may be purchased at the customers option.

The Company has implemented inventory control systems, extensive security
systems and loss prevention procedures to maintain low inventory losses. The
Company screens employment applicants and provides its store personnel with
training in loss prevention. Despite such precautions, the Company experiences
losses from theft from time to time and maintains insurance to cover such
losses.

The Company believes it is important to provide knowledgeable and
responsive customer service. This year, the Company consolidated previously
fragmented customer service departments into a single customer service call
center to more effectively address customer phone calls. The Company has
implemented employee training programs, including training in sales techniques
for new employees, on-the-job training and manager training for store managers.
Under the banner of Zale Corporation University, the Company offers training
to employees at every level of the organization, from store associate to buyer.

Purchasing and Inventory

The Company purchases substantially all of its merchandise in finished
form from a network of established suppliers and manufacturers located
primarily in the United States, Southeast Asia, and Italy. All purchasing is
done through buying offices at the corporate headquarters. The Company either
purchases merchandise from its vendors or obtains merchandise on consignment.
The Company had approximately $186.2 million and $167.9 million of consignment
inventory on hand at July 31, 2001 and 2000, respectively. The Company
historically has not engaged in any substantial amount of hedging activities
with respect to merchandise held in inventory, since the Company has been able
to adjust retail prices to reflect price fluctuations in the commodities that
are used in the merchandise it sells. The Company is not subject to substantial
currency fluctuations because most purchases are U.S. dollar denominated.
During fiscal years 2001 and 2000, the Company purchased approximately 35
percent and 33 percent, respectively, of its merchandise from its top five
vendors, including more than 11 percent from its top vendor.

9



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##### Table of Contents



Credit Operations

The Companys 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 sources. Approximately 40 percent of the Companys net sales from
operations that offer private label credit cards were generated by credit sales
on these credit cards in fiscal year 2001. The Company has found that by
offering its customers a credit account, its sales personnel are able to build
customer relationships that generate loyalty and facilitate repeat purchases,
while at the same time the Companys target marketing capability is enhanced.
In July 2000, the Company sold all of its domestic proprietary credit accounts
receivable to Associates. In connection with this sale, the Company entered
into a ten-year agreement whereby Hurley, an affiliate of Associates (now a
part of Citigroup), will issue private label credit cards branded with
appropriate Company trademarks, and provide financing for the Companys
customers to purchase merchandise in exchange for payment by the Company of a
merchant fee based on a percentage of each credit card sale. The merchant fee
is a percentage per credit sale credited to the Company for standard revolving
accounts and a percent per credit sale charged to the Company under certain
promotional credit programs.

Insurance Affiliates

The Company, through Zale Indemnity Company, Zale Life Insurance Company
and Jewel Re-Insurance Ltd., provides insurance and reinsurance facilities for
various types of insurance coverage, which typically are marketed to the
Companys private label credit card customers. Additionally, the Company
promotes the sale of credit insurance products to customers who use the private
label credit card program. In fiscal year 2001, over 47 percent of the
Companys private label credit card purchasers purchased some form of credit
insurance. The three companies are the insurers (either through direct written
or reinsurance contracts) of the Companys customer credit insurance coverages.
In addition to providing replacement property coverage for certain perils, such
as theft, 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 eligible employees of the Company.
Zale Indemnity Company, in addition to writing direct credit insurance
contracts, also has certain discontinued business that it continues to run off.
Credit insurance operations are dependent on the Companys retail sales on its
private label credit cards. Under the current private label arrangement with
Hurley and AFCC, the Companys insurance affiliates continue to provide
insurance to holders of the Companys private label credit cards and receive
payments for such insurance products.

Employees

As of July 31, 2001, the Company had approximately 20,000 employees, less
than 10% of which were Canadian employees, and less than one percent of whom
were represented by unions. The Company usually hires a limited number of
temporary employees during each holiday season.

Competition

The retailing industry is highly competitive. The industry is fragmented,
and the Company competes with a large number of independent regional and local
jewelry retailers, as well as national jewelry chains. The Company also
competes with other types of retailers who sell jewelry and gift items, such as
department stores, catalog showrooms, discounters, direct mail suppliers,
online retailers and television home shopping programs. Certain of the
Companys competitors are non-specialty retailers which are larger and have
greater financial resources than the Company. The malls where the Companys
stores are located typically contain competing national chains, independent
jewelry stores or department store jewelry departments. The Company believes
that it is also competing for consumers discretionary spending dollars and,
therefore, competes with retailers who offer merchandise other than jewelry or
giftware.

Notwithstanding the national or regional reputation of its competition,
the Company believes that it must compete on a mall-by-mall basis with other
retailers of jewelry as well as with retailers of other types of discretionary
items. Therefore, the Company competes primarily on the basis of reputation for
high quality products, brand recognition, store location, distinctive and
value-priced merchandise, personalized customer service and its ability to
offer private label credit card programs to customers wishing to finance their
purchases. The Companys success is also dependent on its ability to react to
and create customer demand for specific merchandise categories.

10



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##### Table of Contents



The Company holds no material patents, licenses, franchises or
concessions; however, the established trademarks and trade names of the Company
are essential to maintaining its competitive position in the jewelry retailing
industry.

Seasonality

As a specialty retailer of fine jewelry, the Companys business is
seasonal in nature, with its second quarter, which includes the months of
November through January, typically representing a proportionally greater
percentage of annual sales, earnings from operations and cash flow. Management
expects such seasonality to continue.

Management Information Systems

The Companys information systems provide information necessary for: (i)
management operating decisions; (ii) sales and margin management; (iii)
inventory control; (iv) profitability monitoring by many measures (merchandise
category, buyer, store); and (v) expense control programs. Data processing
systems include point-of-sale reporting, purchase order management, receiving,
merchandise planning and control, payroll, general ledger, credit card
administration, and accounts payable. Bar code ticketing is used, and scanning
is utilized at all point-of-sale terminals to ensure timely sales and margin
data compilation and to provide for inventory control monitoring. Information
is made available on-line to merchandising staff on a timely basis, thereby
reducing the need for paper reports.

The Companys information systems allow management to monitor and control
the Companys operations and to generate reports on a daily, monthly, quarterly
and annual basis for each store and transaction. Senior management can
therefore review and analyze activity by store, amount of sale, terms of sale
or employees who sell the merchandise.

The Company has an operations services agreement with a third party for
the management of the Companys mainframe processing operations, client server
systems, LAN operations and desktop support. The agreement, which was
effective August 1, 1997, requires fixed payments totaling $34.4 million over a
60 month term and a variable amount based on usage. Management is evaluating
future outsourcing opportunities since this agreement expires at the end of
fiscal 2002. The Company has an option to extend the current agreement for two
consecutive one year periods. The Company believes that by outsourcing this
portion of its management information systems it achieves additional
efficiencies and allows the Company to focus its internal information
technology efforts on developing new systems to enhance the performance of its
core business.

The Company has historically upgraded, and expects to continue to upgrade,
its information systems to improve operations and support future growth. The
Company estimates it will make capital expenditures of approximately $8 million
in fiscal year 2002 for enhancements to its management information systems and
infrastructure.

Regulation

The Companys 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 the
Companys private label credit cards, credit to the Companys 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 the Companys traditional customer base could
adversely affect the Companys results of operations or financial condition.

The sale of insurance products by the Company is also highly regulated.
State laws currently impose disclosure obligations with respect to the
Companys sale of credit and other insurance. In addition, the Companys sale
of insurance products in connection with its private label credit cards appears
to be subject to certain disclosure and other requirements under the
Gramm-Leach-Bliley Act of 1999. The Companys and its competitors practices
are also subject to review in the ordinary course of business by the Federal
Trade Commission and the Companys and other retail Companys credit cards are
subject to regulation by the Office of the Comptroller of the Currency. See
Business Credit Operations. The Company believes that it is currently in
material compliance with all applicable state and federal regulations.

11



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##### Table of Contents



Merchandise in the retail jewelry industry is frequently sold at a
discount off the regular or original price. A number of jurisdictions in
which the Company operates have regulations which require that retailers
offering merchandise at discounted prices must offer the merchandise at regular
or original prices for stated periods of time. Additionally, the Company is
subject to certain truth-in-advertising and other various laws, including
consumer protection regulations that regulate retailers generally and/or the
promotion and sale of jewelry in particular. The Company undertakes to monitor
changes in those laws and believes that it is in material compliance with
applicable laws with respect to such practices.

Cautionary Notice Regarding Forward-Looking Statements

This Annual Report on Form 10-K contains forward-looking statements,
including statements regarding the Companys objectives and expectations
regarding its sales and earnings, merchandising and marketing strategies, store
renovation, remodeling and expansion, inventory management and performance,
capital expenditures and development of its management information systems and
e-commerce sites, which are based upon managements beliefs as well as on
assumptions made by and data currently available to management. These
forward-looking statements are not guarantees of future performance and a
variety of factors could cause the Companys actual results to differ
materially from the anticipated or expected results expressed in or suggested
by these forward-looking statements. The following list, which is not intended
to be an all encompassing list of risks and uncertainties affecting the
Company, summarizes several factors that could cause the Companys actual
results to differ from those anticipated or expected in these forward-looking
statements: that low or negative growth in the economy or in the financial
markets will occur and reduce discretionary spending on goods that are, or are
perceived to be luxuries; that the events of September 11, 2001 and related
events will negatively impact the economy or the financial markets and reduce
discretionary spending on such goods; that warehousing and distribution
productivity and capacity can be further improved to support the Companys
distribution requirements; that strong competitive responses may impact the
Companys efforts to leverage its brand power with its marketing, merchandising
and promotional efforts; that seasonality of the retail jewelry business or
downturns in consumer spending during the fourth calendar quarter may adversely
affect the Companys results; that the Company may not be able to continue to
manage its inventory and product supply effectively to respond to consumer
demand; that fluctuations in diamond prices may negatively affect the business;
that the Company may not be able to integrate acquisitions into its existing
operations or that new acquisition and alliance opportunities that enhance
shareholder value may not be available on terms acceptable to the Company; that
the efforts to redefine the strategic role of each brand may not be successful;
that litigation may have an adverse effect on the financial results or
reputation of the Company; that alternate sources of merchandise supply may not
be available on favorable terms to the Company during the three month period
leading up to the Christmas season; that key personnel who have been hired or
retained by the Company may depart; that any disruption in the Companys
private label credit card arrangement with Associates First Capital Corporation
may adversely affect the Companys ability to provide consumer credit; or that
changes in government or regulatory requirements may increase the cost of or
adversely affect the Companys operations. The Company disclaims any
obligation to update or revise publicly or otherwise any forward-looking
statements to reflect subsequent events, new information or future
circumstances.




ITEM 2. PRINCIPAL PROPERTIES

The Company leases a 430,000 square foot corporate headquarters facility,
which extends through 2008. The facility is located in Las Colinas, a planned
business development in Irving, Texas, near the Dallas/Fort Worth International
Airport. During fiscal year 1999, the Company sold a 120,000 square foot
warehouse in Dallas, Texas, leasing back approximately 60,000 square feet of
that warehouse. The Company also owns a 73,000 square foot building in
Bethlehem, Pennsylvania that serves as Piercing Pagodas general office and
distribution center. Another 71,000 square foot building located adjacent to
the Bethlehem property is used for additional distribution and warehousing
functions. The Company leases a 7,400 square foot general office facility in
Toronto, Ontario Canada for Peoples, which lease extends to October 2003.

The Company rents most of its store retail space under leases that
generally range from five to ten years and may contain minimum rent
escalations, while kiosk leases generally range from one 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.

12



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##### Table of Contents



The following table indicates the expiration dates of the current terms of
the Companys leases as of July 31, 2001:

|                       |  |        |       |        |  |       |     |       |  |          |   |  |  |  |       |  |  |            |     |  
|---------------------- |  | ------ | ----- | ------ |  | ----- | --- | ----- |  | -------- | - |  |  |  | ----- |  |  | ---------- | --- | -
|                       |  |        |       |        |  |       |     |       |  |          |   |  |  |  |       |  |  | Percentage
|Term Expires           |  | Stores |       | Kiosks |  | Other |     | Total |  | Of Total
|                       |  |        |       |        |  |       |     |       |  |         
|2002 and prior         |  |        | 215   |        |  |       | 304 |       |  |          |  |  |  |  | 519   |  |  |            | 22  | %
|                      
|                      
|                      
|                      
|2003                   |  |        | 79    |        |  |       | 162 |       |  |          | 1 |  |  |  | 242   |  |  |            | 10  | %
|                      
|                      
|                      
|                      
|2004                   |  |        | 107   |        |  |       | 137 |       |  |          |  |  |  |  | 244   |  |  |            | 11  | %
|                      
|                      
|                      
|                      
|2005                   |  |        | 141   |        |  |       | 148 |       |  |          |  |  |  |  | 289   |  |  |            | 12  | %
|                      
|                      
|                      
|                      
|2006 and thereafter    |  |        | 917   |        |  |       | 134 |       |  |          | 2 |  |  |  | 1,053 |  |  |            | 45  | %
|                       |  |        |       |        |  |       |     |       |  |          |   |  |  |  |       |  |  |            |     |  
|Total number of leases |  |        | 1,459 |        |  |       | 885 |       |  |          | 3 |  |  |  | 2,347 |  |  |            | 100 | %
|                       |  |        |       |        |  |       |     |       |  |          |   |  |  |  |       |  |  |            |     |  

Management believes substantially all of the store leases expiring in
fiscal year 2002 that it wishes to renew (including leases which expired
earlier and are on month-to-month extensions) will be renewed on terms not
materially less favorable to the Company than the terms of the expiring leases.
Management believes its facilities are suitable and adequate for the Companys
business as presently conducted.




ITEM 3. LEGAL PROCEEDINGS

The Company is involved in certain legal actions and claims arising in the
ordinary course of business. The Company currently believes that such
litigation and claims, both individually and in the aggregate, will be resolved
without material effect on the Companys financial position or results of
operations.

On November 3, 1999, a plaintiff amended a complaint filed in the Circuit
Court for Colbert County, State of Alabama to commence a purported class action
against the Company, Jewelers National Bank, Zale Indemnity Company, Zale Life
Insurance Company, Jewelers Financial Services, Jewel Re-Insurance, Ltd., and
certain employees of the Company. On July 21, 2000, the same plaintiff
commenced a purported class action in the United States District Court for the
Eastern District of Texas, Texarkana Division against the Company, Jewelers
National Bank, Zale Indemnity Company, Zale Life Insurance Company, Jewel
Re-Insurance, Ltd. and certain employees of the Company. Both purported class
actions concern allegations that the defendants marketed credit insurance to
customers in violation of state statutory and common laws and bring claims
based on, inter alia, fraud, breach of contract, and consumer protection laws.
The federal complaint alleges that the Companys credit insurance practices
violated federal anti-racketeering laws. In both complaints, plaintiff seeks,
among other things, compensatory and punitive damages as well as injunctive
relief. Both actions are in the discovery stage, and neither has been
certified as a class action. The Company intends to vigorously defend the
alleged claims.




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

No matters were submitted to a vote of security holders of the Company
during the quarter ended July 31, 2001.

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##### Table of Contents



EXECUTIVE OFFICERS OF THE REGISTRANT

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

|                   |  |     |    |          |  |                                                       
|------------------ |  | --- | -- | -------- |  | ------------------------------------------------------
|Name               |  | Age |    | Position
|                   |  |     |    |         
|Robert J. DiNicola |  |     | 53 |          |  | Chairman of the Board and Chief Executive Officer     
|                  
|                  
|                  
|                  
|Alan P. Shor       |  |     | 42 |          |  | President and Chief Operating Officer, Director       
|                  
|                  
|                  
|                  
|Mary L. Forté      |  |     | 50 |          |  | Executive Vice President and Chief Merchandise Officer
|                  
|                  
|                  
|                  
|Sue E. Gove        |  |     | 43 |          |  | Executive Vice President and Chief Financial Officer  

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

Mr. Robert J. DiNicolareturned to the Company as Chairman of the Board
and Chief Executive Officer on February 21, 2001. Previously, Mr. DiNicola had
served as Chairman of the Board of the Company from April 18, 1994 to September
6, 2000. From September 6, 2000 until his return as Chairman and Chief
Executive Officer in February, Mr. DiNicola served as a member of the Board.
He also served as Chief Executive Officer of the Company from April 18, 1994
until September 7, 1999. For the three years prior to joining the Company,
Mr. DiNicola was a senior executive officer of the Bon Marche Division of
Federated Department Stores, Inc., having served as Chairman and Chief
Executive Officer of that Division from 1992 to 1994 and as its President and
Chief Operating Officer from 1991 to 1992. From 1989 to 1991, Mr. DiNicola was
a General Merchandise Manager of Richs Department Store Division of Federated.
For 17 years, prior to joining the Federated organization, Mr. DiNicola was
associated with Macys, where he held various executive, management and
merchandising positions, except for a one-year period while he held a division
officer position with The May Department Stores Company, Inc.

Mr. Alan P. Shorwas named President and Chief Operating Officer and was
appointed as a member of the Companys Board of Directors effective September
6, 2000. Before being named President, Mr. Shor had served as Executive Vice
President and Chief Operating Officer since September 1999. From November 1997
to September 1999, Mr. Shor served as Executive Vice President and Chief
Logistics Officer while retaining his position as General Counsel and Secretary
(he relinquished the General Counsel position August 1, 1999 and the Secretary
position in November 1999). From May 1997 to November 1997, Mr. Shor served
as Executive Vice President and Chief Administrative Officer, General Counsel
and Secretary. From June 1995 to May 1997, Mr. Shor served as Senior Vice
President, General Counsel and Secretary. For two years prior to joining the
Company, Mr. Shor was the managing partner of the Washington, D.C. office of
the Troutman Sanders law firm, whose principal office is based in Atlanta,
Georgia. Mr. Shor, a member of Troutman Sanders since 1983, was a partner of
the firm from 1990 to 1995.

Ms. Mary L. Fortéwas named Executive Vice President and Chief Merchandise
Officer on February 21, 2001. From January 1998 to February 2001, she served as
Executive Vice President and Chief Administrative Officer. Ms. Forté joined
the Company in July 1994 as the President of Gordons, and served in that
position until January 1998. From January 1994 to July 1994, Ms. Forté served
as Senior Vice President of QVC  Home Shopping Network. From July 1991 through
January 1994, Ms. Forté served as Senior Vice President of the Bon Marché, Home
Division of the Federated Department Store. From July 1989 to July 1991, Ms.
Forté was Vice President of Richs Department Store, Housewares Division. In
addition to the above, Ms. Forté has an additional 13 years of retailing and
merchandising experience with Macys, The May Department Stores Company, Inc.
and Federated Department Stores.

Ms. Sue E. Govewas appointed Executive Vice President and Chief Financial
Officer on July 15, 1998. From December 1997 to July 1998, she served as Group
Vice President and Chief Financial Officer. From January 1996 to December
1997, she served as Senior Vice President, Corporate Planning and Analysis.
From September 1996 through June 1997, Ms. Gove also served as Senior Vice
President and Treasurer, overseeing Investor Relations and the Treasury, Tax
and Control functions. Ms. Gove joined the Company in 1980 and served in
numerous assignments until her appointment to Vice President in 1989.

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##### Table of Contents






PART II




ITEM 5. MARKET FOR THE REGISTRANTS COMMON EQUITY AND RELATED STOCKHOLDERS EQUITY

The Common Stock is listed on the New York Stock Exchange (NYSE) under
the symbol ZLC. The following table sets forth the high and low sale prices
for the Common Stock for each fiscal quarter during the two most recent fiscal
years.

|       |  |      |       |      |  |      |       |     |  |   |       |  |  |   |       | 
|------ |  | ---- | ----- | ---- |  | ---- | ----- | --- |  | - | ----- |  |  | - | ----- | 
|       |  | 2001 |       | 2000
|       |  |      |       |     
|       |  | High |       | Low  |  | High |       | Low
|       |  |      |       |      |  |      |       |    
|First  |  | $    | 41.75 |      |  | $    | 28.19 |     |  | $ | 42.50 |  |  | $ | 33.50 | 
|      
|      
|      
|      
|Second |  |      | 37.42 |      |  |      | 23.38 |     |  |   | 51.75 |  |  |   | 35.50 | 
|      
|      
|      
|      
|Third  |  |      | 38.00 |      |  |      | 27.20 |     |  |   | 51.00 |  |  |   | 32.06 | 
|      
|      
|      
|      
|Fourth |  |      | 35.58 |      |  |      | 31.00 |     |  |   | 48.13 |  |  |   | 35.25 | 

As of September 5, 2001, the outstanding shares of Common Stock were held
by approximately 1,004 holders of record. The Company has not paid dividends on
the Common Stock since its initial issuance on July 30, 1993, and does not
anticipate paying dividends on the Common Stock in the foreseeable future. In
addition, the Companys long-term debt limits the Companys ability to pay
dividends. See Managements Discussion and Analysis of Financial Condition
and Results of Operations  Liquidity and Capital Resources and Notes to the
Consolidated Financial Statements  Long Term Debt.

15



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##### Table of Contents






ITEM 6. SELECTED FINANCIAL DATA

The following selected financial data is qualified in its entirety by the
Consolidated Financial Statements of the Company (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 years ended July 31, 2001, 2000, 1999, 1998, and 1997 have been
derived from the Companys audited Consolidated Financial Statements.

|                                                      |                                |   |                                                  |           |      |   |           |           |      |   |           |           |  |   |           |           |  |   |           |           | 
|----------------------------------------------------- | ------------------------------ | - | ------------------------------------------------ | --------- | ---- | - | --------- | --------- | ---- | - | --------- | --------- |  | - | --------- | --------- |  | - | --------- | --------- | 
|                                                      |                                |   | Year Ended July 31,                             
|                                                      |                                |   |                                                 
|                                                      |                                |   | 2001                                             |           | 2000 |   | 1999      |           | 1998 |   | 1997     
|                                                      |                                |   |                                                  |           |      |   |           |           |      |   |          
|                                                      |                                |   | (amounts in thousands, except per share amounts)
|Net sales                                             |                                | $ | 2,068,242                                        |           |      | $ | 1,814,362 |           |      | $ | 1,445,634 |           |  | $ | 1,327,063 |           |  | $ | 1,261,650 |          
|                                                     
|                                                     
|                                                     
|                                                     
|Cost of sales                                         |                                |   | 1,034,970                                        |           |      |   | 930,826   |           |      |   | 746,663   |           |  |   | 686,240   |           |  |   | 645,728   |          
|                                                     
|                                                     
|                                                     
|                                                     
|Non-recurring charge                                  |                                |   | 25,236                                           |           |      |   |          |           |      |   |          |           |  |   |          |           |  |   |          |          
|                                                      |                                |   |                                                  |           |      |   |           |           |      |   |           |           |  |   |           |           |  |   |           |          
|Gross margin(a)                                       |                                |   | 1,008,036                                        |           |      |   | 883,536   |           |      |   | 698,971   |           |  |   | 640,823   |           |  |   | 615,922   |          
|                                                     
|                                                     
|                                                     
|                                                     
|Selling, general and
administrative expenses          |                                |   | 804,780                                          |           |      |   | 630,687   |           |      |   | 509,570   |           |  |   | 484,867   |           |  |   | 485,944   |          
|                                                     
|                                                     
|                                                     
|                                                     
|Depreciation and amortization
expense                 |                                |   | 58,290                                           |           |      |   | 42,431    |           |      |   | 29,478    |           |  |   | 22,565    |           |  |   | 14,022    |          
|                                                     
|                                                     
|                                                     
|                                                     
|Unusual items(b)                                      |                                |   | 4,713                                            |           |      |   |          |           |      |   |          |           |  |   | (8,947    | )         |  |   |          |          
|                                                      |                                |   |                                                  |           |      |   |           |           |      |   |           |           |  |   |           |           |  |   |           |          
|Operating earnings                                    |                                |   | 140,253                                          |           |      |   | 210,418   |           |      |   | 159,923   |           |  |   | 142,338   |           |  |   | 115,956   |          
|                                                     
|                                                     
|                                                     
|                                                     
|Interest expense, net                                 |                                |   | 6,857                                            |           |      |   | 32,178    |           |      |   | 30,488    |           |  |   | 32,039    |           |  |   | 36,098    |          
|                                                      |                                |   |                                                  |           |      |   |           |           |      |   |           |           |  |   |           |           |  |   |           |          
|Earnings before income taxes                          |                                |   | 133,396                                          |           |      |   | 178,240   |           |      |   | 129,435   |           |  |   | 110,299   |           |  |   | 79,858    |          
|                                                     
|                                                     
|                                                     
|                                                     
|Income taxes                                          |                                |   | 51,348                                           |           |      |   | 66,726    |           |      |   | 48,503    |           |  |   | 41,362    |           |  |   | 29,305    |          
|                                                      |                                |   |                                                  |           |      |   |           |           |      |   |           |           |  |   |           |           |  |   |           |          
|Net earnings                                          |                                | $ | 82,048                                           |           |      | $ | 111,514   |           |      | $ | 80,932    |           |  | $ | 68,937    |           |  | $ | 50,553    |          
|                                                      |                                |   |                                                  |           |      |   |           |           |      |   |           |           |  |   |           |           |  |   |           |          
|Earnings per common share:                            |                                |   |                                                  |           |      |   |           |           |      |   |           |           |  |   |           |           |  |   |           |          
|                                                     
|                                                     
|                                                     
|                                                     
|                                                      | Basic:                         |   | $                                                | 2.37      |      |   | $         | 3.16      |      |   | $         | 2.24      |  |   | $         | 1.96      |  |   | $         | 1.44      | 
|                                                     
|                                                     
|                                                     
|                                                     
|                                                      | Diluted:                       |   | $                                                | 2.36      |      |   | $         | 3.11      |      |   | $         | 2.21      |  |   | $         | 1.84      |  |   | $         | 1.38      | 
|                                                     
|                                                     
|                                                     
|                                                     
|Weighted average number of
common shares outstanding: |                                |   |                                                  |           |      |   |           |           |      |   |           |           |  |   |           |           |  |   |           |          
|                                                     
|                                                     
|                                                     
|                                                     
|                                                      | Basic                          |   |                                                  | 34,575    |      |   |           | 35,326    |      |   |           | 36,137    |  |   |           | 35,201    |  |   |           | 35,054    | 
|                                                     
|                                                     
|                                                     
|                                                     
|                                                      | Diluted                        |   |                                                  | 34,751    |      |   |           | 35,883    |      |   |           | 36,688    |  |   |           | 37,368    |  |   |           | 36,632    | 
|                                                     
|                                                     
|                                                     
|                                                     
|Balance Sheet Data:                                   |                                |   |                                                  |           |      |   |           |           |      |   |           |           |  |   |           |           |  |   |           |          
|                                                     
|                                                     
|                                                     
|                                                     
|                                                      | Working capital                |   | $                                                | 525,460   |      |   | $         | 666,177   |      |   | $         | 556,886   |  |   | $         | 971,495   |  |   | $         | 877,130   | 
|                                                     
|                                                     
|                                                     
|                                                     
|                                                      | Total assets                   |   |                                                  | 1,394,987 |      |   |           | 1,370,289 |      |   |           | 1,526,932 |  |   |           | 1,445,929 |  |   |           | 1,281,206 | 
|                                                     
|                                                     
|                                                     
|                                                     
|                                                      | Debt                           |   |                                                  | 109,463   |      |   |           | 109,369   |      |   |           | 452,589   |  |   |           | 480,275   |  |   |           | 451,787   | 
|                                                     
|                                                     
|                                                     
|                                                     
|                                                      | Total stockholders investment |   | $                                                | 840,563   |      |   | $         | 781,777   |      |   | $         | 699,611   |  |   | $         | 648,061   |  |   | $         | 541,574   | 



---

|(a)   |  | Data includes amortized revenue and expense from extended service
agreements, previously included in selling, general and administrative
expense. All periods have been restated to reflect the change.                                                                                                                              
|----- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|     
|     
|     
|     
|(b)   |  | Unusual items consist of Executive Transactions of $4.7 million for the
year ended July 31, 2001, the gain on sale of Diamond Park Fine Jewelers
of ($1.6 million) and a gain on sale of land of ($7.3 million) for the
year ended July 31, 1998.                                                                                    
|      |  |                                                                                                                                                                                                                                                                                                                                      
|Note: |  | Data from Peoples Jewellers in 1999 includes results from May 23, 1999,
the date the Company acquired substantially all assets and certain
operational liabilities of Peoples Jewellers Corp. through July 31, 1999.
Data presented in fiscal year 2000 is inclusive of the sale of the
Companys private label credit card business.
|     
|     
|     
|     
|      |  | Data from Piercing Pagoda in 2001 includes results from September 20, 2000,
the date the Company acquired Piercing Pagoda, Inc., through July 31, 2001.                                                                                                                                                                              

16



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##### Table of Contents






|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
Business  Cautionary Notice Regarding Forward-Looking Statements.

Results of Operations

The following table sets forth certain financial information from the
Companys audited consolidated statements of operations expressed as a
percentage of net sales and should be read in conjunction with the Companys
Consolidated Financial Statements and Notes thereto included elsewhere in this
Form 10-K.

|                                             |  |                     |       |      |  |      |       |   |  |  |       |  
|-------------------------------------------- |  | ------------------- | ----- | ---- |  | ---- | ----- | - |  |  | ----- | -
|                                             |  | Year Ended July 31,
|                                             |  |                    
|                                             |  | 2001                |       | 2000 |  | 1999
|                                             |  |                     |       |      |  |     
|Net Sales                                    |  |                     | 100.0 | %    |  |      | 100.0 | % |  |  | 100.0 | %
|                                            
|                                            
|                                            
|                                            
|Cost of Sales                                |  |                     | 50.1  |      |  |      | 51.3  |   |  |  | 51.6  |  
|                                            
|                                            
|                                            
|                                            
|Non-Recurring Charge                         |  |                     | 1.2   |      |  |      |      |   |  |  |      |  
|                                             |  |                     |       |      |  |      |       |   |  |  |       |  
|Gross Margin                                 |  |                     | 48.7  |      |  |      | 48.7  |   |  |  | 48.4  |  
|                                            
|                                            
|                                            
|                                            
|Selling, General and Administrative Expenses |  |                     | 38.9  |      |  |      | 34.8  |   |  |  | 35.2  |  
|                                            
|                                            
|                                            
|                                            
|Depreciation and Amortization Expense        |  |                     | 2.8   |      |  |      | 2.3   |   |  |  | 2.1   |  
|                                            
|                                            
|                                            
|                                            
|Unusual Item  Executive Transactions        |  |                     | 0.2   |      |  |      |      |   |  |  |      |  
|                                             |  |                     |       |      |  |      |       |   |  |  |       |  
|Operating Earnings                           |  |                     | 6.8   |      |  |      | 11.6  |   |  |  | 11.1  |  
|                                            
|                                            
|                                            
|                                            
|Interest Expense, Net                        |  |                     | 0.3   |      |  |      | 1.8   |   |  |  | 2.1   |  
|                                             |  |                     |       |      |  |      |       |   |  |  |       |  
|Earnings Before Income Taxes                 |  |                     | 6.5   |      |  |      | 9.8   |   |  |  | 9.0   |  
|                                            
|                                            
|                                            
|                                            
|Income Taxes                                 |  |                     | 2.5   |      |  |      | 3.7   |   |  |  | 3.4   |  
|                                             |  |                     |       |      |  |      |       |   |  |  |       |  
|Net Earnings                                 |  |                     | 4.0   | %    |  |      | 6.1   | % |  |  | 5.6   | %
|                                             |  |                     |       |      |  |      |       |   |  |  |       |  

Zale Corporation and its wholly owned subsidiaries (the Company) is the
largest specialty retailer of fine jewelry in North America. At July 31, 2001
the Company operated 2,344 specialty retail jewelry locations throughout the
United States, Canada and Puerto Rico. In September 2000, the Company acquired
Piercing Pagoda and broadened its market base to include the opening price
point customer reached principally through kiosks throughout the United States
and Puerto Rico. As this acquisition was accounted for by the purchase method
of accounting for business combinations, the financial statements do not
include any revenues or expenses related to the kiosk operation prior to
September 20, 2000. In connection with its adoption of Staff Accounting
Bulletin No. 101, Revenue Recognition in Financial Statements, the Company
reclassified revenues and costs of extended warranties to net sales and cost of
sales from selling, general and administrative expense. Prior years amounts
have been restated to conform with this presentation.

Year Ended July 31, 2001 Compared to Year Ended July 31, 2000

Net Sales.During fiscal 2001, the Company recorded net sales of $2.068
billion, an increase of 14.0 percent, over net sales of $1.814 billion for the
prior fiscal year. Sales related to the kiosk operations acquired in September
2000 accounted for substantially all of the total sales increase. Excluding
the kiosk operations, sales remained relatively flat over prior year, despite
64 new stores added during the year (which was offset by 26 stores closed
during the year).

Comparable store sales decreased 3.8 percent in fiscal 2001 on a constant
currency basis. Comparable store sales include sales for those stores which
were in operation for a full period in both the current fiscal year and the
prior fiscal year. Management believes the sales reduction in comparable
stores was attributable to merchandising decisions early in the year along with
a slowdown in the economy and stock market. In the first half of the year, the
Company focused more on promotional items at higher markdowns to increase the
volume in a period of softening sales, while the spring brought a renewed focus
to the diamond and solitaire categories.

Management believes that sales were negatively affected as a result of the
effort to realign inventory, subsequent to the Companys change in management.
During the last half of the fiscal year the Company was focusing on the effort
to liquidate or realign inventory that did not meet the Companys strategic
direction. Management believes that once the realignment is completed, sales
will be positively affected.

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##### Table of Contents



Sales focus has shifted to reemphasize the diamond category. Offsetting
the negative factors above, the Company benefited in fiscal 2001 from strong
sales of certified diamonds and exclusive diamonds, such as the 82 faceted
Zales Diamond, which were well received and strengthened the solitaire
merchandise mix.

Gross Margin.Gross Margin as a percentage of sales remained relatively
flat compared to the prior year at 48.7 percent of sales. The Company recorded
a non-recurring charge of $25.2 million in the second quarter to adjust the
valuation of certain inventory that was not of a quality consistent with the
strategic direction of the Companys brands. The negative impact to margin from
the non-recurring charge of 1.2 percent of sales is offset by the addition of
the kiosk operations, which have a higher gross margin rate than the rest of
the companys in-line stores. Gross margin was also negatively impacted by
increased markdowns and point of sale promotional activity used to liquidate
excess inventory. The LIFO provision was $4.9 million for the year ended July
31, 2001, compared to a $3.0 million benefit in the prior year.

Selling, General and Administrative Expenses.Selling, General and
Administrative Expenses (SG&A) increased 4.1 percent to 38.9 percent of sales
for the year ended July 31, 2001 from 34.8 percent for the year ended July 31,
2000. Approximately 1.4 percent of this increase is principally due to the
acquisition of the kiosk operations in September 2000. This business has
significantly higher store expense as a percentage of sales.

Excluding the kiosk operations, SG&A expenses were 37.5 percent of sales,
an increase of 2.7 percentage points over the prior year. While payroll
expenses remained flat as a percentage of sales, other store expenses such as
rent and occupancy and business expenses increased 0.8 percent of sales
principally as a result of increasing rents for both existing and new stores
during a period with lower sales. Advertising costs rose 0.6 percent of sales,
as increased advertising expenses in fiscal 2001 did not result in a
proportionate increase in sales revenue. These increases were partially offset
by the Companys ability to leverage its fixed corporate overhead, which
decreased 0.4 percent as a percent of sales.

Approximately 1.7 percentage points of the increase in SG&A expense as a
percentage of sales is due to the outsourcing of the Companys customer
accounts receivables program to a third party. In the prior year, amounts
related to the customer receivables for finance charge income, net of customer
receivable account charge-offs and credit operating expenses, were included as
a net reduction in SG&A expense. Subsequent to the outsourcing agreement, only
the merchant fees charged by the third party outsourcer to process customer
receivables are included as a charge in SG&A expense. Also as a result of the
outsourcing, interest expense has been significantly reduced as there is no
longer a requirement to finance those customer receivables.

Unusual Item  Executive Transactions.Effective September 6, 2000,
Robert J. DiNicola retired as Chairman of the Board. In connection with his
severance arrangement, the Company agreed to pay certain benefits of
approximately $1.9 million consisting principally of an amount equivalent to
one year of salary and bonus and other severance related benefits including the
accelerated vesting of certain options held by Mr. DiNicola.

Effective February 12, 2001, Beryl B. Raff resigned as Chairman of the
Board and Chief Executive Officer. In connection with her resignation, the
Company agreed to pay certain benefits of approximately $2.5 million consisting
principally of an amount equivalent to three years of salary and other
severance related benefits including accelerated vesting of certain options and
restricted stock.

Depreciation and Amortization Expense.Depreciation and Amortization
Expense increased by $15.9 million, primarily as a result of goodwill
amortization from the acquisition of Piercing Pagoda and depreciation from the
purchase of new assets, principally for new store openings, renovations and
refurbishments.

Interest Expense, Net.Interest Expense, Net was $6.9 million and $32.2
million for the years ended July 31, 2001 and 2000, respectively. The decrease
of $25.3 million is primarily because the Company is no longer required to
finance its customer receivables, as a result of the sale of these receivables
to Associates.

Income Taxes.The income tax expense for the years ended July 31, 2001 and
2000 was $51.3 million and $66.7 million, respectively, reflecting an effective
tax rate of 38.5 and 37.4 percent for the years ended July 31, 2001 and 2000,
respectively. The increase in the effective rates is due to nondeductible
goodwill amortization from the Piercing Pagoda acquisition. The Company will
realize a cash benefit from utilization of tax net operating loss

18



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##### Table of Contents



carryforwards (NOL) (after annual limitations) against current and
future tax liabilities. As of July 31, 2001, the Company had a remaining NOL
(after limitations) of $152.9 million.

Year Ended July 31, 2000 Compared to Year Ended July 31, 1999

Net Sales.Net Sales for the year ended July 31, 2000 increased by $368.7
million to $1.8 billion, a 25.5 percent increase compared to the previous year.
Excluding sales from Peoples Jewellers which was acquired in fiscal 1999,
total sales for the year increased $234.4 million, or 16.5 percent. The sales
increase primarily resulted from a 11.6 percent increase in sales on a constant
currency basis, from stores open for comparable periods, 84 new stores added
during the year and twelve months of sales for Peoples which was acquired in
May 1999. These factors were partially offset by 28 stores closed during the
year.

Gross Margin.Gross Margin as a percentage of net sales was 48.7 percent
for the year ended July 31, 2000 compared to 48.4 percent for the year ended
July 31, 1999, an increase of 0.3 percent. This increase was principally due
to less price promotional activity at the store level and fewer markdowns of
store merchandise. The LIFO benefit was $3.0 million and $0.7 million for the
years ended July 31, 2000 and 1999.

Selling, General and Administrative Expenses.Selling, General and
Administrative Expenses decreased to 34.8 percent of sales for the year ended
July 31, 2000, from 35.2 percent for the year ended July 31, 1999, or 0.4
percent as a percentage of net sales. Store expenses as a percentage of sales
increased by 0.4 percent principally due to increased advertising to promote
the Companys brands. Net corporate expenses decreased by 1.0 percent as a
percentage of net sales. The selling, general and administrative expense
reduction demonstrated the Companys ability to leverage its fixed store and
corporate operating expenses while increasing sales in its stores.

Depreciation and Amortization Expense.Depreciation and Amortization
Expense increased by $13.0 million, primarily as a result of the purchase of
new assets, principally for new store openings, renovation and refurbishment
and amortization of goodwill from the acquisition of Peoples Jewellers. In
addition, the Company refined the Peoples Jewellers goodwill amortization
period from twenty years to fifteen years, resulting in a $0.9 million
adjustment to goodwill amortization expense. Due to fresh start reporting, the
Company wrote off substantially all fixed assets of the Company effective July
31, 1993. As a result, depreciation and amortization relates to capital
expenditures since July 31, 1993.

Interest Expense, Net.Interest Expense, Net was $32.2 million and $30.5
million for the years ended July 31, 2000 and 1999, respectively. The increase
of $1.7 million is principally a result of lower interest income from
investments due to the acquisition of Peoples Jewellers for fiscal year 2000 of
approximately $78 million cash.

Income Taxes.The income tax expense for the years ended July 31, 2000 and
1999 was $66.7 million and $48.5 million, respectively, reflecting an effective
tax rate of 37.4 and 37.5 percent for the years ended July 31, 2000 and 1999,
respectively. The Company will realize a cash benefit from utilization of tax
net operating loss carryforwards (NOL) (after annual limitations) against
current and future tax liabilities. As of July 31, 2000, the Company had a
remaining NOL (after limitations) of approximately $170 million.

Liquidity and Capital Resources

The Companys cash requirements consist principally of funding inventory
growth, capital expenditures primarily for new store growth and renovations,
upgrading its management information systems and debt service. As of July 31,
2001, the Company had cash and cash equivalents of $29.4 million, and no
restricted cash. The retail jewelry business is highly seasonal, with a
significant proportion of sales and operating income being generated in
November and December of each year. Approximately 42 percent and 41 percent of
the Companys annual sales were made during the three months ended January 31,
2001 and 2000, respectively, which includes the holiday selling season. The
Companys working capital requirements fluctuate during the year, increasing
substantially during the fall season as a result of higher planned seasonal
inventory levels.

Operating Activities

Set forth below is certain summary information with respect to the
Companys operations for the most recent eight fiscal quarters.

19



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|                   |  |                                   |         |                            |  |             |         |             |  |          |         |           |  |             |         |             |  |   |         |  |  |   |         |  |  |   |         |  |  |   |         | 
|------------------ |  | --------------------------------- | ------- | -------------------------- |  | ----------- | ------- | ----------- |  | -------- | ------- | --------- |  | ----------- | ------- | ----------- |  | - | ------- |  |  | - | ------- |  |  | - | ------- |  |  | - | ------- | 
|                   |  | Fiscal 2001                       |         | Fiscal 2000               
|                   |  | For the Three Months Ended        |         | For the Three Months Ended
|                   |  |                                   |         |                           
|                   |  | July 31,                          |         | April 30,                  |  | January 31, |         | October 31, |  | July 31, |         | April 30, |  | January 31, |         | October 31,
|                   |  | 2001                              |         | 2001                       |  | 2001        |         | 2000        |  | 2000     |         | 2000      |  | 2000        |         | 1999       
|                   |  |                                   |         |                            |  |             |         |             |  |          |         |           |  |             |         |            
|                   |  | (Unaudited, Amounts in thousands)
|Net sales          |  | $                                 | 417,033 |                            |  | $           | 417,965 |             |  | $        | 861,442 |           |  | $           | 371,802 |             |  | $ | 379,313 |  |  | $ | 366,582 |  |  | $ | 740,923 |  |  | $ | 327,544 | 
|                  
|                  
|                  
|                  
|Gross margin       |  |                                   | 209,995 |                            |  |             | 209,451 |             |  |          | 405,750 |           |  |             | 182,840 |             |  |   | 183,351 |  |  |   | 179,286 |  |  |   | 362,251 |  |  |   | 158,648 | 
|                  
|                  
|                  
|                  
|Operating earnings |  |                                   | 6,935   |                            |  |             | 7,662   |             |  |          | 118,701 |           |  |             | 6,955   |             |  |   | 25,594  |  |  |   | 25,150  |  |  |   | 143,217 |  |  |   | 16,457  | 
|                  
|                  
|                  
|                  
|Net earnings       |  | $                                 | 2,955   |                            |  | $           | 3,477   |             |  | $        | 71,529  |           |  | $           | 4,087   |             |  | $ | 11,577  |  |  | $ | 10,522  |  |  | $ | 83,952  |  |  | $ | 5,463   | 

Net cash provided by operating activities was $90.4 million, $141.9
million and $81.1 million for fiscal years 2001, 2000, and 1999, respectively.
The net cash provided by operating activities decreased from the prior year,
principally due to lower net earnings and the timing of payments of accounts
payable and accrued liabilities, offset by the sale of the Companys customer
receivables. In fiscal 2000, the net cash provided by operating activities
resulted principally from an increase in net earnings and effective inventory
management resulting in the leveraging of accounts payable and accrued
liabilities.

There has been an
increase of approximately $93.7 million in owned
merchandise inventories at July 31, 2001 compared to the balance at July 31,
2000. This increase resulted principally from the acquisition of the kiosk
operations in September 2000, and new store growth.

Net cash used in investing activities was $325.1 million in fiscal 2001,
principally related to the acquisition of Piercing Pagoda. In fiscal 2000,
net cash provided by investing activities was $508.3 million, principally
related to the proceeds from the sale of credit card receivables to AFCC,
offset by slightly higher capital expenditures. In fiscal 1999, net cash used
in investing activities was $154.3 million, principally related to the
acquisition of Peoples, as well as expenditures for new store growth and
expenditures for remodeling existing stores.

Net cash used in financing activities was $34.0 million in fiscal 2001,
principally related to the stock repurchase plan approved in July 2000 and the
repayment of long-term debt acquired in the Piercing Pagoda acquisition,
slightly offset with proceeds from the exercise of stock options. Net cash used
in financing activities was $387.4 million in fiscal 2000, principally related
to the repayment of the Variable Funding Notes and Revolving Credit Agreement,
as well as the stock repurchase plan approved in September 1999. Net cash used
in financial activities in fiscal 1999 was $64.6 million principally related to
the refinancing and reduction of the Zale Funding Trust Securitization (ZFT)
and repurchase of the companys common stock on the open market.

Finance Arrangements

In order to support the Companys growth plans, the Company amended and
restated its unsecured Revolving Credit Agreement on March 30, 2000. The
Revolving Credit Agreement provides for (i) a U.S. Revolving Credit facility to
the Company and to its operating subsidiary, Zale Delaware, Inc., in the
aggregate principal amount of up to $215 million in commitments by certain U.S.
lenders, including a $10 million sublimit for letters of credit, and (ii) a
separate Canadian Revolving Credit facility for a Canadian subsidiary, which
provides for Canadian dollar denominated loans in the aggregate principal
amount of up to a U.S. Dollar equivalent of $10 million in commitments by a
Canadian lender. The total amount of commitments under the Revolving Credit
Agreement to the Company and its subsidiaries is approximately $225 million and
the term is five years. Under the Revolving Credit Agreement the Company may,
subject to approval of the U.S. Agent or the Canadian Agent, as the case may
be, increase the total U.S. commitment to $285 million and the Canadian
commitment to U.S. Dollar equivalent of $25 million provided that the
commitments together do not exceed U.S. Dollar equivalent of $300 million.

The revolving credit loans bear interest at floating rates as follows:
(A) loans outstanding under the U.S. Revolving Credit Facility bear interest,
at the Companys option, at either (i) the applicable Eurodollar Rate plus a
margin equal to 0.50 percent (subject to adjustment as described below), or
(ii) the Base Rate (which is the higher of the annual rate of interest
announced from time to time by the agent bank under the Revolving Credit
Agreement as its base rate or the Federal Funds Effective Rate plus 0.5
percent); and (B) loans outstanding under the Canadian
Revolving Credit Facility bear interest, at the Companys option, at
either (i) Bankers Acceptance Discount Rate (which varies depending upon
whether the Canadian Lender is a bank named under Schedule I or II to the Bank
Act

20



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##### Table of Contents



(Canada or neither) plus a margin equal to 0.50 percent (subject to
adjustment as described below), or (ii) the annual rate of interest announced
from time to time by the Canadian agent bank under the Revolving Credit
Agreement as its prime rate for commercial loans in Canadian dollars to
borrowers in Canada. At July 31, 2001, there were no amounts outstanding under
the U.S. Revolving Credit Facility. At July 31, 2001, the U.S. Dollar
equivalent of $9.8 million in revolving credit loans was outstanding under the
Canadian Revolving Credit Facility, at an applicable interest rate on such date
of 4.90 percent.

In order to support the Companys longer term capital financing
requirements, the Company issued $100 million of Senior Notes (the Senior
Notes) on September 23, 1997. These notes bear interest at 8 1/2 percent
and are due in 2007. The Senior Notes are unsecured. The proceeds were
utilized to repay indebtedness under the Companys Revolving Credit Agreement
and for general corporate purposes. The indenture relating to the Senior Notes
contains certain restrictive covenants including but not limited to limitations
on indebtedness, limitations on dividends and other restricted payments
(including repurchases of the Companys common stock), limitations on
transactions with affiliates, limitations on liens and limitations on
disposition of proceeds of asset sales, among others. Pursuant to the
Indenture, the Company and the Companys subsidiaries subject to the Indenture,
are prohibited from paying any dividend to the direct or indirect holders of
Capital Stock of the Company or such subsidiary, other than stock dividends or
dividends made to the Company or any such subsidiary.

Capital Growth

During the year ended July 31, 2001, the Company made approximately $88
million in capital expenditures, a portion of which was used to open 85 new
locations and remodel, relocate or refurbish other locations. As a result of
current business conditions, the Company has scaled back its capital plan. The
Company plans to open approximately 60 new locations for which it will incur
approximately $13 million in capital expenditures during fiscal year 2002.
During fiscal year 2002, the Company anticipates spending approximately $21
million to remodel, relocate or refurbish approximately 180 additional
locations. This will allow focus on productivity of existing core store
locations. The Company also estimates that it will make capital expenditures
of approximately $8 million during fiscal year 2002 for enhancements to its
management information systems and infrastructure expansion. In total, the
Company anticipates spending approximately $60 million on capital expenditures
during fiscal year 2002. The Revolving Credit Agreement limits the Companys
capital expenditures to $135 million for fiscal year 2002.

Other Activities Affecting Liquidity

 Effective July 31, 2000, the Company sold its private label credit card
operations and outstanding accounts receivable to Associates. The total
purchase price for the accounts receivable was approximately $542 million. With
a portion of the proceeds from this sale, the Company paid off all of its
credit card related indebtedness and the Companys receivables securitization
facility was terminated.

In connection with the sale of its customer receivables, the Company
entered into a ten-year merchant services agreement whereby Hurley, a wholly
owned subsidiary of AFCC, will issue private label credit cards branded with
appropriate Company trademarks and provide financing for the Companys
customers to purchase merchandise in exchange for payment by the Company of a
merchant fee based upon a percentage of each credit card sale. The merchant
fee is a flat percentage per credit sale for standard revolving accounts and
varies for certain special interest free or deferred payment credit sales,
depending on the credit program. The Company received a $41.8 million
incentive for entering into the agreement. Portions of this payment are
subject to refund for early termination of the agreement. This incentive
payment will be recognized ratably over the term of the agreement.

 On August 7, 2001, the Company announced that its Board of Directors had
approved a stock repurchase program pursuant to which the Company, from time to
time and at managements discretion, may purchase throughout the fiscal year,
up to an aggregate of $50 million of Zale common stock on the open market.

 On September 20, 2000, the Company completed the acquisition of Piercing
Pagoda, Inc. (Piercing Pagoda), the largest retailer of gold jewelry through
kiosk stores in the United States, for approximately $203 million, plus
approximately $45 million to pay down existing debt and the assumption of
certain bank debt and
liabilities. The entire cost of the acquisition was funded through the
Companys available cash and from working capital.

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 The Company has an operations services agreement for its management
information systems function with a third-party servicer. The agreement, which
was effective August 1, 1999, requires fixed payments totaling $34.4 million
over a 60 month term and a variable amount based on usage. Management is
evaluating future outsourcing opportunities since this agreement expires at the
end of fiscal 2002. The Company has an option to extend the current agreement
for two consecutive one year periods.

 Future liquidity will be enhanced to the extent that the Company is able
to realize the cash benefit from utilization of its NOL against current and
future tax liabilities. The cash benefit realized in fiscal year 2001 was
approximately $7 million. As of July 31, 2001, the Company had a NOL (after
limitations) of $152.9 million, which represents up to $59 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. The NOL
can be utilized through 2008.

 Management believes that operating cash flow and amounts available under
the Revolving Credit Agreement should be sufficient to fund the Companys
current operations, debt service and currently anticipated capital expenditure
requirements for the foreseeable future.

New Accounting Pronouncements

On July 21, 2001, the Financial Accounting Standards Board issued
Statements of Financial Accounting Standards No. 141 (SFAS No. 141), Business
Combinations, and No. 142 (SFAS No. 142), Goodwill and Other Intangible
Assets. SFAS No. 141 addresses financial accounting and reporting for goodwill
and other intangible assets acquired in a business combination. SFAS No. 141
requires the purchase method of accounting to be used for all business
combinations initiated after June 30, 2001 and establishes specific criteria
for the recognition of intangible assets separate from goodwill. SFAS No. 142
addresses financial accounting and reporting for goodwill and other intangible
assets subsequent to their acquisition, including negative goodwill. SFAS No.
142 provides that goodwill and intangible assets which have indefinite useful
lives will not be amortized but rather will be tested at least annually for
impairment and upon adoption. Negative goodwill related to future acquisitions
will be recorded as an extraordinary item. The Company plans to adopt SFAS No.
142 in the first quarter of fiscal 2002. As a result, the Company expects to
recognize a cumulative effect of a change in accounting principle of
approximately $41 million in the first quarter of fiscal 2002 related to the
write off of the Excess of Revalued Net Assets Over Stockholders Investment.
Additionally, goodwill related to the Companys acquisitions will no longer be
amortized. This change will result in an increase to earnings of approximately
$7 million in fiscal 2002. In accordance with the standard, the Company will
have an appraisal of its reporting units that include goodwill upon adoption to
determine whether an impairment exists.

Inflation

In managements opinion, changes in net sales and net earnings that have
resulted from inflation and changing prices have not been material during the
periods presented. There is no assurance, however, that inflation will not
materially affect the Company in the future.

22



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ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

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

The Company is exposed to interest rate risk primarily through its
borrowing activities, which are described under Long-term Debt in the Notes
to the Consolidated Financial Statements. However, the majority of the
Companys borrowings outstanding at July 31, 2001 are under fixed rate
arrangements. See Long-term Debt in the Notes to the Consolidated Financial
Statements, which are incorporated herein by reference.

The investments of the Companys insurance subsidiaries, primarily stocks
and bonds in the amount of $26.7 million, approximate market value at July 31,
2001.

Based on the Companys market risk sensitive instruments (including
variable rate debt) outstanding at July 31, 2001, the Company has determined
that there was no material market risk exposure to the Companys consolidated
financial position, results of operations or cash flows as of such date.

As a result of its Canadian operations, the Company is exposed to market
risk from currency exchange rate exposure which may adversely affect the
Companys financial position, results of operations and cash flows. In seeking
to minimize this risk, the Company manages exposures through its regular
operating and financing activities. Based on the Companys market risk from
currency exchange rate exposure at July 31, 2001, the Company believes that
there was no material market risk exposure to the Companys consolidated
financial position, results of operations or cash flows on such date.

The Companys commodity risk exposure to diamond and gold market price
fluctuation is not hedged by financial instruments. The Company addresses
commodity price risk through retail price points.

23



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ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

The following Consolidated Financial Statements of the Company and
supplementary data are included as pages F-1 through F-30 at the end of this
Annual Report on Form 10-K:

|                                                    |  |        |      | 
|--------------------------------------------------- |  | ------ | ---- | 
|                                                    |  | Page  
|Index                                               |  | Number
|                                                    |  |       
|Managements Report                                 |  |        | F-2  | 
|                                                   
|                                                   
|                                                   
|                                                   
|Report of Independent Public Accountants            |  |        | F-3  | 
|                                                   
|                                                   
|                                                   
|                                                   
|Consolidated Statements of Operations               |  |        | F-4  | 
|                                                   
|                                                   
|                                                   
|                                                   
|Consolidated Balance Sheets                         |  |        | F-5  | 
|                                                   
|                                                   
|                                                   
|                                                   
|Consolidated Statements of Cash Flows               |  |        | F-6  | 
|                                                   
|                                                   
|                                                   
|                                                   
|Consolidated Statements of Stockholders Investment |  |        | F-8  | 
|                                                   
|                                                   
|                                                   
|                                                   
|Notes to Consolidated Financial Statements          |  |        | F-10 | 




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

None.




PART III




ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS

The information set forth under the headings Proposal No. One: Election
of Directors and Section 16(a) Beneficial Ownership Reporting Compliance in
the Companys definitive Proxy Statement for the 2001 Annual Meeting of
Shareholders is incorporated herein by reference. In addition, the information
set forth under Executive Officers of the Registrant in Part I of this report
is incorporated herein by reference.




ITEM 11. EXECUTIVE COMPENSATION

The information set forth under the heading Executive and Director
Compensation in the Companys definitive Proxy Statement for the 2001 Annual
Meeting of Shareholders is incorporated herein by reference.




ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

The information set forth under the heading Outstanding Voting Securities
of the Company and Principal Holders Thereof in the Companys definitive Proxy
Statement for the 2001 Annual Meeting of Shareholders is incorporated herein by
reference.




ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.

The information set forth under the headings Certain Relationships and
Transactions and Executive Compensation  Compensation Committee Interlocks
and Insider Participation in the Companys definitive Proxy Statement for the
2001 Annual Meeting of Shareholders is incorporated herein by reference.

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##### Table of Contents






PART IV




ITEM 14. EXHIBITS, FINANCIAL STATEMENTS SCHEDULES AND REPORTS ON FORM 8-K

The following documents are filed as part of this report.

1. Financial Statements

The list of financial statements required by this item is set forth in
Item 8.

2. Index to Financial Statement Schedules

|                                                |  |        |    | 
|----------------------------------------------- |  | ------ | -- | 
|                                                |  | Page  
|                                                |  | Number
|                                                |  |       
|Report of Independent Public Accountants        |  |        | 30 | 
|                                               
|                                               
|                                               
|                                               
|Schedule II  Valuation and Qualifying Accounts |  |        | 31 | 

All other financial statements and financial statement schedules for which
provision is made in the applicable accounting regulation of the Securities and
Exchange Commission 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.

25



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##### Table of Contents



3. Exhibits

|            |  |   |  |                                                                                                                                                                                      
|----------- |  | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit No. |  |   |  | Description                                                                                                                                                                          
|            |  |   |  |                                                                                                                                                                                      
|3.1         |  |  |  | Restated Certificate of Incorporation of Zale Corporation, dated July 30, 1993.(1)                                                                                                   
|           
|           
|           
|           
|3.2         |  |  |  | Amended and Restated Bylaws of Zale Corporation.(12)                                                                                                                                 
|           
|           
|           
|           
|4.1         |  |  |  | Amended and Restated Revolving Credit Agreement dated March 30, 2000.(12)                                                                                                            
|           
|           
|           
|           
|4.2         |  |  |  | Indenture dated September 30, 1997, by and among Zale Corporation, Zale Delaware,
Inc. and Bank One, N.A. as Trustee.(8)                                                             
|           
|           
|           
|           
|10.1        |  |  |  | Zale Corporation Savings and Investment Plan.(16)                                                                                                                                    
|           
|           
|           
|           
|10.2        |  |  |  | Indemnification agreement, dated as of July 21, 1993, between Zale Corporation and
certain present and former directors thereof.(3)                                                  
|           
|           
|           
|           
|*10.3a      |  |  |  | Zale Corporation Stock Option Plan.(1)                                                                                                                                               
|           
|           
|           
|           
|*10.3b      |  |  |  | Amended and
Restated Omnibus Stock Incentive Plan.(13)                                                                                                                               
|           
|           
|           
|           
|*10.3c      |  |  |  | Outside Directors 1995 Stock Option Plan.(19)                                                                                                                                       
|           
|           
|           
|           
|*10.4a      |  |  |  | The Executive Severance Plan for Zale Corporation and Its Affiliates, as amended
and restated as of February 10, 1994.(2)                                                            
|           
|           
|           
|           
|*10.4b      |  |  |  | Amendment to The Executive Severance Plan for Zale Corporation and Its Affiliates
effective May 20, 1995.(4)                                                                         
|           
|           
|           
|           
|10.5a       |  |  |  | Lease Agreement Between Principal Mutual Life Insurance Company, As Landlord, and
Zale corporation, as Debtor and Debtor-In-Possession, As Tenant, dated as of
September 17, 1992.(4)
|           
|           
|           
|           
|*10.5b      |  |  |  | First Lease Amendment and Agreement Between Principal Mutual Life Insurance
Company and Zale Delaware, Inc. dated as of February 1, 1996.(4)                                         
|           
|           
|           
|           
|10.6        |  |  |  | Indemnification Agreement, executed on October 30, 1996, and dated as of June 6,
1996, between Zale Corporation and Andrea Jung.(5)                                                  
|           
|           
|           
|           
|10.7        |  |  |  | Receivables Purchase Agreement, between Zale Funding Trust, as Seller, and
Associates Credit Card Services, Inc., as Purchaser, dated as of July 10, 2000.(13)                       
|           
|           
|           
|           
|10.8        |  |  |  | Agreement and Plan of Merger, by and among Jewelers National Bank, Zale Delaware,
Inc. and Hurley State Bank, dated as of July 10, 2000.(13)                                         
|           
|           
|           
|           
|10.9        |  |  |  | Agreement and Plan of Merger, by and among Zale Corporation, Jewelry Expansion
Corp. and Piercing Pagoda, Inc., dates as of August 11, 2000.(14)                                     
|           
|           
|           
|           
|10.11a      |  |  |  | Seconded Amended and Restated Employment Agreement dated August 1, 2000, between
Zale Corporation and Robert J. DiNicola.(13)                                                        
|           
|           
|           
|           
|10.11b      |  |  |  | Consulting Agreement, dated September 6, 2000, between Zale Corporation and Robert
J. DiNicola.(13)                                                                                  
|           
|           
|           
|           
|*10.11c     |  |  |  | Employment Agreement, dated as of February 21, 2001, by and between Zale
Corporation and Robert J. DiNicola.(18)                                                                     

26



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##### Table of Contents



|            |  |   |  |                                                                                                                                   
|----------- |  | - |  | ----------------------------------------------------------------------------------------------------------------------------------
|Exhibit No. |  |   |  | Description                                                                                                                       
|            |  |   |  |                                                                                                                                   
|           
|           
|           
|           
|*10.11d     |  |  |  | Employment Agreement, dated as of August 1, 2001, between Zale Corporation and
Robert J. DiNicola.(19)                            
|           
|           
|           
|           
|*10.12      |  |  |  | Settlement Agreement, dated as of February 11, 2001, by and among Zale
Corporation, Zale Delaware, Inc. and Beryl B. Raff.(17)    
|           
|           
|           
|           
|*10.13      |  |  |  | Employment Agreement, dated as of August 1, 2001, between Zale Corporation and
Alan P. Shor.(19)                                  
|           
|           
|           
|           
|*10.14      |  |  |  | Employment Agreement, dated as of August 1, 2001 between Zale Corporation and Mary
L. Forté.(19)                                  
|           
|           
|           
|           
|*10.15      |  |  |  | Employment Agreement, dated as of August 1, 2001, between Zale Corporation and Sue
E. Gove.(19)                                   
|           
|           
|           
|           
|10.16       |  |  |  | Promissory Note, Stock Pledge Agreement, Dated as of December 4, 2000, between
Zale Corporation and Robert J. DiNicola.(18)       
|           
|           
|           
|           
|10.17       |  |  |  | Real Estate Lien Note, dated as of April 6, 2001, between Zale Corporation and
Robert J. DiNicola.(18)                            
|           
|           
|           
|           
|10.18       |  |  |  | Holdback Agreement, dated as of March 27, 2001, between Zale Corporation and Alan
P. Shor.(18)                                    
|           
|           
|           
|           
|10.19       |  |  |  | Holdback Agreement, dated as of March 27, 2001, between Zale Corporation and Sue
E. Gove.(18)                                     
|           
|           
|           
|           
|10.20       |  |  |  | Holdback Agreement, dated as of March 27, 2001, between Zale Corporation and Mary
Forté.(18)                                      
|           
|           
|           
|           
|10.21       |  |  |  | Amendment to Real Estate Lien Note, dated as of August 1, 2001, between Zale
Corporation and Robert J. DiNicola.(19)              
|           
|           
|           
|           
|10.22       |  |  |  | Amendment and Extension to Real Estate Lien Note, dated as of August 1, 2001,
between Zale Corporation and Robert J. DiNicola.(19)
|           
|           
|           
|           
|10.23       |  |  |  | Zale Executive Bonus Plan.(9)                                                                                                     
|           
|           
|           
|           
|21          |  |  |  | Subsidiaries of the registrant.(19)                                                                                               
|           
|           
|           
|           
|23          |  |  |  | Consent of Independent Public Accountants.(19)                                                                                    



---

|(1) |  | Previously filed as an exhibit to the registrants Form 10-Q (No.
1-04129) for the quarterly period ended September 30, 1993, and
incorporated herein by reference.                     
|--- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|   
|   
|   
|   
|(2) |  | Incorporated by reference to the corresponding exhibit to the
registrants Registration Statement on Form S-1 (No. 33-73310) filed with
the Commission on December 23, 1993, as amended.
|   
|   
|   
|   
|(3) |  | Previously filed as an exhibit to the registrants Form 10-K (No.
0-21526) for the fiscal year ended July 31, 1995, and incorporated herein
by reference.                               
|   
|   
|   
|   
|(4) |  | Previously filed as an exhibit to the registrants Form 10-K (No.
0-21526) for the fiscal year ended July 31, 1996, and incorporated herein
by reference.                               

27



---



##### Table of Contents



|(5)  |  | Previously filed as an exhibit to the registrants Form 10-Q (No.
0-21526) for the quarterly period ended October 31, 1996, and
incorporated herein by reference.            
|---- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|    
|    
|    
|    
|(6)  |  | Previously filed as an exhibit to the registrants Form 10-Q (No.
0-21526) for the quarterly period ended January 31, 1997, and
incorporated herein by reference.            
|    
|    
|    
|    
|(7)  |  | Previously filed as an exhibit to the registrants Form 10-K (No.
0-21526) for the fiscal year ended July 31, 1997, and incorporated herein
by reference.                    
|    
|    
|    
|    
|(8)  |  | Incorporated by reference to Exhibit 4.1 to the registrants
Registration Statement on Form S-4 (No. 33-39473) filed with the
Commission on November 4, 1997.                
|    
|    
|    
|    
|(9)  |  | Previously filed as an exhibit to the registrants Form 10-K (No.
0-21526) for the fiscal year ended July 31, 1998, and incorporated
herein by reference.                    
|    
|    
|    
|    
|(10) |  | Previously filed as an exhibit to the registrants Form 10-Q (No.
0-21526) for the quarterly period ended October 31, 1998, and
incorporated herein by reference.            
|    
|    
|    
|    
|(11) |  | Previously filed as an exhibit to the registrants Form 10-K (No.
1-04129) for the fiscal year ended July 31, 1999, and incorporated herein
by reference.                    
|    
|    
|    
|    
|(12) |  | Previously filed as an exhibit to the registrants Form 10-Q (No.
1-04129) for the quarterly period ended April 30, 2000, and incorporated
herein by reference.              
|    
|    
|    
|    
|(13) |  | Previously filed as an exhibit to the registrants Form 10-K (No.
1-04129) for the fiscal year ended July 31, 2000, and incorporated herein
by reference.                    
|    
|    
|    
|    
|(14) |  | Incorporated by reference to Exhibit 10.64 to Piercing Pagoda, Inc.s
Form 10-Q for the quarter ended June 30, 2000, previously filed with the
Commission on August 14, 2000.
|    
|    
|    
|    
|(15) |  | Incorporated by reference to the corresponding exhibit to the
Registration Statement on Form S-8 (33-01789) filed with the Commission
on March 18, 1996.                     
|    
|    
|    
|    
|(16) |  | Previously filed as an exhibit to the registrants Form 11-K (No.
1-04129) for the fiscal year ended July 31, 2000, and incorporated herein
by reference.                    
|    
|    
|    
|    
|(17) |  | Previously filed as an exhibit to the registrants Form 10-Q (No.
1-04129) for the quarterly period ended January 31, 2001, and
incorporated herein by reference.            
|    
|    
|    
|    
|(18) |  | Previously filed as an exhibit to the registrants Form 10-Q (No.
1-04129) for the quarterly period ended April 30, 2001, and incorporated
herein by reference.              
|    
|    
|    
|    
|(19) |  | Filed herewith.                                                                                                                                                              
|    
|    
|    
|    
|*    |  | Management Contracts and Compensatory Plans.                                                                                                                                 

4. Reports on Form 8-K

On June 11, 2001, the Company filed a Current Report on Form 8-K under
Item 9, Regulation FD
Disclosure, to furnish a slide presentation from a meeting with institutional
investors.

28



---



##### Table of Contents



INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

|                                                    |  |      |      | 
|--------------------------------------------------- |  | ---- | ---- | 
|                                                    |  | Page
|                                                    |  |     
|Managements Report                                 |  |      | F-2  | 
|                                                   
|                                                   
|                                                   
|                                                   
|Report of Independent Public Accountants            |  |      | F-3  | 
|                                                   
|                                                   
|                                                   
|                                                   
|Consolidated Statements of Operations               |  |      | F-4  | 
|                                                   
|                                                   
|                                                   
|                                                   
|Consolidated Balance Sheets                         |  |      | F-5  | 
|                                                   
|                                                   
|                                                   
|                                                   
|Consolidated Statements of Cash Flows               |  |      | F-6  | 
|                                                   
|                                                   
|                                                   
|                                                   
|Consolidated Statements of Stockholders Investment |  |      | F-8  | 
|                                                   
|                                                   
|                                                   
|                                                   
|Notes to Consolidated Financial Statements          |  |      | F-10 | 

F-1



---



##### Table of Contents



MANAGEMENTS REPORT

To the Stockholders of Zale Corporation:

The integrity and consistency of the consolidated financial statements of
Zale Corporation (the Company), which were prepared in accordance with
generally accepted accounting principles, are the responsibility of management
and properly include some amounts that are based upon estimates and judgments.

The Company maintains a system of internal accounting controls to provide
reasonable assurance, at appropriate cost, that the Companys assets are
protected and transactions are properly recorded. Additionally, the integrity
of the financial accounting system is based on careful selection and training
of qualified personnel, organizational arrangements which provide for
appropriate division of responsibilities and communication of established
written policies and procedures.

The consolidated financial statements of the Company have been audited by
Arthur Andersen LLP, independent public accountants. Their report expresses
their opinion as to the fair presentation, in all material respects, of the
financial statements and is based upon their independent audit conducted in
accordance with generally accepted auditing standards.

The Audit Committee, composed solely of outside directors, meets
periodically with the independent public accountants and representatives of
management to discuss auditing and financial reporting matters. In addition,
the independent public accountants meet periodically with the Audit Committee
without management representatives present and have free access to the Audit
Committee at any time. The Audit Committee is responsible for recommending to
the Board of Directors the engagement of the independent public accountants,
which is subject to stockholder approval, and the general oversight review of
managements discharge of its responsibilities with respect to the matters
referred to above.

|                                                                    |  |                                                                
|------------------------------------------------------------------- |  | ---------------------------------------------------------------
|Robert J. DiNicolaChairman of the Board and
Chief Executive Officer |  | Sue E. GoveExecutive Vice President and
Chief Financial Officer

F-2



---



##### Table of Contents



REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS

To the Stockholders and Board of Directors of Zale Corporation:

We have audited the accompanying consolidated balance sheets of Zale
Corporation (a Delaware corporation) and subsidiaries as of July 31, 2001 and
2000, and the related consolidated statements of operations, cash flows, and
stockholders investment for each of the three years in the period ended July
31, 2001. These financial statements are the responsibility of the Companys
management. Our responsibility is to express an opinion on these financial
statements based on our audits.

We conducted our audits in accordance with auditing standards generally
accepted in the 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 financial statements referred to above present fairly,
in all material respects, the financial position of Zale Corporation and
subsidiaries as of July 31, 2001 and 2000, and the results of their operations
and their cash flows for each of the three years in the period ended July 31,
2001, in conformity with accounting principles generally accepted in the United
States.

ARTHUR ANDERSEN LLP

Dallas, Texas
August 27, 2001

F-3



---



##### Table of Contents



ZALE CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS
(amounts in thousands, except per share amounts)

|                                                                                   |         |         |           |            |      |            |           |            |      |   |           |        |      | 
|---------------------------------------------------------------------------------- | ------- | ------- | --------- | ---------- | ---- | ---------- | --------- | ---------- | ---- | - | --------- | ------ | ---- | 
|                                                                                   |         |         |           | Year Ended |      | Year Ended |           | Year Ended
|                                                                                   |         |         |           | July 31,   |      | July 31,   |           | July 31,  
|                                                                                   |         |         |           | 2001       |      | 2000       |           | 1999      
|                                                                                   |         |         |           |            |      |            |           |           
|Net Sales                                                                          |         | $       | 2,068,242 |            |      | $          | 1,814,362 |            |      | $ | 1,445,634 |       
|                                                                                  
|                                                                                  
|                                                                                  
|                                                                                  
|Cost of Sales                                                                      |         |         | 1,034,970 |            |      |            | 930,826   |            |      |   | 746,663   |       
|                                                                                  
|                                                                                  
|                                                                                  
|                                                                                  
|Non-recurring charge                                                               |         |         | 25,236    |            |      |            |          |            |      |   |          |       
|                                                                                   |         |         |           |            |      |            |           |            |      |   |           |       
|Gross Margin                                                                       |         |         | 1,008,036 |            |      |            | 883,536   |            |      |   | 698,971   |       
|                                                                                  
|                                                                                  
|                                                                                  
|                                                                                  
|Selling, General and Administrative Expenses                                       |         |         | 804,780   |            |      |            | 630,687   |            |      |   | 509,570   |       
|                                                                                  
|                                                                                  
|                                                                                  
|                                                                                  
|Depreciation and Amortization Expense                                              |         |         | 58,290    |            |      |            | 42,431    |            |      |   | 29,478    |       
|                                                                                  
|                                                                                  
|                                                                                  
|                                                                                  
|Unusual Item  Executive Transactions                                              |         |         | 4,713     |            |      |            |          |            |      |   |          |       
|                                                                                   |         |         |           |            |      |            |           |            |      |   |           |       
|Operating Earnings                                                                 |         |         | 140,253   |            |      |            | 210,418   |            |      |   | 159,923   |       
|                                                                                  
|                                                                                  
|                                                                                  
|                                                                                  
|Interest Expense, Net                                                              |         |         | 6,857     |            |      |            | 32,178    |            |      |   | 30,488    |       
|                                                                                   |         |         |           |            |      |            |           |            |      |   |           |       
|Earnings Before Income Taxes                                                       |         |         | 133,396   |            |      |            | 178,240   |            |      |   | 129,435   |       
|                                                                                  
|                                                                                  
|                                                                                  
|                                                                                  
|Income Taxes                                                                       |         |         | 51,348    |            |      |            | 66,726    |            |      |   | 48,503    |       
|                                                                                   |         |         |           |            |      |            |           |            |      |   |           |       
|Net Earnings                                                                       |         | $       | 82,048    |            |      | $          | 111,514   |            |      | $ | 80,932    |       
|                                                                                   |         |         |           |            |      |            |           |            |      |   |           |       
|Earnings Per Common Share:                                                         |         |         |           |            |      |            |           |            |      |   |           |       
|                                                                                  
|                                                                                  
|                                                                                  
|                                                                                  
|                                                                                   |         | Basic   |           | $          | 2.37 |            |           | $          | 3.16 |   |           | $      | 2.24 | 
|                                                                                  
|                                                                                  
|                                                                                  
|                                                                                  
|                                                                                   |         | Diluted |           | $          | 2.36 |            |           | $          | 3.11 |   |           | $      | 2.21 | 
|                                                                                  
|                                                                                  
|                                                                                  
|                                                                                  
|Weighted Average Number of Common Shares
and Common Share Equivalents Outstanding: |         |         |           |            |      |            |           |            |      |   |           |       
|                                                                                  
|                                                                                  
|                                                                                  
|                                                                                  
|                                                                                   | Basic   |         |           | 34,575     |      |            |           | 35,326     |      |   |           | 36,137 |     
|                                                                                  
|                                                                                  
|                                                                                  
|                                                                                  
|                                                                                   | Diluted |         |           | 34,751     |      |            |           | 35,883     |      |   |           | 36,688 |     

See Notes to the Consolidated Financial Statements.

F-4



---



##### Table of Contents



ZALE CORPORATION AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS
(amounts in thousands)

|                                                                 |                                               |   |           |         |               |   |               |         |   |  | 
|---------------------------------------------------------------- | --------------------------------------------- | - | --------- | ------- | ------------- | - | ------------- | ------- | - |  | 
|                                                                 |                                               |   |           |         | July 31, 2001 |   | July 31, 2000
|                                                                 |                                               |   |           |         |               |   |              
|ASSETS                                                          
|                                                                
|                                                                
|                                                                
|                                                                
|Current Assets:                                                  |                                               |   |           |         |               |   |               |        
|                                                                
|                                                                
|                                                                
|                                                                
|                                                                 | Cash and Cash Equivalents                     |   | $         | 29,390  |               |   | $             | 298,234 |  
|                                                                
|                                                                
|                                                                
|                                                                
|                                                                 | Restricted Cash                               |   |           |        |               |   |               | 3,913   |  
|                                                                
|                                                                
|                                                                
|                                                                
|                                                                 | Merchandise Inventories                       |   |           | 724,157 |               |   |               | 630,450 |  
|                                                                
|                                                                
|                                                                
|                                                                
|                                                                 | Other Current Assets                          |   |           | 57,153  |               |   |               | 42,551  |  
|                                                                 |                                               |   |           |         |               |   |               |        
|Total Current Assets                                             |                                               |   | 810,700   |         |               |   | 975,148       |        
|                                                                
|                                                                
|                                                                
|                                                                
|Property and Equipment, Net                                      |                                               |   | 296,413   |         |               |   | 231,255       |        
|                                                                
|                                                                
|                                                                
|                                                                
|Goodwill, Net                                                    |                                               |   | 206,402   |         |               |   | 64,482        |        
|                                                                
|                                                                
|                                                                
|                                                                
|Other Assets                                                     |                                               |   | 33,768    |         |               |   | 35,708        |        
|                                                                
|                                                                
|                                                                
|                                                                
|Deferred Tax Asset, Net                                          |                                               |   | 47,704    |         |               |   | 63,696        |        
|                                                                 |                                               |   |           |         |               |   |               |        
|Total Assets                                                     |                                               | $ | 1,394,987 |         |               | $ | 1,370,289     |        
|                                                                 |                                               |   |           |         |               |   |               |        
|                                                                
|LIABILITIES AND STOCKHOLDERS INVESTMENT                        
|                                                                
|Current Liabilities:                                             |                                               |   |           |         |               |   |               |        
|                                                                
|                                                                
|                                                                
|                                                                
|                                                                 | Accounts Payable and Accrued Liabilities      |   | $         | 269,111 |               |   | $             | 286,279 |  
|                                                                
|                                                                
|                                                                
|                                                                
|                                                                 | Deferred Tax Liability, Net                   |   |           | 16,129  |               |   |               | 22,692  |  
|                                                                 |                                               |   |           |         |               |   |               |        
|Total Current Liabilities                                        |                                               |   | 285,240   |         |               |   | 308,971       |        
|                                                                
|                                                                
|                                                                
|                                                                
|Non-current Liabilities                                          |                                               |   | 118,434   |         |               |   | 122,987       |        
|                                                                
|                                                                
|                                                                
|                                                                
|Long-term Debt                                                   |                                               |   | 109,463   |         |               |   | 109,369       |        
|                                                                
|                                                                
|                                                                
|                                                                
|Excess of Revalued Net Assets Over
Stockholders Investment, Net |                                               |   | 41,287    |         |               |   | 47,185        |        
|                                                                
|                                                                
|                                                                
|                                                                
|Commitments and Contingencies                                    |                                               |   |           |         |               |   |               |        
|                                                                
|                                                                
|                                                                
|                                                                
|Stockholders Investment:                                        |                                               |   |           |         |               |   |               |        
|                                                                
|                                                                
|                                                                
|                                                                
|                                                                 | Preferred Stock                               |   |           |        |               |   |               |        |  
|                                                                
|                                                                
|                                                                
|                                                                
|                                                                 | Common Stock                                  |   |           | 404     |               |   |               | 396     |  
|                                                                
|                                                                
|                                                                
|                                                                
|                                                                 | Additional Paid-In Capital                    |   |           | 539,904 |               |   |               | 518,326 |  
|                                                                
|                                                                
|                                                                
|                                                                
|                                                                 | Accumulated Other Comprehensive (Loss) Income |   |           | (2,355  | )             |   |               | 411     |  
|                                                                
|                                                                
|                                                                
|                                                                
|                                                                 | Accumulated Earnings                          |   |           | 485,835 |               |   |               | 403,787 |  
|                                                                
|                                                                
|                                                                
|                                                                
|                                                                 | Deferred Compensation                         |   |           | (8,253  | )             |   |               | (1,786  | )
|                                                                 |                                               |   |           |         |               |   |               |        
|                                                                 |                                               |   | 1,015,535 |         |               |   | 921,134       |        
|                                                                
|                                                                
|                                                                
|                                                                
|Treasury Stock                                                   |                                               |   | (174,972  | )       |               |   | (139,357      | )      
|                                                                 |                                               |   |           |         |               |   |               |        
|Total Stockholders Investment                                   |                                               |   | 840,563   |         |               |   | 781,777       |        
|                                                                 |                                               |   |           |         |               |   |               |        
|Total Liabilities and Stockholders Investment                   |                                               | $ | 1,394,987 |         |               | $ | 1,370,289     |        
|                                                                 |                                               |   |           |         |               |   |               |        

See Notes to the Consolidated Financial Statements.

F-5



---



##### Table of Contents



ZALE CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS
(amounts in thousands)

|                                                                                              |                                                    |   |            |         |            |   |            |         |   |   |          |         |  
|--------------------------------------------------------------------------------------------- | -------------------------------------------------- | - | ---------- | ------- | ---------- | - | ---------- | ------- | - | - | -------- | ------- | -
|                                                                                              |                                                    |   | Year Ended |         | Year Ended |   | Year Ended
|                                                                                              |                                                    |   | July 31,   |         | July 31,   |   | July 31,  
|                                                                                              |                                                    |   | 2001       |         | 2000       |   | 1999      
|                                                                                              |                                                    |   |            |         |            |   |           
|Net Cash Flows from Operating Activities:                                                     |                                                    |   |            |         |            |   |            |         |   |   |          |        
|                                                                                             
|                                                                                             
|                                                                                             
|                                                                                             
|Net earnings                                                                                  |                                                    | $ | 82,048     |         |            | $ | 111,514    |         |   | $ | 80,932   |        
|                                                                                             
|                                                                                             
|                                                                                             
|                                                                                             
|Adjustments to reconcile net earnings
to net cash provided by operating activities:           |                                                    |   |            |         |            |   |            |         |   |   |          |        
|                                                                                             
|                                                                                             
|                                                                                             
|                                                                                             
|                                                                                              | Non-recurring cost of sales charge                 |   |            | 25,236  |            |   |            |        |   |   |          |        |  
|                                                                                             
|                                                                                             
|                                                                                             
|                                                                                             
|                                                                                              | Depreciation and amortization expense              |   |            | 59,261  |            |   |            | 44,325  |   |   |          | 31,252  |  
|                                                                                             
|                                                                                             
|                                                                                             
|                                                                                             
|                                                                                              | Amortization of deferred compensation              |   |            | 650     |            |   |            | 3,219   |   |   |          | 709     |  
|                                                                                             
|                                                                                             
|                                                                                             
|                                                                                             
|                                                                                              | Deferred taxes and utilization of NOL              |   |            | 20,281  |            |   |            | 23,427  |   |   |          | 7,633   |  
|                                                                                             
|                                                                                             
|                                                                                             
|                                                                                             
|                                                                                              | Tax benefit associated with stock option exercises |   |            | 998     |            |   |            | 4,156   |   |   |          | 6,800   |  
|                                                                                             
|                                                                                             
|                                                                                             
|                                                                                             
|Changes in assets and liabilities, net of
Peoples Jewellers and Piercing Pagoda acquisitions: |                                                    |   |            |         |            |   |            |         |   |   |          |        
|                                                                                             
|                                                                                             
|                                                                                             
|                                                                                             
|                                                                                              | Restricted cash                                    |   |            | 3,913   |            |   |            | 2,116   |   |   |          | 163     |  
|                                                                                             
|                                                                                             
|                                                                                             
|                                                                                             
|                                                                                              | Customer receivables, net                          |   |            |        |            |   |            | (27,036 | ) |   |          | (15,223 | )
|                                                                                             
|                                                                                             
|                                                                                             
|                                                                                             
|                                                                                              | Merchandise inventories                            |   |            | (46,403 | )          |   |            | (56,209 | ) |   |          | (57,976 | )
|                                                                                             
|                                                                                             
|                                                                                             
|                                                                                             
|                                                                                              | Other current assets                               |   |            | (5,147  | )          |   |            | (5,715  | ) |   |          | (7,966  | )
|                                                                                             
|                                                                                             
|                                                                                             
|                                                                                             
|                                                                                              | Other assets                                       |   |            | 1,952   |            |   |            | (517    | ) |   |          | 367     |  
|                                                                                             
|                                                                                             
|                                                                                             
|                                                                                             
|                                                                                              | Accounts payable and accrued liabilities           |   |            | (47,861 | )          |   |            | 43,178  |   |   |          | 34,628  |  
|                                                                                             
|                                                                                             
|                                                                                             
|                                                                                             
|                                                                                              | Non-current liabilities                            |   |            | (4,553  | )          |   |            | (525    | ) |   |          | (173    | )
|                                                                                              |                                                    |   |            |         |            |   |            |         |   |   |          |        
|Net Cash Provided by Operating Activities                                                     |                                                    |   | 90,375     |         |            |   | 141,933    |         |   |   | 81,146   |        
|                                                                                              |                                                    |   |            |         |            |   |            |         |   |   |          |        
|Net Cash Flows from Investing Activities:                                                     |                                                    |   |            |         |            |   |            |         |   |   |          |        
|                                                                                             
|                                                                                             
|                                                                                             
|                                                                                             
|Additions to property and equipment                                                           |                                                    |   | (87,656    | )       |            |   | (78,618    | )       |   |   | (59,538  | )      
|                                                                                             
|                                                                                             
|                                                                                             
|                                                                                             
|Dispositions of property and equipment                                                        |                                                    |   | 2,060      |         |            |   | 3,198      |         |   |   | 1,941    |        
|                                                                                             
|                                                                                             
|                                                                                             
|                                                                                             
|Proceeds from sale of credit card receivables, net of
transaction costs                       |                                                    |   |           |         |            |   | 583,676    |         |   |   |         |        
|                                                                                             
|                                                                                             
|                                                                                             
|                                                                                             
|Acquisition of Peoples Jewellers, net of cash acquired                                        |                                                    |   |           |         |            |   |           |         |   |   | (96,662  | )      
|                                                                                             
|                                                                                             
|                                                                                             
|                                                                                             
|Acquisition of Piercing Pagoda, net of cash acquired                                          |                                                    |   | (239,530   | )       |            |   |           |         |   |   |         |        
|                                                                                              |                                                    |   |            |         |            |   |            |         |   |   |          |        
|Net Cash (Used in) Provided by Investing Activities                                           |                                                    |   | (325,126   | )       |            |   | 508,256    |         |   |   | (154,259 | )      
|                                                                                              |                                                    |   |            |         |            |   |            |         |   |   |          |        
|Net Cash Flows from Financing Activities:                                                     |                                                    |   |            |         |            |   |            |         |   |   |          |        
|                                                                                             
|                                                                                             
|                                                                                             
|                                                                                             
|Net (decrease) increase in short term borrowings                                              |                                                    |   |           |         |            |   | (250,000   | )       |   |   | 250,000  |        
|                                                                                             
|                                                                                             
|                                                                                             
|                                                                                             
|Payments on Long Term Debt                                                                    |                                                    |   | (8,012     | )       |            |   |           |         |   |   |         |        
|                                                                                             
|                                                                                             
|                                                                                             
|                                                                                             
|Payments on receivables securitization facility                                               |                                                    |   |           |         |            |   |           |         |   |   | (380,760 | )      
|                                                                                             
|                                                                                             
|                                                                                             
|                                                                                             
|Payments on revolving credit agreement                                                        |                                                    |   | (563,374   | )       |            |   | (568,038   | )       |   |   | (3,500   | )      
|                                                                                             
|                                                                                             
|                                                                                             
|                                                                                             
|Borrowings under revolving credit agreement                                                   |                                                    |   | 563,701    |         |            |   | 474,782    |         |   |   | 106,500  |        
|                                                                                             
|                                                                                             
|                                                                                             
|                                                                                             
|Debt issue and capitalized financing costs                                                    |                                                    |   |           |         |            |   | (2,226     | )       |   |   | (1,094   | )      
|                                                                                             
|                                                                                             
|                                                                                             
|                                                                                             
|Proceeds from exercise of stock options                                                       |                                                    |   | 12,445     |         |            |   | 8,042      |         |   |   | 14,244   |        
|                                                                                             
|                                                                                             
|                                                                                             
|                                                                                             
|Purchase of common stock                                                                      |                                                    |   | (38,736    | )       |            |   | (49,997    | )       |   |   | (49,943  | )      
|                                                                                              |                                                    |   |            |         |            |   |            |         |   |   |          |        
|Net Cash Used in Financing Activities                                                         |                                                    |   | (33,976    | )       |            |   | (387,437   | )       |   |   | (64,553  | )      
|                                                                                              |                                                    |   |            |         |            |   |            |         |   |   |          |        
|Effect of Exchange Rate Changes on Cash                                                       |                                                    |   | (117       | )       |            |   | 79         |         |   |   |         |        
|                                                                                             
|                                                                                             
|                                                                                             
|                                                                                             
|Net (Decrease) Increase in Cash and Cash Equivalents                                          |                                                    |   | (268,844   | )       |            |   | 262,831    |         |   |   | (137,666 | )      
|                                                                                             
|                                                                                             
|                                                                                             
|                                                                                             
|Cash and Cash Equivalents at Beginning of Period                                              |                                                    |   | 298,234    |         |            |   | 35,403     |         |   |   | 173,069  |        
|                                                                                              |                                                    |   |            |         |            |   |            |         |   |   |          |        
|Cash and Cash Equivalents at End of Period                                                    |                                                    | $ | 29,390     |         |            | $ | 298,234    |         |   | $ | 35,403   |        
|                                                                                              |                                                    |   |            |         |            |   |            |         |   |   |          |        

See Notes to the Consolidated Financial Statements.

F-6



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##### Table of Contents



ZALE CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS
(amounts in thousands)

|                                    |                                             |  |               |        |               |  |               |        |  |  |   |        | 
|----------------------------------- | ------------------------------------------- |  | ------------- | ------ | ------------- |  | ------------- | ------ |  |  | - | ------ | 
|                                    |                                             |  | Year Ended    |        | Year Ended    |  | Year Ended   
|                                    |                                             |  | July 31, 2001 |        | July 31, 2000 |  | July 31, 1999
|                                    |                                             |  |               |        |               |  |              
|Supplemental cash flow information: |                                             |  |               |        |               |  |               |        |  |  |   |       
|                                   
|                                   
|                                   
|                                   
|                                    | Interest paid                               |  | $             | 10,408 |               |  | $             | 32,897 |  |  | $ | 35,956 | 
|                                   
|                                   
|                                   
|                                   
|                                    | Interest received                           |  | $             | 3,992  |               |  | $             | 1,465  |  |  | $ | 7,289  | 
|                                   
|                                   
|                                   
|                                   
|                                    | Income taxes paid (net of refunds received) |  | $             | 34,886 |               |  | $             | 44,785 |  |  | $ | 39,403 | 

See Notes to the Consolidated Financial Statements.

F-7



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##### Table of Contents



ZALE CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF STOCKHOLDERS INVESTMENT
(amounts in thousands)

|                                              |  |               |        |        |  |         |     |               |  |       |         |   |  |             |        |  
|--------------------------------------------- |  | ------------- | ------ | ------ |  | ------- | --- | ------------- |  | ----- | ------- | - |  | ----------- | ------ | -
|                                              |  |               |        |        |  |         |     |               |  |       |         |   |  | Accumulated
|                                              |  | Number of     |        |        |  |         |     | Additional    |  | Other
|                                              |  | Common Shares |        | Common |  | Paid-In |     | Comprehensive
|                                              |  | Outstanding   |        | Stock  |  | Capital |     | Income       
|                                              |  |               |        |        |  |         |     |              
|Balance July 31, 1998                         |  |               | 36,400 |        |  | $       | 380 |               |  | $     | 477,657 |   |  | $           | 2,851  |  
|                                             
|                                             
|                                             
|                                             
|Net Earnings                                  |  |               |       |        |  |         |    |               |  |       |        |   |  |             |       |  
|                                             
|                                             
|                                             
|                                             
|Unrealized Loss on Securities, net            |  |               |       |        |  |         |    |               |  |       |        |   |  |             | (285   | )
|                                             
|                                             
|                                             
|                                             
|Cumulative Translation
Adjustments            |  |               |       |        |  |         |    |               |  |       |        |   |  |             | (2,190 | )
|                                             
|                                             
|                                             
|                                             
|Exercise of Stock Options, net of tax
benefit |  |               | 1,019  |        |  |         | 10  |               |  |       | 21,034  |   |  |             |       |  
|                                             
|                                             
|                                             
|                                             
|Purchase of Common Stock                      |  |               | (1,669 | )      |  |         |    |               |  |       |        |   |  |             |       |  
|                                             
|                                             
|                                             
|                                             
|Contribution to 401(k) plan                   |  |               | 52     |        |  |         |    |               |  |       | (104    | ) |  |             |       |  
|                                             
|                                             
|                                             
|                                             
|Restricted Stock Awards                       |  |               | 181    |        |  |         | 2   |               |  |       | 5,713   |   |  |             |       |  
|                                             
|                                             
|                                             
|                                             
|Deferred Compensation Amortization            |  |               |       |        |  |         |    |               |  |       |        |   |  |             |       |  
|                                              |  |               |        |        |  |         |     |               |  |       |         |   |  |             |        |  
|Balance July 31, 1999                         |  |               | 35,983 |        |  | $       | 392 |               |  | $     | 504,300 |   |  | $           | 376    |  
|                                              |  |               |        |        |  |         |     |               |  |       |         |   |  |             |        |  
|Net Earnings                                  |  |               |       |        |  |         |    |               |  |       |        |   |  |             |       |  
|                                             
|                                             
|                                             
|                                             
|Unrealized Loss on Securities, net            |  |               |       |        |  |         |    |               |  |       |        |   |  |             | (1,578 | )
|                                             
|                                             
|                                             
|                                             
|Cumulative Translation
Adjustments            |  |               |       |        |  |         |    |               |  |       |        |   |  |             | 1,613  |  
|                                             
|                                             
|                                             
|                                             
|Exercise of Stock Options, net of tax
benefit |  |               | 422    |        |  |         | 4   |               |  |       | 12,194  |   |  |             |       |  
|                                             
|                                             
|                                             
|                                             
|Purchase of Common Stock                      |  |               | (1,275 | )      |  |         |    |               |  |       |        |   |  |             |       |  
|                                             
|                                             
|                                             
|                                             
|Contribution to 401(k) plan                   |  |               | 131    |        |  |         |    |               |  |       | 1,832   |   |  |             |       |  
|                                             
|                                             
|                                             
|                                             
|Deferred Compensation Amortization            |  |               |       |        |  |         |    |               |  |       |        |   |  |             |       |  
|                                              |  |               |        |        |  |         |     |               |  |       |         |   |  |             |        |  
|Balance July 31, 2000                         |  |               | 35,261 |        |  | $       | 396 |               |  | $     | 518,326 |   |  | $           | 411    |  
|                                              |  |               |        |        |  |         |     |               |  |       |         |   |  |             |        |  
|Net Earnings                                  |  |               |       |        |  |         |    |               |  |       |        |   |  |             |       |  
|                                             
|                                             
|                                             
|                                             
|Unrealized Loss on Securities, net            |  |               |       |        |  |         |    |               |  |       |        |   |  |             | (20    | )
|                                             
|                                             
|                                             
|                                             
|Cumulative Translation
Adjustments            |  |               |       |        |  |         |    |               |  |       |        |   |  |             | (2,746 | )
|                                             
|                                             
|                                             
|                                             
|Exercise of Stock Options, net of tax
benefit |  |               | 485    |        |  |         | 5   |               |  |       | 13,438  |   |  |             |       |  
|                                             
|                                             
|                                             
|                                             
|Purchase of Common Stock                      |  |               | (1,272 | )      |  |         |    |               |  |       |        |   |  |             |       |  
|                                             
|                                             
|                                             
|                                             
|Contribution to 401(k) plan                   |  |               | 117    |        |  |         |    |               |  |       | 205     |   |  |             |       |  
|                                             
|                                             
|                                             
|                                             
|Restricted Stock, Issued/Cancelled            |  |               | 224    |        |  |         | 3   |               |  |       | 7,935   |   |  |             |       |  
|                                             
|                                             
|                                             
|                                             
|Deferred Compensation Amortization            |  |               |       |        |  |         |    |               |  |       |        |   |  |             |       |  
|                                              |  |               |        |        |  |         |     |               |  |       |         |   |  |             |        |  
|Balance July 31, 2001                         |  |               | 34,815 |        |  | $       | 404 |               |  | $     | 539,904 |   |  | $           | (2,355 | )
|                                              |  |               |        |        |  |         |     |               |  |       |         |   |  |             |        |  

See Notes to the Consolidated Financial Statements.

F-8



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##### Table of Contents



ZALE CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF STOCKHOLDERS INVESTMENT  (continued)
(amounts in thousands)

|                                              |  |             |         |              |  |          |        |            |  |               |          |   |  |   |         |   |  |   |         |  
|--------------------------------------------- |  | ----------- | ------- | ------------ |  | -------- | ------ | ---------- |  | ------------- | -------- | - |  | - | ------- | - |  | - | ------- | -
|                                              |  | Accumulated |         | Deferred     |  | Treasury |        | Total      |  | Comprehensive
|                                              |  | Earnings    |         | Compensation |  | Stock    |        | Investment |  | Income       
|                                              |  |             |         |              |  |          |        |            |  |              
|Balance July 31, 1998                         |  | $           | 211,341 |              |  | $        |       |            |  | $             | (44,168  | ) |  | $ | 648,061 |   |  | $ | 69,606  |  
|                                             
|                                             
|                                             
|                                             
|Net Earnings                                  |  |             | 80,932  |              |  |          |       |            |  |               |         |   |  |   | 80,932  |   |  |   | 80,932  |  
|                                             
|                                             
|                                             
|                                             
|Unrealized Gain on Securities, net            |  |             |        |              |  |          |       |            |  |               |         |   |  |   | (285    | ) |  |   | (285    | )
|                                             
|                                             
|                                             
|                                             
|Cumulative Translation
Adjustments            |  |             |        |              |  |          |       |            |  |               |         |   |  |   | (2,190  | ) |  |   | (2,190  | )
|                                             
|                                             
|                                             
|                                             
|Exercise of Stock Options, net of tax
benefit |  |             |        |              |  |          |       |            |  |               |         |   |  |   | 21,044  |   |  |   |        |  
|                                             
|                                             
|                                             
|                                             
|Purchase of Common Stock                      |  |             |        |              |  |          |       |            |  |               | (49,943  | ) |  |   | (49,943 | ) |  |   |        |  
|                                             
|                                             
|                                             
|                                             
|Contribution to 401(k) plan                   |  |             |        |              |  |          |       |            |  |               | 1,386    |   |  |   | 1,282   |   |  |   |        |  
|                                             
|                                             
|                                             
|                                             
|Restricted Stock Awards                       |  |             |        |              |  |          | (5,715 | )          |  |               |         |   |  |   |        |   |  |   |        |  
|                                             
|                                             
|                                             
|                                             
|Deferred Compensation Amortization            |  |             |        |              |  |          | 710    |            |  |               |         |   |  |   | 710     |   |  |   |        |  
|                                              |  |             |         |              |  |          |        |            |  |               |          |   |  |   |         |   |  |   |         |  
|Balance July 31, 1999                         |  | $           | 292,273 |              |  | $        | (5,005 | )          |  | $             | (92,725  | ) |  | $ | 699,611 |   |  | $ | 78,457  |  
|                                              |  |             |         |              |  |          |        |            |  |               |          |   |  |   |         |   |  |   |         |  
|Net Earnings                                  |  |             | 111,514 |              |  |          |       |            |  |               |         |   |  |   | 111,514 |   |  |   | 111,514 |  
|                                             
|                                             
|                                             
|                                             
|Unrealized Gain on Securities, net            |  |             |        |              |  |          |       |            |  |               |         |   |  |   | (1,578  | ) |  |   | (1,578  | )
|                                             
|                                             
|                                             
|                                             
|Cumulative Translation
Adjustments            |  |             |        |              |  |          |       |            |  |               |         |   |  |   | 1,613   |   |  |   | 1,613   |  
|                                             
|                                             
|                                             
|                                             
|Exercise of Stock Options, net of tax
benefit |  |             |        |              |  |          |       |            |  |               |         |   |  |   | 12,198  |   |  |   |        |  
|                                             
|                                             
|                                             
|                                             
|Purchase of Common Stock                      |  |             |        |              |  |          |       |            |  |               | (49,997  | ) |  |   | (49,997 | ) |  |   |        |  
|                                             
|                                             
|                                             
|                                             
|Contribution to 401(k) plan                   |  |             |        |              |  |          |       |            |  |               | 3,365    |   |  |   | 5,197   |   |  |   |        |  
|                                             
|                                             
|                                             
|                                             
|Deferred Compensation Amortization            |  |             |        |              |  |          | 3,219  |            |  |               |         |   |  |   | 3,219   |   |  |   |        |  
|                                              |  |             |         |              |  |          |        |            |  |               |          |   |  |   |         |   |  |   |         |  
|Balance July 31, 2000                         |  | $           | 403,787 |              |  | $        | (1,786 | )          |  | $             | (139,357 | ) |  | $ | 781,777 |   |  | $ | 111,549 |  
|                                              |  |             |         |              |  |          |        |            |  |               |          |   |  |   |         |   |  |   |         |  
|Net Earnings                                  |  |             | 82,048  |              |  |          |       |            |  |               |         |   |  |   | 82,048  |   |  |   | 82,048  |  
|                                             
|                                             
|                                             
|                                             
|Unrealized Gain on Securities, net            |  |             |        |              |  |          |       |            |  |               |         |   |  |   | (20     | ) |  |   | (20     | )
|                                             
|                                             
|                                             
|                                             
|Cumulative Translation
Adjustments            |  |             |        |              |  |          |       |            |  |               |         |   |  |   | (2,746  | ) |  |   | (2,746  | )
|                                             
|                                             
|                                             
|                                             
|Exercise of Stock Options, net of tax
benefit |  |             |        |              |  |          |       |            |  |               |         |   |  |   | 13,443  |   |  |   |        |  
|                                             
|                                             
|                                             
|                                             
|Purchase of Common Stock                      |  |             |        |              |  |          |       |            |  |               | (38,736  | ) |  |   | (38,736 | ) |  |   |        |  
|                                             
|                                             
|                                             
|                                             
|Contribution to 401(k) plan                   |  |             |        |              |  |          |       |            |  |               | 3,942    |   |  |   | 4,147   |   |  |   |        |  
|                                             
|                                             
|                                             
|                                             
|Restricted Stock, Issued/Cancelled            |  |             |        |              |  |          | (7,117 | )          |  |               | (821     | ) |  |   |        |   |  |   |        |  
|                                             
|                                             
|                                             
|                                             
|Deferred Compensation Amortization            |  |             |        |              |  |          | 650    |            |  |               |         |   |  |   | 650     |   |  |   |        |  
|                                              |  |             |         |              |  |          |        |            |  |               |          |   |  |   |         |   |  |   |         |  
|Balance July 31, 2001                         |  | $           | 485,835 |              |  | $        | (8,253 | )          |  | $             | (174,972 | ) |  | $ | 840,563 |   |  | $ | 79,282  |  
|                                              |  |             |         |              |  |          |        |            |  |               |          |   |  |   |         |   |  |   |         |  

See Notes to the Consolidated Financial Statements.

F-9



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##### Table of Contents



ZALE CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Summary of Significant Accounting Policies

The Accompanying Consolidated Financial Statementsinclude the accounts of
Zale Corporation and its wholly owned subsidiaries (the Company or Zale).
The Company consolidates substantially all its U.S. operations into Zale
Delaware, Inc. (ZDel). ZDel is the parent company for several subsidiaries,
including three that are engaged primarily in providing credit insurance to
credit customers of the Company. The Company consolidates its Canadian retail
operations into Zale International, Inc., which is a wholly owned subsidiary of
Zale Corporation. All significant intercompany transactions have been
eliminated.

Use of Estimates.The preparation of financial statements in conformity
with accounting principles generally accepted in the United States 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.

Cash and Cash Equivalentsincludes cash on hand, deposits in banks and
short-term marketable securities at varying interest rates with maturities of
three months or less. The carrying amount approximates fair value because of
the short term maturity of those instruments. At July 31, 2000, $3.9 million
was restricted primarily by the capital requirements of Jewelers National Bank
(JNB), the Companys national credit card bank and consignment arrangement
with certain vendors.

Customer Receivables.Effective July 31, 2000, the Company sold, without
recourse, all of its customer receivables. See Sale of Customer Receivables.
Historically, customer receivables were classified as current assets,
including amounts which were due after one year, in accordance with industry
practices. Finance charge income was $106.1 million and $102.6 million for the
years ended July 31, 2000 and 1999, respectively, and net earnings from credit
insurance subsidiaries was $13.4 million, $13.8 million and $15.9 million for
the years ended July 31, 2001, 2000 and 1999, respectively, both of which have
been reflected as a reduction of Selling, General and Administrative Expenses.
Finance charge and insurance charge income are recorded pursuant to the
calculation set forth in the Companys credit card agreements.

Merchandise Inventoriesare stated at the lower of cost or market. Cost
for inventories is determined primarily in accordance with the retail inventory
method. Substantially all U.S. inventories represent finished goods which are
valued using the last-in, first-out (LIFO) retail method. Merchandise
inventory of Peoples Jewellers are valued using the first-in, first-out
(FIFO) retail method.

Long Lived Assets.Intangibles and long-lived assets are reviewed for
impairment whenever events or changes in circumstances indicate the carrying
amount may not be recoverable. Any impairment would be recognized in operating
results if a permanent reduction were to occur. Impairments were not material
in the periods presented.

Depreciation and Amortizationare computed using the straight-line method
over the estimated useful lives of the assets or remaining lease life.
Estimated useful lives of the assets range from three to fifteen years.
Original cost and related accumulated depreciation or amortization are 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. Computer software costs related to the development of major
systems are capitalized as incurred and are amortized over their useful lives.

Excess of Revalued Net Assets Over Stockholders Investmentis being
amortized over fifteen years. Amortization was $5.9 million for each of the
years ended July 31, 2001, 2000 and 1999. Accumulated amortization was $47.2
million and $41.3 million at July 31, 2001 and 2000, respectively. The Company
plans to adopt SFAS No. 142 in the first quarter of fiscal 2002. As a result,
the Company will recognize a cumulative effect of a change in accounting
principle of approximately $41 million credit in the first quarter of fiscal
2002 related to the write off of the Excess of Revalued Net Assets Over
Stockholders Investment.

F-10



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##### Table of Contents



ZALE CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (continued)

Revenue Recognition.The Company recognizes revenue in accordance with the
Securities and Exchange Commissions Staff Accounting Bulletin No. 101, Revenue
Recognition in Financial Statements (SAB 101). Revenue related to
merchandise sales is recognized at the time of the sale, reduced by a provision
for returns. The provision for sales returns is based on historical evidence
of the Companys return rate. Repair revenues are recognized when the service
is complete and the merchandise is delivered to the customers. Net Sales
include amortized extended service agreements (ESA) which are amortized over
the two year service agreement period. ESA revenue and related expenses were
previously netted in selling, general and administrative expense. Prior
periods sales and cost of sales have been restated to reflect ESA revenue. The
amortized ESA revenues were $25.0 million, $20.8 million, and $16.8 million for
the years ended July 31, 2001, 2000 and 1999, respectively, and related ESA
costs were $12.5 million, $10.8 million and $9.5 million for the years ended
July 31, 2001, 2000 and 1999, respectively.

Advertising Expensesare charged against operations when incurred and are
a component of selling, general and administrative expense in the consolidated
income statements. Amounts charged against operations were $78.5 million, $66.4
million and $49.0 million for the years ended July 31, 2001, 2000 and 1999,
respectively, net of amounts contributed by vendors to the Company. The
amounts of prepaid advertising at July 31, 2001 and 2000, are $6.0 million and
$6.4 million, respectively, and are classified as components of other assets in
the Consolidated Balance Sheet.

Reclassifications.The classifications in use at July 31, 2001, have been
applied to the financial statements for July 31, 2000 and 1999.

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 Consolidated Statements of Stockholders Investment.

Derivative Financial Instruments.Effective August 1, 2000, the Company
adopted Statement of Financial Accounting Standard (SFAS) No. 133,
Accounting for Derivative Instruments and Hedging Activities, as amended by
SFAS No. 138, Accounting for Certain Derivative Instruments and Certain
Hedging Activities, which establishes accounting and reporting standards for
derivative instruments, including certain derivative instruments embedded in
other contracts, and for hedging activities. SFAS No. 133, as amended,
requires the recognition of all derivative instruments as either assets or
liabilities in the statement of financial position measured at fair value. The
impact of the adoption of SFAS No. 133 was immaterial to the Companys
financial statements taken as a whole. As of July 31, 2001, the Company had no
foreign currency contracts outstanding.

Acquisition of Piercing Pagoda, Inc.

On September 20, 2000, the Company completed the acquisition of Piercing
Pagoda, Inc. (Piercing Pagoda), for approximately $203 million, plus
approximately $45 million for existing debt and the assumption of certain bank
debt and liabilities.

The excess of the purchase price over the fair value of the net assets
acquired, approximately $155 million, is classified as goodwill, and is being
amortized on a straight line basis over twenty years. At July 31, 2001, the
Company had $6.9 million of accumulated amortization relating to this goodwill.
However, the Company will adopt Statement of Financial Accounting Standards
No. 142 Goodwill and Other Intangible Assets in the first quarter of fiscal
year 2002. As a result, goodwill related to the Companys acquisitions will
no longer be amortized, and instead will be reviewed for impairment. Assets
acquired and liabilities assumed have been recorded at their estimated fair
values and are subject to adjustment when additional information concerning the
alignment of operations is finalized. These adjustments will relate to the cost
of relocating the Piercing Pagoda head office functions to Dallas, and the
Company believes these adjustments will be immaterial to the Financial
Statements.

F-11



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##### Table of Contents



ZALE CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (continued)

The acquisition described above was accounted for by the purchase method
of accounting for business combinations. Accordingly, the accompanying
Consolidated Statements of Operations do not include any revenues or expenses
related to Piercing Pagoda prior to September 20, 2000. The entire cost of the
acquisition was funded through the Companys available cash and from working
capital.

The following unaudited pro forma information presents a summary of our
consolidated results of operations including Piercing Pagoda as if the
acquisition was effective on August 1, 1999.

|                   |  |                                                  |           |      |  |   |           | 
|------------------ |  | ------------------------------------------------ | --------- | ---- |  | - | --------- | 
|                   |  | Year Ended July 31,                             
|                   |  |                                                 
|                   |  | 2001                                             |           | 2000
|                   |  |                                                  |           |     
|                   |  | (unaudited)                                     
|                   |  | (amounts in thousands, except per share amounts)
|                   |  |                                                 
|Sales              |  | $                                                | 2,098,690 |      |  | $ | 2,097,201 | 
|                  
|                  
|                  
|                  
|Net Income         |  |                                                  | 81,491    |      |  |   | 120,764   | 
|                  
|                  
|                  
|                  
|Earnings Per Share |  | $                                                | 2.34      |      |  | $ | 3.37      | 

The proforma results are not necessarily indicative of what would have
occurred if the acquisition had been in effect for the periods presented. In
addition, they are not intended to be a projection of future results.

Merchandise Inventories

The Companys U.S. operations use the LIFO retail method of accounting for
inventory. The LIFO provision (benefit) was $4.9 million, ($3.0) million and
($0.7) million for the years ended July 31, 2001, 2000 and 1999, respectively.
The estimated cost of replacing the Companys inventories exceeds its net LIFO
cost by approximately $14.7 million and $9.8 million at July 31, 2001 and 2000,
respectively. Domestic inventories on a FIFO basis were $680.9 million and
$588.7 million at July 31, 2001 and 2000, respectively. The Company also
maintained consigned inventory at its domestic retail locations of
approximately $172.8 million and $163.8 million at July 31, 2001 and 2000,
respectively.

The Companys Canadian operations use the FIFO retail method of accounting
for inventory. Inventory net of reserves was approximately $57.9 million and
$51.5 million at July 31, 2001 and 2000, respectively and consigned inventory
at retail locations was approximately $13.4 million and $4.1 million at July
31, 2001 and 2000, respectively.

Consigned inventory and related contingent obligations are not reflected
in the Companys financial statements. At the time consigned inventory is sold,
the Company records the purchase liability in accounts payable and the related
cost of merchandise in Cost of Sales.

Sale of Customer Receivables

Effective July 31, 2000, the Company sold its private label credit card
operations and outstanding accounts receivables, without recourse, to
Associates First Capital Corporation (AFCC) and its subsidiary Associates
Credit Card Services, Inc. (Associates). The total purchase price for the
accounts receivable was approximately $542 million. With a portion of the
proceeds from this sale, the Company paid off all of its credit card related
indebtedness and the Companys receivables securitization facility was
terminated. This sale was accounted for in accordance with Statement of
Financial Accounting Standards No. 125, Accounting for Transfers and Servicing
of Financial Assets and Extinguishment of Liabilities.

F-12



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##### Table of Contents



ZALE CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (continued)

In connection with the sale of its customer receivables, the Company
entered into a ten year merchant services agreement whereby Hurley State Bank
(Hurley), a wholly owned subsidiary of AFCC, will issue private label credit
cards, branded with appropriate Company trademarks, and provide financing for
the Companys customers to purchase merchandise in exchange for payment by the
Company of a merchant fee based upon a percentage of each credit card sale.
The merchant fee is a flat percentage per credit sale for standard revolving
accounts and varies for certain special interest free or deferred payment
credit sales, depending on the credit program. The Company received a $41.8
million incentive for entering into the agreement, the non-current portion of
which is classified as a non-current liability on the Consolidated Balance
Sheet. Portions of this payment are subject to refund for early termination of
the agreement. This incentive payment will be recognized ratably over the term
of the agreement. Deferred revenues of $37.6 million and $41.8 million are
included in the accompanying Consolidated Balance Sheet at July 31, 2001 and
2000, respectively.

In connection with the sale of its customer receivables, the Company
agreed pursuant to an Agreement and Plan of Merger, dated as of July 10, 2000,
to merge Jewelers National Bank (JNB), a wholly owned subsidiary of the
Company, with and into Hurley State Bank (Hurley), a wholly owned subsidiary
of AFCC (the Merger). The closing of the transactions contemplated under the
Agreement and Plan of Merger took place on March 8, 2001. Prior to the merger
of JNB with and into Hurley, the Company sold without recourse its credit card
receivables to Associates on a daily basis pursuant to an interim purchase and
servicing arrangement the non-current portion of which is classified as a
non-current liability on the Consolidated Balance Sheet. Following
consummation of the Merger, AFCC and its affiliates assumed responsibility for
JNBs previously owned credit operations.

As a result of the sale of the Companys customer receivables to AFCC and
the Merger, the Companys previous credit processing service agreement with a
third party servicer was terminated upon conversion to AFCCs systems.

Investments

Investments in debt and equity securities are reported as other assets in
the Consolidated Balance Sheet. All long-term debt securities outstanding at
July 31, 2001 will contractually mature within 1 to 30 years. Investments,
principally from the Companys insurance subsidiaries as of July 31, 2001 and
2000 were as follows:

|                            |  |                        |        |               |  |   |        | 
|--------------------------- |  | ---------------------- | ------ | ------------- |  | - | ------ | 
|                            |  | July 31, 2001          |        | July 31, 2000
|                            |  |                        |        |              
|                            |  | (amounts in thousands)
|U.S. government obligations |  | $                      | 15,300 |               |  | $ | 15,911 | 
|                           
|                           
|                           
|                           
|Corporate bonds and notes   |  |                        | 6,741  |               |  |   | 6,168  | 
|                           
|                           
|                           
|                           
|Corporate equity securities |  |                        | 4,637  |               |  |   | 5,693  | 
|                            |  |                        |        |               |  |   |        | 
|                            |  | $                      | 26,678 |               |  | $ | 27,772 | 
|                            |  |                        |        |               |  |   |        | 

All investments are classified as available for sale. At July 31, 2001
and 2000, the carrying value of corporate equity securities included net
unrealized gains of $1.0 million for both years. Net realized gains on
investments totaled $0.3 million in 2001, $2.1 million in 2000, and $1.6
million in 1999.

F-13



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##### Table of Contents



ZALE CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (continued)

Property And Equipment

The Companys property and equipment consists of the following:

|                                                |  |                        |          |               |  |   |          |  
|----------------------------------------------- |  | ---------------------- | -------- | ------------- |  | - | -------- | -
|                                                |  | July 31, 2001          |          | July 31, 2000
|                                                |  |                        |          |              
|                                                |  | (amounts in thousands)
|Land                                            |  | $                      | 881      |               |  | $ |         |  
|                                               
|                                               
|                                               
|                                               
|Building and Leasehold Improvements             |  |                        | 169,741  |               |  |   | 133,498  |  
|                                               
|                                               
|                                               
|                                               
|Furniture and Fixtures                          |  |                        | 285,546  |               |  |   | 218,668  |  
|                                               
|                                               
|                                               
|                                               
|Construction in Progress                        |  |                        | 13,670   |               |  |   | 9,644    |  
|                                                |  |                        |          |               |  |   |          |  
|                                                |  |                        | 469,838  |               |  |   | 361,810  |  
|                                               
|                                               
|                                               
|                                               
|Less: Accumulated Amortization and Depreciation |  |                        | (173,425 | )             |  |   | (130,555 | )
|                                                |  |                        |          |               |  |   |          |  
|Total Net Property and Equipment                |  | $                      | 296,413  |               |  | $ | 231,255  |  
|                                                |  |                        |          |               |  |   |          |  

Depreciation expense of $52.4 million, $43.6 million and $34.4 million was
recorded at July 31, 2001, 2000 and 1999.

Accounts Payable, Accrued Liabilities And Non-Current Liabilities

The Companys accounts payable and accrued liabilities consist of the
following:

|                                               |  |                        |         |               |  |   |         | 
|---------------------------------------------- |  | ---------------------- | ------- | ------------- |  | - | ------- | 
|                                               |  | July 31, 2001          |         | July 31, 2000
|                                               |  |                        |         |              
|                                               |  | (amounts in thousands)
|Accounts Payable                               |  | $                      | 112,953 |               |  | $ | 131,664 | 
|                                              
|                                              
|                                              
|                                              
|Accrued Payroll                                |  |                        | 24,518  |               |  |   | 27,789  | 
|                                              
|                                              
|                                              
|                                              
|Accrued Taxes                                  |  |                        | 26,759  |               |  |   | 23,503  | 
|                                              
|                                              
|                                              
|                                              
|Extended Warranty Deferred Revenue             |  |                        | 29,106  |               |  |   | 24,081  | 
|                                              
|                                              
|                                              
|                                              
|Accrued Percentage Rent                        |  |                        | 21,090  |               |  |   | 18,571  | 
|                                              
|                                              
|                                              
|                                              
|Other Accruals                                 |  |                        | 54,685  |               |  |   | 60,671  | 
|                                               |  |                        |         |               |  |   |         | 
|Total Accounts Payable and Accrued
Liabilities |  | $                      | 269,111 |               |  | $ | 286,279 | 
|                                               |  |                        |         |               |  |   |         | 

The Companys non-current liabilities consist principally of the
accumulated obligation for postretirement benefits under SFAS No. 106,
Employers Accounting for Postretirement Benefits Other Than Pensions, loss
reserves for insurance subsidiaries, reserves for tax contingencies and the
long-term portion of the incentive payment received from AFCC discussed above.

Postretirement Benefits.The Company provides medical and dental insurance
benefits for all eligible retirees and spouses with benefits to the latter
continuing after the death of the retiree. Substantially all of the Companys
full-time employees who were hired on or before November 14, 1994 become
eligible for those benefits upon reaching age 55 while working for the Company
and having ten years continuous service. The medical and dental benefits are
provided under two plans. The lifetime maximum on medical benefits is
$500,000. These benefits include deductibles, retiree contributions and
co-insurance provisions that are assumed to grow with the health care cost
trend rate. The costs of the postretirement benefits are recognized in
selling, general and administrative expense in the Consolidated Statements of
Operations over an employees active career on an accrual basis. The Company
funds actual claims as they occur.

F-14



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##### Table of Contents



ZALE CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (continued)

|                                        |  |                        |         |               |  |   |         |  
|--------------------------------------- |  | ---------------------- | ------- | ------------- |  | - | ------- | -
|                                        |  | July 31, 2001          |         | July 31, 2000
|                                        |  |                        |         |              
|                                        |  | (amounts in thousands)
|Change in Benefit Obligation:           |  |                        |         |               |  |   |         |  
|                                       
|                                       
|                                       
|                                       
|Benefit Obligation At Beginning Of Year |  | $                      | 14,194  |               |  | $ | 13,590  |  
|                                       
|                                       
|                                       
|                                       
|Service Cost                            |  |                        | 332     |               |  |   | 306     |  
|                                       
|                                       
|                                       
|                                       
|Interest Cost                           |  |                        | 1,113   |               |  |   | 1,018   |  
|                                       
|                                       
|                                       
|                                       
|Plan participant contributions          |  |                        | 806     |               |  |   | 984     |  
|                                       
|                                       
|                                       
|                                       
|Amendments                              |  |                        | 6,546   |               |  |   |        |  
|                                       
|                                       
|                                       
|                                       
|Actuarial Gain                          |  |                        | (4,476  | )             |  |   | (45     | )
|                                       
|                                       
|                                       
|                                       
|Benefits Paid                           |  |                        | (1,260  | )             |  |   | (1,659  | )
|                                        |  |                        |         |               |  |   |         |  
|Benefit Obligation At End of Year       |  | $                      | 17,255  |               |  | $ | 14,194  |  
|                                        |  |                        |         |               |  |   |         |  
|Change in Plan Assets:                  |  |                        |         |               |  |   |         |  
|                                       
|                                       
|                                       
|                                       
|Market value at beginning of year       |  | $                      |        |               |  | $ |        |  
|                                       
|                                       
|                                       
|                                       
|Employer contributions                  |  |                        | 454     |               |  |   | 675     |  
|                                       
|                                       
|                                       
|                                       
|Plan participant contributions          |  |                        | 806     |               |  |   | 984     |  
|                                       
|                                       
|                                       
|                                       
|Benefit payments                        |  |                        | (1,260  | )             |  |   | (1,659  | )
|                                        |  |                        |         |               |  |   |         |  
|Market value at end of year             |  | $                      |        |               |  | $ |        |  
|                                        |  |                        |         |               |  |   |         |  
|Funded Status                           |  | $                      | (17,255 | )             |  | $ | (14,194 | )
|                                       
|                                       
|                                       
|                                       
|Unrecognized net actuarial gain         |  |                        | (9,607  | )             |  |   | (5,638  | )
|                                       
|                                       
|                                       
|                                       
|Unrecognized prior service cost         |  |                        | 5,306   |               |  |   | (1,079  | )
|                                        |  |                        |         |               |  |   |         |  
|Adjusted Prepaid (accrued) benefit cost |  | $                      | (21,556 | )             |  | $ | (20,911 | )
|                                        |  |                        |         |               |  |   |         |  

The weighted average assumption of the discount rate is 7.75 percent as of
July 31, 2001 and 2000, respectively. For measurement purposes, an initial
annual rate of increase in the per capita cost of covered non-HMO health care
benefits of 8 percent and 9 percent was assumed for July 31, 2001 and July 31,
2002, respectively, with an ultimate assumed rate of 6 percent. All assumed
rates of increase for HMO health care benefits were 1 percent lower.

Components of net periodic benefit cost:

|                                   |  |                        |       |               |  |               |       |   |  |   |       |  
|---------------------------------- |  | ---------------------- | ----- | ------------- |  | ------------- | ----- | - |  | - | ----- | -
|                                   |  | July 31, 2001          |       | July 31, 2000 |  | July 31, 1999
|                                   |  |                        |       |               |  |              
|                                   |  | (amounts in thousands)
|Service Cost                       |  | $                      | 332   |               |  | $             | 306   |   |  | $ | 339   |  
|                                  
|                                  
|                                  
|                                  
|Interest Cost                      |  |                        | 1,113 |               |  |               | 1,018 |   |  |   | 1,053 |  
|                                  
|                                  
|                                  
|                                  
|Amortization of Prior Service Cost |  |                        | (497  | )             |  |               | (855  | ) |  |   | (572  | )
|                                   |  |                        |       |               |  |               |       |   |  |   |       |  
|Net Periodic Benefit Cost          |  | $                      | 948   |               |  | $             | 469   |   |  | $ | 820   |  
|                                   |  |                        |       |               |  |               |       |   |  |   |       |  

Assumed health care cost trend rates have a significant effect on the
amounts reported for the health care plans. A one-percentage-point change in
assumed health care cost trend rates would have the following effects:

|                                                     |  |                             |       |                             |  |  |      |   |  |   |        |   |  |  |       |   
|---------------------------------------------------- |  | --------------------------- | ----- | --------------------------- |  |  | ---- | - |  | - | ------ | - |  |  | ----- | --
|                                                     |  | 1-Percentage-Point Increase |       | 1-Percentage-Point Decrease
|                                                     |  |                             |       |                            
|                                                     |  | (amounts in thousands)     
|Effect on total service and
interest cost components |  | $                           | 80    |                             |  |  | 5.5  | % |  | $ | (68    | ) |  |  | (4.7  | )%
|                                                    
|                                                    
|                                                    
|                                                    
|Effect on post retirement
benefit obligation         |  | $                           | 2,035 |                             |  |  | 11.8 | % |  | $ | (1,845 | ) |  |  | (10.7 | )%

F-15



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##### Table of Contents



ZALE CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (continued)

Short-Term Debt

Zale Funding Trust Securitization.On July 15, 1999, the Company redeemed
approximately $380.8 million, net of discount, aggregate principal amount of
Receivables Backed Notes (Receivables Notes) issued by Zale Funding Trust
(ZFT), a Delaware statutory business trust and indirect wholly owned
subsidiary of the Company, to finance customer accounts receivable. The
Receivables Notes were redeemed with available cash and proceeds of advances
under the Companys Revolving Credit Agreement and through the issuance of
Variable Funding Notes (Variable Notes) to a purchaser group under a new
securitization facility in the initial aggregate principal amount of $250
million. The Variable Notes were part of a 364-day liquidity facility and were
secured by a lien on customer accounts receivable. In September 1999, the
Company amended the original facility to increase the total aggregate amount to
$350 million. On July 31, 2000, the Company redeemed the then outstanding
balance of approximately $335 million aggregate principal amount of Variable
Notes with the proceeds from the sale of its customer receivables and
terminated its securitization facility. The Variable Notes bore interest at the
market commercial paper rate plus a dealer fee of 0.05 percent. In addition,
the Company paid a fee of 0.375 percent per annum on the funded portion of the
facility and a commitment fee of 0.25 percent per annum on the unfunded
portion.

Long-term Debt

The Companys long-term debt consists of the following:

|                           |  |                        |         |               |  |   |         | 
|-------------------------- |  | ---------------------- | ------- | ------------- |  | - | ------- | 
|                           |  | July 31, 2001          |         | July 31, 2000
|                           |  |                        |         |              
|                           |  | (amounts in thousands)
|Revolving Credit Agreement |  | $                      | 9,798   |               |  | $ | 9,744   | 
|                          
|                          
|                          
|                          
|Senior Notes               |  |                        | 99,665  |               |  |   | 99,625  | 
|                           |  |                        |         |               |  |   |         | 
|Total Long-Term Debt       |  | $                      | 109,463 |               |  | $ | 109,369 | 
|                           |  |                        |         |               |  |   |         | 

Revolving Credit Agreement.The Company amended and restated its
unsecured revolving credit agreement with a group of banks on March 30, 2000.
The amended and restated revolving credit agreement (the Revolving Credit
Agreement) provides for (i) a revolving credit loan facility to the Company
and to its operating subsidiary, Zale Delaware, Inc. (such facility, the U.S.
Revolving Credit Facility), in the aggregate principal amount of up to $215
million in commitments by certain U.S. lenders (the U.S. Commitments),
including a $10 million sublimit for letters of credit, and (ii) a separate
revolving credit facility for a Canadian subsidiary (the Canadian Revolving
Credit Facility), which provides for Canadian Dollar denominated loans in the
aggregate principal amount of up to a U.S. Dollar equivalent of $10 million in
commitments by a Canadian lender (the Canadian Commitment). The total amount
of commitments under the Revolving Credit Agreement to the Company and its
subsidiaries is approximately $225 million. The Revolving Credit Agreement
term is five years. Under the Revolving Credit Agreement the Company may,
subject to approval of the U.S. Agent or the Canadian Agent, as the case may
be, increase the total U.S. commitment to $285 million and the Canadian
commitment to U.S. Dollar equivalent of $25 million provided that the
commitments together do not exceed U.S. Dollar equivalent of $300 million.

F-16



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##### Table of Contents



ZALE CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (continued)

The revolving credit loans bear interest at floating rates as follows:
(A) loans outstanding under the U.S. Revolving Credit Facility bear interest,
at the Companys option, at either (i) the applicable Eurodollar Rate plus a
margin equal to 0.50 percent (subject to adjustment as described below), or
(ii) the Base Rate (which is the higher of the annual rate of interest
announced from time to time by the agent bank under the Revolving Credit
Agreement as its base rate or the Federal Funds Effective Rate plus 0.5
percent); and (B) loans outstanding under the Canadian Revolving Credit
Facility bear interest, at the Companys option, at either (i) Bankers
Acceptance Discount Rate (which varies depending upon whether the Canadian
Lender is a bank named under Schedule I or II to the Bank Act (Canada or
neither)) plus a margin equal to 0.50 percent (subject to adjustment as
described below), or (ii) the annual rate of interest announced from time to
time by the Canadian agent bank under the Revolving Credit Agreement as its
prime rate for commercial loans in Canadian Dollars to borrowers in Canada.
The margin applicable to Eurodollar Rates and Bankers Acceptance Discount
Rates and letter of credit commission rates will be automatically reduced or
increased from time to time based on certain future performance levels attained
by the Company and its subsidiaries. Such margin will also be reduced if the
debt of the Company and its subsidiaries under the Revolving Credit Agreement
achieves an investment grade rating, and thereafter will be reduced or
increased based upon changes in such rating. A utilization fee of 0.125
percent is to be paid on the average daily amount during each calendar quarter
to the extent that the outstanding amount of loans under the U.S. Revolving
Credit Facility exceeds 50 percent of the total U.S. Commitments during the
preceding quarter, and/or if and to the extent that the outstanding amount of
loans under the Canadian Revolving Credit Facility exceeds 50 percent of the
total Canadian Commitments during the preceding fiscal quarter, such
utilization fee being payable in each case on the average daily amount of such
excess. The Company currently pays a commitment fee of 0.25 percent per annum
on the preceding months unused U.S. Commitments and Canadian Commitment, which
commitment fee is also subject to reduction or increase based on future
performance and upon changes in the debt rating. The Company and its
subsidiaries may repay the revolving credit loans under the Revolving Credit
Agreement at any time without penalty prior to the maturity date. At July 31,
2001, there were no amounts outstanding under the U.S. Revolving Credit
Facility. At July 31, 2001, the U.S. Dollar equivalent of $9.8 million in
revolving credit loans was outstanding under the Canadian Revolving Credit
Facility, at an applicable interest rate on such date of 4.90 percent. The
Revolving Credit Agreement contains certain restrictive covenants, which, among
other restrictions, requires the Company to comply with certain financial
covenants including limitations on indebtedness, investments and capital
expenditures. The Company is currently in compliance with all of its
obligations under the Revolving Credit Agreement and the instruments governing
its other indebtedness.

Senior Notes.On September 23, 1997, the Company issued $100 million in
aggregate principal amount of 81⁄2 percent Senior Notes (the Senior Notes)
due 2007. All proceeds from the sale of the Senior Notes were used by the
Company to repay outstanding indebtedness under its Revolving Credit Agreement
and for general corporate purposes. The Senior Notes are unsecured. The
Senior Notes are redeemable for cash at any time on or after October 1, 2002,
at the option of the Company, in whole or in part, at declining redemption
prices starting at 104.25 percent of the principal amount.

The indenture relating to the Senior Notes contains certain restrictive
covenants including, but not limited to, limitations on indebtedness,
limitations on dividends and other restricted payments (including repurchases
of the Companys common stock), limitation on transactions with affiliates,
limitations on liens and limitations on disposition proceeds of asset sales,
among others. Pursuant to a registration rights agreement relating to the
Senior Notes, the Company has exchanged for the Senior Notes new notes of the
Company registered with the Securities and Exchange Commission and with terms
identical in all material respects to the Senior Notes. The Senior Notes are
included in Long-term Debt on the accompanying Balance Sheet.

Scheduled maturities of long-term debt for the next five years at July 31,
2001 are as follows: 2002-$0; 2003-$0; 2004-$0; 2005-$9.8 million; 2006-$0;
thereafter-$99.7 million; for a total of $109.5 million.

F-17



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##### Table of Contents



ZALE CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (continued)

Lease Commitments

The Company rents most of its retail space under leases that generally
range from five to ten years and may contain base rent escalations. The Company
amended and extended its corporate headquarters lease for ten and one-half
years starting in September 1997. The Company has the option to extend the
lease for up to ten years beyond the expiration of the current lease. Lease
incentives of approximately $3 million for reimbursement of certain leasehold
improvement expenditures are being amortized against lease payments over the
life of the lease. All existing real estate leases are treated as operating
leases. Sublease rental income under noncancelable leases is not material.

Rent expense is as follows:

|                                     |                        |   |                        |         |            |   |            |         |  |   |         |        | 
|------------------------------------ | ---------------------- | - | ---------------------- | ------- | ---------- | - | ---------- | ------- |  | - | ------- | ------ | 
|                                     |                        |   | Year Ended             |         | Year Ended |   | Year Ended
|                                     |                        |   | July 31,               |         | July 31,   |   | July 31,  
|                                     |                        |   | 2001                   |         | 2000       |   | 1999      
|                                     |                        |   |                        |         |            |   |           
|                                     |                        |   | (amounts in thousands)
|Retail Space:                        |                        |   |                        |         |            |   |            |         |  |   |         |       
|                                    
|                                    
|                                    
|                                    
|                                     | Minimum Rentals        |   | $                      | 149,671 |            |   | $          | 105,802 |  |   | $       | 88,943 | 
|                                    
|                                    
|                                    
|                                    
|                                     | Rentals Based on Sales |   |                        | 15,135  |            |   |            | 14,192  |  |   |         | 12,069 | 
|                                     |                        |   |                        |         |            |   |            |         |  |   |         |       
|                                     |                        |   | 164,806                |         |            |   | 119,994    |         |  |   | 101,012 |       
|                                    
|                                    
|                                    
|                                    
|Equipment and Corporate Headquarters |                        |   | 2,778                  |         |            |   | 3,017      |         |  |   | 2,770   |       
|                                     |                        |   |                        |         |            |   |            |         |  |   |         |       
|Total Rent Expense                   |                        | $ | 167,584                |         |            | $ | 123,011    |         |  | $ | 103,782 |       
|                                     |                        |   |                        |         |            |   |            |         |  |   |         |       

Rent expense is included in selling, general and administrative expense in
the accompanying Consolidated Statements of Operations.

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.

Future minimum rent commitments as of July 31, 2001, for all noncancelable
leases of ongoing operations were as follows: 2002 
$148.5 million; 2003 
$137.4 million; 2004  $128.2 million; 2005 
$116.3 million; 2006  $100.5
million; thereafter 265.3 million; for a total of $896.2 million.

Interest

Interest expense for the years ended July 31, 2001, 2000 and 1999 was
approximately $12.1 million, $33.7 million and $37.5 million, respectively.

Interest income for the years ended July 31, 2001, 2000 and 1999 was
approximately $5.2 million, $1.5 million and $7.0 million, respectively.

F-18



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##### Table of Contents



ZALE CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (continued)

Income Taxes

Currently, the Company files a consolidated income tax return. The
effective income tax rate varies from the federal statutory rate as follows:

|                                                                            |  |                        |        |            |  |            |        |   |  |   |        |  
|--------------------------------------------------------------------------- |  | ---------------------- | ------ | ---------- |  | ---------- | ------ | - |  | - | ------ | -
|                                                                            |  | Year Ended             |        | Year Ended |  | Year Ended
|                                                                            |  | July 31,               |        | July 31,   |  | July 31,  
|                                                                            |  | 2001                   |        | 2000       |  | 1999      
|                                                                            |  |                        |        |            |  |           
|                                                                            |  | (amounts in thousands)
|Federal Income Tax Expense at Statutory Rate                                |  | $                      | 46,689 |            |  | $          | 61,242 |   |  | $ | 45,495 |  
|                                                                           
|                                                                           
|                                                                           
|                                                                           
|Amortization of Excess of Revalued Net
Assets Over Stockholders Investment |  |                        | (2,064 | )          |  |            | (2,064 | ) |  |   | (2,064 | )
|                                                                           
|                                                                           
|                                                                           
|                                                                           
|Goodwill Amortization                                                       |  |                        | 2,658  |            |  |            | 186    |   |  |   | 186    |  
|                                                                           
|                                                                           
|                                                                           
|                                                                           
|State Income Taxes, Net of Federal Income
Tax Benefit                       |  |                        | 2,899  |            |  |            | 6,044  |   |  |   | 5,128  |  
|                                                                           
|                                                                           
|                                                                           
|                                                                           
|Other                                                                       |  |                        | 1,166  |            |  |            | 1,318  |   |  |   | (242   | )
|                                                                            |  |                        |        |            |  |            |        |   |  |   |        |  
|Total Income Tax Expense                                                    |  | $                      | 51,348 |            |  | $          | 66,726 |   |  | $ | 48,503 |  
|                                                                            |  |                        |        |            |  |            |        |   |  |   |        |  
|Effective Income Tax Rate                                                   |  |                        | 38.5   | %          |  |            | 37.4   | % |  |   | 37.5   | %
|                                                                            |  |                        |        |            |  |            |        |   |  |   |        |  

|                           |                          |   |                        |        |            |   |            |        |  |   |        |        | 
|-------------------------- | ------------------------ | - | ---------------------- | ------ | ---------- | - | ---------- | ------ |  | - | ------ | ------ | 
|                           |                          |   | Year Ended             |        | Year Ended |   | Year Ended
|                           |                          |   | July 31,               |        | July 31,   |   | July 31,  
|                           |                          |   | 2001                   |        | 2000       |   | 1999      
|                           |                          |   |                        |        |            |   |           
|                           |                          |   | (amounts in thousands)
|Current Provision:         |                          |   |                        |        |            |   |            |        |  |   |        |       
|                          
|                          
|                          
|                          
|                           | Federal                  |   | $                      | 27,532 |            |   | $          | 39,547 |  |   | $      | 37,746 | 
|                          
|                          
|                          
|                          
|                           | State                    |   |                        | 3,535  |            |   |            | 3,752  |  |   |        | 3,124  | 
|                           |                          |   |                        |        |            |   |            |        |  |   |        |       
|                           | Total Current Provision  |   |                        | 31,067 |            |   |            | 43,299 |  |   |        | 40,870 | 
|                          
|                          
|                          
|                          
|Deferred Provision         |                          |   |                        |        |            |   |            |        |  |   |        |       
|                          
|                          
|                          
|                          
|                           | Federal                  |   |                        | 19,356 |            |   |            | 20,401 |  |   |        | 5,629  | 
|                          
|                          
|                          
|                          
|                           | State                    |   |                        | 925    |            |   |            | 3,026  |  |   |        | 2,004  | 
|                           |                          |   |                        |        |            |   |            |        |  |   |        |       
|                           | Total Deferred Provision |   |                        | 20,281 |            |   |            | 23,427 |  |   |        | 7,633  | 
|                           |                          |   |                        |        |            |   |            |        |  |   |        |       
|Total Income Tax Provision |                          | $ | 51,348                 |        |            | $ | 66,726     |        |  | $ | 48,503 |       
|                           |                          |   |                        |        |            |   |            |        |  |   |        |       

As of July 31, 2001, the Company has a NOL carryforward (after
limitations) of $152.9 million. The utilization of this asset is subject to
limitations. The most restrictive is the Internal Revenue Code Section 382
annual limitation. The NOL carryforward can be utilized through 2008.

F-19



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##### Table of Contents



ZALE CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (continued)

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 effects of
temporary differences that give rise to significant components of the deferred
tax assets and deferred tax liabilities at July 31, 2001 and 2000 are presented
below.

|                                    |               |                                                          |         |                        |         |               |         |   |         |  
|----------------------------------- | ------------- | -------------------------------------------------------- | ------- | ---------------------- | ------- | ------------- | ------- | - | ------- | -
|                                    |               |                                                          |         | July 31, 2001          |         | July 31, 2000
|                                    |               |                                                          |         |                        |         |              
|                                    |               |                                                          |         | (amounts in thousands)
|Current Deferred Taxes:             |               |                                                          |         |                        |         |               |         |  
|                                   
|                                   
|                                   
|                                   
|                                    | Assets       |                                                          |         |                        |         |               |         |   |        
|                                   
|                                   
|                                   
|                                   
|                                    |               | Customer receivables                                     |         | $                      | 1,169   |               |         | $ |        |  
|                                   
|                                   
|                                   
|                                   
|                                    |               | Accrued liabilities                                      |         |                        | 49,777  |               |         |   | 47,933  |  
|                                   
|                                   
|                                   
|                                   
|                                    |               | State and local taxes                                    |         |                        | 4,230   |               |         |   | 1,720   |  
|                                   
|                                   
|                                   
|                                   
|                                    |               | Net operating loss carryforward                          |         |                        | 7,601   |               |         |   | 7,601   |  
|                                   
|                                   
|                                   
|                                   
|                                    |               | Other                                                    |         |                        | 2,156   |               |         |   | 262     |  
|                                    |               |                                                          |         |                        |         |               |         |  
|                                    |               | Total Assets                                             |         |                        | 64,933  |               |         |   | 57,516  |  
|                                   
|                                   
|                                   
|                                   
|                                    | Liabilities  |                                                          |         |                        |         |               |         |   |        
|                                   
|                                   
|                                   
|                                   
|                                    |               | Customer receivables                                     |         |                        |        |               |         |   | (5,252  | )
|                                   
|                                   
|                                   
|                                   
|                                    |               | Merchandise inventories, principally due to
LIFO reserve |         |                        | (81,062 | )             |         |   | (74,956 | )
|                                    |               |                                                          |         |                        |         |               |         |  
|Deferred Current Tax Liability, Net |               | $                                                        | (16,129 | )                      |         | $             | (22,692 | )
|                                    |               |                                                          |         |                        |         |               |         |  
|Non-Current Deferred Taxes:         |               |                                                          |         |                        |         |               |         |  
|                                   
|                                   
|                                   
|                                   
|                                    | Assets       |                                                          |         |                        |         |               |         |   |        
|                                   
|                                   
|                                   
|                                   
|                                    |               | Property
and equipment, net                              |         | $                      |        |               |         | $ | 4,635   |  
|                                   
|                                   
|                                   
|                                   
|                                    |               | Net operating loss carryforward                          |         |                        | 51,914  |               |         |   | 59,708  |  
|                                   
|                                   
|                                   
|                                   
|                                    |               | Postretirement benefits                                  |         |                        | 7,963   |               |         |   | 7,137   |  
|                                   
|                                   
|                                   
|                                   
|                                    |               | Other                                                    |         |                        | 1,258   |               |         |   | 3,098   |  
|                                    |               |                                                          |         |                        |         |               |         |  
|                                    |               | Total Assets                                             |         |                        | 61,135  |               |         |   | 74,578  |  
|                                   
|                                   
|                                   
|                                   
|                                    | Liabilities  |                                                          |         |                        |         |               |         |   |        
|                                   
|                                   
|                                   
|                                   
|                                    |               | Property and equipment                                   |         |                        | (4,894  | )             |         |   |        |  
|                                   
|                                   
|                                   
|                                   
|                                    |               | Goodwill                                                 |         |                        | (8,537  | )             |         |   | (10,882 | )
|                                    |               |                                                          |         |                        |         |               |         |  
|Deferred Non-Current Tax Asset, Net |               | $                                                        | 47,704  |                        |         | $             | 63,696  |  
|                                    |               |                                                          |         |                        |         |               |         |  

A valuation allowance must be provided when it is more likely than not
that the deferred income tax asset will not be realized. There was no valuation
reserve at July 31, 2001 and 2000 respectively. The Company believes that, as
of July 31, 2001, the realization of the deferred income tax asset is more
likely than not.

Capital Stock

Common Stock.At July 31, 2001 and 2000, 70,000,000 shares of Common
Stock, par value of $0.01 per share, were authorized, and 40,419,830 shares and
39,683,674 shares, respectively, were issued, of which 34,815,150 shares and
35,260,814 shares, respectively, were outstanding.

Preferred Stock.At July 31, 2001 and 2000, 5,000,000 shares of Preferred
Stock, par value of $0.01, were authorized. None were issued or outstanding.

Treasury Stock.The Company held 5,603,680 and 4,422,860 treasury shares
at July 31, 2001 and 2000 respectively.

F-20



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##### Table of Contents



ZALE CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (continued)

In June 1999, the Company completed a $50 million repurchase program,
which was authorized during August 1998. Under this program, the Company
repurchase 1.7 million shares in fiscal 1999.

During September 1999, the Board of Directors approved a stock repurchase
program pursuant to which the Company, from time to time and at managements
discretion, may purchase through fiscal year 2000, up to an aggregate of $50
million of common stock on the open market. Under this program, the Company
repurchased 1.3 million shares at an aggregate cost of $50 million.

On July 18, 2000, the Company announced a stock repurchase program pursuant to
which the Company, from time to time at the discretion of management and the
Board of Directors and in accordance with the Companys usual policies and
applicable securities laws, may purchase up to an aggregate of $50 million of
Zale Corporation common stock on the open market through July 31, 2001. The
Company repurchased 1.3 million shares at an aggregate cost of $38.7 million in
fiscal 2001.

On August 7, 2001, the Company announced that its Board of Directors has
approved a stock repurchase program pursuant to which the Company, from time to
time and at managements discretion, may purchase throughout the fiscal year,
up to an aggregate of $50 million of common stock on the open market.

Incentive Stock Plan.As of July 31, 2001, the Company had two stock
incentive plans. On July 30, 1993, the Company adopted an incentive stock
option plan (the Incentive Stock Plan) to enable the Company to attract,
retain and motivate officers and key employees by providing for proprietary
interest of such individuals in the Company. Stock awards to purchase an
aggregate of 8,405,000 shares of common stock may be granted under the
Incentive Stock Plan to eligible employees. The Incentive Stock Plan allows
for the granting of restricted stock, stock options, stock bonuses and stock
appreciation rights subject to the provisions of the Incentive Stock Plan.
Restricted Stock granted under the Incentive Stock Plan usually vests ratably
over a four to five year vesting period and are non-transferable prior to
vesting. Options granted under the Incentive Stock Plan (i) must be granted at
an exercise price not less than the fair market value of the shares of common
stock into which such options are exercisable, (ii) vest ratably over a
four-year vesting period and (iii) expire ten years from the date of grant. The
1995 Outside Director Stock Option Plan, (the Director Plan) authorizes the
Company to grant common stock to non-employee directors at fair market value of
the Company common stock on the date of grant. The options vest over a four
year period and expire ten years from the date of grant. The maximum number of
shares which may be granted under the Director Plan is 300,000 shares.

During February 1999, 180,692 shares of restricted Common Stock were
granted to certain key employees valued at $5.7 million as of the grant date.
These shares will vest ratably on each of the anniversaries ranging from two to
four years from the date of grant and are subject to restrictions on their sale
or transfer. During July 2001, 250,000 shares of restricted common stock was
granted to a key employee, valued at $7.9 million as of the grant date, and
these shares will vest ratably over five years. In fiscal year 2001, 25,962
restricted shares were cancelled and returned to treasury stock due to the
resignation of an executive. The total cost of restricted stock is amortized
to income as compensation expense ratably over the vesting period and amounted
to $0.7 million, $3.2 million, and $0.7 million for the twelve month periods
ended July 31, 2001, 2000, and 1999 respectively. Compensation expense
is included in selling, general and administrative expense in the
accompanying Consolidated Statements of Operations.

F-21



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##### Table of Contents



ZALE CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (continued)

Stock option transactions are summarized as follows:

|                               |  |        |           |             |  |        |           |        |  |        |            |        |  |        |             |        |  |        |             |  |  |   |             |  |  |                           |       |  |  |   |       |  |  |   |       | 
|------------------------------ |  | ------ | --------- | ----------- |  | ------ | --------- | ------ |  | ------ | ---------- | ------ |  | ------ | ----------- | ------ |  | ------ | ----------- |  |  | - | ----------- |  |  | ------------------------- | ----- |  |  | - | ----- |  |  | - | ----- | 
|                               |  |        |           |             |  |        |           |        |  |        |            |        |  |        |             |        |  |        |             |  |  |   |             |  |  | Weighted Average Exercise
|                               |  | Shares |           | Grant Price |  | Price 
|                               |  |        |           |             |  |       
|                               |  | Fiscal |           | Fiscal      |  | Fiscal |           | Fiscal |  | Fiscal |            | Fiscal |  | Fiscal |             | Fiscal |  | Fiscal
|                               |  | 2001   |           | 2000        |  | 1999   |           | 2001   |  | 2000   |            | 1999   |  | 2001   |             | 2000   |  | 1999  
|                               |  |        |           |             |  |        |           |        |  |        |            |        |  |        |             |        |  |       
|Outstanding,
beginning of year |  |        | 3,241,313 |             |  |        | 2,912,157 |        |  |        | 3,365,757  |        |  | $      | 8.68-45.56  |        |  | $      | 8.68-43.50  |  |  | $ | 8.68-33.44  |  |  | $                         | 34.70 |  |  | $ | 30.01 |  |  | $ | 22.65 | 
|                              
|                              
|                              
|                              
|Granted                        |  |        | 1,066,650 |             |  |        | 816,500   |        |  |        | 643,500    |        |  |        | 28.22-40.13 |        |  |        | 33.91-45.56 |  |  |   | 23.88-43.50 |  |  |                           | 31.82 |  |  |   | 42.97 |  |  |   | 42.17 | 
|                              
|                              
|                              
|                              
|Exercised                      |  |        | (485,156  | )           |  |        | (422,669  | )      |  |        | (1,018,775 | )      |  |        | 9.00-33.44  |        |  |        | 9.00-33.44  |  |  |   | 8.68-33.44  |  |  |                           | 25.44 |  |  |   | 18.90 |  |  |   | 14.00 | 
|                              
|                              
|                              
|                              
|Canceled                       |  |        | (575,025  | )           |  |        | (64,675   | )      |  |        | (78,325    | )      |  |        | 9.74-43.72  |        |  |        | 9.74-43.50  |  |  |   | 9.74-33.44  |  |  |                           | 40.54 |  |  |   | 31.17 |  |  |   | 20.22 | 
|                               |  |        |           |             |  |        |           |        |  |        |            |        |  |        |             |        |  |        |             |  |  |   |             |  |  |                           |       |  |  |   |       |  |  |   |       | 
|Outstanding,
end of year       |  |        | 3,247,782 |             |  |        | 3,241,313 |        |  |        | 2,912,157  |        |  | $      | 8.68-45.56  |        |  | $      | 8.68-45.56  |  |  | $ | 8.68-43.50  |  |  | $                         | 34.10 |  |  | $ | 34.70 |  |  | $ | 30.01 | 
|                               |  |        |           |             |  |        |           |        |  |        |            |        |  |        |             |        |  |        |             |  |  |   |             |  |  |                           |       |  |  |   |       |  |  |   |       | 

The following table summarizes information about stock options outstanding
at July 31, 2001.

|                    |       |                     |   |                |  |          |       |             |  |          |           |         |  |  |   |          |  |          |       |       |  |  |           |          |  |   |       |       |  | 
|------------------- | ----- | ------------------- | - | -------------- |  | -------- | ----- | ----------- |  | -------- | --------- | ------- |  |  | - | -------- |  | -------- | ----- | ----- |  |  | --------- | -------- |  | - | ----- | ----- |  | 
|Options Outstanding |       | Options Exercisable
|                    |       |                    
|                    |       |                     |   |                |  |          |       |             |  |          |           |         |  |  |   | Weighted |  | Weighted |       |       |  |  |           | Weighted
|                    |       |                     |   |                |  |          |       |             |  |          |           |         |  |  |   | Average  |  | Average  |       |       |  |  |           | Average 
|Range of Exercise   |       | Number              |   | Remaining Life |  | Exercise |       | Number      |  | Exercise
|Prices              |       | Outstanding         |   | (Years)        |  | Price    |       | Exercisable |  | Price   
|                    |       |                     |   |                |  |          |       |             |  |         
|$                   | 4.56  |                     |   |               |  |          | $     | 9.11        |  |          |           | 2,000   |  |  |   | 3        |  |          | $     | 9.00  |  |  |           | 2,000    |  |   | $     | 9.00  | 
|                   
|                   
|                   
|                   
|                    | 9.11  |                     |   |               |  |          |       | 13.67       |  |          |           | 42,750  |  |  |   | 3        |  |          |       | 10.49 |  |  |           | 42,750   |  |   |       | 10.49 | 
|                   
|                   
|                   
|                   
|                    | 13.67 |                     |   |               |  |          |       | 18.23       |  |          |           | 103,157 |  |  |   | 5        |  |          |       | 16.85 |  |  |           | 103,157  |  |   |       | 16.85 | 
|                   
|                   
|                   
|                   
|                    | 18.23 |                     |   |               |  |          |       | 22.78       |  |          |           | 169,375 |  |  |   | 6        |  |          |       | 21.62 |  |  |           | 169,375  |  |   |       | 21.62 | 
|                   
|                   
|                   
|                   
|                    | 22.78 |                     |   |               |  |          |       | 27.34       |  |          |           | 43,350  |  |  |   | 7        |  |          |       | 26.04 |  |  |           | 24,600   |  |   |       | 26.00 | 
|                   
|                   
|                   
|                   
|                    | 27.34 |                     |   |               |  |          |       | 31.89       |  |          |           | 962,400 |  |  |   | 10       |  |          |       | 31.48 |  |  |           | 16,000   |  |   |       | 28.63 | 
|                   
|                   
|                   
|                   
|                    | 31.89 |                     |   |               |  |          |       | 36.45       |  |          |           | 989,625 |  |  |   | 7        |  |          |       | 33.46 |  |  |           | 763,625  |  |   |       | 33.43 | 
|                   
|                   
|                   
|                   
|                    | 36.45 |                     |   |               |  |          |       | 41.01       |  |          |           | 10,500  |  |  |   | 9        |  |          |       | 38.69 |  |  |           | 3,000    |  |   |       | 38.73 | 
|                   
|                   
|                   
|                   
|$41.01              |       |                     |  |                |  | $        | 45.56 |             |  |          | 924,625   |         |  |  | 9 |          |  |          | 43.21 |       |  |  | 325,875   |          |  |   | 43.30 |      
|                    |       |                     |   |                |  |          |       |             |  |          |           |         |  |  |   |          |  |          |       |       |  |  |           |          |  |   |       |      
|                    |       |                     |   |                |  |          |       |             |  |          | 3,247,782 |         |  |  | 8 |          |  | $        | 34.10 |       |  |  | 1,450,382 |          |  | $ | 32.21 |      
|                    |       |                     |   |                |  |          |       |             |  |          |           |         |  |  |   |          |  |          |       |       |  |  |           |          |  |   |       |      

As of July 31, 2001, 2000 and 1999, 1,450,382, 1,315,021, and 918,448, of
options outstanding were exercisable at a weighted average exercise price of
$32.21, $28.69, and $23.45, respectively.

The Company accounts for the Stock Option Plan under Accounting Principles
Bulletin Opinion No. 25, under which no compensation cost has been recognized.
Had compensation cost for this plan been determined pursuant to the provisions
of SFAS No. 123, Accounting for StockBased Compensation, the Companys
pro-forma net earnings for fiscal years 2001, 2000 and 1999 would have been
(amounts in thousands) $74,244, $106,643, and $77,149 respectively, resulting
in diluted earnings per share of $2.14, $2.97 and $2.10, respectively. The fair
value of each option grant is estimated on the date of grant using the Black
Scholes option pricing model with the following weighted-average assumptions
used for options granted in fiscal years 2001, 2000, and 1999 respectively:
risk-free interest rate of 4.9 percent, 6.3 percent, and 5.3 percent, expected
dividend yield of zero, expected lives of five years, and expected volatility
of 38.9 percent, 36.0 percent, and 34.0 percent. The weighted average fair
value of options granted for fiscal years 2001, 2000 and 1999 is $13.37, $18.60
and $17.34, respectively.

Because the SFAS No. 123 method of accounting has not been applied to
options granted prior to August 1, 1996, the resulting pro forma compensation
cost may not be representative of that to be expected in future years.

Earnings Per Common Share

Basic earnings per share is computed by dividing income available to
common stockholders by the weighted average number of common shares outstanding
for the reporting period. Diluted earnings per share 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
and warrants issued by the Company represent the only dilutive effect reflected
in diluted weighted average shares. For the years ended July 31, 2001, 2000
and 1999, there were antidilutive common stock equivalents of 1,846,613,
1,386,500, and 593,000, respectively.

F-22



---



##### Table of Contents



ZALE CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (continued)

|                                                                 |  |                                                  |        |      |  |      |         |  |  |   |        | 
|---------------------------------------------------------------- |  | ------------------------------------------------ | ------ | ---- |  | ---- | ------- |  |  | - | ------ | 
|                                                                 |  | Year Ended July 31,                             
|                                                                 |  |                                                 
|                                                                 |  | 2001                                             |        | 2000 |  | 1999
|                                                                 |  |                                                  |        |      |  |     
|                                                                 |  | (amounts in thousands, except per share amounts)
|Net earnings available to stockholders                           |  | $                                                | 82,048 |      |  | $    | 111,514 |  |  | $ | 80,932 | 
|                                                                
|                                                                
|                                                                
|                                                                
|Basic:                                                           |  |                                                  |        |      |  |      |         |  |  |   |        | 
|                                                                
|                                                                
|                                                                
|                                                                
|Weighted average number of common shares outstanding             |  |                                                  | 34,575 |      |  |      | 35,326  |  |  |   | 36,137 | 
|                                                                
|                                                                
|                                                                
|                                                                
|Earnings per common share  basic                                |  | $                                                | 2.37   |      |  | $    | 3.16    |  |  | $ | 2.24   | 
|                                                                 |  |                                                  |        |      |  |      |         |  |  |   |        | 
|Diluted:                                                         |  |                                                  |        |      |  |      |         |  |  |   |        | 
|                                                                
|                                                                
|                                                                
|                                                                
|Weighted average number of common shares outstanding             |  |                                                  | 34,575 |      |  |      | 35,326  |  |  |   | 36,137 | 
|                                                                
|                                                                
|                                                                
|                                                                
|Effect of dilutive securities:                                   |  |                                                  |        |      |  |      |         |  |  |   |        | 
|                                                                
|                                                                
|                                                                
|                                                                
|Stock options                                                    |  |                                                  | 176    |      |  |      | 557     |  |  |   | 551    | 
|                                                                
|                                                                
|                                                                
|                                                                
|Weighted average number of common shares outstanding
as adjusted |  |                                                  | 34,751 |      |  |      | 35,883  |  |  |   | 36,688 | 
|                                                                
|                                                                
|                                                                
|                                                                
|Earnings per common share-diluted                                |  | $                                                | 2.36   |      |  | $    | 3.11    |  |  | $ | 2.21   | 
|                                                                 |  |                                                  |        |      |  |      |         |  |  |   |        | 

Comprehensive Income

Comprehensive income is defined as the change in equity during a period
from transactions and other events, except those resulting from investments by
and distributions to stockholders. The components of comprehensive income are
reported in the Consolidated Statements of Stockholders Investment.

Segments

The Company has one reportable segment given the similarities of economic
characteristics and products offered between the operations represented by the
Companys six brands. Revenues of international retail operations represent
approximately 7.3 percent and 8.6 percent of the Companys revenues for fiscal
2001 and fiscal 2000, respectively. Net property and equipment of
international operations, represents approximately 5.1 percent and 5.4 percent
of the Companys net property and equipment for fiscal 2001 and fiscal 2000,
respectively. The Companys international retail operations commenced with the
acquisition of Peoples Jewellers effective May 23, 1999.

Non-recurring Charge

Upon the return of Robert J. DiNicola as Chairman and Chief Executive
Officer on February 21, 2001, the Company performed an in depth review to
determine the inventory that was not of a quality consistent with the strategic
direction of the Companys brands. As a result of that review, the Company
recorded a non-recurring charge in Cost of Sales of $25.2 million to adjust the
valuation of such inventory and provide for markdowns to liquidate or
sell-through the inventory.

Unusual Item  Executive Transactions

Effective September 6, 2000, Robert J. DiNicola retired as Chairman of the
Board but remained as a non-employee member of the Board. In connection with
his severance arrangement, the Company agreed to pay certain benefits of
approximately $1.9 million consisting principally of an amount equivalent to
one year of salary and bonus and other severance related benefits including the
accelerated vesting of certain options held by Mr. DiNicola.

Additionally, the
Board approved the provision to Mr. DiNicola by the Company of a full recourse,
$2.2 million interest-bearing loan at 8.74 percent for the sole purpose of
purchasing 125,000 stock options prior to their expiration. The Company also
extended the exercise period on an additional 500,000 stock options set to
expire on September 6, 2002 to the earlier of the original 10 year term (to
expire July 9, 2007), the maximum term pursuant to the Companys stock option
plan, or two years after Mr. DiNicola leaves the Board of Directors. Based on
the intrinsic value of these stock options on the modification date, no
compensation charge was recorded by the Company.

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##### Table of Contents



ZALE CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (continued)

Effective February 12, 2001, Beryl B. Raff resigned as Chairman of the
Board and Chief Executive Officer. In connection with her resignation, the
Company agreed to pay certain benefits of approximately $2.5 million consisting
principally of an amount equivalent to three years of salary and other
severance related benefits including accelerated vesting of certain options and
restricted stock.

Robert J. DiNicola was re-appointed as Chairman of the Board and Chief
Executive Officer, effective February 21, 2001 under a three year contract with
terms substantially consistent with his previous contract when he held the same
position. In August 2001, the Company entered into a five year employment
agreement with Mr. DiNicola effective upon Mr. DiNicolas reelection as
Chairman of the Board and Chief Executive Officer, replacing the earlier
employment agreement. In April 2001, the Company extended a $2.1 million, three
year interest bearing loan at 7.25 percent to Mr. DiNicola for the purpose of
purchasing a home. In August 2001, the loan was modified and extended with the
entire principal amount to be repaid in August 2006.

Commitments And Contingencies

The Company is involved in certain legal actions and claims arising in the
ordinary course of business. Management believes that such litigation and
claims will be resolved without material effect on the Companys financial
position or results of operations.

In July of 2000, a suit was filed against the Company seeking class action
status relating to its credit insurance operations. Management intends to
vigorously defend itself against such actions and believes that such litigation
and claims will be resolved without material effect on the Companys financial
position or results of operations.

The Company has an operations services agreement for management
information systems with a third-party servicer. The agreement, effective
August 1, 1999, requires fixed payments totaling $34.4 million over a 60 month
term and a variable amount based on usage. Management is evaluating future
outsourcing opportunities, since this agreement expires at the end of fiscal
2002. The Company has an option to extend the current agreement for two
consecutive one year periods.

Benefit Plans

Defined Contribution Retirement Plan

At July 31, 2001, the Company maintained the Zale Corporation Savings &
Investment Plan. Substantially all employees who are at least age 21 are
eligible to participate in the plan. New employees are required to complete
one year of continuous service with the Company to be eligible to participate
in the plan. Each employee can contribute from one percent to fifteen percent
of their annual salary. Under this plan, the company matches one dollar in
Zale stock for every dollar an employee contributes up to four percent of
annual compensation, subject to Internal Revenue Service limitations.

Matching contributions are made on a monthly basis, and are vested
immediately. The Companys matching contributions were $4.1 million, $5.2
million and $1.3 million for fiscal years 2001, 2000 and 1999, respectively.
The Company contributed 117,342 and 130,449 treasury shares to its 401(k) plan
in fiscal year 2001 and 2000, respectively.

From the date of acquisition through July 31, 2001, Piercing Pagoda
employees continued to contribute to a separate defined contribution retirement
plan that was in place prior to the acquisition. Effective August 1, 2001,
this plan was merged with and into the Zale Corporation Savings & Investment
Plan.

F-24



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##### Table of Contents



ZALE CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (continued)

Non-Qualified Retirement Plan

On September 14, 1995, the Boards of Directors of Zale and ZDel approved
the preparation and implementation of the Zale Delaware, Inc. Supplemental
Executive Retirement Plan (the Plan), which was executed on behalf of the
Company February 23, 1996, to be effective as of September 15, 1995. The
purpose of the Plan is to provide eligible executives with the opportunity to
receive payments each year after retirement equal to a portion of their final
average pay as defined. Effective August 1, 2000, the eligibility requirements
were changed to include corporate vice-presidents, division presidents, and
division senior vice-presidents. The benefits provided by this plan are funded
by corporate owned life insurance policies. There is no material impact to the
financial statements from this Plan.

Financial Instruments

As cash and short-term cash investments, the revolving credit agreement,
trade payables and certain other short-term financial instruments are all
short-term in nature, their carrying amount approximates fair value. Also, the
carrying amount of the $99.7 million, net of discount, Senior Notes
approximates fair value.

The investments of the Companys insurance subsidiaries, primarily stocks
and bonds in the amount of $26.7 million and $27.8 million, approximate market
value at July 31, 2001 and July 31, 2000 respectively and are reflected in
Other Assets on the Consolidated Balance Sheets. Investments are classified as
available for sale and are carried at fair value. Changes in unrealized gains
and losses are recorded directly to stockholders investment. Net realized
gains recognized for the years ended July 31, 2001, 2000 and 1999 were $0.3
million, $2.1 million, and $1.6 million, respectively.

Concentrations of Credit Risk.As of July 31, 2001 and 2000, the Company
had no significant concentrations of credit risk.

Related-Party Transactions

One of the Companys directors serves as a director of a company from
which the Company purchased approximately $2.4 million and $2.8 million of
jewelry merchandise during fiscal year 2001 and 2000, respectively. The Company
believes the terms were equivalent to those of transactions with unrelated
parties.

During fiscal year 2001, the Company retained the firm of Whitehead Mann,
Inc. to perform certain executive search services for the Company. Mr. A.
David Brown, a member of the Companys compensation committee and Board of
Directors, serves as managing partner of Whitehead Mann. In exchange for
executive search services, Whitehead Mann received fees of approximately
$100,000. The Company believes the terms were equivalent to
those transactions with unrelated parties.

In August 2000, the Board approved the provision to Mr. DiNicola by the
Company of a full recourse, $2.2 million interest-bearing loan at 8.74 percent
for the sole purpose of purchasing 125,000 stock options prior to their
expiration. Also, in April 2001, the Company extended a $2.1 million, three
year interest bearing loan at 7.25 percent to Mr. DiNicola for the purpose of
purchasing a home. In August 2001, the loan was modified and extended with the
entire principal amount to be repaid in August 2006.

Effective March 27, 2001, the Company extended loans to Alan P. Shor, Mary
Forté, and Sue E. Gove, in the amounts of $23,838, $16,685 and $16,685,
respectively, to pay income taxes due on the value of restricted stock grants
to each, which vested on February 25, 2001. Under the loan agreements, the
named executives agreed not to sell all or a portion of the restricted stock to
generate funds to pay the taxes due. In any event, the loans must be repaid by
September 30, 2002. As of July 31, 2001, $23,838, $16,685 and $16,685,
respectively remained outstanding on the loans.

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##### Table of Contents



ZALE CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (continued)

New Financial Accounting Pronouncements

On July 21, 2001, the Financial Accounting Standards Board issued
Statements of Financial Accounting Standards No. 141 (SFAS No. 141), Business
Combinations, and No. 142 (SFAS No. 142), Goodwill and Other Intangible
Assets. SFAS No. 141 addresses financial accounting and reporting for
goodwill and other intangible assets acquired in a business combination. SFAS
No. 141 requires the purchase method of accounting to be used for all business
combinations initiated after June 30, 2001 and establishes specific criteria
for the recognition of intangible assets separate from goodwill. SFAS No. 142
addresses financial accounting and reporting for goodwill and other intangible
assets subsequent to their acquisition, including negative goodwill. SFAS No.
142 provides that goodwill and intangible assets which have indefinite useful
lives will not be amortized but rather will be tested at least annually for
impairment and upon adoption. Negative goodwill related to future acquisitions
will be recorded as an extraordinary item. The Company plans to adopt SFAS No.
142 in the first quarter of fiscal 2002. As a result, the Company expects to
recognize a cumulative effect of a change in accounting principle of
approximately $41 million in the first quarter of fiscal 2002 related to the
write off of the Excess of Revalued Net Assets Over Stockholders Investment.
Additionally, goodwill related to the Companys acquisitions will no longer be
amortized. This change will result in an increase to earnings of approximately
$7 million in fiscal 2002. In accordance with the standard the Company will
have an appraisal of its reporting units that include goodwill upon adoption to
determine whether an impairment exists.

Supplemental Condensed Consolidating Financial Information

On September 23, 1997, the Company issued $100 million in aggregate
principal amount of 81⁄2 percent Senior Notes (the Senior Notes) due 2007 by
means of an offering memorandum to qualified institutional buyers under Rule
144A promulgated under the Securities Act of 1933, as amended.

The Companys payment obligations under the Senior Notes are guaranteed by
ZDel (the Guarantor Subsidiary). Such guarantee is full and unconditional
with respect to ZDel. Separate financial statements of the Guarantor Subsidiary
are not presented because the Companys management has determined that they
would not be material to investors. The following supplemental financial
information sets forth, on an unconsolidated basis, statements of operations,
balance sheets, and statements of cash flow information for the Company
(Parent Company Only), for the Guarantor Subsidiary and for the Companys
other subsidiaries (the Non-Guarantor Subsidiaries). The supplemental
financial information reflects the investments of the Company and the Guarantor
Subsidiary in the Guarantor and Non-Guarantor Subsidiaries using the equity
method of accounting. Certain reclassifications have been made to provide for
uniform disclosure of all periods presented. These reclassifications are not
material.

F-26



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##### Table of Contents



ZALE CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (continued)

SUPPLEMENTAL CONDENSED CONSOLIDATING FINANCIAL INFORMATION  (continued)
SUPPLEMENTAL CONDENSED CONSOLIDATING STATEMENT OF OPERATIONS

Year Ended July 31, 2001
(amounts in thousands)

|                                                   |  |   |         |   |            |   |               |  |              |   |              |  |  |   |         |   |  |   |           |  | 
|-------------------------------------------------- |  | - | ------- | - | ---------- | - | ------------- |  | ------------ | - | ------------ |  |  | - | ------- | - |  | - | --------- |  | 
|                                                   |  |   | Parent  |   |            |   |               |  |              |   |              |  |  |   |         |   |  |   |          
|                                                   |  |   | Company |   | Guarantor  |   | Non-Guarantor |  |              |   |              |  |  |   |        
|                                                   |  |   | Only    |   | Subsidiary |   | Subsidiaries  |  | Eliminations |   | Consolidated
|                                                   |  |   |         |   |            |   |               |  |              |   |             
|Net Sales                                          |  | $ |        |   |            | $ | 1,625,865     |  |              | $ | 442,377      |  |  | $ |        |   |  | $ | 2,068,242 | 
|                                                  
|                                                  
|                                                  
|                                                  
|Cost of Sales                                      |  |   |        |   |            |   | 847,533       |  |              |   | 187,437      |  |  |   |        |   |  |   | 1,034,970 | 
|                                                  
|                                                  
|                                                  
|                                                  
|Non-recurring Charge                               |  |   |        |   |            |   | 25,236        |  |              |   |             |  |  |   |        |   |  |   | 25,236    | 
|                                                   |  |   |         |   |            |   |               |  |              |   |              |  |  |   |         |   |  |   |           | 
|Gross Margin                                       |  |   |        |   |            |   | 753,096       |  |              |   | 254,940      |  |  |   |        |   |  |   | 1,008,036 | 
|                                                  
|                                                  
|                                                  
|                                                  
|Selling, General and Administrative Expenses       |  |   | 150     |   |            |   | 627,046       |  |              |   | 177,584      |  |  |   |        |   |  |   | 804,780   | 
|                                                  
|                                                  
|                                                  
|                                                  
|Depreciation and Amortization Expense              |  |   |        |   |            |   | 37,457        |  |              |   | 20,833       |  |  |   |        |   |  |   | 58,290    | 
|                                                  
|                                                  
|                                                  
|                                                  
|Unusual Item  Executive Transactions              |  |   |        |   |            |   | 4,713         |  |              |   |             |  |  |   |        |   |  |   | 4,713     | 
|                                                   |  |   |         |   |            |   |               |  |              |   |              |  |  |   |         |   |  |   |           | 
|Operating Earnings (Loss)                          |  |   | (150    | ) |            |   | 83,880        |  |              |   | 56,523       |  |  |   |        |   |  |   | 140,253   | 
|                                                  
|                                                  
|                                                  
|                                                  
|Interest Expense (Income), Net                     |  |   | (70,286 | ) |            |   | 59,810        |  |              |   | 17,333       |  |  |   |        |   |  |   | 6,857     | 
|                                                   |  |   |         |   |            |   |               |  |              |   |              |  |  |   |         |   |  |   |           | 
|Income Before Income Taxes                         |  |   | 70,136  |   |            |   | 24,070        |  |              |   | 39,190       |  |  |   |        |   |  |   | 133,396   | 
|                                                  
|                                                  
|                                                  
|                                                  
|Income Taxes                                       |  |   | 27,523  |   |            |   | 9,445         |  |              |   | 14,380       |  |  |   |        |   |  |   | 51,348    | 
|                                                   |  |   |         |   |            |   |               |  |              |   |              |  |  |   |         |   |  |   |           | 
|Earnings Before Equity in Earnings of Subsidiaries |  |   | 42,613  |   |            |   | 14,625        |  |              |   | 24,810       |  |  |   |        |   |  |   | 82,048    | 
|                                                  
|                                                  
|                                                  
|                                                  
|Equity in Earnings of Subsidiaries                 |  |   | 39,435  |   |            |   | 19,781        |  |              |   |             |  |  |   | (59,216 | ) |  |   |          | 
|                                                   |  |   |         |   |            |   |               |  |              |   |              |  |  |   |         |   |  |   |           | 
|Net Earnings                                       |  | $ | 82,048  |   |            | $ | 34,406        |  |              | $ | 24,810       |  |  | $ | (59,216 | ) |  | $ | 82,048    | 
|                                                   |  |   |         |   |            |   |               |  |              |   |              |  |  |   |         |   |  |   |           | 

F-27



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##### Table of Contents



ZALE CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (continued)

SUPPLEMENTAL CONDENSED CONSOLIDATING FINANCIAL INFORMATION  (continued)
SUPPLEMENTAL CONDENSED CONSOLIDATING STATEMENT OF OPERATIONS

Year Ended July 31, 2000
(amounts in thousands)

|                                                   |  |   |         |   |            |   |               |  |              |   |              |  |  |   |         |   |  |   |           |  | 
|-------------------------------------------------- |  | - | ------- | - | ---------- | - | ------------- |  | ------------ | - | ------------ |  |  | - | ------- | - |  | - | --------- |  | 
|                                                   |  |   | Parent  |   |            |   |               |  |              |   |              |  |  |   |         |   |  |   |          
|                                                   |  |   | Company |   | Guarantor  |   | Non-Guarantor |  |              |   |              |  |  |   |        
|                                                   |  |   | Only    |   | Subsidiary |   | Subsidiaries  |  | Eliminations |   | Consolidated
|                                                   |  |   |         |   |            |   |               |  |              |   |             
|Net Sales                                          |  | $ |        |   |            | $ | 1,625,213     |  |              | $ | 189,149      |  |  | $ |        |   |  | $ | 1,814,362 | 
|                                                  
|                                                  
|                                                  
|                                                  
|Cost of Sales                                      |  |   |        |   |            |   | 836,026       |  |              |   | 94,800       |  |  |   |        |   |  |   | 930,826   | 
|                                                   |  |   |         |   |            |   |               |  |              |   |              |  |  |   |         |   |  |   |           | 
|Gross Margin                                       |  |   |        |   |            |   | 789,187       |  |              |   | 94,349       |  |  |   |        |   |  |   | 883,536   | 
|                                                  
|                                                  
|                                                  
|                                                  
|Selling, General and Administrative Expenses       |  |   | 150     |   |            |   | 611,354       |  |              |   | 19,183       |  |  |   |        |   |  |   | 630,687   | 
|                                                  
|                                                  
|                                                  
|                                                  
|Depreciation and Amortization Expense              |  |   |        |   |            |   | 31,678        |  |              |   | 10,753       |  |  |   |        |   |  |   | 42,431    | 
|                                                   |  |   |         |   |            |   |               |  |              |   |              |  |  |   |         |   |  |   |           | 
|Operating Earnings (Loss)                          |  |   | (150    | ) |            |   | 146,155       |  |              |   | 64,413       |  |  |   |        |   |  |   | 210,418   | 
|                                                  
|                                                  
|                                                  
|                                                  
|Interest Expense (Income), Net                     |  |   | (67,500 | ) |            |   | 77,435        |  |              |   | 22,243       |  |  |   |        |   |  |   | 32,178    | 
|                                                   |  |   |         |   |            |   |               |  |              |   |              |  |  |   |         |   |  |   |           | 
|Income Before Income Taxes                         |  |   | 67,350  |   |            |   | 68,720        |  |              |   | 42,170       |  |  |   |        |   |  |   | 178,240   | 
|                                                  
|                                                  
|                                                  
|                                                  
|Income Taxes                                       |  |   | 25,408  |   |            |   | 25,926        |  |              |   | 15,392       |  |  |   |        |   |  |   | 66,726    | 
|                                                   |  |   |         |   |            |   |               |  |              |   |              |  |  |   |         |   |  |   |           | 
|Earnings Before Equity in Earnings of Subsidiaries |  |   | 41,942  |   |            |   | 42,794        |  |              |   | 26,778       |  |  |   |        |   |  |   | 111,514   | 
|                                                  
|                                                  
|                                                  
|                                                  
|Equity in Earnings of Subsidiaries                 |  |   | 69,572  |   |            |   | 23,231        |  |              |   |             |  |  |   | (92,803 | ) |  |   |          | 
|                                                   |  |   |         |   |            |   |               |  |              |   |              |  |  |   |         |   |  |   |           | 
|Net Earnings                                       |  | $ | 111,514 |   |            | $ | 66,025        |  |              | $ | 26,778       |  |  | $ | (92,803 | ) |  | $ | 111,514   | 
|                                                   |  |   |         |   |            |   |               |  |              |   |              |  |  |   |         |   |  |   |           | 

F-28



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##### Table of Contents



ZALE CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (continued)

SUPPLEMENTAL CONDENSED CONSOLIDATING FINANCIAL INFORMATION  (continued)
SUPPLEMENTAL CONDENSED CONSOLIDATING STATEMENT OF OPERATIONS

Year Ended July 31, 1999
(amounts in thousands)

|                                      |                          |   |         |     |            |   |               |         |              |   |              |         |   |   |         |   |  |   |           |         | 
|------------------------------------- | ------------------------ | - | ------- | --- | ---------- | - | ------------- | ------- | ------------ | - | ------------ | ------- | - | - | ------- | - |  | - | --------- | ------- | 
|                                      |                          |   | Parent  |     |            |   |               |         |              |   |              |         |   |   |         |   |  |   |          
|                                      |                          |   | Company |     | Guarantor  |   | Non-Guarantor |         |              |   |              |         |   |   |        
|                                      |                          |   | Only    |     | Subsidiary |   | Subsidiaries  |         | Eliminations |   | Consolidated
|                                      |                          |   |         |     |            |   |               |         |              |   |             
|Net Sales                             |                          | $ |        |     |            | $ | 1,395,436     |         |              | $ | 50,198       |         |   | $ |        |   |  | $ | 1,445,634 |        
|                                     
|                                     
|                                     
|                                     
|Cost of Sales                         |                          |   |        |     |            |   | 721,547       |         |              |   | 25,116       |         |   |   |        |   |  |   | 746,663   |        
|                                      |                          |   |         |     |            |   |               |         |              |   |              |         |   |   |         |   |  |   |           |        
|Gross Margin                          |                          |   |        |     |            |   | 673,889       |         |              |   | 25,082       |         |   |   |        |   |  |   | 698,971   |        
|                                     
|                                     
|                                     
|                                     
|Selling, General and Administrative   |                          |   |         |     |            |   |               |         |              |   |              |         |   |   |         |   |  |   |           |        
|                                     
|                                     
|                                     
|                                     
|                                      | Expenses (Income)        |   |         | 150 |            |   |               | 536,410 |              |   |              | (26,990 | ) |   |         |  |  |   |           | 509,570 | 
|                                     
|                                     
|                                     
|                                     
|Depreciation and Amortization Expense |                          |   |        |     |            |   | 26,193        |         |              |   | 3,285        |         |   |   |        |   |  |   | 29,478    |        
|                                      |                          |   |         |     |            |   |               |         |              |   |              |         |   |   |         |   |  |   |           |        
|Operating Earnings (Loss)             |                          |   | (150    | )   |            |   | 111,286       |         |              |   | 48,787       |         |   |   |        |   |  |   | 159,923   |        
|                                     
|                                     
|                                     
|                                     
|Interest Expense (Income), Net        |                          |   |        |     |            |   | (11,718       | )       |              |   | 42,206       |         |   |   |        |   |  |   | 30,488    |        
|                                      |                          |   |         |     |            |   |               |         |              |   |              |         |   |   |         |   |  |   |           |        
|Income (Loss) Before Income Taxes     |                          |   | (150    | )   |            |   | 123,004       |         |              |   | 6,581        |         |   |   |        |   |  |   | 129,435   |        
|                                     
|                                     
|                                     
|                                     
|Income Taxes                          |                          |   | (56     | )   |            |   | 46,254        |         |              |   | 2,305        |         |   |   |        |   |  |   | 48,503    |        
|                                      |                          |   |         |     |            |   |               |         |              |   |              |         |   |   |         |   |  |   |           |        
|Earnings (Loss) Before Equity in      |                          |   |         |     |            |   |               |         |              |   |              |         |   |   |         |   |  |   |           |        
|                                     
|                                     
|                                     
|                                     
|                                      | Earnings of Subsidiaries |   |         | (94 | )          |   |               | 76,750  |              |   |              | 4,276   |   |   |         |  |  |   |           | 80,932  | 
|                                     
|                                     
|                                     
|                                     
|Equity in Earnings of Subsidiaries    |                          |   | 81,026  |     |            |   | 4,459         |         |              |   |             |         |   |   | (85,485 | ) |  |   |          |        
|                                      |                          |   |         |     |            |   |               |         |              |   |              |         |   |   |         |   |  |   |           |        
|Net Earnings                          |                          | $ | 80,932  |     |            | $ | 81,209        |         |              | $ | 4,276        |         |   | $ | (85,485 | ) |  | $ | 80,932    |        
|                                      |                          |   |         |     |            |   |               |         |              |   |              |         |   |   |         |   |  |   |           |        

F-29



---



##### Table of Contents



ZALE CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (continued)

SUPPLEMENTAL CONDENSED
CONSOLIDATING FINANCIAL INFORMATION  (continued)
SUPPLEMENTAL CONDENSED CONSOLIDATING BALANCE SHEET

July 31, 2001
(amounts in thousands)

ASSETS

|                                               |                              |                                    |              |       |         |         |            |         |               |           |              |         |              |         |            |   |   |            |           |         |        |           | 
|---------------------------------------------- | ---------------------------- | ---------------------------------- | ------------ | ----- | ------- | ------- | ---------- | ------- | ------------- | --------- | ------------ | ------- | ------------ | ------- | ---------- | - | - | ---------- | --------- | ------- | ------ | --------- | 
|                                               |                              |                                    |              |       | Parent  |         |            |         |               |           |              |         |              |         |            |   |   |            |           |         |       
|                                               |                              |                                    |              |       | Company |         | Guarantor  |         | Non-Guarantor |           |              |         |              |         |            |   |  
|                                               |                              |                                    |              |       | Only    |         | Subsidiary |         | Subsidiaries  |           | Eliminations |         | Consolidated
|                                               |                              |                                    |              |       |         |         |            |         |               |           |              |         |             
|Current Assets:                                |                              |                                    |              |       |         |         |            |         |               |           |              |         |              |         |            |   |   |            |           |        
|                                              
|                                              
|                                              
|                                              
|                                               | Cash and Cash Equivalents    |                                    | $            |      |         |         | $          | 11,440  |               |           | $            | 17,950  |              |         | $          |  |   |            | $         | 29,390  |       
|                                              
|                                              
|                                              
|                                              
|                                               | Merchandise Inventories      |                                    |              |      |         |         |            | 593,887 |               |           |              | 130,270 |              |         |            |  |   |            |           | 724,157 |       
|                                              
|                                              
|                                              
|                                              
|                                               | Other Current Assets         |                                    |              |      |         |         |            | 57,028  |               |           |              | 125     |              |         |            |  |   |            |           | 57,153  |       
|                                               |                              |                                    |              |       |         |         |            |         |               |           |              |         |              |         |            |   |   |            |           |        
|Total Current Assets                           |                              |                                    |             |       |         |         | 662,355    |         |               |           | 148,345      |         |              |         |           |   |   |            | 810,700   |        
|                                              
|                                              
|                                              
|                                              
|Investment in Subsidiaries                     |                              |                                    | 76,127       |       |         |         | 125,918    |         |               |           |             |         |              |         | (202,045   | ) |   |            |          |        
|                                              
|                                              
|                                              
|                                              
|Property and Equipment, Net                    |                              |                                    |             |       |         |         | 254,384    |         |               |           | 42,029       |         |              |         |           |   |   |            | 296,413   |        
|                                              
|                                              
|                                              
|                                              
|Intercompany Receivable                        |                              |                                    | 859,771      |       |         |         |           |         |               |           |             |         |              |         | (859,771   | ) |   |            |          |        
|                                              
|                                              
|                                              
|                                              
|Goodwill, Net                                  |                              |                                    |             |       |         |         | 5,020      |         |               |           | 201,382      |         |              |         |           |   |   |            | 206,402   |        
|                                              
|                                              
|                                              
|                                              
|Other Assets                                   |                              |                                    |             |       |         |         | 3,762      |         |               |           | 30,006       |         |              |         |           |   |   |            | 33,768    |        
|                                              
|                                              
|                                              
|                                              
|Deferred Tax Assets, Net                       |                              |                                    | 785          |       |         |         | 51,534     |         |               |           | (4,615       | )       |              |         |           |   |   |            | 47,704    |        
|                                               |                              |                                    |              |       |         |         |            |         |               |           |              |         |              |         |            |   |   |            |           |        
|                                               |                              |                                    | Total Assets |       | $       | 936,683 |            |         | $             | 1,102,973 |              |         | $            | 417,147 |            |   | $ | (1,061,816 | )         |         | $      | 1,394,987 | 
|                                               |                              |                                    |              |       |         |         |            |         |               |           |              |         |              |         |            |   |   |            |           |        
|                                              
|                                              
|                                              
|                                              
|                                              
|                                              
|                                              
|                                              
|LIABILITIES AND STOCKHOLDERS INVESTMENT      
|                                              
|                                              
|                                              
|                                              
|                                              
|                                              
|                                              
|                                              
|Current Liabilities:                           |                              |                                    |              |       |         |         |            |         |               |           |              |         |              |         |            |   |   |            |           |        
|                                              
|                                              
|                                              
|                                              
|                                               | Accounts Payable and Accrued |                                    | $            | 4,633 |         |         | $          | 236,180 |               |           | $            | 28,298  |              |         | $          |  |   |            | $         | 269,111 |       
|                                              
|                                              
|                                              
|                                              
|                                               | Liabilities                  |                                    |              |       |         |         |            |         |               |           |              |         |              |         |            |   |   |            |           |         |       
|                                              
|                                              
|                                              
|                                              
|                                               | Deferred Tax Liability, Net  |                                    |              | 646   |         |         |            | 31,934  |               |           |              | (16,451 | )            |         |            |  |   |            |           | 16,129  |       
|                                               |                              |                                    |              |       |         |         |            |         |               |           |              |         |              |         |            |   |   |            |           |        
|Total Current Liabilities                      |                              |                                    | 5,279        |       |         |         | 268,114    |         |               |           | 11,847       |         |              |         |           |   |   |            | 285,240   |        
|                                              
|                                              
|                                              
|                                              
|Non-current Liabilities                        |                              |                                    |             |       |         |         | 109,077    |         |               |           | 9,357        |         |              |         |           |   |   |            | 118,434   |        
|                                              
|                                              
|                                              
|                                              
|Intercompany Payable                           |                              |                                    |             |       |         |         | 706,609    |         |               |           | 153,148      |         |              |         | (859,757   | ) |   |            |          |        
|                                              
|                                              
|                                              
|                                              
|Long-term Debt                                 |                              |                                    | 99,665       |       |         |         |           |         |               |           | 9,798        |         |              |         |           |   |   |            | 109,463   |        
|                                              
|                                              
|                                              
|                                              
|Excess of Revalued Net Assets                  |                              |                                    |              |       |         |         |            |         |               |           |              |         |              |         |            |   |   |            |           |        
|                                              
|                                              
|                                              
|                                              
|                                               |                              | Over Stockholders Investment, Net |              |       |        |         |            |         | 41,287        |           |              |         |             |         |            |   |  |            |           |         | 41,287 |          
|                                              
|                                              
|                                              
|                                              
|Total Stockholders Investment                 |                              |                                    | 831,739      |       |         |         | (22,114    | )       |               |           | 232,997      |         |              |         | (202,059   | ) |   |            | 840,563   |        
|                                               |                              |                                    |              |       |         |         |            |         |               |           |              |         |              |         |            |   |   |            |           |        
|Total Liabilities and Stockholders Investment |                              | $                                  | 936,683      |       |         | $       | 1,102,973  |         |               | $         | 417,147      |         |              | $       | (1,061,816 | ) |   | $          | 1,394,987 |        
|                                               |                              |                                    |              |       |         |         |            |         |               |           |              |         |              |         |            |   |   |            |           |        

F-30



---



##### Table of Contents



ZALE CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (continued)

SUPPLEMENTAL CONDENSED
CONSOLIDATING FINANCIAL INFORMATION  (continued)
SUPPLEMENTAL CONDENSED CONSOLIDATING BALANCE SHEET

July 31, 2000
(amounts in thousands)

ASSETS

|                                               |                                          |                                    |         |       |         |   |            |         |               |   |              |        |              |   |          |   |   |   |           |         |        |  | 
|---------------------------------------------- | ---------------------------------------- | ---------------------------------- | ------- | ----- | ------- | - | ---------- | ------- | ------------- | - | ------------ | ------ | ------------ | - | -------- | - | - | - | --------- | ------- | ------ |  | 
|                                               |                                          |                                    |         |       | Parent  |   |            |         |               |   |              |        |              |   |          |   |   |   |           |         |       
|                                               |                                          |                                    |         |       | Company |   | Guarantor  |         | Non-Guarantor |   |              |        |              |   |          |   |  
|                                               |                                          |                                    |         |       | Only    |   | Subsidiary |         | Subsidiaries  |   | Eliminations |        | Consolidated
|                                               |                                          |                                    |         |       |         |   |            |         |               |   |              |        |             
|Current Assets:                                |                                          |                                    |         |       |         |   |            |         |               |   |              |        |              |   |          |   |   |   |           |        
|                                              
|                                              
|                                              
|                                              
|                                               | Cash and Cash Equivalents                |                                    | $       |      |         |   | $          | 281,213 |               |   | $            | 17,021 |              |   | $        |  |   |   | $         | 298,234 |       
|                                              
|                                              
|                                              
|                                              
|                                               | Restricted Cash                          |                                    |         |      |         |   |            | 193     |               |   |              | 3,720  |              |   |          |  |   |   |           | 3,913   |       
|                                              
|                                              
|                                              
|                                              
|                                               | Merchandise Inventories                  |                                    |         |      |         |   |            | 566,958 |               |   |              | 63,492 |              |   |          |  |   |   |           | 630,450 |       
|                                              
|                                              
|                                              
|                                              
|                                               | Other Current Assets                     |                                    |         |      |         |   |            | 47,336  |               |   |              | (4,785 | )            |   |          |  |   |   |           | 42,551  |       
|                                               |                                          |                                    |         |       |         |   |            |         |               |   |              |        |              |   |          |   |   |   |           |        
|Total Current Assets                           |                                          |                                    |        |       |         |   | 895,700    |         |               |   | 79,448       |        |              |   |         |   |   |   | 975,148   |        
|                                              
|                                              
|                                              
|                                              
|Investment in Subsidiaries                     |                                          |                                    | (20,229 | )     |         |   | 66,268     |         |               |   |             |        |              |   | (46,039  | ) |   |   |          |        
|                                              
|                                              
|                                              
|                                              
|Property and Equipment, Net                    |                                          |                                    |        |       |         |   | 214,721    |         |               |   | 16,534       |        |              |   |         |   |   |   | 231,255   |        
|                                              
|                                              
|                                              
|                                              
|Intercompany Receivable                        |                                          |                                    | 903,825 |       |         |   |           |         |               |   | 24,396       |        |              |   | (928,221 | ) |   |   |          |        
|                                              
|                                              
|                                              
|                                              
|Goodwill, Net                                  |                                          |                                    |        |       |         |   | 5,551      |         |               |   | 58,931       |        |              |   |         |   |   |   | 64,482    |        
|                                              
|                                              
|                                              
|                                              
|Other Assets                                   |                                          |                                    |        |       |         |   | 2,462      |         |               |   | 33,246       |        |              |   |         |   |   |   | 35,708    |        
|                                              
|                                              
|                                              
|                                              
|Deferred Tax Assets, Net                       |                                          |                                    | 59      |       |         |   | 63,667     |         |               |   | (30          | )      |              |   |         |   |   |   | 63,696    |        
|                                               |                                          |                                    |         |       |         |   |            |         |               |   |              |        |              |   |          |   |   |   |           |        
|Total Assets                                   |                                          | $                                  | 883,655 |       |         | $ | 1,248,369  |         |               | $ | 212,525      |        |              | $ | (974,260 | ) |   | $ | 1,370,289 |        
|                                               |                                          |                                    |         |       |         |   |            |         |               |   |              |        |              |   |          |   |   |   |           |        
|                                              
|                                              
|                                              
|                                              
|                                              
|                                              
|                                              
|                                              
|LIABILITIES AND STOCKHOLDERS INVESTMENT      
|                                              
|                                              
|                                              
|                                              
|                                              
|                                              
|                                              
|                                              
|Current Liabilities:                           |                                          |                                    |         |       |         |   |            |         |               |   |              |        |              |   |          |   |   |   |           |        
|                                              
|                                              
|                                              
|                                              
|                                               | Accounts Payable and Accrued Liabilities |                                    | $       | 2,819 |         |   | $          | 265,190 |               |   | $            | 18,270 |              |   | $        |  |   |   | $         | 286,279 |       
|                                              
|                                              
|                                              
|                                              
|                                               | Deferred Tax Liability, Net              |                                    |         | 646   |         |   |            | 22,942  |               |   |              | (896   | )            |   |          |  |   |   |           | 22,692  |       
|                                               |                                          |                                    |         |       |         |   |            |         |               |   |              |        |              |   |          |   |   |   |           |        
|Total Current Liabilities                      |                                          |                                    | 3,465   |       |         |   | 288,132    |         |               |   | 17,374       |        |              |   |         |   |   |   | 308,971   |        
|                                              
|                                              
|                                              
|                                              
|Non-current Liabilities                        |                                          |                                    |        |       |         |   | 112,846    |         |               |   | 10,141       |        |              |   |         |   |   |   | 122,987   |        
|                                              
|                                              
|                                              
|                                              
|Intercompany Payable                           |                                          |                                    |        |       |         |   | 924,011    |         |               |   | 4,229        |        |              |   | (928,240 | ) |   |   |          |        
|                                              
|                                              
|                                              
|                                              
|Long-term Debt                                 |                                          |                                    | 99,625  |       |         |   |           |         |               |   | 9,744        |        |              |   |         |   |   |   | 109,369   |        
|                                              
|                                              
|                                              
|                                              
|Excess of Revalued Net Assets                  |                                          |                                    |         |       |         |   |            |         |               |   |              |        |              |   |          |   |   |   |           |        
|                                              
|                                              
|                                              
|                                              
|                                               |                                          | Over Stockholders Investment, Net |         |       |        |   |            |         | 47,185        |   |              |        |             |   |          |   |  |   |           |         | 47,185 | 
|                                              
|                                              
|                                              
|                                              
|Total Stockholders Investment                 |                                          |                                    | 780,565 |       |         |   | (123,805   | )       |               |   | 171,037      |        |              |   | (46,020  | ) |   |   | 781,777   |        
|                                               |                                          |                                    |         |       |         |   |            |         |               |   |              |        |              |   |          |   |   |   |           |        
|Total Liabilities and Stockholders Investment |                                          | $                                  | 883,655 |       |         | $ | 1,248,369  |         |               | $ | 212,525      |        |              | $ | (974,260 | ) |   | $ | 1,370,289 |        
|                                               |                                          |                                    |         |       |         |   |            |         |               |   |              |        |              |   |          |   |   |   |           |        

F-31



---



##### Table of Contents



ZALE CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (continued)

SUPPLEMENTAL CONDENSED
CONSOLIDATING FINANCIAL INFORMATION  (continued)
SUPPLEMENTAL CONDENSED CONSOLIDATING STATEMENT OF CASH FLOWS

Year Ended July 31, 2001
(amounts in thousands)

|                                                          |             |   |         |   |            |   |               |   |              |   |              |   |  |   |         |   |  |   |          |   | 
|--------------------------------------------------------- | ----------- | - | ------- | - | ---------- | - | ------------- | - | ------------ | - | ------------ | - |  | - | ------- | - |  | - | -------- | - | 
|                                                          |             |   | Parent  |   |            |   |               |   |              |   |              |   |  |   |         |   |  |   |         
|                                                          |             |   | Company |   | Guarantor  |   | Non-Guarantor |   |              |   |              |   |  |   |        
|                                                          |             |   | Only    |   | Subsidiary |   | Subsidiaries  |   | Eliminations |   | Consolidated
|                                                          |             |   |         |   |            |   |               |   |              |   |             
|Net Cash Provided by (Used in) Operating Activities       |             | $ | 26,291  |   |            | $ | (194,723      | ) |              | $ | 269,413      |   |  | $ | (10,606 | ) |  | $ | 90,375   |  
|                                                         
|                                                         
|                                                         
|                                                         
|Net Cash Flows from Investing Activities:                 |             |   |         |   |            |   |               |   |              |   |              |   |  |   |         |   |  |   |          |  
|                                                         
|                                                         
|                                                         
|                                                         
|Additions to property and equipment                       |             |   |        |   |            |   | (76,252       | ) |              |   | (11,404      | ) |  |   |        |   |  |   | (87,656  | )
|                                                         
|                                                         
|                                                         
|                                                         
|Dispositions of property and equipment                    |             |   |        |   |            |   | 1,202         |   |              |   | 858          |   |  |   |        |   |  |   | 2,060    |  
|                                                         
|                                                         
|                                                         
|                                                         
|Acquisition of Piercing Pagoda Inc., net of cash
acquired |             |   |        |   |            |   |              |   |              |   | (239,530     | ) |  |   |        |   |  |   | (239,530 | )
|                                                          |             |   |         |   |            |   |               |   |              |   |              |   |  |   |         |   |  |   |          |  
|Net Cash Used in Investing Activities                     |             |   |        |   |            |   | (75,050       | ) |              |   | (250,076     | ) |  |   |        |   |  |   | (325,126 | )
|                                                          |             |   |         |   |            |   |               |   |              |   |              |   |  |   |         |   |  |   |          |  
|Net Cash Flows from Financing Activities:                 |             |   |         |   |            |   |               |   |              |   |              |   |  |   |         |   |  |   |          |  
|                                                         
|                                                         
|                                                         
|                                                         
|Payments on long term debt                                |             |   |        |   |            |   |              |   |              |   | (8,012       | ) |  |   |        |   |  |   | (8,012   | )
|                                                         
|                                                         
|                                                         
|                                                         
|Payments on revolving credit agreement                    |             |   |        |   |            |   | (547,050      | ) |              |   | (16,324      | ) |  |   |        |   |  |   | (563,374 | )
|                                                         
|                                                         
|                                                         
|                                                         
|Borrowings under revolving credit agreement               |             |   |        |   |            |   | 547,050       |   |              |   | 16,651       |   |  |   |        |   |  |   | 563,701  |  
|                                                         
|                                                         
|                                                         
|                                                         
|Proceeds from exercise of stock options                   |             |   | 12,445  |   |            |   |              |   |              |   |             |   |  |   |        |   |  |   | 12,445   |  
|                                                         
|                                                         
|                                                         
|                                                         
|Purchase of common stock                                  |             |   | (38,736 | ) |            |   |              |   |              |   |             |   |  |   |        |   |  |   | (38,736  | )
|                                                         
|                                                         
|                                                         
|                                                         
|Dividends paid                                            |             |   |        |   |            |   |              |   |              |   | (10,606      | ) |  |   | 10,606  |   |  |   |         |  
|                                                          |             |   |         |   |            |   |               |   |              |   |              |   |  |   |         |   |  |   |          |  
|Net Cash Used in Financing Activities                     |             |   | (26,291 | ) |            |   |              |   |              |   | (18,291      | ) |  |   | 10,606  |   |  |   | (33,976  | )
|                                                          |             |   |         |   |            |   |               |   |              |   |              |   |  |   |         |   |  |   |          |  
|Effect of Exchange Rate Changes on Cash                   |             |   |        |   |            |   |              |   |              |   | (117         | ) |  |   |        |   |  |   | (117     | )
|                                                         
|                                                         
|                                                         
|                                                         
|Net (Decrease) Increase in Cash and Cash                  |             |   |        |   |            |   | (269,773      | ) |              |   | 929          |   |  |   |        |   |  |   | (268,844 | )
|                                                         
|                                                         
|                                                         
|                                                         
|                                                          | Equivalents |   |         |   |            |   |               |   |              |   |              |   |  |   |         |   |  |   |          |   | 
|                                                         
|                                                         
|                                                         
|                                                         
|Cash and Cash Equivalents at Beginning of Period          |             |   |        |   |            |   | 281,213       |   |              |   | 17,021       |   |  |   |        |   |  |   | 298,234  |  
|                                                          |             |   |         |   |            |   |               |   |              |   |              |   |  |   |         |   |  |   |          |  
|Cash and Cash Equivalents at End of Period                |             | $ |        |   |            | $ | 11,440        |   |              | $ | 17,950       |   |  | $ |        |   |  | $ | 29,390   |  
|                                                          |             |   |         |   |            |   |               |   |              |   |              |   |  |   |         |   |  |   |          |  

F-32



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##### Table of Contents



ZALE CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (continued)

SUPPLEMENTAL CONDENSED CONSOLIDATING FINANCIAL INFORMATION  (continued)
SUPPLEMENTAL CONDENSED CONSOLIDATING STATEMENT OF CASH FLOWS

Year Ended July 31, 2000
(amounts in thousands)

|                                                    |  |         |         |            |  |               |          |              |  |              |          |   |  |   |        |   |  |   |          |  
|--------------------------------------------------- |  | ------- | ------- | ---------- |  | ------------- | -------- | ------------ |  | ------------ | -------- | - |  | - | ------ | - |  | - | -------- | -
|                                                    |  | Parent  |         |            |  |               |          |              |  |              |          |   |  |   |        |   |  |  
|                                                    |  | Company |         | Guarantor  |  | Non-Guarantor |          |              |  |              |          |   |  |  
|                                                    |  | Only    |         | Subsidiary |  | Subsidiaries  |          | Eliminations |  | Consolidated
|                                                    |  |         |         |            |  |               |          |              |  |             
|Net Cash Provided by (Used in) Operating Activities |  | $       | 41,955  |            |  | $             | 422,579  |              |  | $            | (314,428 | ) |  | $ | (8,173 | ) |  | $ | 141,933  |  
|                                                   
|                                                   
|                                                   
|                                                   
|Net Cash Flows from Investing Activities:           |  |         |         |            |  |               |          |              |  |              |          |   |  |   |        |   |  |   |          |  
|                                                   
|                                                   
|                                                   
|                                                   
|Additions to property and equipment                 |  |         |        |            |  |               | (71,164  | )            |  |              | (7,454   | ) |  |   |       |   |  |   | (78,618  | )
|                                                   
|                                                   
|                                                   
|                                                   
|Dispositions of property and equipment              |  |         |        |            |  |               | 2,986    |              |  |              | 212      |   |  |   |       |   |  |   | 3,198    |  
|                                                   
|                                                   
|                                                   
|                                                   
|Proceeds from Sale of Credit Card Receivables       |  |         |        |            |  |               |         |              |  |              | 583,676  |   |  |   |       |   |  |   | 583,676  |  
|                                                    |  |         |         |            |  |               |          |              |  |              |          |   |  |   |        |   |  |   |          |  
|Net Cash (Used in) Provided by Investing Activities |  |         |        |            |  |               | (68,178  | )            |  |              | 576,434  |   |  |   |       |   |  |   | 508,256  |  
|                                                    |  |         |         |            |  |               |          |              |  |              |          |   |  |   |        |   |  |   |          |  
|Net Cash Flows from Financing Activities:           |  |         |         |            |  |               |          |              |  |              |          |   |  |   |        |   |  |   |          |  
|                                                   
|                                                   
|                                                   
|                                                   
|Net increase in short-term borrowings               |  |         |        |            |  |               |         |              |  |              | (250,000 | ) |  |   |       |   |  |   | (250,000 | )
|                                                   
|                                                   
|                                                   
|                                                   
|Payments on revolving credit agreement              |  |         |        |            |  |               | (568,038 | )            |  |              |         |   |  |   |       |   |  |   | (568,038 | )
|                                                   
|                                                   
|                                                   
|                                                   
|Borrowings under revolving credit agreement         |  |         |        |            |  |               | 474,782  |              |  |              |         |   |  |   |       |   |  |   | 474,782  |  
|                                                   
|                                                   
|                                                   
|                                                   
|Debt issue and capitalized financing costs          |  |         |        |            |  |               | (2,226   | )            |  |              |         |   |  |   |       |   |  |   | (2,226   | )
|                                                   
|                                                   
|                                                   
|                                                   
|Proceeds from exercise of stock options             |  |         | 8,042   |            |  |               |         |              |  |              |         |   |  |   |       |   |  |   | 8,042    |  
|                                                   
|                                                   
|                                                   
|                                                   
|Purchase of common stock                            |  |         | (49,997 | )          |  |               |         |              |  |              |         |   |  |   |       |   |  |   | (49,997  | )
|                                                   
|                                                   
|                                                   
|                                                   
|Dividends paid                                      |  |         |        |            |  |               |         |              |  |              | (8,173   | ) |  |   | 8,173  |   |  |   |         |  
|                                                    |  |         |         |            |  |               |          |              |  |              |          |   |  |   |        |   |  |   |          |  
|Net Cash Used in Financing Activities               |  |         | (41,955 | )          |  |               | (95,482  | )            |  |              | (258,173 | ) |  |   | 8,173  |   |  |   | (387,437 | )
|                                                    |  |         |         |            |  |               |          |              |  |              |          |   |  |   |        |   |  |   |          |  
|Effect of Exchange Rate Changes on Cash             |  |         |        |            |  |               |         |              |  |              | 79       |   |  |   |       |   |  |   | 79       |  
|                                                   
|                                                   
|                                                   
|                                                   
|Net Increase in Cash and Cash Equivalents           |  |         |        |            |  |               | 258,919  |              |  |              | 3,912    |   |  |   |       |   |  |   | 262,831  |  
|                                                   
|                                                   
|                                                   
|                                                   
|Cash and Cash Equivalents at Beginning of Period    |  |         |        |            |  |               | 22,294   |              |  |              | 13,109   |   |  |   |       |   |  |   | 35,403   |  
|                                                    |  |         |         |            |  |               |          |              |  |              |          |   |  |   |        |   |  |   |          |  
|Cash and Cash Equivalents at End of Period          |  | $       |        |            |  | $             | 281,213  |              |  | $            | 17,021   |   |  | $ |       |   |  | $ | 298,234  |  
|                                                    |  |         |         |            |  |               |          |              |  |              |          |   |  |   |        |   |  |   |          |  

F-33



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##### Table of Contents



ZALE CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (continued)

SUPPLEMENTAL CONDENSED CONSOLIDATING FINANCIAL INFORMATION  (continued)
SUPPLEMENTAL CONDENSED CONSOLIDATING STATEMENT OF CASH FLOWS

Year Ended July 31, 1999
(amounts in thousands)

|                                                       |  |         |         |            |  |               |          |              |  |              |          |   |  |   |          |   |  |   |          |  
|------------------------------------------------------ |  | ------- | ------- | ---------- |  | ------------- | -------- | ------------ |  | ------------ | -------- | - |  | - | -------- | - |  | - | -------- | -
|                                                       |  | Parent  |         |            |  |               |          |              |  |              |          |   |  |   |          |   |  |  
|                                                       |  | Company |         | Guarantor  |  | Non-Guarantor |          |              |  |              |          |   |  |  
|                                                       |  | Only    |         | Subsidiary |  | Subsidiaries  |          | Eliminations |  | Consolidated
|                                                       |  |         |         |            |  |               |          |              |  |             
|Net Cash Provided by (Used in) Operating Activities    |  | $       | 132,361 |            |  | $             | (86,411  | )            |  | $            | 47,435   |   |  | $ | (12,239  | ) |  | $ | 81,146   |  
|                                                      
|                                                      
|                                                      
|                                                      
|Net Cash Flows from Investing Activities:              |  |         |         |            |  |               |          |              |  |              |          |   |  |   |          |   |  |   |          |  
|                                                      
|                                                      
|                                                      
|                                                      
|Additions to property and equipment                    |  |         |        |            |  |               | (58,418  | )            |  |              | (1,120   | ) |  |   |         |   |  |   | (59,538  | )
|                                                      
|                                                      
|                                                      
|                                                      
|Dispositions of property and equipment                 |  |         |        |            |  |               | 1,875    |              |  |              | 66       |   |  |   |         |   |  |   | 1,941    |  
|                                                      
|                                                      
|                                                      
|                                                      
|Acquisition of Peoples Jewellers, net of cash acquired |  |         | (96,662 | )          |  |               |         |              |  |              |         |   |  |   |         |   |  |   | (96,662  | )
|                                                       |  |         |         |            |  |               |          |              |  |              |          |   |  |   |          |   |  |   |          |  
|Net Cash Used in Investing Activities                  |  |         | (96,662 | )          |  |               | (56,543  | )            |  |              | (1,054   | ) |  |   |         |   |  |   | (154,259 | )
|                                                       |  |         |         |            |  |               |          |              |  |              |          |   |  |   |          |   |  |   |          |  
|Net Cash Flows from Financing Activities:              |  |         |         |            |  |               |          |              |  |              |          |   |  |   |          |   |  |   |          |  
|                                                      
|                                                      
|                                                      
|                                                      
|Net increase in short-term borrowings                  |  |         |        |            |  |               |         |              |  |              | 250,000  |   |  |   |         |   |  |   | 250,000  |  
|                                                      
|                                                      
|                                                      
|                                                      
|Payments on receivables securitization facility        |  |         |        |            |  |               |         |              |  |              | (380,760 | ) |  |   |         |   |  |   | (380,760 | )
|                                                      
|                                                      
|                                                      
|                                                      
|Payments on revolving credit agreement                 |  |         |        |            |  |               | (3,500   | )            |  |              |         |   |  |   |         |   |  |   | (3,500   | )
|                                                      
|                                                      
|                                                      
|                                                      
|Borrowings under revolving credit agreement            |  |         |        |            |  |               | 106,500  |              |  |              |         |   |  |   |         |   |  |   | 106,500  |  
|                                                      
|                                                      
|                                                      
|                                                      
|Debt issue and capitalized financing costs             |  |         |        |            |  |               |         |              |  |              | (1,094   | ) |  |   |         |   |  |   | (1,094   | )
|                                                      
|                                                      
|                                                      
|                                                      
|Proceeds from exercise of stock options                |  |         | 14,244  |            |  |               |         |              |  |              |         |   |  |   |         |   |  |   | 14,244   |  
|                                                      
|                                                      
|                                                      
|                                                      
|Purchase of common stock                               |  |         | (49,943 | )          |  |               |         |              |  |              |         |   |  |   |         |   |  |   | (49,943  | )
|                                                      
|                                                      
|                                                      
|                                                      
|Proceeds from issuance of Common Stock                 |  |         |        |            |  |               |         |              |  |              | 103,000  |   |  |   | (103,000 | ) |  |   |         |  
|                                                      
|                                                      
|                                                      
|                                                      
|Dividends paid                                         |  |         |        |            |  |               | (103,000 | )            |  |              | (12,239  | ) |  |   | 115,239  |   |  |   |         |  
|                                                       |  |         |         |            |  |               |          |              |  |              |          |   |  |   |          |   |  |   |          |  
|Net Cash Used in Financing Activities                  |  |         | (35,699 | )          |  |               |         |              |  |              | (41,093  | ) |  |   | 12,239   |   |  |   | (64,553  | )
|                                                       |  |         |         |            |  |               |          |              |  |              |          |   |  |   |          |   |  |   |          |  
|Net (Decrease) Increase in Cash and Cash Equivalents   |  |         |        |            |  |               | (142,954 | )            |  |              | 5,288    |   |  |   |         |   |  |   | (137,666 | )
|                                                      
|                                                      
|                                                      
|                                                      
|Cash and Cash Equivalents at Beginning of Period       |  |         |        |            |  |               | 165,248  |              |  |              | 7,821    |   |  |   |         |   |  |   | 173,069  |  
|                                                       |  |         |         |            |  |               |          |              |  |              |          |   |  |   |          |   |  |   |          |  
|Cash and Cash Equivalents at End of Period             |  | $       |        |            |  | $             | 22,294   |              |  | $            | 13,109   |   |  | $ |         |   |  | $ | 35,403   |  
|                                                       |  |         |         |            |  |               |          |              |  |              |          |   |  |   |          |   |  |   |          |  

F-34



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##### Table of Contents



ZALE CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (continued)

Quarterly Results Of Operations (Unaudited)

Unaudited quarterly results of operations for the years ended July 31,
2001 and 2000 were as follows
(amounts in thousands except per share data):

|                                      |  |                            |         |           |  |             |         |             |  |   |         |  |  |   |         | 
|------------------------------------- |  | -------------------------- | ------- | --------- |  | ----------- | ------- | ----------- |  | - | ------- |  |  | - | ------- | 
|                                      |  | Fiscal 2001               
|                                      |  | For the Three Months Ended
|                                      |  |                           
|                                      |  | July 31,                   |         | April 30, |  | January 31, |         | October 31,
|                                      |  | 2001                       |         | 2001      |  | 2001        |         | 2000       
|                                      |  |                            |         |           |  |             |         |            
|Net sales                             |  | $                          | 417,033 |           |  | $           | 417,965 |             |  | $ | 861,442 |  |  | $ | 371,802 | 
|                                     
|                                     
|                                     
|                                     
|Gross margin                          |  |                            | 209,995 |           |  |             | 209,451 |             |  |   | 405,750 |  |  |   | 182,840 | 
|                                     
|                                     
|                                     
|                                     
|Net Earnings                          |  |                            | 2,955   |           |  |             | 3,477   |             |  |   | 71,529  |  |  |   | 4,087   | 
|                                     
|                                     
|                                     
|                                     
|Net earnings per diluted common share |  | $                          | 0.09    |           |  | $           | 0.10    |             |  | $ | 2.07    |  |  | $ | 0.12    | 

|                                      |  |                            |         |           |  |             |         |             |  |   |         |  |  |   |         | 
|------------------------------------- |  | -------------------------- | ------- | --------- |  | ----------- | ------- | ----------- |  | - | ------- |  |  | - | ------- | 
|                                      |  | Fiscal 2000               
|                                      |  | For the Three Months Ended
|                                      |  |                           
|                                      |  | July 31,                   |         | April 30, |  | January 31, |         | October 31,
|                                      |  | 2000                       |         | 2000      |  | 2000        |         | 1999       
|                                      |  |                            |         |           |  |             |         |            
|Net sales                             |  | $                          | 379,313 |           |  | $           | 366,582 |             |  | $ | 740,923 |  |  | $ | 327,544 | 
|                                     
|                                     
|                                     
|                                     
|Gross margin                          |  |                            | 183,351 |           |  |             | 179,286 |             |  |   | 362,251 |  |  |   | 158,648 | 
|                                     
|                                     
|                                     
|                                     
|Net Earnings                          |  |                            | 11,577  |           |  |             | 10,522  |             |  |   | 83,952  |  |  |   | 5,463   | 
|                                     
|                                     
|                                     
|                                     
|Net earnings per diluted common share |  | $                          | 0.32    |           |  | $           | 0.30    |             |  | $ | 2.33    |  |  | $ | 0.15    | 

F-35



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##### Table of Contents






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 5th day
of October, 2001.

|                                                                                              
|----------------------------------------------------------------------------------------------
|ZALE CORPORATION                                                                              
|                                                                                              
|By: /s/ ROBERT J. DINICOLA
Robert J. DiNicolaChairman of the Board
and Chief Executive Officer

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/ ROBERT J. DINICOLARobert J. DiNicola         |  | Chairman of the Board
and Chief Executive Officer
(principal executive officer
of the registrant)    |  | October 5, 2001
|                                                
|/s/ SUE E. GOVESue E. Gove                       |  | Executive Vice President and
Chief Financial Officer
(principal financial
officer of the registrant) |  | October 5, 2001
|                                                
|/s/ MARK R. LENZMark R. Lenz                     |  | Senior Vice President,
Controller (principal
accounting officer of the
registrant)                   |  | October 5, 2001
|                                                
|/s/ GLEN ADAMSGlen Adams                         |  | Director                                                                                             |  | October 5, 2001
|                                                
|/s/ A. DAVID BROWNA. David Brown                 |  | Director                                                                                             |  | October 5, 2001
|                                                
|/s/ PETER P. COPSESPeter P. Copses               |  | Director                                                                                             |  | October 5, 2001
|                                                
|/s/ RICHARD C. MARCUSRichard C. Marcus           |  | Director                                                                                             |  | October 5, 2001
|                                                
|/s/ CHARLES H. PISTOR, JR.Charles H. Pistor, Jr. |  | Director                                                                                             |  | October 5, 2001
|                                                
|/s/ ALAN P. SHORAlan P. Shor                     |  | President and Chief Operating
Officer, Director                                                      |  | October 5, 2001
|                                                
|/s/ ANDREW H. TISCHAndrew H. Tisch               |  | Director                                                                                             |  | October 5, 2001



29



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##### Table of Contents



REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS

To the Stockholders and Board of Directors of Zale Corporation:

We have audited in accordance with generally accepted auditing standards,
the financial statements of Zale Corporation (a Delaware corporation) and
subsidiaries included in this Form 10-K, and have issued our report thereon
dated August 27, 2001. Our audit was made for the purpose of forming an
opinion on the basic financial statements taken as a whole. Schedule II is the
responsibility of the Companys management and is presented for the purpose of
complying with the Securities and Exchange Commissions rules and is not part
of the basic financial statements. This schedule has been subjected to the
auditing procedures applied in the audit of the basic financial statements and,
in our opinion, fairly states in all material respects the financial data
required to be set forth therein in relation to the basic financial statements
taken as a whole.

ARTHUR ANDERSEN LLP

Dallas,Texas,
August 27, 2001



30



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##### Table of Contents



SCHEDULE II

ZALE CORPORATION AND SUBSIDIARIES
VALUATION AND QUALIFYING ACCOUNTS

|                                                                |  |            |        |            |  |                        |        |           |  |            |         |     |  |   |        | 
|--------------------------------------------------------------- |  | ---------- | ------ | ---------- |  | ---------------------- | ------ | --------- |  | ---------- | ------- | --- |  | - | ------ | 
|                                                                |  | Balance At |        | Additions  |  |                        |        |           |  | Balance At
|                                                                |  | Beginning  |        | Charged to |  |                        |        |           |  | End       
|                                                                |  | of Period  |        | Earnings   |  | Deductions             |        | of Period
|                                                                |  |            |        |            |  |                        |        |          
|                                                                |  |            |        |            |  | (amounts in thousands) |        |           |  |           
|Fiscal year ended July 31, 2001
Allowance for doubtful accounts |  | $          |       |            |  | $                      |       |           |  | $          |        |     |  | $ |       | 
|                                                               
|                                                               
|                                                               
|                                                               
|Fiscal year ended July 31, 2000
Allowance for doubtful accounts |  | $          | 76,534 |            |  | $                      | 71,593 |           |  | $          | 148,127 | (2) |  | $ |       | 
|                                                               
|                                                               
|                                                               
|                                                               
|Fiscal year ended July 31, 1999
Allowance for doubtful accounts |  | $          | 67,285 |            |  | $                      | 72,126 |           |  | $          | 62,877  | (1) |  | $ | 76,534 | 



---

|(1) |  | Accounts written off, less recoveries and other adjustments.                               
|--- |  | -------------------------------------------------------------------------------------------
|   
|   
|   
|   
|(2) |  | Accounts eliminated in conjunction with the Sale of the Private Label
Credit Card Business.



31



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##### Table of Contents



EXHIBIT INDEX

|            |  |             |  |                                                                                                                               
|----------- |  | ----------- |  | ------------------------------------------------------------------------------------------------------------------------------
|Exhibit No. |  | Description
|            |  |            
|10.3b       |  |            |  | Amended and
Restated Omnibus Stock Incentive Plan.                                                                            
|           
|           
|           
|           
|10.3c       |  |            |  | Outside
Directors' 1995 Stock Option Plan.                                                                                    
|           
|           
|           
|           
|*10.11d     |  |            |  | Employment Agreement, dated as of August 1, 2001, between
Zale Corporation and Robert J. DiNicola.                            
|           
|           
|           
|           
|*10.13      |  |            |  | Employment Agreement, dated as of August 1, 2001, between
Zale Corporation and Alan P. Shor.                                  
|           
|           
|           
|           
|*10.14      |  |            |  | Employment Agreement, dated as of August 1, 2001 between
Zale Corporation and Mary L. Forté.                                  
|           
|           
|           
|           
|*10.15      |  |            |  | Employment Agreement, dated as of August 1, 2001, between
Zale Corporation and Sue E. Gove.                                   
|           
|           
|           
|           
|10.21       |  |            |  | Amendment to Real Estate Lien Note, dated as of August 1,
2001, between Zale Corporation and Robert J. DiNicola.              
|           
|           
|           
|           
|10.22       |  |            |  | Amendment and Extension to Real Estate Lien Note, dated as
of August 1, 2001, between Zale Corporation and Robert J.
DiNicola.
|           
|           
|           
|           
|21          |  |            |  | Subsidiaries of the registrant.                                                                                               
|           
|           
|           
|           
|23          |  |            |  | Consent of Independent Public Accountants.