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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, 2003
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 exchangeon 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. [  ]

Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act). Yes [X]    No [  ]

As of September 16, 2003 the aggregate market value of the registrants
voting stock held by non-affiliates of the registrant was approximately
$1,315,650,096.

As of
September 16, 2003, the registrant had outstanding 27,409,377 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 6, 2003.



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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                                  
|EXECUTIVE OFFICERS AND KEY EMPLOYEES OF THE REGISTRANT
|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                                      
|                                                       | ITEM 14. CONTROLS AND PROCEDURES                                                             
|                                                       | ITEM 15. PRINCIPAL ACCOUNTANT FEES AND SERVICES                                              
|PART IV                                               
|                                                       | ITEM 16. EXHIBITS, FINANCIAL STATEMENTS SCHEDULES AND REPORTS ON FORM 8-K                    
|3. Exhibits                                           
|MANAGEMENTS REPORT                                   
|REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS              
|CONSOLIDATED STATEMENTS OF OPERATIONS                 
|CONSOLIDATED BALANCE SHEETS                           
|CONSOLIDATED STATEMENTS OF CASH FLOWS                 
|CONSOLIDATED STATEMENTS OF CASH FLOWS                 
|CONSOLIDATED STATEMENTS OF STOCKHOLDERS INVESTMENT    
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS            
|SIGNATURES                                            
|EX-4.1 Revolving Credit Agreement                     
|EX-4.2 Security Agreement of Revolving Credit Agmt    
|EX-10.4 2003 Stock Option Plan                        
|EX-10.12 Employment Agreement - Mark R. Lenz          
|EX-10.13 Employment Agreement - Pamela J. Romano      
|EX-10.14 Executive Bonus Plan                         
|EX-14 Code of Ethics                                  
|EX-21 Subsidiaries                                    
|EX-23.1 Consent of KPMG LLP                           
|EX-31.1 Rule 13a-14(a) Certification of CEO           
|EX-31.2 Rule 13a-14(a) Certification of CFO           
|EX-32.1 Section 1350 Certification of CEO             
|EX-32.2 Section 1350 Certification of CFO             
|EX-99.1 Audit Committee Charter                       
|EX-99.2 Compensation Committee Charter                
|EX-99.3 Nominating/Corporate Governance Charter       



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PART I




ITEM 1. BUSINESS

General

Zale Corporation, along with its wholly owned subsidiaries (the Company)
is the largest and most diversified specialty retailer of fine jewelry in North
America. At July 31, 2003, the Company operated 2,234 specialty retail jewelry
stores and kiosks located primarily in shopping malls throughout the United
States, Canada and Puerto Rico. The Company primarily operates under six
principal brands, each targeted to reach a distinct customer. Zales Jewelers®
is the Companys national brand which provides traditional, moderately priced
jewelry to a broad range of customers. Zales Jewelers has extended the reach
of its brand to Zales the Diamond Store Outlet® and Zales.com. Zales the
Diamond Store Outlet focuses on the brand conscious, value oriented shopper,
offering jewelry at discounts off everyday retail prices in outlet centers.
Peoples Jewellers®, the Companys national brand in Canada, offers traditional
moderately priced jewelry to customers throughout Canada. Gordons Jewelers®
in the United States, and Mappins Jewelers® in Canada, target the moderate and
more discerning customer with merchandise assortments designed to promote
slightly higher priced purchases. Bailey Banks & Biddle Fine Jewelers®
operates upscale jewelry stores that are considered among the finest jewelry
stores in their markets, offering designer jewelry and watches to attract more
affluent customers. Piercing Pagoda® reaches the opening price point jewelry
customer primarily through mall based kiosks. During the fiscal year ended
July 31, 2003 (fiscal year 2003), the Company generated $2.2 billion of net
revenues.

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 brand name recognition is an
important advantage in jewelry retailing as products are generally unbranded
and consumers must trust in a retailers reliability, credibility and
commitment to customer service. The Company believes that consumers rely on
known brand names to ensure quality. This assurance is especially important
when consumers feel they lack the expertise to evaluate quality and value of
jewelry purchases. As an industry leader, the Company continues to set the
standard for delivering innovative and creative products to consumers. The
Company believes its proven ability to capitalize on evolving merchandise
trends is what differentiates it from its competition. In addition, as the
largest specialty retailer of fine jewelry in North America, the Company
believes it realizes economies of scale in purchasing, 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 reduce earnings volatility typically associated
with local or regional conditions.

The Company was incorporated in Delaware in 1993, and through its
predecessors has been in business since 1924. 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

In fiscal year 2003, the Company established and executed initiatives
aimed at meeting the current business needs and establishing a framework
consistent with the Companys long term strategic direction. In a year marked
by a challenging external environment, the Company focused on stabilizing and
strengthening its core businesses and positioning its brands. The Company
believes it achieved its objectives of keeping the business stable while also
committing to enhancing shareholder value by staying flexible in its approach
to the business and making the necessary adjustments in merchandising,
marketing and operations.

In its effort to grow the business in both a competitive retail
environment and volatile external environment, the Company expanded upon the
key initiatives embarked upon in fiscal year 2002 to stabilize the business and
exploit the strengths of its size.

The Company continues to rely on its merchandising and marketing
strategies to differentiate its brands to consumers. Management has developed
a key item strategy as the foundation for merchandising and marketing
initiatives. Key items are selected from among the best selling products in
the retail jewelry industry. The Company

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advertises these items heavily and works to ensure these items are
available to customers at all times. In fiscal year 2003, the Company continued
to maximize its opportunities during the key gift giving periods by
capitalizing on its merchandising and marketing strengths.

The Company capitalizes on jewelry trends, such as demand for solitaires,
three-stone jewelry, white metals, and princess cut fashion jewelry. The
Company considers bridal the cornerstone of the fine jewelry business. During
the year, progress continued on the development of the core bridal business
across the traditional in-line brands as evidenced by the Companys 7 percent
sales increase over last year in this category. Along with the further
differentiation of the brands, the bridal business was enhanced through the
launch of several new branding initiatives. This included the expansion of The
Zales Diamond® Collection to the Zales Anniversary band and Zales Diamond
three-stone ring, the launch of The Gordons Diamond® solitaire and three-stone
ring and the successful introduction of the Peoples Diamond in Canada. The
introduction of these proprietary stones along with a further emphasis on
refining merchandise assortments contributed to the positive performance this
year in the Companys bridal business.

Consistent with optimizing the Companys traditional key item approach,
overall inventory management systems have been updated this year. The
Companys goal is to execute an aggressive approach to inventory management by
keeping key items in stock and purchasing to a rate of sale. Product
assortments capitalize on year round gift giving, fashion and special
occasions, while the primary focus continues to remain on the bridal category.
One of the Companys key infrastructure enhancements was the implementation of
management information systems directed specifically at impacting inventory
management. The Company believes that an element of brand integrity is to
maintain an in-stock position across the most popular products at the store
level. The current forecasting process is being updated by the implementation
of a store level forecasting system in fiscal year 2003.

The Company furthered its commitment to training both store and corporate
personnel through targeted training programs. The Company supported the
development of the bridal categories by enhancing the product knowledge of its
sales associates through targeted training programs focused on diamonds and
solitaires. The Company has a buyer training program to develop and train new
buyers on merchandise and Company standards. The Company also has a
centralized purchasing process 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s marketing efforts are designed to enhance brand identity
through distinctive brand communication to the customers. The Company has
created highly visible marketing programs specifically targeted in television,
newspaper inserts, radio and magazines. Most of these programs are product and
event-focused, usually highlighting key items as well as capitalizing on
jewelry trends, such as solitaires, three-stone jewelry and princess cut
fashion jewelry. The Company maintains a balance in advertising between media
and targeted direct mail. While the Company believes it dominates jewelry
advertising on television during the Holiday season, marketing efforts extend
beyond the Holiday season to tie in with other gift-giving holidays, such as
Valentines Day and Mothers Day. 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 fiscal year 2003, the Company also dedicated resources to improve the
effectiveness in its marketing function. This increased focus included an
investment in marketing development tools and establishing a database marketing
team. The Companys goal is to establish predictive customer data to maximize
its marketing efforts to both its existing 18 million customer names and target
new opportunities to individuals with a high propensity to spend. In addition,
the Company believes ongoing research will enable it to better target the needs
of each customer segment. These initiatives were also instrumental in
identifying leveraging opportunities. By centralizing each of the brands
marketing efforts, significant savings were realized which could be reinvested
in the marketing budget.

In addition to the focus on store level inventory management and
marketing, additional infrastructure changes were made to further establish a
framework that will allow the Company to maximize opportunities ahead. A
centralized product sourcing organization was established to take advantage of
optimal product pricing across all brands and to coordinate the purchase and
assembly of core diamond products. The Company will purchase loose polished
diamonds and mountings and assemble finished product. The initiative is being
tested in the Companys Canadian brands with anticipated expansion to the
domestic brands during late fiscal year 2004 and throughout the following
years. The Company expects direct sourcing to contribute improvements in
merchandise margin and to allow the Company to be more flexible and competitive
in merchandising certain items over the next several years.

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In fiscal year 2004, the Company is cautiously optimistic regarding the
external environment. The Company plans to continue to focus on long term
growth opportunities, as well as identifying improvement opportunities to
strengthen store operations. One of the new growth opportunities is the
expansion of the Zale Outlet concept into the value-oriented power-strip
shopping centers. Such centers are value-oriented and characterized by their
convenience to the suburban customer and co-tenants such as Bed Bath & Beyond,
Office Depot, Target or Kohls. The Company performed research which indicated
todays jewelry consumers are interested in the convenience of such locations.
The Company is also planning to enhance the training and development of its
sales associates. Areas of emphasis will include diamond training and
developing clientele in the stores. In addition, the Company will further
strengthen the use of its clienteling system to continue to enhance the
marketing focus on the customer.

The Company plans to open approximately 66 new locations, principally
under the brand names Zales, Zales Outlet, and Piercing Pagoda for which it
expects to incur approximately $15 million in capital expenditures during
fiscal year 2004. The Company is seeking strategic locations where it is
underrepresented to solidify the Companys core mall business and expand into
new outlet centers. 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 also plans to
refurbish, remodel or relocate approximately 176 stores and kiosks at a cost of
approximately $29 million during fiscal year 2004.

Current Year

Payoff of Senior Notes.In the fourth quarter of fiscal year 2003, the
Company called and retired the remaining $87 million of its
81/2 percent
Senior Notes (the Senior Notes). The Company recognized a $5.9 million loss
related to this early retirement of debt.

Stock Repurchase Plan.During fiscal year 2002, the Company purchased 0.2
million shares of its common stock, par value $.01 per share (Common Stock),
at an aggregate cost of $4 million under an existing program which was approved
by its Board of Directors in July 2002 to allow the Company to purchase up to
an aggregate of $50 million of its Common Stock on the open market through July
31, 2003. In October 2002, the Company repurchased 1.5 million shares of its
Common Stock at an aggregate cost of $46 million under the same program. In
total, the Company repurchased 1.7 million shares of its Common Stock at a cost
of $50 million to complete this program.

On March 18, 2003, 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 up to an aggregate of $50
million of its Common Stock on the open market. Under this program, the
Company purchased 209,000 shares at an aggregate cost of $7.5 million through
July 31, 2003.

On July 1, 2003, the Company entered into a modified Dutch Auction
tender offer (the Tender Offer) to purchase up to 6,400,000 shares of its
outstanding Common Stock at a price per share of not less than $42.00 nor in
excess of $48.00 per share, for an aggregate purchase price of up to $307.2
million. The Tender Offer enabled the Company to repurchase approximately 4.7
million shares at an aggregate cost of approximately $225.6 million.

On August 28, 2003, 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 up to an additional $100
million of its Common Stock on the open market. This action brings the
Companys remaining availability of the total authorization under its stock
repurchase program to approximately $142 million.

New Revolving Credit Facility.In connection with the Tender Offer, the
Company entered into a new $500 million secured revolving credit facility with
a syndicate of lenders led by Fleet National Bank, as administrative agent, to
replace its existing $225 million unsecured facility. The new revolving credit
facility is secured largely by inventory. See Item 7-Managements Discussion
and Analysis of Financial Condition and Results of Operations for further
details.

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Industry

The U.S. retail jewelry industrys sales were approximately $40 billion in
2002. Specialty retail jewelry stores (such as the Company) account for
approximately 60 percent of the industry, according to publicly available data.
Historically, retail jewelry store sales have exhibited only limited effects
of cyclicality. The United States Census Bureauhas recorded only three years
of negative growth in specialty retail jewelry store sales from 1984 to 2002.
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 shopping networks (such as QVC, Inc.) and
on-line jewelers.

The U.S. retail jewelry industry is highly fragmented with the seven
largest companies accounting for approximately 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 retail jewelry chain in North
America, with approximately nine percent of the specialty retail jewelry market
share, based on estimates from the United States Census Bureau.Only two other
specialty retail jewelers had greater than three percent market share.

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Operations

The Company operates under six principal brands. The following table
presents total revenues, average sales per location and the number of locations
for Zales, Zales the Diamond Store Outlet (Zales Outlet), Gordons, Bailey
Banks & Biddle, Peoples (including Mappins stores), and Piercing Pagoda for the
periods indicated.

|                               |                            |   |                     |           |      |   |           |           |  |   |           |           | 
|------------------------------ | -------------------------- | - | ------------------- | --------- | ---- | - | --------- | --------- |  | - | --------- | --------- | 
|                               |                            |   | Year Ended July 31,
|                               |                            |   |                    
|                               |                            |   | 2003                |           | 2002 |   | 2001     
|                               |                            |   |                     |           |      |   |          
|Total Revenues (in thousands)  |                            |   |                     |           |      |   |           |           |  |   |           |          
|                               | Zales (including Zale.com) |   | $                   | 1,040,537 |      |   | $         | 1,004,223 |  |   | $         | 918,725   | 
|                               | Zales Outlet               |   |                     | 119,270   |      |   |           | 112,366   |  |   |           | 96,075    | 
|                               | Gordons                   |   |                     | 314,345   |      |   |           | 321,120   |  |   |           | 324,199   | 
|                               | Bailey Banks & Biddle      |   |                     | 314,886   |      |   |           | 315,002   |  |   |           | 323,744   | 
|                               | Peoples (a)                |   |                     | 150,416   |      |   |           | 147,466   |  |   |           | 150,989   | 
|                               | Piercing Pagoda (b)        |   |                     | 256,665   |      |   |           | 273,225   |  |   |           | 254,510   | 
|                               | Insurance Revenues         |   |                     | 16,122    |      |   |           | 18,325    |  |   |           | 18,957    | 
|                               |                            |   |                     |           |      |   |           |           |  |   |           |           | 
|                               |                            | $ | 2,212,241           |           |      | $ | 2,191,727 |           |  | $ | 2,087,199 |          
|                               |                            |   |                     |           |      |   |           |           |  |   |           |           | 
|Average sales per location (c) |                            |   |                     |           |      |   |           |           |  |   |           |          
|                               | Zales                      |   | $                   | 1,369,000 |      |   | $         | 1,316,000 |  |   | $         | 1,210,000 | 
|                               | Zales Outlet               |   |                     | 1,261,000 |      |   |           | 1,294,000 |  |   |           | 1,266,000 | 
|                               | Gordons                   |   |                     | 1,084,000 |      |   |           | 1,063,000 |  |   |           | 1,050,000 | 
|                               | Bailey Banks & Biddle      |   |                     | 2,702,000 |      |   |           | 2,614,000 |  |   |           | 2,825,000 | 
|                               | Peoples                    |   |                     | 878,000   |      |   |           | 856,000   |  |   |           | 878,000   | 
|                               | Piercing Pagoda (b)        |   |                     | 322,000   |      |   |           | 312,000   |  |   |           | N/A       | 
|                               |                            |   |                    
|Locations opened during period |                            |   |                     |           |      |   |           |           |  |   |           |          
|                               | Zales                      |   |                     | 13        |      |   |           | 18        |  |   |           | 27        | 
|                               | Zales Outlet               |   |                     | 4         |      |   |           | 10        |  |   |           | 16        | 
|                               | Gordons                   |   |                     | 1         |      |   |           | 2         |  |   |           | 5         | 
|                               | Bailey Banks & Biddle      |   |                     | 1         |      |   |           | 6         |  |   |           | 11        | 
|                               | Peoples                    |   |                     | 3         |      |   |           | 4         |  |   |           | 5         | 
|                               | Piercing Pagoda (b)        |   |                     | 15        |      |   |           | 8         |  |   |           | 21        | 
|                               |                            |   |                     |           |      |   |           |           |  |   |           |           | 
|                               |                            |   | 37                  |           |      |   | 48        |           |  |   | 85        |          
|                               |                            |   |                     |           |      |   |           |           |  |   |           |           | 
|Locations closed during period |                            |   |                     |           |      |   |           |           |  |   |           |          
|                               | Zales                      |   |                     | 15        |      |   |           | 11        |  |   |           | 13        | 
|                               | Zales Outlet               |   |                     | 0         |      |   |           | 1         |  |   |           | 1         | 
|                               | Gordons                   |   |                     | 12        |      |   |           | 6         |  |   |           | 9         | 
|                               | Bailey Banks & Biddle      |   |                     | 5         |      |   |           | 6         |  |   |           | 2         | 
|                               | Peoples                    |   |                     | 7         |      |   |           | 5         |  |   |           | 1         | 
|                               | Piercing Pagoda (b)        |   |                     | 59        |      |   |           | 68        |  |   |           | 41        | 
|                               |                            |   |                     |           |      |   |           |           |  |   |           |           | 
|                               |                            |   | 98                  |           |      |   | 97        |           |  |   | 67        |          
|                               |                            |   |                     |           |      |   |           |           |  |   |           |           | 
|Total Locations                |                            |   |                     |           |      |   |           |           |  |   |           |          
|                               | Zales                      |   |                     | 755       |      |   |           | 757       |  |   |           | 750       | 
|                               | Zales Outlet               |   |                     | 96        |      |   |           | 92        |  |   |           | 83        | 
|                               | Gordons                   |   |                     | 287       |      |   |           | 298       |  |   |           | 302       | 
|                               | Bailey Banks & Biddle      |   |                     | 116       |      |   |           | 120       |  |   |           | 120       | 
|                               | Peoples                    |   |                     | 167       |      |   |           | 171       |  |   |           | 172       | 
|                               | Piercing Pagoda (b)        |   |                     | 813       |      |   |           | 857       |  |   |           | 917       | 
|                               |                            |   |                     |           |      |   |           |           |  |   |           |           | 
|                               |                            |   | 2,234               |           |      |   | 2,295     |           |  |   | 2,344     |          
|                               |                            |   |                     |           |      |   |           |           |  |   |           |           | 



|(a) |  | Reflects all revenue from foreign operations.                                                                                                                                        
|--- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|   
|(b) |  | Data from Piercing Pagoda in the fiscal year ended July 31, 2001 includes
results from September 20, 2000, the date the Company acquired Piercing
Pagoda Inc., through July 31, 2001.
|   
|(c) |  | Based on merchandise sales for locations open a full twelve months during
the respective year.                                                                                       

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Zales Jewelers

Zales, the Companys national flagship and the nations largest specialty
jeweler, is a leading brand name in jewelry retailing in the United States. At
July 31, 2003, Zales had 755 stores in 50 states and Puerto Rico. Zales
average store size is 1,575 square feet, and the average selling price per unit
sold is $284. The Zales brand accounted for 47 percent of the Companys total
revenues in fiscal year 2003.

Zales merchandise selection is generally standardized across the nation
and targeted at customers representing a cross-section of mainstream America.
In fiscal year 2003, bridal merchandise represented 39 percent of merchandise
sales, while fashion jewelry and watches comprised the remaining 61 percent.
The bridal merchandise category consists of engagement rings, bridal sets and
diamond anniversary bands. Fashion jewelry consists generally of diamond
fashion, jewelry, precious and semi-precious jewelry, gold jewelry, watches and
various other items. The Company believes that the prominence of diamond
jewelry in its product selection and its reputation for customer service for
over 79 years 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 watches to
drive gift giving occasions throughout the year.

Zales also introduces innovative items and capitalizes on industry trends,
including platinum engagement rings, white gold, princess cut fashion jewelry
and three-stone jewelry. In 2001, Zales introduced the Companys first
proprietary diamond, the Zales Diamond. The exclusive Zales Diamond
collection was expanded to include the Zales anniversary band and the Zales
three-stone ring, now available in two different carat sizes in a platinum
setting. In fiscal year 2004, this expansion will continue from exclusively
bridal into fashion, with the introduction of three-stone earrings, a solitaire
pendant and a solitaire mens ring.

The combination of Zales national presence and centralized merchandise
selection allows it to use television advertising across the nation as its
primary advertising medium, supplemented by newspaper inserts and direct mail.
Zales continues to support its brand awareness through its sponsorship of the
Rockefeller Center Christmas Tree Lighting. Zales serves the Internet customer
through its web site Zales.com, which accounted for less than one percent of
the Companys total revenues in fiscal year 2003.

Zales the Diamond Store Outlet

At July 31, 2003, the Company operated 96 Zales Outlet stores in 34 states
and Puerto Rico. The average store size is 2,276 square feet, and the average
selling price per unit sold is $270. Zales Outlet accounted for 5 percent of
the Companys total revenues in fiscal year 2003. Zales Outlet benefits from
Zales brand recognition and national advertising programs.

The outlet concept has evolved to be one of the strongest concepts in
retail shopping today, featuring top brands in every major retail category. The
merchandise assortment in a Zales Outlet store caters to the brand conscious
and value-oriented female shopper, offering 20-70 percent off traditional
retail prices everyday. The Company has grown its Zales Outlet concept during
the past six years and plans to continue its growth over the next several
years. The new growth opportunity for the Zale Outlet is expansion into power
strip shopping centers. Such centers are value-oriented characterized by
their convenience to the suburban customer and co-tenants such as Bed Bath &
Beyond, Office Depot, Target, or Kohls.

Although Zales Outlet was established as an extension of the Zales brand
and capitalizes on Zales national advertising and brand recognition, Zales
Outlet offers its own product line and promotional efforts are geared
specifically to the outlet consumer. In addition to fashion forward looks in
diamonds, gemstones, gold and name brand watches, Zales Outlet has been
successful with certified and exclusive products, such as the Lilla Diamond,
a diamond exclusive to Zales Outlet. Also, the Zales Outlets special
collection of Exceptional Values offers good value on best selling items in
each merchandise category.

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Gordons Jewelers

Gordons is positioned as the Companys major regional brand. As of July 31, 2003, Gordons had 287 stores in 34 states and Puerto Rico. Average store
size is 1,444 square feet and the average selling price per unit sold is $355.
Gordons accounted for 14 percent of the Companys total revenues in fiscal
year 2003.

The Company is continuing steps to differentiate Gordons image from other
moderate jewelers, including store remodeling and improved merchandise and
marketing, with a focus on exclusive and certified diamond merchandise.

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,
jewelry set in platinum and semi-precious gems. Gordons introduced the
Gordons Diamond, which is exclusive to Gordons, in August 2002. The
Gordons Diamond collection was expanded to also include a three-stone ring.
In fiscal year 2004, this collection will further be enhanced by the addition
of a princess cut solitaire.

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

Bailey Banks & Biddle Fine Jewelers

For 171 years, Bailey Banks & Biddle has combined classic jewelry with
contemporary designs, offering 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 branded and 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 are carefully selected to provide treasures that will
be appreciated for generations with a focus on diamonds, precious stones and
gold jewelry, as well as watches and giftware.

At July 31, 2003, Bailey Banks & Biddle operated 116 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 $916, have an average store size of 3,593 square feet and
accounted for 14 percent of the Companys total revenues in fiscal year 2003.

Bailey Banks & Biddle communicates with a loyal customer base and selected
prospects with upscale direct-mail catalogs and invitations to special events,
enabling the stores to focus on specific products for specific customers. In
fiscal year 2003, Bailey Banks & Biddle continued to expand its advertising
reach with a repetitive presence in nationally distributed and high profile
magazines such as Town & Country, Architectural Digest, Departures, InStyle,
Vogue, and W.

In fiscal year 2004, Bailey Banks & Biddle expects to utilize targeted
direct mail and an extensive magazine campaign to increase brand awareness
while expanding its customer base. Bailey Banks & Biddle also plans to
continue to utilize exclusive private label merchandise to provide unique
assortments. Extensive ongoing training campaigns were developed in fiscal year
2003 that are expected to enhance the shopping experiences for their customers.

Peoples Jewellers

In May 1999, the Company acquired the Peoples Jewellers Corporation, a
privately owned chain of jewelry retail outlets in Canada, operating under the
banners of Peoples Jewellers and Mappins Jewellers. This operation now has 167
stores in nine 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 $177, an average store size of 1,586 square feet and accounted for 7
percent of the Companys total revenues in fiscal year 2003.

The primary banner, Peoples Jewellers, is one of the most recognized brand
names in Canada. Peoples Jewellers offers traditional jewelry at affordable
prices, attracting a wide variety of Canadian customers. Peoples stores are
based predominately in malls with the targeted customer being between the ages
of 25-59. Using the trademark Peoples, the Diamond Store in Canada, Peoples
emphasizes its diamond business, while also offering a wide selection of gold

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jewelry, gemstone jewelry and watches. Due to the similarity in marketing
and store designs, Peoples Jewellers is able to take advantage of leveraging
opportunities with Zales Jewelers.

Since 2000, the Peoples brand has been building recognition with an
aggressive television campaign. Over the past three years, Peoples had the
largest television campaign of any Canadian jewelry retailer by a wide margin.
In addition, seasonal newspaper inserts are a key element to the marketing
campaign. Peoples also produces a seasonal bridal book, which is mailed to its
best customers twice a year.

Mappins Jewellers continues to be a strong second brand in Canada.
Building on a history from 1936, Mappins is recognized as a jeweler catering to
the aspiring customer in key mall locations. The Mappins consumer selects from
classic fashion styles at upper moderate price points. Since 2000, Mappins
has had the benefit of focused newspaper inserts and targeted direct mail
offers.

Piercing Pagoda

Effective September 20, 2000, the Company acquired Piercing Pagoda, Inc.,
one of the countrys largest retailers of gold jewelry principally through
kiosk locations in the U.S. At July 31, 2003, Piercing Pagoda operated 813
locations in 43 states and Puerto Rico, under the names Piercing Pagoda, Plum
Gold, and Silver and Gold Connection. Piercing Pagoda represented 12 percent of
the Companys total revenues in fiscal year 2003.

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. In addition, ear piercing services are performed by trained associates
on site.

The Piercing Pagoda locations are generally located in high traffic
concourses of regional shopping malls. The kiosk locations average 192 square
feet in size and are easily accessible and visible within malls. In fiscal year
2003, the average price per unit was $27. The kiosks focus on the opening price
point customer.

In fiscal year 2004, there will be a continued and expanded focus on the
key strategies implemented during the second half of fiscal year 2003. Such
initiatives included an expanded offering of lower price point merchandise,
particularly charms, earrings and body jewelry. Additionally, increased
assortments of silver, stainless steel and diamond accent product are aimed at
offsetting the decline in demand for gold products. The Company will continue
the expansion of the updated kiosk design introduced in fiscal year 2003. The
new look is expected to improve productivity and allows for greater merchandise
capacity.

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. 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. In fiscal year 2003, over 38 percent of the Companys
private label credit card purchasers purchased some form of credit insurance.
Under the current private label arrangement with Citi Commerce Solutions,
(Citi) 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. Insurance premium revenues of $16.1 million, $18.3
million, and $19.0 million for fiscal years ended July 31, 2003, 2002 and 2001,
respectively are included in total revenues.

Store Operations

The Companys stores are designed to create an attractive environment, to
make shopping convenient and enjoyable, and to maximize operating efficiencies.
The Company pays careful attention to store layout, particularly in areas such
as

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lighting, choice of materials and arrangement of display cases to maximize
merchandise presentation. Promotional displays are changed periodically to
provide variety or to reflect seasonal events.

Each of the Companys stores is led by a store manager who is responsible
for certain store-level operations, including overall store sales and certain
personnel matters. 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
that 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. In
fiscal year 2003, the Company experienced significant improvements in internal
and external 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 external losses.

The Company believes it is important to provide knowledgeable and
responsive customer service. There continues to be a strong focus on connecting
with the customer, both through advertising and once the customer is in the
store. The goal is to service the customer from the first sale to maintaining
a customer connection through client services. The Company recently
consolidated previously fragmented customer service departments into a single
customer service call center to more effectively address customer phone calls.
The Company has employee training programs, including training in sales
techniques for new employees, on-the-job training and management training for
store managers. Under the banner of Zale Corporation University, the Company
offers training to employees at every level of the organization.

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
currently purchases finished merchandise from its vendors or obtains finished
merchandise on consignment. As discussed in the section Business Initiatives
and Strategy, a centralized product sourcing organization has also been
established to coordinate the purchase and assembly of core diamond products
such as solitaire rings, earrings and pendants. Consignment inventory
historically consists of test programs, merchandise at higher price points or
merchandise that otherwise does not warrant the risk of ownership. Consignment
merchandise can be returned to the vendor at any time. The Company had
approximately $170.8 million and $162.2 million of consignment inventory on
hand at July 31, 2003 and 2002, respectively. During fiscal years 2003 and
2002, the Company purchased approximately 33 percent and 34 percent,
respectively, of its merchandise from its top five vendors, including more than
13 percent from its top vendor. If supply between the Company and these top
vendors were disrupted, particularly at certain critical times during the year,
the Companys sales could be adversely affected in the short term until
alternative supply arrangements could be established.

The Company historically has engaged in a limited amount of hedging
activities with respect to merchandise held in inventory, as commodity prices
have remained relatively stable. The Company is not subject to substantial
currency fluctuations because most purchases are U.S. dollar-denominated. The
Company continually reviews its position on hedging and will take steps to
hedge certain commodity components or currency positions if appropriate. In
prior fiscal years, the Company has entered into foreign exchange hedge
contracts to minimize the market risk from currency exchange rate exposure. In
fiscal year 2003, the Company entered into forward contracts for the purchase
of gold in order to reduce the effects of fluctuating gold prices on inventory.
These contracts are used to hedge forecasted inventory purchases of finished
goods made of gold for periods and amounts consistent with the Companys
identified exposure.

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

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sustained interruption in the supply of diamonds or any oversupply from the
producing countries could adversely affect the Company and the retail jewelry
industry as a whole.

There has been continued focus on conflict diamonds, which are allegedly
extracted from war-torn regions and sold by organizations to fund insurrection.
Through an international system of certification and legislative initiatives,
the diamond trade has taken steps to ensure the exclusion of these diamonds,
which represent a small fraction of the worlds supply. It is not expected that
such efforts, if successful, will substantially affect the supply of diamonds.
However, in the near term, efforts by non-governmental organizations to
increase consumer awareness of the issue and encourage legislative response
could affect consumer demand for diamonds.

Proprietary Credit

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. The Company offers Revolving and Interest Free programs
under its private label credit card program. Approximately 42 percent and 44
percent of the Companys U.S. total sales excluding Piercing Pagoda, which does
not offer proprietary credit, were generated by the proprietary credit cards in
fiscal year 2003 and 2002, respectively. The Companys Canadian propriety
credit card sales represented approximately 27 percent and 25 percent of the
Canadian total sales for the same respective time period.

In fiscal year 2003, the proprietary credit offers expanded to include
Same As Cash (SAC) options, as well as continued offerings of Revolving and
Interest Free programs, all of which allowed the sales personnel to further
enhance the customers buying experience. In July 2000, the Company entered
into a ten-year agreement with Citi whereby Citi 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 on a percentage of each credit card sale. The
merchant fee varies according to the credit plan that is chosen by the customer
(i.e., Revolving, Interest Free, SAC). In fiscal year 2001, the Company
converted its Canadian private label credit agreement to Citi Commerce
Solutions Canada.

Employees

As of July 31, 2003, the Company had approximately 17,000 employees, less
than 10 percent of whom 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 with 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 its 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.

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.

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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. Significant data
processing systems include point-of-sale reporting, purchase order management,
replenishment, warehouse management, merchandise planning and control, payroll,
general ledger, sales audit, and accounts payable. Bar code ticketing and
scanning are used at all point-of-sale terminals to ensure 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. In fiscal year 2003, a store-level
forecasting system was implemented to enhance the current forecasting process
used by the buyers. Future initiatives include improved connectivity between
stores and the home office to enhance operating efficiencies.

The Companys information systems allow management to monitor, review and
control operational performance 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, Local Area Network operations, Wide Area Network management and
e-commerce hosting. The agreement, which was effective August 1, 2002,
requires fixed payments totaling $11 million over a 36 month term plus a
variable amount based on usage. The Company has an option to extend the current
agreement for two consecutive one year periods. In fiscal year 2003, the
payments under this contract reflected an annual cost savings of over $3
million as a result of investments in certain infrastructure over the past
several years. 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
and enhancing enterprise systems for its core business.

The Company has historically upgraded, and expects to continue to upgrade,
its information systems to improve operations and support future growth. In
fiscal year 2003, the Company developed a three year strategic plan for
information technology to support the Companys long term goals of gaining
operating efficiencies and generating future growth. The Company estimates it
will make capital expenditures of approximately $10 million in fiscal year 2004
for enhancements to its 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 Company is subject to the jurisdiction of various state and other
taxing authorities. From time to time, these taxing authorities conduct
reviews or audits of the Company.

The sale of insurance products by 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
12Table of Contents

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 companies credit cards are
subject to regulation by state and federal banking regulators. The Company
believes that it is currently in material compliance with all applicable state
and federal regulations.

Merchandise in the retail jewelry industry is frequently sold at a
discount off the regular or original price. A number of jurisdictions in
which the Company operates have regulations that 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 monitors changes in
those laws and believes that it is in material compliance with applicable laws
with respect to such practices.

Available Information

The Company provides links to its filings with the Securities and Exchange
Commission (SEC) and to the SEC filings of its directors and executive
officers under Section 16 of the Securities Exchange Act (Forms 3, 4 and 5), on
the Companys website at http://www.zalecorp.com/section16reports.htm.These
links are automatically updated, so the filings also are available immediately
after they are made publicly available by the SEC. These filings also are
available through the SECs EDGAR system at http://www.sec.gov.

The Companys certificate of incorporation and bylaws, the charters for
the compensation, audit, nominating and corporate governance committees of its
Board of Directors and the corporate governance guidelines are available on the
Companys website at http://www.zalecorp.com/corporategovernance.htm. The
Company has also filed these documents as exhibits to this report and,
accordingly, they are available as described above.

The Company has a Code of Business Conduct and Ethics. All of its
directors, executive officers and employees are subject to the Code. The Code
is available on the Companys website at
http://www.zalecorp.com/codeofconduct.htm Waivers of the Code will be disclosed
in a SEC filing on Form 8-K. The Company has also filed the Code as an exhibit
to this report and, accordingly, it and any related Form 8-K filings are
available as described above.

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,
liquidity and cash flows, capital expenditures, development of its management
information systems, reserves for future credit losses under the private label
credit arrangement and the impact of recent accounting developments, which are
based upon managements beliefs as well as on assumptions made by and data
currently available to management. In addition, the words anticipate,
estimate, project, intend, expect, believe, forecast, and similar
expressions may identify forward looking statements, but some of these
statements may use other phrasing. 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 materially 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 levels of
mall traffic may decline as a result of economic or other factors; that
warehousing and distribution productivity and capacity can be maintained and
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
gold and 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 define
the strategic role of each brand may not be successful; that the Company may be
unable to lease new
13Table of Contents

and existing stores on suitable terms in desirable locations; that legal
or governmental proceedings 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 Holiday season; that key personnel who have been hired
or retained by the Company may depart; that any disruption in or changes to the
Companys private label credit card arrangement with Citi may adversely affect
the Companys ability to provide consumer credit and write credit insurance; 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 lease 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 40,000
square feet of that warehouse. In June 2003, this property was subleased to a
third party through the remainder of the lease term which extends through March
2009. The Company also owns a 73,000 square foot building in Bethlehem,
Pennsylvania that formerly served as Piercing Pagodas distribution center. The
Company plans to sell this building and is currently holding it available for
sale. Another 71,000 square foot building owned by the Company is located
adjacent to the Bethlehem property was used for additional distribution and
warehousing functions. The Company leases a 7,400 square foot distribution and
warehousing facility in Toronto, Ontario, Canada for Peoples. This lease
extends to October 2005. The Company also leases a 20,000 square foot
distribution and warehousing facility in Irving, Texas that serves as the
Piercing Pagoda distribution center.

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 three to five years. Most
of the store leases provide for the payment of base rentals plus real estate
taxes, insurance, common area maintenance fees and merchants association dues,
as well as percentage rents based on the stores gross sales.

The following table indicates the expiration dates of the current terms
of the Companys leases as of July 31, 2003:

|                       |  |        |       |        |  |       |     |       |  |          |   |  |  |  |       |  |  |            |       |  
|---------------------- |  | ------ | ----- | ------ |  | ----- | --- | ----- |  | -------- | - |  |  |  | ----- |  |  | ---------- | ----- | -
|                       |  |        |       |        |  |       |     |       |  |          |   |  |  |  |       |  |  | Percentage
|Term Expires           |  | Stores |       | Kiosks |  | Other |     | Total |  | Of Total
|                       |  |        |       |        |  |       |     |       |  |         
|2004 and prior         |  |        | 171   |        |  |       | 279 |       |  |          | 2 |  |  |  | 452   |  |  |            | 20.2  | %
|2005                   |  |        | 159   |        |  |       | 197 |       |  |          | 0 |  |  |  | 356   |  |  |            | 15.9  | %
|2006                   |  |        | 153   |        |  |       | 172 |       |  |          | 1 |  |  |  | 326   |  |  |            | 14.5  | %
|2007                   |  |        | 181   |        |  |       | 69  |       |  |          | 0 |  |  |  | 250   |  |  |            | 11.2  | %
|2008 and thereafter    |  |        | 782   |        |  |       | 71  |       |  |          | 2 |  |  |  | 855   |  |  |            | 38.2  | %
|                       |  |        |       |        |  |       |     |       |  |          |   |  |  |  |       |  |  |            |       |  
|Total number of leases |  |        | 1,446 |        |  |       | 788 |       |  |          | 5 |  |  |  | 2,239 |  |  |            | 100.0 | %
|                       |  |        |       |        |  |       |     |       |  |          |   |  |  |  |       |  |  |            |       |  

Management believes substantially all of the store leases expiring in
fiscal year 2004 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.

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ITEM 3. LEGAL PROCEEDINGS

The Company is involved in various legal proceedings and claims arising in
the ordinary course of business. Management believes that such litigation and
claims will be resolved without any material adverse 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 federal
anti-racketeering laws. During the first quarter of fiscal year 2003, the
Company reached an agreement with counsel for the plaintiff to settle the
actions. Preliminary court approval of the settlement agreement has been
granted, with final approval expected to occur in late November 2003.

On October 23, 2001 a plaintiff filed a complaint against Zale Corporation
and Zale Delaware, Inc. in the Superior Court of California, County of Los
Angeles, Central District. The complaint is a purported class action on behalf
of current and former salaried store managers and assistant store managers of
the Company in California. The complaint alleges that these individuals were
entitled to overtime pay and should not have been classified as exempt
employees under California law. During the third quarter of fiscal year 2003,
the Company reached an agreement with counsel for the plaintiff to settle the
action. Final approval of the settlement agreement was granted by the court on
July 24, 2003.




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, 2003.

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EXECUTIVE OFFICERS AND KEY EMPLOYEES OF THE REGISTRANT

The following individuals serve as executive officers or are other key
employees 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                                                                          
|                      |  |     |  |                                                                                   
|Executive Officers:   |  |     |  |                                                                                   
|                      |  |     |  |                                                                                   
|Mary L. Forté         |  | 52  |  | President, Chief Executive Officer and Director                                   
|                      |  |     |  |                                                                                   
|Sue E. Gove           |  | 45  |  | Executive Vice President, Chief Operating Officer                                 
|                      |  |     |  |                                                                                   
|Mark R. Lenz          |  | 47  |  | Group Senior Vice President, Chief Financial Officer                              
|                      |  |     |  |                                                                                   
|Pamela J. Romano      |  | 45  |  | Group Senior Vice President and President, Zales Jewelers®                        
|                      |  |     |  |                                                                                   
|David W. Howard       |  | 53  |  | Senior Vice President and Chief Information Officer                               
|                      |  |     |  |                                                                                   
|Key Employees:        |  |     |  |                                                                                   
|                      |  |     |  |                                                                                   
|Charles E. Fieramosca |  | 55  |  | Senior Vice President and President, Bailey Banks & Biddle Fine
Jewelers®         
|Frank C. Mroczka      |  | 45  |  | Senior Vice President and President, Gordons Jewelers®                           
|Paul G. Leonard       |  | 48  |  | Senior Vice President and President, Piercing Pagoda®                             
|John A. Zimmermann    |  | 44  |  | Senior Vice President and President, Peoples Jewellers®                           
|Nancy O. Skinner      |  | 53  |  | Senior Vice President and President, Zales the Diamond Store
Outlet®              
|Cynthia T. Gordon     |  | 39  |  | Senior Vice President, Controller                                                 
|Gregory Humenesky     |  | 52  |  | Senior Vice President, Human Resources                                            
|Stephen C. Massanelli |  | 47  |  | Senior Vice President, Treasurer                                                  
|                      |  |     |  |                                                                                   
|Ervin G. Polze        |  | 51  |  | Senior Vice President, Support Operations                                         
|Bernie Sensale        |  | 41  |  | Senior Vice President, Marketing                                                  
|Robert A. Shapiro     |  | 56  |  | Senior Vice President, Real Estate                                                
|George J. Slicho      |  | 54  |  | Senior Vice President, Loss Prevention                                            
|                      |  |     |  |                                                                                   
|Stephen L. Strong     |  | 43  |  | Senior Vice President, Executive Vice President, Store
Operations, Zales Jewelers®
|Charleen R. Wuellner  |  | 52  |  | Senior Vice President, President, Corporate Merchandising                         
|Hilary Molay          |  | 49  |  | Vice President, General Counsel and Corporate Secretary                           

Executive Officers

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

Ms. Mary L. Fortéwas named President and Chief Executive Officer and
appointed to the Companys Board of Directors, effective August 1, 2002. Prior
to that appointment, Ms. Forté served as Executive Vice President and Chief
Merchandise Officer from February 2001 to July 2002. 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.

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Ms. Sue E. Govewas appointed Chief Operating Officer effective August 1,
2002. She also remained in the position of Chief Financial Officer until
February 2003. Prior to that appointment, Ms. Gove served as Executive Vice
President, Chief Financial Officer from July 1998 to July 2002. From December
1997 to July 1998, she served as Group Vice President, 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.

Mr. Mark R. Lenzwas appointed Group Senior Vice President, Chief
Financial Officer in February 2003. Prior to this appointment, Mr. Lenz served
as Senior Vice President, Controller from November 1997 to February 2003. Mr.
Lenz held various management positions in finance for the Company until his
appointment to Vice President, Controller in February 1995. Prior to joining
the Company in 1988, Mr. Lenz served in various positions in the audit division
of Arthur Andersen LLP in Dallas, Texas.

Ms. Pamela J. Romanowas promoted to Group Senior Vice President,
President of Zales Jewelers® in September 2003. Ms. Romano joined the Company
in September 1997 as Senior Vice President and President of Zales Jewelers®. In
January 2002, Ms. Romano assumed additional responsibility of Zales.com, the
Companys Web-based business. Prior to joining the Company, Ms. Romano held
various merchandising positions with Macys.

Mr. David W. Howardwas appointed Senior Vice President and Chief
Information Officer in March 2001. Mr. Howard oversees the Companys
management information systems. Prior to re-joining the Company in March 2001,
Mr. Howard was Vice President and Chief Information Officer for Cole National
Corporation from October 2000 to March 2001. From April 1998 to September 2000,
Mr. Howard served as Zale Corporations Senior Vice President of Management
Information Systems and, prior to that position, he was Senior Vice President
of Information Services for Sportmart, Inc., a publicly owned sporting goods
chain, from November 1996 to April 1998.

Key Employees

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

Mr. Frank C. Mroczkawas promoted to Senior Vice President and President,
Gordons Jewelers® in April 2003. Mr. Mroczka was previously the Senior Vice
President of Store Operations for Gordons Jewelers, to which he was appointed
in 1997. In 1993, Mr. Mroczka was promoted to Director of Stores for Gordons
West Region. Mr Mroczka joined the Company in 1983 and has served in numerous
assignments until his appointment to Vice President in 1997.

Mr. Paul G. Leonardrejoined the Company in January 2002 and was appointed
Senior Vice President and President of Piercing Pagoda®. From May 1999 to
January 2002, Mr. Leonard served as Executive Vice President, Chief Merchandise
and Marketing Officer, for Friedmans Jewelers. From January 1998 to May 1999,
Mr. Leonard served as Senior Vice President and President of Corporate
Merchandising. From January 1995 to January 1998, Mr. Leonard served as
President of Bailey Banks and Biddle Fine Jewelers®. Prior to joining the
Company in 1994 as President of Corporate Merchandising, Mr. Leonard held
various positions with Macys, the May Company, and Ames Department Stores.

Mr. John A. Zimmermannjoined the Company in May 2001 as Senior Vice
President and President of Peoples Jewellers®. Prior to joining the Company,
Mr. Zimmermann was the Senior Vice President of Merchandising, Planning and
Sales Promotion for SmarterKids.com from June 1998 to May 2001. He served as
Senior Vice President of Merchandising and Sales Promotion for Big Party from
November 1996 to May 1998. Mr. Zimmermanns background in retailing includes
management positions for companies such as Federated Department Stores, where
he served as Divisional Vice President for Womens Fashion Accessories for The
Bon Marché, and Bradley Stores Inc.

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Ms. Nancy O. Skinnerwas promoted to Senior Vice President and President
of Zales the Diamond Store Outlet® in August 2003. Ms. Skinner served as Vice
President and Senior Vice President of Merchandising, Zales the Diamond Store
Outlet® from April 2001 to July 2003. From May 1998 to April 2001, Ms. Skinner
was a Diamond Buyer for Zales the Diamond Store Outlet®. Ms. Skinner joined the
Company in April 1984 and has held numerous senior-buying positions in Diamond
Park Fine Jewelers, Gordons Jewelers®, and Bailey Banks & Biddle Fine
Jewelers®. Prior to joining the Company, Ms. Skinner held various merchandising
positions with Gordons Jewelry Corporation.

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

Mr. Gregory Humeneskywas appointed Senior Vice President, Human Resources
in April 1996. From January 1995 to April 1996, Mr. Humenesky held the position
of Vice President, Personnel Development and Staffing for the Company. Prior to
joining the Company in 1995, Mr. Humenesky served in various positions in human
resources with Macys.

Mr. Stephen C. Massanellijoined the Company in June 1997 as Senior Vice
President, Treasurer. From 1993 to 1997, Mr. Massanelli was a principal and
member of the Board of Directors of The Treadstone Group, Inc., a private
merchant banking organization in Dallas. Prior to 1993, Mr. Massanelli served
in various financial roles in companies such as AMRESCO, Inc. and NationsBank
of Texas.

Mr. Ervin G. Polzewas appointed Senior Vice President, Support Operations
in January 1996. From February 1995 through January 1996, he served as Vice
President, Operations. Mr. Polze held the position of Vice President,
Controller from March 1988 through February 1995. Mr. Polze joined the Company
in January 1983 and served in several assignments until his appointment to Vice
President in March 1988. Prior to 1983, Mr. Polze served in accounting roles
with Contintal Emsco, a division of LTV Corporation.

Mr. Bernie Sensalewas promoted to Senior Vice President, Marketing in
February 2003. Prior to this promotion, Mr. Sensale served as Vice President of
Strategic Development from September 2002 to February 2003. From April 2001 to
August 2002, Mr. Sensale served as Senior Vice President of Store Operations
for Piercing Pagoda. From 1998 to April 2001, Mr. Sensale served as Vice
President of Planning and Analysis. Mr. Sensale joined Zale Corporation in 1995
as Vice President of Marketing & Planning for Bailey Banks & Biddle. Prior to
joining Zale Corporation, Mr. Sensale was Vice President, General Merchandise
Manager for Ames Department Stores.

Mr. Robert A. Shapirojoined the Company in March 2001 as Senior Vice
President, Real Estate. Prior to joining the Company, Mr. Shapiro was the
founder and President of RetailEstate Advisors, Inc., a retail real estate
consulting company whose clients included Gymboree and Eddie Bauer. Prior to
his role at RetailEstate Advisors, Inc., Mr. Shapiro held various positions in
real estate development, including Vice President for Eddie Bauer.

Mr. George J. Slichowas appointed to the position of Senior Vice
President, Loss Prevention in November 2000. Mr. Slicho began his career with
the Company in March 1991 as Vice President of Loss Prevention. Prior to
joining the Company, Mr. Slicho held various positions in corporate security,
including Vice President of Loss Prevention and Audit for P.A. Bergner &
Company.

Mr. Stephen L. Strongwas appointed Senior Vice President, Executive Vice
President, Store Operations of Zales Jewelers® in January 2002. Prior to this
appointment, Mr. Strong served as President of Zales the Diamond Store Outlet®
from April 2001 to January 2002. From August 2000 to April 2001, Mr. Strong
served as Senior Vice President of Store Operations for Zales the Diamond Store
Outlet®. From May 1998 to August 2000, Mr. Strong served as Vice President of
Store Operations for Zales the Diamond Store Outlet®. Mr. Strong joined the
Company in 1981 and has served in numerous assignments, including Director of
Stores for Zales Jewelers® from 1994 to 1998.

Ms. Charleen Wuellnerwas appointed Senior Vice President, President of
Corporate Merchandising in April 2003. Prior to this appointment, Ms. Wuellner
served as Senior Vice President and President, Gordons Jewelers ® from April
2001 to April 2003. Ms. Wuellner was previously the President of Zales the
Diamond Store Outlet®, to which she was appointed in August 2000. In August
1999, Ms. Wuellner was promoted to Senior Vice President of Zales the Diamond

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Store Outlet®. From April 1995 to August 1999, Ms. Wuellner held senior
buying positions in Zales.com and Gordons Jewelers. Prior to joining the
Company in April 1995, Ms. Wuellner held various merchandising positions with
Macys.

Ms. Hilary Molaywas promoted to Vice President, General Counsel and
Corporate Secretary of the Company in August 2002. Ms. Molay also serves as
Secretary to the Zale Board of Directors. Previously, Ms. Molay served as
Director, Senior Attorney for Zale Corporation when she joined the Company in
February 2000. Prior to working for the Company, Ms. Molay served in various
legal positions, including Senior Attorney for J. C. Penney Company, Inc.

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PART II




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

The common stock of the Company (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.

|       |  |      |       |      |  |      |       |     |  |   |       |  |  |   |       | 
|------ |  | ---- | ----- | ---- |  | ---- | ----- | --- |  | - | ----- |  |  | - | ----- | 
|       |  | 2003 |       | 2002
|       |  |      |       |     
|       |  | High |       | Low  |  | High |       | Low
|       |  |      |       |      |  |      |       |    
|First  |  | $    | 32.65 |      |  | $    | 26.50 |     |  | $ | 34.10 |  |  | $ | 24.65 | 
|Second |  |      | 37.71 |      |  |      | 28.65 |     |  |   | 45.75 |  |  |   | 28.10 | 
|Third  |  |      | 35.00 |      |  |      | 28.35 |     |  |   | 45.84 |  |  |   | 37.90 | 
|Fourth |  |      | 48.68 |      |  |      | 34.06 |     |  |   | 44.63 |  |  |   | 27.05 | 

As of September 16, 2003, the outstanding shares of Common Stock were held
by approximately 872 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.

Equity Compensation Plan Information

The following table provides information about Common Stock that may be
issued upon the exercise of options and rights under all existing equity
compensation plans as of July 31, 2003.

Equity Compensation Plan Information

|                                                           |  |                         |           |                   |  |                              |       |  |  |                         |        | 
|---------------------------------------------------------- |  | ----------------------- | --------- | ----------------- |  | ---------------------------- | ----- |  |  | ----------------------- | ------ | 
|                                                           |  |                         |           |                   |  |                              |       |  |  | Number of securities   
|                                                           |  |                         |           |                   |  |                              |       |  |  | remaining available for
|                                                           |  | Number of securities to |           | Weighted-average  |  | future issuance under equity
|                                                           |  | be issued upon exercise |           | exercise price of |  | compensation plans          
|                                                           |  | of outstanding options  |           | outstanding       |  | (excluding securities       
|Plan Category                                              |  | (1)                     |           | options           |  | reflected in 1st column) (2)
|                                                           |  |                         |           |                   |  |                             
|Equity
compensation
plans approved
by security
holders     |  |                         | 2,788,126 |                   |  | $                            | 36.10 |  |  |                         | 83,500 | 
|Equity
compensation
plans not
approved by
security
holders |  |                         |          |                   |  |                              |      |  |  |                         |       | 
|                                                           |  |                         |           |                   |  |                              |       |  |  |                         |        | 
|Total                                                      |  |                         | 2,788,126 |                   |  | $                            | 36.10 |  |  |                         | 83,500 | 



|(1) |  | Includes securities to be issued upon the exercise of outstanding options
under the Zale Corporation Omnibus Stock Incentive Plan and the Zale
Corporation Outside Directors 1995 Stock Option Plan.                                                                                                                                                                                                                              
|--- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|   
|(2) |  | Includes securities available for future issuance under the Zale
Corporation Outside Directors 1995 Stock Option Plan. Does not include
securities available for future issuance under the Zale Corporation 2003
Stock Incentive Plan (the 2003 Plan). The 2003 Plan has been submitted
for stockholder approval at the 2003 annual meeting of stockholders to
authorize the issuance of up to 3,000,000 shares of Common Stock.

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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, 2003, 2002, 2001, 2000, and 1999 have been
derived from the Companys audited Consolidated Financial Statements.

|                                                      |                                |                                                 |           |                                                  |       |      |           |           |      |      |           |           |      |   |           |           |      |   |           |           |      | 
|----------------------------------------------------- | ------------------------------ | ----------------------------------------------- | --------- | ------------------------------------------------ | ----- | ---- | --------- | --------- | ---- | ---- | --------- | --------- | ---- | - | --------- | --------- | ---- | - | --------- | --------- | ---- | 
|                                                      |                                |                                                 |           | Year Ended July 31,                             
|                                                      |                                |                                                 |           |                                                 
|                                                      |                                |                                                 |           | 2003                                             |       | 2002 |           | 2001      |      | 2000 |           | 1999     
|                                                      |                                |                                                 |           |                                                  |       |      |           |           |      |      |           |          
|                                                      |                                |                                                 |           | (amounts in thousands, except per share amounts)
|Total revenues (a)                                    |                                | $                                               | 2,212,241 |                                                  |       | $    | 2,191,727 |           |      | $    | 2,087,199 |           |      | $ | 1,834,090 |           |      | $ | 1,466,146 |          
|Costs and expenses:                                   |                                |                                                 |           |                                                  |       |      |           |           |      |      |           |           |      |   |           |           |      |   |           |          
|Cost of sales (b)                                     |                                |                                                 | 1,101,030 |                                                  |       |      | 1,083,053 |           |      |      | 1,034,913 |           |      |   | 930,826   |           |      |   | 746,663   |          
|Special Inventory Charge                              |                                |                                                 |          |                                                  |       |      |          |           |      |      | 25,236    |           |      |   |          |           |      |   |          |          
|Selling, general and
administrative expenses          |                                |                                                 | 884,069   |                                                  |       |      | 873,265   |           |      |      | 818,205   |           |      |   | 644,487   |           |      |   | 525,406   |          
|Cost of insurance operations                          |                                |                                                 | 8,228     |                                                  |       |      | 8,620     |           |      |      | 5,589     |           |      |   | 5,928     |           |      |   | 4,676     |          
|Depreciation and amortization
expense                 |                                |                                                 | 55,690    |                                                  |       |      | 58,340    |           |      |      | 58,290    |           |      |   | 42,431    |           |      |   | 29,478    |          
|Impairment of Goodwill                                |                                |                                                 | 136,300   |                                                  |       |      |          |           |      |      |          |           |      |   |          |           |      |   |          |          
|Unusual items (c)                                     |                                |                                                 |          |                                                  |       |      | (1,202    | )         |      |      | 4,713     |           |      |   |          |           |      |   |          |          
|                                                      |                                |                                                 |           |                                                  |       |      |           |           |      |      |           |           |      |   |           |           |      |   |           |          
|Operating earnings                                    |                                |                                                 | 26,924    |                                                  |       |      | 169,651   |           |      |      | 140,253   |           |      |   | 210,418   |           |      |   | 159,923   |          
|Interest expense, net                                 |                                |                                                 | 6,319     |                                                  |       |      | 7,750     |           |      |      | 6,857     |           |      |   | 32,178    |           |      |   | 30,488    |          
|Costs of Early Retirement of Debt                     |                                |                                                 | 5,910     |                                                  |       |      |          |           |      |      |          |           |      |   |          |           |      |   |          |          
|                                                      |                                |                                                 |           |                                                  |       |      |           |           |      |      |           |           |      |   |           |           |      |   |           |          
|Earnings before income
taxes                          |                                |                                                 | 14,695    |                                                  |       |      | 161,901   |           |      |      | 133,396   |           |      |   | 178,240   |           |      |   | 129,435   |          
|Income taxes                                          |                                |                                                 | 55,340    |                                                  |       |      | 59,256    |           |      |      | 51,348    |           |      |   | 66,726    |           |      |   | 48,503    |          
|                                                      |                                |                                                 |           |                                                  |       |      |           |           |      |      |           |           |      |   |           |           |      |   |           |          
|Earnings before effect of
accounting change           |                                |                                                 | (40,645   | )                                                |       |      | 102,645   |           |      |      | 82,048    |           |      |   | 111,514   |           |      |   | 80,932    |          
|Effect of change in accounting principle (d)          |                                |                                                 |          |                                                  |       |      | (41,287   | )         |      |      |          |           |      |   |          |           |      |   |          |          
|                                                      |                                |                                                 |           |                                                  |       |      |           |           |      |      |           |           |      |   |           |           |      |   |           |          
|                                                      | Net earnings                   |                                                 | $         | (40,645                                          | )     |      | $         | 143,932   |      |      | $         | 82,048    |      |   | $         | 111,514   |      |   | $         | 80,932    |     
|                                                      |                                |                                                 |           |                                                  |       |      |           |           |      |      |           |           |      |   |           |           |      |   |           |          
|(Loss) Earnings Per Common Share 
Basic:             |                                |                                                 |           |                                                  |       |      |           |           |      |      |           |           |      |   |           |           |      |   |           |          
|                                                      |                                | Before effect of change in accounting
principle |           | $                                                | (1.26 | )    |           | $         | 2.97 |      |           | $         | 2.37 |   |           | $         | 3.16 |   |           | $         | 2.24 | 
|                                                      | Net (Loss) earnings Per Share  |                                                 | $         | (1.26                                            | )     |      | $         | 4.16      |      |      | $         | 2.37      |      |   | $         | 3.16      |      |   | $         | 2.24      |     
|(Loss) Earnings Per Common Share 
Diluted:           |                                |                                                 |           |                                                  |       |      |           |           |      |      |           |           |      |   |           |           |      |   |           |          
|                                                      |                                | Before effect of change in accounting
principle |           | $                                                | (1.26 | )    |           | $         | 2.95 |      |           | $         | 2.36 |   |           | $         | 3.11 |   |           | $         | 2.21 | 
|                                                      | Net (Loss) earnings Per Share  |                                                 | $         | (1.26                                            | )     |      | $         | 4.13      |      |      | $         | 2.36      |      |   | $         | 3.11      |      |   | $         | 2.21      |     
|Weighted average number of common shares
outstanding: |                                |                                                 |           |                                                  |       |      |           |           |      |      |           |           |      |   |           |           |      |   |           |          
|                                                      | Basic                          |                                                 |           | 32,264                                           |       |      |           | 34,589    |      |      |           | 34,575    |      |   |           | 35,326    |      |   |           | 36,137    |     
|                                                      | Diluted                        |                                                 |           | 32,264                                           |       |      |           | 34,846    |      |      |           | 34,751    |      |   |           | 35,883    |      |   |           | 36,688    |     
|Balance Sheet Data:                                   |                                |                                                 |           |                                                  |       |      |           |           |      |      |           |           |      |   |           |           |      |   |           |          
|                                                      | Working capital                |                                                 | $         | 532,443                                          |       |      | $         | 561,939   |      |      | $         | 512,418   |      |   | $         | 651,505   |      |   | $         | 556,886   |     
|                                                      | Total assets                   |                                                 |           | 1,294,106                                        |       |      |           | 1,489,265 |      |      |           | 1,408,029 |      |   |           | 1,384,961 |      |   |           | 1,526,932 |     
|                                                      | Debt                           |                                                 |           | 184,400                                          |       |      |           | 86,749    |      |      |           | 109,463   |      |   |           | 109,369   |      |   |           | 452,589   |     
|                                                      | Total stockholders investment |                                                 | $         | 652,323                                          |       |      | $         | 939,807   |      |      | $         | 840,563   |      |   | $         | 781,777   |      |   | $         | 699,611   |     



---



|(a) |  | Data includes insurance premium revenue from credit insurance operation.                                                                                                                                                                                                                                                                                                                                                                                                                            
|--- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|   
|(b) |  | In fiscal year 2002, the Company changed its method of determining price
indices used in the valuation of last-in, first-out (LIFO)
inventories. The effect of using internal indices instead of the Bureau
of Labor Statistics price indices was to increase fiscal year 2002 net
income by approximately $4.8 million. The impact on the individual prior
years presented and the cumulative effect of this change on earnings at
the beginning of fiscal year 2002 is not determinable.        
|   
|(c) |  | Unusual items consist of Executive Transactions charge of $2.3 million
and Retiree Medical Plan Curtailment gain of $3.5 million for the year
ended July 31, 2002, and Executive Transactions charge of $4.7 million for
the year ended July 31, 2001.                                                                                                                                                                                                                                              
|   
|(d) |  | Change in accounting principle for the write off of the excess of
revalued net assets over stockholders equity (negative goodwill).                                                                                                                                                                                                                                                                                                                                                                 
|   
|    |  | 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.

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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 total revenues 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,
|                                                                                                                      |  |                    
|                                                                                                                      |  | 2003                |       | 2002 |  | 2001
|                                                                                                                      |  |                     |       |      |  |     
|Total Revenues                                                                                                        |  |                     | 100.0 | %    |  |      | 100.0 | % |  |  | 100.0 | %
|Costs and Expenses:                                                                                                   |  |                     |       |      |  |      |       |   |  |  |       |  
|Cost of Sales                                                                                                         |  |                     | 49.8  |      |  |      | 49.4  |   |  |  | 49.6  |  
|Special Inventory Charge                                                                                              |  |                     |      |      |  |      |      |   |  |  | 1.2   |  
|Selling, General and Administrative Expenses                                                                          |  |                     | 39.9  |      |  |      | 39.8  |   |  |  | 39.2  |  
|Cost of Insurance Operations                                                                                          |  |                     | 0.4   |      |  |      | 0.4   |   |  |  | 0.3   |  
|Depreciation and Amortization Expense                                                                                 |  |                     | 2.5   |      |  |      | 2.7   |   |  |  | 2.8   |  
|Impairment of Goodwill                                                                                                |  |                     | 6.2   |      |  |      |      |   |  |  |      |  
|Unusual Items                                                                                                         |  |                     |      |      |  |      |      |   |  |  | 0.2   |  
|                                                                                                                      |  |                     |       |      |  |      |       |   |  |  |       |  
|Operating Earnings                                                                                                    |  |                     | 1.2   |      |  |      | 7.7   |   |  |  | 6.7   |  
|Interest Expense, Net                                                                                                 |  |                     | 0.3   |      |  |      | 0.3   |   |  |  | 0.3   |  
|Costs of Early Retirement of Debt                                                                                     |  |                     | 0.2   |      |  |      |      |   |  |  |      |  
|                                                                                                                      |  |                     |       |      |  |      |       |   |  |  |       |  
|Earnings Before Income Taxes                                                                                          |  |                     | 0.7   |      |  |      | 7.4   |   |  |  | 6.4   |  
|Income Taxes                                                                                                          |  |                     | 2.5   |      |  |      | 2.7   |   |  |  | 2.5   |  
|                                                                                                                      |  |                     |       |      |  |      |       |   |  |  |       |  
|Earnings Before Effect of Accounting Change                                                                           |  |                     | (1.8  | )    |  |      | 4.7   |   |  |  | 3.9   |  
|Effect of a Change in Accounting for the
Write Off of the Excess of Revalued Net
Assets Over Stockholders Investment |  |                     |      |      |  |      | (1.9  | ) |  |  |      |  
|                                                                                                                      |  |                     |       |      |  |      |       |   |  |  |       |  
|Net (Loss) Earnings                                                                                                   |  |                     | (1.8  | )%   |  |      | 6.6   | % |  |  | 3.9   | %
|                                                                                                                      |  |                     |       |      |  |      |       |   |  |  |       |  

The Company is the largest specialty retailer of fine jewelry in North
America. At July 31, 2003, the Company operated 2,234 specialty retail jewelry
locations throughout the United States, Canada and Puerto Rico.

Year Ended July 31, 2003 Compared to Year Ended July 31, 2002

Total Revenues.Total revenues for fiscal year 2003 were $2.212 billion,
an increase of 0.9 percent over total revenues for the prior fiscal year.
During fiscal year 2003, the Company opened 22 new stores and closed 39 stores.
In addition, the Company opened 15 kiosks and closed 59 kiosks during fiscal
year 2003. Comparable store sales increased 0.8 percent for the fiscal year.
Comparable store sales include sales for those stores that were in operation
for a full twelve-month period in both the current fiscal year and prior fiscal
year. Total revenues include insurance premium revenue for credit insurance
operations of $16.1 and $18.3 for the fiscal years ending July 31, 2003 and
2002, respectively.

The continued development of the core bridal business which included the
expansion of the Zales Diamond collection to include an anniversary band and a
three-stone ring, the launch of The Gordons Diamond Solitaire and
three-stone ring and the introduction of the Peoples Diamond in Canada,
contributed to the total revenue increase. In addition to the introduction of
these proprietary stones, the Company continued to fine tune its merchandise
assortments throughout fiscal year 2003.

Despite the volatility of the external environment, three of the brands,
Zales Jewelers, Peoples Jewellers, and Bailey, Banks and Biddle all had a
positive performance that offset the negative performance of the other brands,
primarily the kiosk business. The kiosk business showed improvements in the
fourth quarter primarily due to the expansion of lower price point merchandise,
such as charms and body jewelry.

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Cost of Sales. Cost of sales as a percentage of revenues was 49.8 for the
fiscal year 2003, an increase of 0.4 percentage points over last fiscal year.
The cost of sales increase was primarily driven by higher promotional
markdowns, especially in the kiosk business, in response to the external
environment and the mix shift to bridal and solitaire categories which
traditionally have lower margins. The increase was partially offset by
improvement in inventory shrink results in fiscal year 2003.

The Companys LIFO provision was $2.9 and $1.4 million for the fiscal
years ended July 31, 2003 and 2002, respectively.

Selling, General and Administrative Expenses.Selling, General, and
Administrative Expenses (SG&A) were $884.1 million, an increase of 1.2
percent. As a percent of revenues, SG&A was slightly higher than last year at
39.9 percent for fiscal year 2003 compared to 39.8 percent for fiscal year
2002. The slight increase as a percentage of total revenues is primarily due to
increased proprietary credit costs offset by lower corporate expenses resulting
from cost savings initiatives.

Cost of Insurance Operations.The cost of insurance operations was $8.2
million, a decrease of 4.5 percent. As a percentage of revenues, cost of
insurance operations remained consistent at 0.4 percent for the current fiscal
year, as well as the prior year.

Depreciation and Amortization Expense.Depreciation and Amortization
Expense was $55.7 million, a decrease of 4.5 percent, primarily due to the
reduced capital expenditures over the past two years. Older assets are being
retired or have been fully depreciated.

Impairment of Goodwill.In accordance with SFAS No. 142 Goodwill and
Other Intangible Assets, the Company tests goodwill for impairment annually,
at the end of its second quarter, or more frequently if events occur which
indicate a potential reduction in the fair value of a reporting units net
assets below its carrying value. An impairment is deemed to exist if the net
book value of a reporting unit exceeds its estimated fair value. In the second
quarter of fiscal year 2003, the Company performed its annual review for
impairment of goodwill related to its Piercing Pagoda, Peoples Jewellers and
other smaller acquisitions. The Company has concluded that there is no
evidence of impairment related to the Goodwill of approximately $57.8 million
recorded for the Peoples acquisition and $5.0 million for other smaller
acquisitions. To perform the impairment test for Piercing Pagoda, the Company
engaged an independent third party valuation firm. This firm calculated the
estimated fair value of Piercing Pagoda using the expected present value of
corresponding future cash flows and fair market values of comparable businesses
where available. The calculation indicated that the fair value of Piercing
Pagoda was lower than its carrying value, reflective of the current market
conditions and lower than expected performance. The Company recorded a non-cash
charge of $136.3 million in the second quarter of fiscal year 2003, which is
included as a component of operating earnings in the Consolidated Statement of
Operations, to reduce the carrying value of the Piercing Pagoda goodwill to
approximately $19.4 million.

Interest Expense, Net.Interest Expense, Net was $6.3 million and $7.8
million for the fiscal years ended July 31, 2003 and 2002, respectively. The
decrease of approximately $1.4 million is primarily a result of lower
outstanding debt balance during fiscal year 2003.

Costs of Early Retirement of Debt.The Company called and retired the
remaining $87 million of its Senior Notes in July 2003, for which it incurred a
$5.9 million loss on retirement of debt.

Income Taxes.The income tax provision for the fiscal years ended July 31,
2003 and 2002 was $55.3 million and $59.3 million, respectively, reflecting an
effective tax rate of 36.7 percent (excluding goodwill impairment of $136.3
million taken in the second quarter of fiscal year 2003), and 36.6 percent for
the fiscal years ended July 31, 2003 and 2002, respectively. The effective tax
rate for the year ended July 31, 2003, including the effect of the goodwill
impairment charge of $136.3 million, is 376.6 percent. The Company will not
recognize a tax benefit associated with the write-down of Piercing Pagoda
goodwill since the original acquisition was a non-taxable business combination
for which goodwill is not deductible for tax purposes. The Company realized a
cash benefit from utilization of tax net operating loss carry-forwards (NOL)
(after annual limitations of $19.5 million) against current and future tax
liabilities. As of July 31, 2003, the Company had a remaining NOL (after
limitations) of $106.2 million.

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Effect of a Change in Accounting for the Write Off of the Excess of
Revalued Net Assets Over Stockholders Investment.On July 21, 2001, the
Financial Accounting Standards Board issued SFAS No. 141 Business
Combinations. SFAS No. 141 establishes specific criteria for the recognition
of intangible assets subsequent to their acquisition, including negative
goodwill. Negative goodwill related to future acquisitions should be recorded
as an extraordinary item. In addition, upon adoption, existing negative
goodwill (or excess of revalued net assets over stockholders investment) should
be written off as a change in accounting principle. The Company adopted SFAS
No. 141 in the first quarter of fiscal year 2002. As a result, the Company
wrote off the Excess of Revalued Net Assets Over Stockholders Investment
(negative goodwill) and recognized income of approximately $41.3 million in the
first quarter of fiscal year 2002.

Year Ended July 31, 2002 Compared to Year Ended July 31, 2001

Total Revenues.In fiscal year 2002, the Company focused on rebuilding
and managing the business through the external volatility of the economy. The
Company recorded total revenues of $2.192 billion in fiscal year 2002, an
increase of 5.0 percent, over total revenues of $2.087 billion for the prior
fiscal year.

Comparable store sales increased 1.4 percent in fiscal year 2002.
Comparable store sales include sales for those stores that were in operation
for a full 12-month period in both the current fiscal year and the prior fiscal
year. The more moderate brands led the sales improvements, with the Zales brand
comparative store sales increasing 7 percent over the prior year. The high-end
business was most affected by the uncertain economic environment, with a 7
percent decrease in comparable store sales for the year. However, this
business demonstrated improvement near the end of fiscal year 2002 compared to
previous quarters. The revenue increase in comparable stores was attributable
to continued strength in the bridal and solitaire categories. Three-stone
jewelry and signature stones were especially strong sellers. The Company
attributes the strength of its diamond categories to improved merchandise
quality and selection, along with an enhanced credit offering which has in turn
improved the average check across all brands.

The Company also believes that inventory management has positively
affected sales. In fiscal year 2002, the Company has enhanced its focus on
inventory management, adjusting inventory levels based on rate of sales in each
store. This inventory management allowed stores to be in-stock on key items,
as well as to maintain current inventory levels.

Total Revenues include insurance premium revenues for credit insurance
operations of $18.3 million and $19.0 million for fiscal years ended July 31,
2002 and 2001, respectively. These revenues were previously included in SG&A
as an offset to such expense. All periods presented have been reclassified to
reflect this change.

The Company opened 40 new stores during the year and closed 29 stores. In
addition, the Company opened eight kiosks and closed 68 kiosks during the year.
Most of these closures were Piercing Pagoda kiosks previously identified as
under-performing locations at the time of the acquisition of Piercing Pagoda
in September 2000.

Cost of Sales.In fiscal year 2002, Cost of Sales as a percentage of
revenues was 49.4 percent, an improvement of 1.4 percentage points over the
same period in the prior year. Cost of Sales in fiscal year 2001 included a
special inventory charge of $25.2 million, or 1.2 percent of revenues, in
January 2001, to adjust the valuation of certain inventory that was not of a
quality consistent with the strategic direction of the Companys brands. Cost
of Sales was positively impacted in fiscal year 2002 by the reduced reliance on
clearance merchandise and point of sale promotional activity. This improvement
was offset by the higher proportion of sales in the bridal and solitaire
categories that have a slightly lower margin rate. However, management
believes the focus on inventory management and narrowing the assortment at
certain stores contributes to improved margins by reducing markdowns.

The LIFO inventory provision was $1.4 million for the fiscal year ended
July 31, 2002, compared to a $4.9 million provision in the prior year. Prior
to fiscal year 2002, the Company used the Bureau of Labor Statistics(BLS)
producer price indices applied against inventory values to calculate the value
of inventory on a LIFO basis. In fiscal year 2002, the Company applied
internally developed indices that the Company believes more consistently
measure inflation or deflation in the components of its merchandise (i.e.,
diamonds, gold and other metals and precious stones) and its merchandise mix.
The Company believes the internally developed indices more accurately reflect
inflation or deflation in its own prices than the BLS producer price indices.
The impact on the individual prior years presented and the cumulative effect of
this change on earnings at the beginning of fiscal year 2002 is not
determinable. At the end of fiscal year 2002, the effect of using internal
indices instead of the BLSs producer price indices was to increase net income
by approximately $4.8

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million, or $0.14 per share. Adjustments to other inventory reserves for
slow moving merchandise were $1.7 million and ($1.5) million for the years
ended July 31, 2002 and 2001, respectively. See  Critical Accounting
Policies.

Selling, General and Administrative Expenses.SG&A increased 0.6
percentage points to 39.8 percent of revenues for the year ended July 31, 2002
from 39.2 percent for the year ended July 31, 2001.

Store expenses such as rent and occupancy increased 0.7 percent of
revenues principally as a result of increasing lease costs for both lease
renewals and new leases. Payroll expenses increased 0.4 percent of revenues.
Advertising costs decreased 0.9 percent of revenues, due to the Companys
decision to allocate resources towards creating a more competitive credit
offering. This expanded twelve-month interest free credit offering resulted in
increased credit expense of 0.9 percent of revenues. Corporate expenses
remained relatively flat as a percent of revenues.

Cost of Insurance Operations.The Cost of Insurance Operations, which was
previously netted with insurance premium revenue in SG&A, increased 0.1 percent
of revenues over the prior year. These costs were reclassified to a separate
line on the Income Statement to improve business reporting.

Unusual Item  Executive Transactions.Robert J. DiNicola retired as
Chief Executive Officer at the end of fiscal year 2002. In connection with his
retirement, the Company agreed to pay certain expenses on an ongoing basis
including life insurance premiums, relocation and medical costs totaling $0.8
million. He will remain Chairman of the Board in a non-executive role, and has
entered into a consulting agreement with the Company.

In addition, Alan P. Shor resigned as President and Chief Operating
Officer at the end of fiscal year 2002. In connection with his resignation,
the Company agreed to pay over a three year period certain benefits of
approximately $1.5 million consisting principally of an amount equivalent to
three years of salary and other related benefits, including accelerated vesting
of restricted stock. Mr. Shor also received accelerated vesting of certain
stock options.

In fiscal year 2001, Executive Transaction charges included the effect of
the resignation of Beryl B. Raff, who resigned as Chairman of the Board and
Chief Executive Officer in February 2001. 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. Also in fiscal year 2001, Robert J. DiNicola
retired as Chairman of the Board in September 2000. In connection with his
severance arrangement, the Company paid 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. Mr. DiNicola returned to the
Company in February 2001 at the request of the Board of Directors.

Unusual Item  Retiree Medical Plan Curtailment Gain.In January 2002,
the Company amended its Retiree Medical plan to limit retiree health coverage
to only those retirees who were already participants in the plan and to those
otherwise eligible employees who elected to retire prior to April 1, 2002.
Retiree health benefits will no longer be available to those current employees
who were previously in the eligible class of employees (i.e., those hired prior
to November 15, 1994, if they retired at age 55 or older with 10 or more years
of continuous service). In January 2002, the Company recorded a $3.5 million
gain related to this curtailment of its retiree medical plan.

Depreciation and Amortization Expense.Depreciation and Amortization
Expense remained unchanged compared to the prior year, primarily as a result of
the elimination of goodwill amortization and the excess of revalued net assets
(negative goodwill) amortization, due to the adoption of SFAS No. 141 and 142
on August 1, 2001. This adoption resulted in a decrease in net amortization
expense for the fiscal year 2002 of approximately $5.9 million. This decrease
is offset by additional depreciation from the purchase of new assets,
principally for new store openings, renovations and refurbishments.

Interest Expense, Net.Interest Expense, Net was $7.8 million and $6.9
million for the years ended July 31, 2002 and 2001, respectively. The increase
of $0.9 million is primarily a result of reduced interest income (which offsets
interest expense) as compared to the same period in the prior year. During the
first two months of the first quarter of fiscal year 2001, the Company invested
cash proceeds from the sale of its customer receivables in interest earning
assets. A significant portion of those cash proceeds were subsequently used to
acquire Piercing Pagoda, Inc. in September 2000 and to pay down debt.
Additionally, the Company repurchased $13 million of Senior Notes on the open
market in June 2002,

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for which it incurred an $0.8 million loss on retirement of debt recorded
in Interest Expense. This repurchase reduced interest expense owed to the
note holders in fiscal year 2002 by $0.2 million.

Income Taxes.The income tax expense for the years ended July 31, 2002 and
2001 was $59.3 million and $51.3 million, respectively, reflecting an effective
tax rate of 36.6 and 38.5 percent for the years ended July 31, 2002 and 2001,
respectively. The decrease in the effective rate is principally due to the
elimination of the goodwill amortization in the current year due to the
adoption of SFAS Nos. 141 and 142 on August 1, 2001 and a decrease in the state
effective tax rate. The Company may realize a cash benefit from utilization of
tax NOL (after annual limitations of $19.5 million) against current and future
tax liabilities. As of July 31, 2002, the Company had a remaining NOL (after
limitations) of $130 million.

Effect of a Change in Accounting for the Write Off of the Excess of
Revalued Net Assets Over Stockholders Investment.On July 21, 2001, the
Financial Accounting Standards Board issued SFAS No. 141 which establishes
specific criteria for the recognition of intangible assets subsequent to their
acquisition, including negative goodwill. Negative goodwill related to future
acquisitions should be recorded as an extraordinary item. In addition, upon
adoption, existing negative goodwill (or excess of revalued net assets over
stockholders investment) should be written off as a change in accounting
principle. The Company adopted SFAS No. 141 in the first quarter of fiscal
year 2002. As a result, the Company wrote off the Excess of Revalued Net
Assets Over Stockholders Investment (negative goodwill) and recognized income
of approximately $41.3 million in the first quarter of fiscal year 2002.

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,
2003, the Company had cash and cash equivalents of $30.3 million, and
restricted cash of $5.0 million set aside as per an agreement with Citi
Commerce Solutions (Citi). This agreement requires the Company to pledge an
amount as collateral to Citi in an interest bearing depository account that
will fluctuate monthly based on the account balances of the shared risk
programs. See Notes to Consolidated Financial Statements- Guarantee
Obligations. 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 41 percent of the Companys
annual revenues were made during both the three months ended January 31, 2003
and the three months ended January 31, 2002, which include 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

Net cash provided by operating activities was $158.6 million, $175.0
million and $85.5 million for fiscal years 2003, 2002, and 2001, respectively.
In fiscal year 2003, the decrease in cash provided by operating activities was
due mainly from the change in accounts payable and inventories. There has been
an increase of approximately $9.1 million in owned merchandise inventories at
July 31, 2003 compared to the balance at July 31, 2002. In fiscal year 2002,
the net cash provided by operating activities increased from the prior year
primarily due to the timing of payments of accounts payable, including taxes
payable, and accrued liabilities.

Net cash used in investing activities was $36.2 million in fiscal year
2003, related to capital expenditures for new store openings, renovations and
refurbishments and net purchases of investments. Net cash used in investing
activities was $51.0 million in fiscal year 2002, mainly from capital
expenditure for new store openings and renovations. In fiscal year 2001, net
cash used in investing activities was $324.2 million, principally related to
the acquisition of Piercing Pagoda, as well as $88 million in capital
expenditures.

Net cash used in financing activities was $172.5 million in fiscal year
2003, principally related to the called and retired Senior Notes, the
repurchase of approximately 6.4 million shares of stock, offset by the
borrowings under the new revolving credit facility. Net cash used in financing
activities was $68.4 in fiscal year 2002, principally related to the stock
repurchase plan approved in July 2001, as well as the fiscal year 2003 stock
repurchase plan which commenced in July 2002. The Company also repurchased on
the open market and retired $13.0 million of Senior Notes in the fourth quarter
of fiscal year 2002 for which in incurred an $0.8 million loss on retirement of
debt. Net cash used in financing activities was $34.0 million in fiscal year
2001, principally related to the stock repurchase plan approved in July 2000
and

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the repayment of long-term debt acquired in the Piercing Pagoda acquisition,
slightly offset with proceeds from the exercise of stock options.

Finance Arrangements

In
September 1997, the Company issued $100 million of
8 1/2 percent
Senior Notes due 2007. In fiscal year 2002, the Company repurchased $13
million of the Senior Notes. The remaining $87 million of the Senior Notes
were called and retired in July 2003. The Company recognized a $5.9 million
loss related to this early retirement of debt. This loss is reported as Costs
of Early Retirement of Debt in the Statement of Operations.

In July 2003, the Company entered into a new $500 million secured
revolving credit facility (the Revolving Credit Agreement) with a syndicate
of lenders led by Fleet National Bank, as administrative agent, to replace its
existing $225 million unsecured facility. The Revolving Credit Agreement is
primarily secured by domestic merchandise inventory.

The revolving credit loans bear interest at a floating rate at either (i)
the applicable LIBOR Rate plus a margin equal to 1.75 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). The margin applicable to LIBOR Rates and letter of
credit commission rates will be automatically reduced or increased from time to
time based upon excess availability under the Revolving Credit Agreement. The
Company pays a commitment fee of 0.375 percent on the preceding months unused
commitment. 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, 2003, there was $184 million outstanding under
the Revolving Credit Agreement. The Revolving Credit Agreement requires the
Company to comply with certain restrictive covenants including, among other
things, limitations on indebtedness, investments, liens, acquisitions, and
asset sales. In addition, if remaining borrowing availability under the
facility is less than $75 million, the Company will be restricted in its
ability to repurchase stock or pay dividends. If remaining borrowing
availability is less than $50 million, the Company will be required to meet a
minimum fixed charge coverage ratio. The Company is currently in compliance
with all of its obligations under the Revolving Credit Agreement.

Capital Growth

During the year ended July 31, 2003, the Company made $44 million of
capital expenditures, a portion of which was used to open 37 new locations and
remodel, relocate or refurbish other locations. The Company plans to open 66
new locations, including 10 new kiosks, for which it will incur $15 million in
capital expenditures during fiscal year 2004. During fiscal year 2004, the
Company anticipates spending $29 million to remodel, relocate or refurbish 176
additional locations. This will allow the Company to focus on productivity of
existing core store locations. The Company also estimates that it will incur
capital expenditures of $10 million during fiscal year 2004 for enhancements to
its management information systems and infrastructure expansion. In total, the
Company anticipates making $75 million of capital expenditures during fiscal
year 2004.

Other Activities Affecting Liquidity

     The Company has an operations services agreement with a third party for
the management of the Companys mainframe processing operations, client server
systems, Local Area Network, Wide Area Network management and e-commerce
hosting. The agreement, which was effective August 1, 2002, requires fixed
payments totaling $11 million over a 36-month term plus a variable amount based
on usage. The Company has an option to extend the current agreement for two
consecutive one year periods.

     On March 18, 2003 the Company announced that its Board of Directors had
approved a stock repurchase program under which the Company, from time to time
and at managements discretion and in accordance with the Companys usual
policies and applicable securities laws, may purchase up to an aggregate of $50
million of its Common Stock on the open market. Under this program, the
Company has purchased 209,000 shares at as aggregate cost of $7.5 million
through July 31, 2003.

     On July 1, 2003, the Company entered into a Tender Offer to purchase up
to 6,400,000 shares of its outstanding Common Stock at a price per share of not
less than $42.00 nor in excess of $48.00 per share, for an aggregate purchase

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price of up to $307.2 million. The Tender Offer enabled the Company to
repurchase approximately 4.7 million shares at an aggregate cost of
approximately $225.6 million.

     On August 28, 2003, 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 up to an aggregate of
$100 million of its Common Stock on the open market. This action brings the
Companys remaining availability of the total authorization under its stock
repurchase program to approximately $142 million.

     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 2003 was
approximately $9.6 million. As of July 31, 2003, the Company had a NOL (after
limitations) of $106.2 million, which represents up to $40.8 million in future
tax benefits. The utilization of this asset is subject to limitations. The most
restrictive limitation is the Internal Revenue Code Section 382 annual
limitation of $19.5 million. The NOL can be utilized through 2008.

     Contractual obligations Aggregated information about the Companys
contractual obligations as of July 31, 2003 is presented in the following
table.

|                              |                  |       |                        |      |  |      |     |      |  |      |     |      |  |               |     |     |  |   |     |     |  |   |     |     |  |   |     |     | 
|----------------------------- | ---------------- | ----- | ---------------------- | ---- |  | ---- | --- | ---- |  | ---- | --- | ---- |  | ------------- | --- | --- |  | - | --- | --- |  | - | --- | --- |  | - | --- | --- | 
|                              |                  |       | Payments due by period
|                              |                  |       |                       
|($ in millions)               |                  | Total |                        | 2004 |  | 2005 |     | 2006 |  | 2007 |     | 2008 |  | After 5 years
|                              |                  |       |                        |      |  |      |     |      |  |      |     |      |  |              
|Contractual cash
obligations: |                  |       |                        |      |  |      |     |      |  |      |     |      |  |               |     |     |  |   |     |     |  |   |     |     |  |   |     |    
|                              | Long-term debt   |       | $                      | 184  |  |      | $   |     |  |      | $   |     |  |               | $   |    |  |   | $   |    |  |   | $   | 184 |  |   | $   |    | 
|                              | Operating leases |       |                        | 871  |  |      |     | 167  |  |      |     | 152  |  |               |     | 134 |  |   |     | 116 |  |   |     | 94  |  |   |     | 208 | 
|                              |                  |       |                        |      |  |      |     |      |  |      |     |      |  |               |     |     |  |   |     |     |  |   |     |     |  |   |     |     | 
|Total                         |                  | $     | 1,055                  |      |  | $    | 167 |      |  | $    | 152 |      |  | $             | 134 |     |  | $ | 116 |     |  | $ | 278 |     |  | $ | 208 |    
|                              |                  |       |                        |      |  |      |     |      |  |      |     |      |  |               |     |     |  |   |     |     |  |   |     |     |  |   |     |    



| |                                                                                                                                                                                                                                               
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |      The Company issues purchase orders to numerous vendors for the
purchase of its merchandise. Substantially all of the Companys
merchandise purchase obligations may be cancelled several weeks
prior to the vendors scheduled shipment.

Management believes that operating cash flow and amounts available under
the Credit Facility 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

In November 2002, the Emerging Issues Task Force (EITF) discussed issue
00-21, Revenue Arrangements with Multiple Deliverables. This issue addresses
when and, if so, how an arrangement involving multiple deliverables should be
divided into separate units of accounting. The principles are: (a) how the
arrangement consideration should be measured, (b) whether the arrangement
should be divided into separate units of accounting for revenue recognition
purposes, and (c) how the arrangement consideration should be allocated among
the separate units of accounting. The consensus on EITF 00-21 will be applied
prospectively for revenue arrangements entered into fiscal years beginning
after December 15, 2002. The Company will adopt EITF 00-21 for the first
quarter of fiscal year 2004. The Company is currently evaluating the impact
that EITF 00-21 will have on its financial position, results of operations or
cash flows.

On December 31, 2002, the Financial Accounting Standards Board (FASB)
issued Statement of Financial Accounting Standards (SFAS) No. 148,
Accounting for Stock-Based Compensation  Transition and Disclosure (SFAS
148), which amends SFAS No. 123, Accounting for Stock-Based Compensation
(SFAS 123). SFAS 148 provides alternative methods of transition for a
voluntary change to the fair value based method of accounting for stock-based
employee compensation. In addition, SFAS 148 amends the disclosure requirements
of SFAS 123 to require more prominent and more frequent disclosures in
financial statements of the effects of stock-based compensation. The Company
will continue to apply Accounting Principles Board Opinion No. 25, Accounting
for Stock Issued to Employees and provide the amended disclosure requirements
of SFAS 148. Accordingly, the adoption of this standard had no impact on the
Companys financial position, results of operations or cash flows.

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In November 2002, the EITF reached a consensus on Issue 1 of Issue 02-16,
Accounting by a Reseller (including a Retailer) for Cash Consideration
Received from a Vendor. This issue addresses circumstances under which cash
consideration received from a vendor by a reseller should be considered (a) an
adjustment of the prices of the vendors product and therefore, characterized
as a reduction of cost of sales, (b) an adjustment to cost incurred by the
reseller and therefore characterized as a reduction of that expense, or (c) a
payment for assets or services delivered to the vendor and therefore,
characterized as revenue on the income statement. The consensus on EITF 02-16
should be applied prospectively to new arrangements, or modifications to
existing arrangements, entered into as of January 1, 2003. The Company has
adopted the provisions of the consensus EITF 02-16, and that adoption had no
impact on its financial position, results of operations or cash flows for the
current reporting periods.

In accordance with EITF 02-16, the Company is applying the new rules to
its renewals of existing contracts that are effective at the beginning of each
new fiscal year. Effective in fiscal year 2004, cooperative advertising support
received from vendors, which was previously recorded as an offset to
advertising expense, will be included as a reduction of the purchase cost of
the related inventory and flow through the retail inventory calculation as a
reduction in cost of sales as the inventory is sold. Due to the nature of the
retail inventory calculation, the inventory turn impact, and the estimated LIFO
impact of the prospective adoption, this will result in an estimated $0.12
reduction to earnings per share for fiscal year 2004. This adoption is not
expected to have a financial impact on future periods after fiscal year 2004.

In May 2003, the FASB issued SFAS No. 150,Accounting for Certain
Financial Instruments with Characteristics of Both Liabilities and
Equity (SFAS 150). SFAS 150 establishes standards for how an issuer
classifies and measures certain financial instruments with characteristics of
both liabilities and equity. It requires that an issuer classify a financial
instrument that is within its scope as a liability (or an asset in some
circumstances). Many of those instruments were previously classified as equity.
The Company adopted SFAS 150 in the fourth quarter of fiscal year 2003, and the
adoption had no impact on its financial position, results of operations and
cash flows for the current reporting operations.

Inflation

In managements opinion, changes in net revenues, net earnings, and
inventory valuation that have resulted from inflation and changing prices have
not been material during the periods presented. The trends in inflation rates
pertaining to merchandise inventories, especially as they relate to gold and
diamond costs, are primary components in determining the Companys LIFO
inventory. There is no assurance that inflation will not materially affect the
Company in the future.

Critical Accounting Policies

The preparation of financial statements and related disclosures 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. For example, unexpected changes in market conditions or
a downturn in the economy could adversely affect actual results. Estimates are
used in accounting for, among other things, inventory obsolescence, goodwill
and long lived asset valuation, LIFO inventory retail method, legal liability,
credit insurance liability, product warranty, depreciation, employee benefits,
taxes, and contingencies. Estimates and assumptions are reviewed periodically
and the effects of revisions are reflected in the Consolidated Financial
Statements in the period they are determined to be necessary.

Management believes the following critical accounting policies, among
others, affect its more significant judgments and estimates used in the
preparation of its Consolidated Financial Statements.

Merchandise Inventories Merchandise Inventories are stated at the lower
of cost or market. Substantially all U.S. inventories represent finished goods
which are valued using the last-in, first-out (LIFO) retail inventory method.
Merchandise inventory of Peoples Jewellers of Canada is valued using the
first-in, first-out (FIFO) retail inventory method. Under the retail method,
inventory is segregated into categories of merchandise with similar
characteristics at its current retail selling value. The determination of
inventory at cost and the resulting gross margins are calculated by applying an
average cost to retail ratio to the retail value of inventory.

The Company is required to determine the LIFO cost on an interim basis by
estimating annual inflation trends, annual purchases and ending inventory
levels for the fiscal year. Actual annual inflation rates and inventory
balances as of the end of any fiscal year may differ from interim estimates.
Prior to fiscal year 2002, the Company used the Bureau of

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Labor Statistics(BLS) producer price indices applied against inventory
values to calculate the value of inventory on a LIFO basis. In fiscal year
2002, the Company applied internally developed indices that the Company
believes more consistently measure inflation or deflation in the components of
its merchandise (i.e., diamonds, gold and other metals and precious stones) and
its merchandise mix. The Company believes the internally developed indices
more accurately reflect inflation or deflation in its own prices than the BLS
producer price indices. The impact on the individual prior years presented and
the cumulative effect of this change on earnings at the beginning of fiscal
year 2002 was not determinable. At the end of fiscal year 2002, the effect of
using internal indices instead of the BLS producer price indices was to
increase net income by approximately $4.8 million, or $0.14 per share.

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

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

Long-lived Assets and Goodwill Long-lived assets are periodically
reviewed for impairment by comparing the carrying value of the assets with
their estimated fair values. If the evaluation indicates that the carrying
amount of the asset may not be recoverable, the potential impairment is
measured based on a projected discounted cashflow method, using a discount rate
that is considered to be commensurate with the risk inherent in the Companys
current business model. Assumptions are made with respect to cash flows
expected to be generated by the related assets based upon updated projections.
Any changes in key assumptions or market conditions could result in an
unanticipated impairment charge. For instance, in the event of a major market
downturn, individual stores may become unprofitable, which could result in a
write-down of the carrying value of the assets located in those stores. Any
impairment would be recognized in operating results if a permanent reduction
were to occur.

Goodwill, which represents the cost in excess of fair value of net assets
acquired, is subject to an impairment test on an annual basis, or when
there is reason to believe that the value has been diminished or impaired. The
fair value of the Companys identified reporting units was estimated using the
expected present value of corresponding future cash flows and market values
of comparable businesses where available. In accordance with SFAS No. 142,
Goodwill and Other Intangible Assets, the Company tests goodwill for
impairment annually, at the end of its second quarter, or more frequently if
events occur which indicate a potential reduction in the fair value of a
reporting units net assets below its carrying value. An impairment is deemed
to exist if the net book value of a reporting unit exceeds its estimated fair
value. In the second quarter of fiscal year 2003, the Company performed its
annual review for impairment of goodwill related to its Piercing Pagoda,
Peoples and other smaller acquisitions. The Company has concluded that there
is no evidence of impairment related to the goodwill of approximately $57.8
million recorded for the Peoples acquisition and $5.0 million for other
smaller acquisitions. To perform the impairment test for Piercing Pagoda, the
Company engaged an independent third party valuation firm. This firm
calculated the estimated fair value of Piercing Pagoda using the expected
present value of corresponding future cash flows and fair market values of
comparable businesses where available. The calculation indicated that the fair
value of Piercing Pagoda was lower than its carrying value, reflective of the
current market conditions and lower than expected performance. The Company
recorded a non-cash charge of $136.3 million in the second quarter of fiscal
year 2003, which is included as a component of operating earnings in the
Consolidated Statement of Operations, to reduce the carrying value of the
Piercing Pagoda goodwill to approximately $19.4 million.

Revenue Recognition The Company recognizes revenue in accordance with
the Securities and Exchange Commissions Staff Accounting Bulletin No. 101
Revenue Recognition in Financial Statements (SAB 101). Revenue related to
merchandise sales, which is approximately ninety-five percent of total revenues
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. Total Revenues include extended
service agreements which are recognized over the period the services are
performed. Revenues also include premiums from the Companys insurance
businesses, principally related to credit

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insurance policies sold to customers who purchase the Companys
merchandise under the proprietary credit program. Insurance premiums are
recognized over the coverage period.

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

Income taxes are estimated for each jurisdiction in which the Company
operates. This involves assessing the current tax exposure together with
temporary differences resulting from differing treatment of items for tax and
financial statement accounting purposes. Any resulting deferred tax assets are
evaluated for recoverability based on estimated future taxable income. To the
extent that recovery is deemed not likely, a valuation allowance is recorded.
The Company believes that as of July 31, 2003 the realization of the deferred
income tax asset is more likely than not, and thus there was no valuation
reserve recorded.

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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. 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 $25.1 million, approximate market value at July 31,
2003.

Based on the Companys market risk sensitive instruments (including
variable rate debt) outstanding at July 31, 2003, 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.

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Commodity Risk-The Company principally addresses commodity risk through
retail price points. The Companys commodity risk exposure to diamond price
fluctuation is not currently hedged by financial instruments.

In fiscal year 2003, the Company entered into forward contracts for the
purchase of some of its gold in order to hedge the risk of gold price
fluctuations. The table below provides information about the Companys
derivative financial instruments that are sensitive to gold prices.

Forward Commodity Agreements(As of July 31, 2003)

|          |  |                 |          |                |  |                 |       |               |  |   |         |  |  |   |        | 
|--------- |  | --------------- | -------- | -------------- |  | --------------- | ----- | ------------- |  | - | ------- |  |  | - | ------ | 
|          |  | Contract        |          | Fine Troy      |  | Contract Gold   |       | Contract Fair
|Commodity |  | Settlement Date |          | Ounces of Gold |  | Price Per Ounce |       | Market Value 
|          |  |                 |          |                |  |                 |       |              
|Gold      |  |                 | 08-07-03 |                |  |                 | 682   |               |  | $ | 335.624 |  |  | $ | 12,566 | 
|Gold      |  |                 | 08-07-03 |                |  |                 | 682   |               |  |   | 350.613 |  |  |   | 2,344  | 
|Gold      |  |                 | 08-21-03 |                |  |                 | 682   |               |  |   | 335.851 |  |  |   | 12,506 | 
|Gold      |  |                 | 08-21-03 |                |  |                 | 682   |               |  |   | 350.817 |  |  |   | 2,299  | 
|Gold      |  |                 | 09-08-03 |                |  |                 | 657   |               |  |   | 336.143 |  |  |   | 11,972 | 
|Gold      |  |                 | 09-08-03 |                |  |                 | 657   |               |  |   | 351.079 |  |  |   | 2,159  | 
|Gold      |  |                 | 09-22-03 |                |  |                 | 657   |               |  |   | 336.371 |  |  |   | 11,913 | 
|Gold      |  |                 | 09-22-03 |                |  |                 | 657   |               |  |   | 351.283 |  |  |   | 2,116  | 
|Gold      |  |                 | 10-07-03 |                |  |                 | 546   |               |  |   | 336.614 |  |  |   | 9,835  | 
|Gold      |  |                 | 10-07-03 |                |  |                 | 546   |               |  |   | 351.502 |  |  |   | 1,707  | 
|Gold      |  |                 | 10-07-03 |                |  |                 | 592   |               |  |   | 346.172 |  |  |   | 5,006  | 
|Gold      |  |                 | 10-21-03 |                |  |                 | 546   |               |  |   | 336.841 |  |  |   | 9,784  | 
|Gold      |  |                 | 10-21-03 |                |  |                 | 546   |               |  |   | 351.706 |  |  |   | 1,668  | 
|Gold      |  |                 | 10-21-03 |                |  |                 | 592   |               |  |   | 346.373 |  |  |   | 4,966  | 
|Gold      |  |                 | 11-07-03 |                |  |                 | 1,730 |               |  |   | 337.117 |  |  |   | 30,772 | 
|Gold      |  |                 | 11-07-03 |                |  |                 | 1,398 |               |  |   | 351.954 |  |  |   | 4,124  | 
|Gold      |  |                 | 11-07-03 |                |  |                 | 1,912 |               |  |   | 346.617 |  |  |   | 15,845 | 
|Gold      |  |                 | 11-21-03 |                |  |                 | 1,730 |               |  |   | 337.345 |  |  |   | 30,603 | 
|Gold      |  |                 | 11-21-03 |                |  |                 | 1,399 |               |  |   | 352.158 |  |  |   | 4,025  | 
|Gold      |  |                 | 11-21-03 |                |  |                 | 1,912 |               |  |   | 346.819 |  |  |   | 15,709 | 
|Gold      |  |                 | 12-08-03 |                |  |                 | 344   |               |  |   | 347.063 |  |  |   | 2,789  | 
|Gold      |  |                 | 12-22-03 |                |  |                 | 344   |               |  |   | 347.264 |  |  |   | 2,763  | 
|Gold      |  |                 | 01-07-04 |                |  |                 | 802   |               |  |   | 347.494 |  |  |   | 6,375  | 
|Gold      |  |                 | 01-21-04 |                |  |                 | 802   |               |  |   | 347.695 |  |  |   | 6,317  | 

The Company generally enters into forward gold purchase contracts with
maturity dates of not longer than twelve months.

Foreign Currency Contracts-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 foreign currency hedge contracts. Based on the Companys
market risk from currency exchange rate exposure at July 31, 2003, 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. As a result, the Company did not enter into any new foreign currency
contracts this year.

Energy Contract-The Company fixed the prices of certain electricity
purchases under an electricity requirements contract. The contract is for a
three-year period and is with a utility company to purchase electricity in the
State of Texas. This contract qualifies as a normal purchase under SFAS No.
138, Accounting for Certain Derivative Instruments and Certain Hedging
Activities; accordingly, the fair value of the contract is not required to be
recorded on the balance sheet. Payments under this contract are expected to
approximate $750,000 annually based on current usage patterns.

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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-33 at the end of this
Annual Report on Form 10-K:

|                                                    |  |        |      | 
|--------------------------------------------------- |  | ------ | ---- | 
|                                                    |  | Page  
|Index                                               |  | Number
|                                                    |  |       
|Managements Report                                 |  |        | F-2  | 
|Reports of Independent Public Accountants           |  |        | F-3  | 
|Consolidated Statements of Operations               |  |        | F-5  | 
|Consolidated Balance Sheets                         |  |        | F-6  | 
|Consolidated Statements of Cash Flows               |  |        | F-7  | 
|Consolidated Statements of Stockholders Investment |  |        | F-9  | 
|Notes to Consolidated Financial Statements          |  |        | F-11 | 
|                                                    |  |        |     




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

In June 2002, the Company announced that the Board of Directors, upon
recommendation of its Audit Committee, ended the engagement of Arthur Andersen
LLP as the Companys independent public accountants, and engaged KPMG LLP to
serve as the Companys independent public accountants for the fiscal year
ending July 31, 2002. For more information, see the Companys current report on
Form 8-K, filed with the SEC on June 6, 2002.




PART III




ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS

The information set forth under the headings Proposal No. 1: Election of
Directors, Corporate Governance and Section 16(a) Beneficial Ownership
Reporting Compliance in the Companys definitive Proxy Statement for the 2003
Annual Meeting of Stockholders 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 2003 Annual
Meeting of Stockholders 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 2003 Annual Meeting of Stockholders is incorporated herein by
reference.

The information included under Equity Compensation Plan Information in
Item 5 is incorporated herein by reference.




ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

Not Applicable.




ITEM 14. CONTROLS AND PROCEDURES

Under the supervision and with the participation of the Companys
management, including its Chief Executive Officer and Chief Financial Officer,
the Company has evaluated the effectiveness of its disclosure controls and
procedures, as of the end of the period covered by this report. Based on that
evaluation, the Chief Executive Officer and Chief Financial Officer have
concluded that these disclosure controls and procedures are effective in
enabling the Company to record, process, summarize and report information
required to be included in its periodic SEC filings within

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the required time period. There has been no change in the Companys internal
control over financial reporting that occurred during the Companys most recent
fiscal quarter that has materially affected, or is reasonably likely to
materially affect, the Companys internal control over financial reporting.




ITEM 15. PRINCIPAL ACCOUNTANT FEES AND SERVICES

The information set forth under the heading Independent Auditor Fee
Information in the Companys definitive Proxy Statement for the 2003 Annual
Meeting of Stockholders is incorporated herein by reference.




PART IV




ITEM 16. 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

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

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3. Exhibits

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

|        |  |                                                                                                                     |  |                                            
|------- |  | ------------------------------------------------------------------------------------------------------------------- |  | -------------------------------------------
|        |  |                                                                                                                     |  | The filings referenced                     
|        |  |                                                                                                                     |  | for incorporation by reference are         
|Exhibit |  |                                                                                                                     |  | Zale Corporation filings (File No.         
|Number  |  | Description of Exhibit                                                                                              |  | 1-04129) unless otherwise noted            
|        |  |                                                                                                                     |  |                                            
|3.1     |  | Restated Certificate of Incorporation of Zale Corporation                                                           |  | October 31, 2001 Form 10-Q,
Exhibit 3.1    
|        |  |                                                                                                                     |  |                                            
|3.2     |  | Bylaws of Zale Corporation                                                                                          |  | July 31, 2000 Form 10-K,
Exhibit 3.2       
|        |  |                                                                                                                     |  |                                            
|4.1     |  | Revolving Credit Agreement, dated as of July 23, 2003                                                               |  | Filed herewith.                            
|        |  |                                                                                                                     |  |                                            
|4.2     |  | Security Agreement of Revolving Credit Agreement
Dated as of July 23, 2003                                          |  | Filed herewith.                            
|        |  |                                                                                                                     |  |                                            
|10.1a*  |  | Zale Corporation Savings and Investment Plan                                                                        |  | July 31, 2000 Form 11-K,
Exhibit 99        
|        |  |                                                                                                                     |  |                                            
|10.1b*  |  | Amendment to Zale Corporation Savings and Investment
Plan                                                           |  | July 31, 2001 Form 11-K,
Exhibit 99        
|        |  |                                                                                                                     |  |                                            
|10.2*   |  | Form of Indemnification Agreement between Zale
Corporation and its directors                                        |  | July 31, 1995 Form 10-K
Exhibit 10.2       
|        |  |                                                                                                                     |  |                                            
|10.3*   |  | Zale Corporation Omnibus Stock Incentive Plan                                                                       |  | July 31, 2000 Form 10-K,
Exhibit 10.3a     
|        |  |                                                                                                                     |  |                                            
|10.4*   |  | Zale Corporation 2003 Stock Option Plan                                                                             |  | Filed herewith.                            
|        |  |                                                                                                                     |  |                                            
|10.5*   |  | Outside Directors 1995 Stock Option Plan                                                                           |  | July 31, 2001 Form 10-K,
Exhibit 10.3c     
|        |  |                                                                                                                     |  |                                            
|10.6a*  |  | The Executive Severance Plan for Zale Corporation,
Gordon Jewelry Corporation and their Affiliates                  |  | Form S-1 (Reg. No. 33-27225),
Exhibit 10.23
|        |  |                                                                                                                     |  |                                            
|10.6b*  |  | Amendment to The Executive Severance Plan for
Zale Corporation and its Affiliates effective
May 20, 1995            |  | July 31, 1996 Form 10-K,
Exhibit 10.8a     
|        |  |                                                                                                                     |  |                                            
|10.7a   |  | Lease Agreement Between Principal Mutual Life Insurance
Company and Zale Corporation dated as of September 17,
1992 |  | July 31, 1996 Form 10-K,
Exhibit 10.11     

36



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##### Table of Contents



|        |  |                                                                                                                                       |  |                                        
|------- |  | ------------------------------------------------------------------------------------------------------------------------------------- |  | ---------------------------------------
|        |  |                                                                                                                                       |  | The filings referenced                 
|        |  |                                                                                                                                       |  | for incorporation by reference are     
|Exhibit |  |                                                                                                                                       |  | Zale Corporation filings (File No.     
|Number  |  | Description of Exhibit                                                                                                                |  | 1-04129) unless otherwise noted        
|        |  |                                                                                                                                       |  |                                        
|10.7b   |  | First Lease Amendment and Agreement Between Principal
Mutual Life Insurance Company and
Zale Corporation dated as of February 1, 1996 |  | July 31, 1996 Form 10-K,
Exhibit 10.11a
|        |  |                                                                                                                                       |  |                                        
|10.8*   |  | Consulting Agreement, dated August 1, 2002,
between Zale Corporation and Robert J. DiNicola                                           |  | July 31, 2002 Form 10-K,
Exhibit 10.6a 
|        |  |                                                                                                                                       |  |                                        
|10.9*   |  | Employment Agreement, dated as of August 1, 2002 between
Zale Corporation and David W. Howard                                         |  | July 31, 2002 Form 10-K,
Exhibit 10.8  
|        |  |                                                                                                                                       |  |                                        
|10.10*  |  | Employment Agreement, dated as of August 1, 2002 between
Zale Corporation and Mary L. Forte                                           |  | July 31, 2002 Form 10-K,
Exhibit 10.9  
|        |  |                                                                                                                                       |  |                                        
|10.11*  |  | Employment Agreement, dated as of August 1, 2002 between
Zale Corporation and Sue E. Gove                                             |  | July 31, 2002 Form 10-K,
Exhibit 10.10 
|        |  |                                                                                                                                       |  |                                        
|10.12*  |  | Employment Agreement dated as of August 1, 2003 between
Zale Corporation and Mark R. Lenz                                             |  | Filed herewith.                        
|        |  |                                                                                                                                       |  |                                        
|10.13*  |  | Employment Agreement dated as of February 28, 2003,
between Zale Corporation and Pamela J. Romano                                     |  | Filed herewith.                        
|        |  |                                                                                                                                       |  |                                        
|10.14*  |  | Zale Corporation Executive Bonus Plan                                                                                                 |  | Filed herewith.                        
|        |  |                                                                                                                                       |  |                                        
|10.15   |  | Amendment to Citibank USA, N.A. Agreement, dated as of
April 4, 2003                                                                  |  | April 30, 2003 Form 10-Q,
Exhibit 99.2 
|        |  |                                                                                                                                       |  |                                        
|14      |  | Code of Ethics                                                                                                                        |  | Filed herewith.                        
|        |  |                                                                                                                                       |  |                                        
|16      |  | Letter from Arthur Andersen LLP to the Securities
and Exchange Commission                                                             |  | June 6, 2002 Form 8-K,
Exhibit 16.1    
|        |  |                                                                                                                                       |  |                                        
|21      |  | Subsidiaries of the registrant                                                                                                        |  | Filed herewith.                        
|        |  |                                                                                                                                       |  |                                        
|23.1    |  | Consent of KPMG LLP                                                                                                                   |  | Filed herewith.                        
|        |  |                                                                                                                                       |  |                                        
|31.1    |  | Rule 13a-14(a) Certification of Chief Executive Officer                                                                               |  | Filed herewith.                        
|        |  |                                                                                                                                       |  |                                        
|31.2    |  | Rule 13a-14(a) Certification of Chief Financial Officer                                                                               |  | Filed herewith.                        
|        |  |                                                                                                                                       |  |                                        
|32.1    |  | Section 1350 Certification of Chief Executive Officer                                                                                 |  | Filed herewith.                        
|        |  |                                                                                                                                       |  |                                        
|32.2    |  | Section 1350 Certification of Chief Financial Officer                                                                                 |  | Filed herewith.                        

37



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|        |  |                                                   |  |                                    |  |  |  | 
|------- |  | ------------------------------------------------- |  | ---------------------------------- |  |  |  | 
|        |  |                                                   |  | The filings referenced            
|        |  |                                                   |  | for incorporation by reference are
|Exhibit |  |                                                   |  | Zale Corporation filings (File No.
|Number  |  | Description of Exhibit                            |  | 1-04129) unless otherwise noted   
|        |  |                                                   |  |                                   
|99.1    |  | Audit Committee Charter                           |  | Filed herewith.                   
|        |  |                                                   |  |                                   
|99.2    |  | Compensation Committee Charter                    |  | Filed herewith.                   
|        |  |                                                   |  |                                   
|99.3    |  | Nominating/Corporate Governance Committee Charter |  | Filed herewith.                   

4.     Reports on Form 8-K



|1) |  | On May 8, 2003, the Company filed a Current Report on Form 8-K under Item
7 and Item 9, Regulation FD Disclosure, to furnish a press release
reporting its sales results for the third quarter ended April 30, 2003.     
|-- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|  
|2) |  | On May 15, 2003, the Company filed a Current Report on Form 8-K under
Item 7 and Item 9, Regulation FD Disclosure, to furnish a press release
reporting its financial results for the third quarter ended April 30,
2003.

38



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##### Table of Contents



INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

|                                                    |  |      |      | 
|--------------------------------------------------- |  | ---- | ---- | 
|                                                    |  | Page
|                                                    |  |     
|Managements Report                                 |  |      | F-2  | 
|Reports of Independent Public Accountants           |  |      | F-3  | 
|Consolidated Statements of Operations               |  |      | F-5  | 
|Consolidated Balance Sheets                         |  |      | F-6  | 
|Consolidated Statements of Cash Flows               |  |      | F-7  | 
|Consolidated Statements of Stockholders Investment |  |      | F-9  | 
|Notes to Consolidated Financial Statements          |  |      | F-11 | 
|                                                    |  |     

F-1



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##### 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 as of and for the
year ended July 31, 2003 have been audited by KPMG 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 submitted for stockholder approval, and the general oversight review
of managements discharge of its responsibilities with respect to the matters
referred to above.

|                                   |  |                             
|---------------------------------- |  | ----------------------------
|Mary L. Forté                      |  | Mark R. Lenz                
|President, Chief Executive Officer |  | Group Senior Vice President,
|and Director                       |  | Chief Financial Officer     

F-2



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REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS




To the Stockholders and Board of Directors Zale Corporation:

We have audited the accompanying consolidated balance sheets of Zale
Corporation and subsidiaries as of July 31, 2003 and 2002, and the related
consolidated statements of operations, cash flows, and stockholders investment
for each of the years then ended. These consolidated financial statements are
the responsibility of the Companys management. Our responsibility is to
express an opinion on these consolidated financial statements based on our
audits. The consolidated financial statements for the year ended July 31, 2001
were audited by other auditors who have ceased operations. Those auditors
expressed an unqualified opinion on those consolidated financial statements in
their audit report dated August 27, 2001.

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

In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of Zale Corporation
and subsidiaries as of July 31, 2003 and 2002, and the results of their
operations and their cash flows for the years then ended in conformity with
accounting principles generally accepted in the United States of America.

As discussed on pages F-12 and F-16 of the Notes to the Consolidated Financial
Statements, the Company adopted the provisions of the Financial Accounting
Standards Boards Statement of Financial Accounting Standards No. 141 Business
Combinations and No. 142, Goodwill and Other Intangible Assets, in fiscal
year 2002. Also, as discussed on page F-17 of the Notes to the Consolidated
Financial Statements, the Company changed its method of determining price
indices used in the valuation of LIFO inventories in fiscal year 2002.

KPMG LLP
Fort Worth, Texas
August 28, 2003

F-3



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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 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 of America.

Arthur Andersen LLP (1)
Dallas, Texas
August 27, 2001

(1)  The report of Arthur Andersen LLP (Arthur Andersen) is a copy of a report
previously issued by Arthur Andersen on August 27, 2001. This audit report has
not been reissued by Arthur Andersen in connection with this filing on Form
10-K. As a result of the status of Arthur Andersen, we have been unable to
obtain the consent of Arthur Andersen, our former independent public
accountants, as to the incorporation by reference of their report for our
fiscal year ended July 31, 2001 into our previously filed registration
statements (Nos. 333-67527, 333-51607, 333-20673, 333-01789, 33-87782,
333-53802, and 333-53804) under the Securities Act of 1933, and we have not
filed that consent with this Annual Report on Form 10-K in reliance on Rule
437a of the Securities Act of 1933. Because we have not been able to obtain
Arthur Andersens consent, you will not be able to recover against Arthur
Andersen under Section 11 of the Securities Act for any untrue statements of a
material fact contained in our financial statements audited by Arthur Andersen
or any omissions to state a material fact required to be stated therein.

F-4



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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,  
|                                                                                                                      |                                                 |   | 2003       |           | 2002       |   | 2001      
|                                                                                                                      |                                                 |   |            |           |            |   |           
|Total Revenue                                                                                                         |                                                 | $ | 2,212,241  |           |            | $ | 2,191,727  |           |   | $ | 2,087,199 |          
|                                                                                                                      | Cost and Expenses:                              |   |            |           |            |   |            |           |   |   |           |           | 
|                                                                                                                      | Cost of Sales                                   |   |            | 1,101,030 |            |   |            | 1,083,053 |   |   |           | 1,034,913 | 
|                                                                                                                      | Special Inventory Charge                        |   |            |          |            |   |            |          |   |   |           | 25,236    | 
|                                                                                                                      | Selling, General and Administrative Expenses    |   |            | 884,069   |            |   |            | 873,265   |   |   |           | 818,205   | 
|                                                                                                                      | Cost of Insurance Operations                    |   |            | 8,228     |            |   |            | 8,620     |   |   |           | 5,589     | 
|                                                                                                                      | Depreciation and Amortization Expense           |   |            | 55,690    |            |   |            | 58,340    |   |   |           | 58,290    | 
|                                                                                                                      | Impairment of Goodwill                          |   |            | 136,300   |            |   |            |          |   |   |           |          | 
|                                                                                                                      | Unusual Item-Executive Transaction              |   |            |          |            |   |            | 2,300     |   |   |           | 4,713     | 
|                                                                                                                      | Unusual Item-Retiree Medical Curtailment        |   |            |          |            |   |            | (3,502    | ) |   |           |          | 
|                                                                                                                      |                                                 |   |            |           |            |   |            |           |   |   |           |          
|Operating Earnings                                                                                                    |                                                 |   | 26,924     |           |            |   | 169,651    |           |   |   | 140,253   |          
|Interest Expense, Net                                                                                                 |                                                 |   | 6,319      |           |            |   | 7,750      |           |   |   | 6,857     |          
|Cost of Early Retirement of Debt                                                                                      |                                                 |   | 5,910      |           |            |   |           |           |   |   |          |          
|                                                                                                                      |                                                 |   |            |           |            |   |            |           |   |   |           |          
|Earnings Before Income Taxes                                                                                          |                                                 |   | 14,695     |           |            |   | 161,901    |           |   |   | 133,396   |          
|Income Taxes                                                                                                          |                                                 |   | 55,340     |           |            |   | 59,256     |           |   |   | 51,348    |          
|                                                                                                                      |                                                 |   |            |           |            |   |            |           |   |   |           |          
|(Loss) Earnings Before Effect of Accounting
Change                                                                    |                                                 |   | (40,645    | )         |            |   | 102,645    |           |   |   | 82,048    |          
|Effect of a Change in Accounting for the Write-Off of
the Excess of Revalued Net Assets over Stockholders
Investment |                                                 |   |           |           |            |   | (41,287    | )         |   |   |          |          
|                                                                                                                      |                                                 |   |            |           |            |   |            |           |   |   |           |          
|Net (Loss) Earnings                                                                                                   |                                                 | $ | (40,645    | )         |            | $ | 143,932    |           |   | $ | 82,048    |          
|                                                                                                                      |                                                 |   |            |           |            |   |            |           |   |   |           |          
|(Loss) Earnings Per Common Share-Basic:                                                                               |                                                 |   |            |           |            |   |            |           |   |   |           |          
|                                                                                                                      | Before Effect on Change in Accounting
Principal |   | $          | (1.26     | )          |   | $          | 2.97      |   |   | $         | 2.37      | 
|                                                                                                                      | Net (Loss) Earnings Per Share                   |   | $          | (1.26     | )          |   | $          | 4.16      |   |   | $         | 2.37      | 
|(Loss) Earnings Per Common Share-Diluted:                                                                             |                                                 |   |            |           |            |   |            |           |   |   |           |          
|                                                                                                                      | Before Effect on Change in Accounting
Principal |   | $          | (1.26     | )          |   | $          | 2.95      |   |   | $         | 2.36      | 
|                                                                                                                      | Net (Loss) Earnings Per Share                   |   | $          | (1.26     | )          |   | $          | 4.13      |   |   | $         | 2.36      | 
|Weighted Average Number of Common Shares and Common Share
Equivalents Outstanding:                                    |                                                 |   |            |           |            |   |            |           |   |   |           |          
|                                                                                                                      | Basic                                           |   |            | 32,264    |            |   |            | 34,589    |   |   |           | 34,575    | 
|                                                                                                                      | Diluted                                         |   |            | 32,264    |            |   |            | 34,846    |   |   |           | 34,751    | 

See Notes to the Consolidated Financial Statements.

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ZALE CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS




(amounts in thousands, except per share amounts)

|                                               |                                                                                                                                                                                 |        |           |               |  |               |           |         |   | 
|---------------------------------------------- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- | ------ | --------- | ------------- |  | ------------- | --------- | ------- | - | 
|                                               |                                                                                                                                                                                 |        |           | July 31, 2003 |  | July 31, 2002
|                                               |                                                                                                                                                                                 |        |           |               |  |              
|                                               |                                                                                                                                                                                 | ASSETS |           |               |  |               |           |         |   | 
|Current Assets:                                |                                                                                                                                                                                 |        |           |               |  |               |           |        
|                                               | Cash and Cash Equivalents                                                                                                                                                       |        | $         | 35,273        |  |               | $         | 84,887  |  
|                                               | Merchandise Inventories                                                                                                                                                         |        |           | 798,761       |  |               |           | 782,316 |  
|                                               | Other Current Assets                                                                                                                                                            |        |           | 52,450        |  |               |           | 47,915  |  
|                                               |                                                                                                                                                                                 |        |           |               |  |               |           |        
|Total Current Assets                           |                                                                                                                                                                                 |        | 886,484   |               |  |               | 915,118   |        
|Property and Equipment, Net                    |                                                                                                                                                                                 |        | 266,167   |               |  |               | 284,438   |        
|Goodwill, Net                                  |                                                                                                                                                                                 |        | 82,199    |               |  |               | 212,039   |        
|Other Assets                                   |                                                                                                                                                                                 |        | 38,133    |               |  |               | 34,654    |        
|Deferred Tax Asset, Net                        |                                                                                                                                                                                 |        | 21,123    |               |  |               | 43,016    |        
|                                               |                                                                                                                                                                                 |        |           |               |  |               |           |        
|Total Assets                                   |                                                                                                                                                                                 | $      | 1,294,106 |               |  | $             | 1,489,265 |        
|                                               |                                                                                                                                                                                 |        |           |               |  |               |           |         |  
|LIABILITIES AND STOCKHOLDERS INVESTMENT       |                                                                                                                                                                                 |        |           |               |  |               |           |        
|Current Liabilities:                           |                                                                                                                                                                                 |        |           |               |  |               |           |        
|                                               | Accounts Payable and Accrued Liabilities                                                                                                                                        |        | $         | 307,775       |  |               | $         | 331,663 |  
|                                               | Deferred Tax Liability, Net                                                                                                                                                     |        |           | 46,266        |  |               |           | 21,516  |  
|                                               |                                                                                                                                                                                 |        |           |               |  |               |           |        
|Total Current Liabilities                      |                                                                                                                                                                                 |        | 354,041   |               |  |               | 353,179   |        
|Non-current Liabilities                        |                                                                                                                                                                                 |        | 103,342   |               |  |               | 109,530   |        
|Long-term Debt                                 |                                                                                                                                                                                 |        | 184,400   |               |  |               | 86,749    |        
|Commitments and Contingencies                  |                                                                                                                                                                                 |        |           |               |  |               |           |        
|Stockholders Investment:                      |                                                                                                                                                                                 |        |           |               |  |               |           |        
|                                               | Preferred Stock (Par value $0.01, 5,000 shares authorized)                                                                                                                      |        |           |              |  |               |           |        |  
|                                               | Common Stock (Par value $0.01, 70,000 shares authorized,
41,191 and 40,746 shares issued, and 27,611 and
33,569 shares outstanding as of July 31, 2003 and 2002,
respectively.) |        |           | 415           |  |               |           | 407     |  
|                                               | Additional Paid-In Capital                                                                                                                                                      |        |           | 566,689       |  |               |           | 549,848 |  
|                                               | Accumulated Other Comprehensive Income (Loss)                                                                                                                                   |        |           | 6,834         |  |               |           | (6,559  | )
|                                               | Accumulated Earnings                                                                                                                                                            |        |           | 589,122       |  |               |           | 629,767 |  
|                                               | Deferred Compensation                                                                                                                                                           |        |           |              |  |               |           | (115    | )
|                                               |                                                                                                                                                                                 |        |           |               |  |               |           |         |  
|                                               |                                                                                                                                                                                 |        | 1,163,060 |               |  |               | 1,173,348 |        
|Treasury Stock                                 |                                                                                                                                                                                 |        | (510,737  | )             |  |               | (233,541  | )      
|                                               |                                                                                                                                                                                 |        |           |               |  |               |           |        
|Total Stockholders Investment                 |                                                                                                                                                                                 |        | 652,323   |               |  |               | 939,807   |        
|                                               |                                                                                                                                                                                 |        |           |               |  |               |           |        
|Total Liabilities and Stockholders Investment |                                                                                                                                                                                 | $      | 1,294,106 |               |  | $             | 1,489,265 |        
|                                               |                                                                                                                                                                                 |        |           |               |  |               |           |         |  

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,   |          | July 31,   |  | July 31,  
|                                                                                           |  | 2003       |          | 2002       |  | 2001      
|                                                                                           |  |            |          |            |  |           
|Net Cash Flows from Operating Activities:                                                  |  |            |          |            |  |            |          |   |  |   |          |  
|Net (loss) earnings                                                                        |  | $          | (40,645  | )          |  | $          | 143,932  |   |  | $ | 82,048   |  
|Adjustments to reconcile net (loss) earnings
to net cash provided by operating activities: |  |            |          |            |  |            |          |   |  |   |          |  
|Special inventory charge                                                                   |  |            |         |            |  |            |         |   |  |   | 25,236   |  
|Depreciation and amortization expense                                                      |  |            | 56,153   |            |  |            | 58,787   |   |  |   | 59,261   |  
|Deferred compensation expense                                                              |  |            | 115      |            |  |            | 1,916    |   |  |   | 650      |  
|Impairment of Goodwill                                                                     |  |            | 136,300  |            |  |            |         |   |  |   |         |  
|Impairment of Fixed Assets                                                                 |  |            | 2,092    |            |  |            | 1,788    |   |  |   | 437      |  
|Deferred taxes                                                                             |  |            | 46,286   |            |  |            | 13,668   |   |  |   | 20,281   |  
|Tax benefit associated with stock option exercises                                         |  |            | 2,292    |            |  |            | 1,537    |   |  |   | 998      |  
|Effect of change in accounting principle for the
write-off of negative goodwill            |  |            |         |            |  |            | (41,287  | ) |  |   |         |  
|Retiree medical curtailment gain                                                           |  |            |         |            |  |            | (3,502   | ) |  |   |         |  
|Changes in assets and liabilities, net of
Piercing Pagoda acquisition in 2001:             |  |            |          |            |  |            |          |   |  |   |          |  
|Merchandise inventories                                                                    |  |            | (9,073   | )          |  |            | (60,940  | ) |  |   | (46,403  | )
|Other current assets                                                                       |  |            | 2,419    |            |  |            | 9,092    |   |  |   | (5,147   | )
|Other assets                                                                               |  |            | (5,114   | )          |  |            | 2,009    |   |  |   | 605      |  
|Accounts payable and accrued liabilities                                                   |  |            | (26,011  | )          |  |            | 53,409   |   |  |   | (47,861  | )
|Non-current liabilities                                                                    |  |            | (6,188   | )          |  |            | (5,402   | ) |  |   | (4,553   | )
|                                                                                           |  |            |          |            |  |            |          |   |  |   |          |  
|Net Cash Provided by Operating Activities                                                  |  |            | 158,626  |            |  |            | 175,007  |   |  |   | 85,552   |  
|                                                                                           |  |            |          |            |  |            |          |   |  |   |          |  
|Net Cash Flows from Investing Activities:                                                  |  |            |          |            |  |            |          |   |  |   |          |  
|Additions to property and equipment                                                        |  |            | (43,579  | )          |  |            | (54,159  | ) |  |   | (87,656  | )
|Dispositions of property and equipment                                                     |  |            | 6,194    |            |  |            | 3,908    |   |  |   | 1,623    |  
|Purchase of available for sale investments                                                 |  |            | (12,964  | )          |  |            | (8,197   | ) |  |   | (7,553   | )
|Proceeds from sale of available for sale investments                                       |  |            | 14,190   |            |  |            | 7,471    |   |  |   | 8,900    |  
|Acquisition of Piercing Pagoda, net of cash acquired                                       |  |            |         |            |  |            |         |   |  |   | (239,530 | )
|                                                                                           |  |            |          |            |  |            |          |   |  |   |          |  
|Net Cash Used in Investing Activities                                                      |  |            | (36,159  | )          |  |            | (50,977  | ) |  |   | (324,216 | )
|                                                                                           |  |            |          |            |  |            |          |   |  |   |          |  
|Net Cash Flows from Financing Activities:                                                  |  |            |          |            |  |            |          |   |  |   |          |  
|Payments on long term debt                                                                 |  |            |         |            |  |            |         |   |  |   | (8,012   | )
|Payments on revolving credit agreement                                                     |  |            | (169,154 | )          |  |            | (239,747 | ) |  |   | (563,374 | )
|Borrowings under revolving credit agreement                                                |  |            | 353,554  |            |  |            | 230,281  |   |  |   | 563,701  |  
|Senior notes repurchase                                                                    |  |            | (86,787  | )          |  |            | (12,735  | ) |  |   |         |  
|Proceeds from exercise of stock options                                                    |  |            | 14,711   |            |  |            | 8,213    |   |  |   | 12,445   |  
|Loan origination on new revolving credit agreement                                         |  |            | (6,563   | )          |  |            |         |   |  |   |         |  
|Purchase of common stock                                                                   |  |            | (278,236 | )          |  |            | (54,399  | ) |  |   | (38,736  | )
|                                                                                           |  |            |          |            |  |            |          |   |  |   |          |  
|Net Cash Used in Financing Activities                                                      |  |            | (172,475 | )          |  |            | (68,387  | ) |  |   | (33,976  | )
|                                                                                           |  |            |          |            |  |            |          |   |  |   |          |  
|Effect of Exchange Rate Changes on Cash                                                    |  |            | 394      |            |  |            | (146     | ) |  |   | (117     | )
|Net (Decrease) Increase in Cash and Cash Equivalents                                       |  |            | (49,614  | )          |  |            | 55,497   |   |  |   | (272,757 | )
|Cash and Cash Equivalents at Beginning of Period                                           |  |            | 84,887   |            |  |            | 29,390   |   |  |   | 302,147  |  
|                                                                                           |  |            |          |            |  |            |          |   |  |   |          |  
|Cash and Cash Equivalents at End of Period                                                 |  | $          | 35,273   |            |  | $          | 84,887   |   |  | $ | 29,390   |  
|                                                                                           |  |            |          |            |  |            |          |   |  |   |          |  

See Notes to Consolidated Financial Statements.

F-7



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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, 2003 |        | July 31, 2002 |  | July 31, 2001
|                                    |                                             |  |               |        |               |  |              
|Supplemental cash flow information: |                                             |  |               |        |               |  |               |        |  |  |   |       
|                                    | Interest paid                               |  | $             | 9,767  |               |  | $             | 9,667  |  |  | $ | 10,408 | 
|                                    | Interest received                           |  | $             | 1,368  |               |  | $             | 2,141  |  |  | $ | 3,992  | 
|                                    | Income taxes paid (net of refunds received) |  | $             | 33,302 |               |  | $             | 14,543 |  |  | $ | 34,886 | 

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
(amounts in thousands)




|                                                         |  |               |        |        |  |         |     |               |  |       |         |   |  |             |        |  
|-------------------------------------------------------- |  | ------------- | ------ | ------ |  | ------- | --- | ------------- |  | ----- | ------- | - |  | ----------- | ------ | -
|                                                         |  |               |        |        |  |         |     |               |  |       |         |   |  | Accumulated
|                                                         |  | Number of     |        |        |  |         |     | Additional    |  | Other
|                                                         |  | Common Shares |        | Common |  | Paid-In |     | Comprehensive
|                                                         |  | Outstanding   |        | Stock  |  | Capital |     | Income (Loss)
|                                                         |  |               |        |        |  |         |     |              
|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, including
related 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 | )
|                                                         |  |               |        |        |  |         |     |               |  |       |         |   |  |             |        |  
|Net Earnings                                             |  |               |       |        |  |         |    |               |  |       |        |   |  |             |       |  
|Unrealized Loss on Securities, net                       |  |               |       |        |  |         |    |               |  |       |        |   |  |             | (626   | )
|Unrealized Gain on Derivatives                           |  |               |       |        |  |         |    |               |  |       |        |   |  |             | 1      |  
|Cumulative Translation Adjustments                       |  |               |       |        |  |         |    |               |  |       |        |   |  |             | (3,579 | )
|Exercise of Stock Options, including
related tax benefit |  |               | 327    |        |  |         | 3   |               |  |       | 9,747   |   |  |             |       |  
|Purchase of Common Stock                                 |  |               | (1,447 | )      |  |         |    |               |  |       |        |   |  |             |       |  
|Contribution to 401(k) plan                              |  |               | 74     |        |  |         |    |               |  |       | 197     |   |  |             |       |  
|Restricted Stock Cancelled                               |  |               | (200   | )      |  |         |    |               |  |       |        |   |  |             |       |  
|Deferred Compensation Amortization                       |  |               |       |        |  |         |    |               |  |       |        |   |  |             |       |  
|                                                         |  |               |        |        |  |         |     |               |  |       |         |   |  |             |        |  
|Balance July 31, 2002                                    |  |               | 33,569 |        |  | $       | 407 |               |  | $     | 549,848 |   |  | $           | (6,559 | )
|                                                         |  |               |        |        |  |         |     |               |  |       |         |   |  |             |        |  
|Net Loss                                                 |  |               |       |        |  |         |    |               |  |       |        |   |  |             |       |  
|Unrealized Loss on Securities, net                       |  |               |       |        |  |         |    |               |  |       |        |   |  |             | (243   | )
|Unrealized Gain on Derivatives                           |  |               |       |        |  |         |    |               |  |       |        |   |  |             | 259    |  
|Cumulative Translation Adjustments                       |  |               |       |        |  |         |    |               |  |       |        |   |  |             | 13,377 |  
|Exercise of Stock Options, including
related tax benefit |  |               | 445    |        |  |         | 8   |               |  |       | 16,995  |   |  |             |       |  
|Purchase of Common Stock                                 |  |               | (6,432 | )      |  |         |    |               |  |       |        |   |  |             |       |  
|Contribution to 401(k) plan                              |  |               | 29     |        |  |         |    |               |  |       | (154    | ) |  |             |       |  
|Restricted Stock Cancelled                               |  |               |       |        |  |         |    |               |  |       |        |   |  |             |       |  
|Deferred Compensation Amortization                       |  |               |       |        |  |         |    |               |  |       |        |   |  |             |       |  
|                                                         |  |               |        |        |  |         |     |               |  |       |         |   |  |             |        |  
|Balance July 31, 2003                                    |  |               | 27,611 |        |  | $       | 415 |               |  | $     | 566,689 |   |  | $           | 6,834  |  
|                                                         |  |               |        |        |  |         |     |               |  |       |         |   |  |             |        |  

See Notes to the Consolidated Financial Statements.

F-9



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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 (Loss)
|                                                         |  |             |         |              |  |          |        |            |               |              
|Balance July 31, 2000                                    |  | $           | 403,787 |              |  | $        | (1,786 | )          |               | $             | (139,357 | ) |  | $ | 781,777  |   |  | $ | 111,549 |  
|Net Earnings                                             |  |             | 82,048  |              |  |          |       |            |               |               |         |   |  |   | 82,048   |   |  |   | 82,048  |  
|Unrealized Loss on Securities, net                       |  |             |        |              |  |          |       |            |               |               |         |   |  |   | (20      | ) |  |   | (20     | )
|Cumulative Translation Adjustments                       |  |             |        |              |  |          |       |            |               |               |         |   |  |   | (2,746   | ) |  |   | (2,746  | )
|Exercise of Stock Options, including
related 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  |  
|                                                         |  |             |         |              |  |          |        |            |               |               |          |   |  |   |          |   |  |   |         |  
|Net Earnings                                             |  |             | 143,932 |              |  |          |       |            |               |               |         |   |  |   | 143,932  |   |  |   | 143,932 |  
|Unrealized Loss on Securities, net                       |  |             |        |              |  |          |       |            |               |               |         |   |  |   | (626     | ) |  |   | (626    | )
|Unrealized Gain on Derivatives                           |  |             |        |              |  |          |       |            |               |               |         |   |  |   | 1        |   |  |   | 1       |  
|Cumulative Translation Adjustments                       |  |             |        |              |  |          |       |            |               |               |         |   |  |   | (3,579   | ) |  |   | (3,579  | )
|Exercise of Stock Options, including
related tax benefit |  |             |        |              |  |          |       |            |               |               |         |   |  |   | 9,750    |   |  |   |        |  
|Purchase of Common Stock                                 |  |             |        |              |  |          |       |            |               |               | (54,399  | ) |  |   | (54,399  | ) |  |   |        |  
|Contribution to 401(k) plan                              |  |             |        |              |  |          |       |            |               |               | 2,048    |   |  |   | 2,245    |   |  |   |        |  
|Restricted Stock Cancelled                               |  |             |        |              |  |          | 6,218  |            |               |               | (6,218   | ) |  |   |         |   |  |   |        |  
|Deferred Compensation Amortization                       |  |             |        |              |  |          | 1,920  |            |               |               |         |   |  |   | 1,920    |   |  |   |        |  
|                                                         |  |             |         |              |  |          |        |            |               |               |          |   |  |   |          |   |  |   |         |  
|Balance July 31, 2002                                    |  | $           | 629,767 |              |  | $        | (115   | )          |               | $             | (233,541 | ) |  | $ | 939,807  |   |  | $ | 139,728 |  
|                                                         |  |             |         |              |  |          |        |            |               |               |          |   |  |   |          |   |  |   |         |  
|Net Loss                                                 |  |             | (40,645 | )            |  |          |       |            |               |               |         |   |  |   | (40,645  | ) |  |   | (40,645 | )
|Unrealized Loss on Securities, net                       |  |             |        |              |  |          |       |            |               |               |         |   |  |   | (243     | ) |  |   | (243    | )
|Unrealized Gain on Derivatives                           |  |             |        |              |  |          |       |            |               |               |         |   |  |   | 259      |   |  |   | 259     |  
|Cumulative Translation Adjustments                       |  |             |        |              |  |          |       |            |               |               |         |   |  |   | 13,377   |   |  |   | 13,377  |  
|Exercise of Stock Options, including
related tax benefit |  |             |        |              |  |          |       |            |               |               |         |   |  |   | 17,003   |   |  |   |        |  
|Purchase of Common Stock                                 |  |             |        |              |  |          |       |            |               |               | (278,236 | ) |  |   | (278,236 | ) |  |   |        |  
|Contribution to 401(k) plan                              |  |             |        |              |  |          |       |            |               |               | 1,040    |   |  |   | 886      |   |  |   |        |  
|Restricted Stock Cancelled                               |  |             |        |              |  |          |       |            |               |               |         |   |  |   |         |   |  |   |        |  
|Deferred Compensation Amortization                       |  |             |        |              |  |          | 115    |            |               |               |         |   |  |   | 115      |   |  |   |        |  
|                                                         |  |             |         |              |  |          |        |            |               |               |          |   |  |   |          |   |  |   |         |  
|Balance July 31, 2003                                    |  | $           | 589,122 |              |  | $        |       |            |               | $             | (510,737 | ) |  | $ | 652,323  |   |  | $ | (27,252 | )
|                                                         |  |             |         |              |  |          |        |            |               |               |          |   |  |   |          |   |  |   |         |  

See Notes to the Consolidated Financial Statements.

F-10



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##### Table of Contents



ZALE CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS




Summary of Significant Accounting Policies

Nature of Operations.Zale Corporation, along with its wholly owned
subsidiaries (the Company or Zale) is the largest specialty retailer of
fine jewelry in North America. At July 31, 2003, the Company operated 2,234
specialty retail jewelry stores and kiosks located primarily in shopping malls
throughout the United States, Canada and Puerto Rico. The Company primarily
operates under six principal brands, each targeted to reach a distinct
customer. The specialty retail jewelry stores operate under the following brand
names, Zales Jewelers® (including Zale.com), Zales the Diamond Store
Outlet®, Gordons Jewelers®, Bailey Banks & Biddle Fine Jewelers®,
Peoples Jewellers® in Canada, Mappins Jewelers® in Canada. In addition, the
Company operates mall-based kiosks under the brand name, Piercing Pagoda®.

The Accompanying Consolidated Financial Statements include the accounts of
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
the Company. All significant intercompany transactions have been eliminated.

Use of Estimates.The preparation of financial statements and related
disclosures 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. For example, unexpected changes in market
conditions or a downturn in the economy could adversely affect actual results.
Estimates are used in accounting for, among other things, inventory
obsolescence, goodwill and long-lived asset valuations, last-in, first-out
(LIFO) retail inventory method, legal liability, credit insurance liability,
product warranty, depreciation, employee benefits, taxes and contingencies.
Estimates and assumptions are reviewed periodically and the effects of
revisions are reflected in the Consolidated Financial Statements in the period
they are determined to be necessary.

Cash and Cash Equivalents.Cash and Cash Equivalents includes 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. In addition, this amount as of July 31, 2003 includes restricted
cash of $5.0 million per the agreement with Citi Commerce Solutions (Citi) as
discussed in Guarantee Obligations on page F-30.

Merchandise Inventories. Merchandise Inventories are stated at the lower
of cost or market. Substantially all United States (U.S.) inventories
represent finished goods which are valued using the LIFO retail inventory
method. Merchandise inventory of Peoples Jewellers of Canada is valued using
the first-in, first-out (FIFO) retail inventory method. Under the retail
method, inventory is segregated into categories of merchandise with similar
characteristics at its current retail selling value. The determination of
inventory at cost and the resulting gross margins are calculated by applying an
average cost to retail ratio to the retail value of inventory.

The Company is required to determine the LIFO cost on an interim basis by
estimating annual inflation trends, annual purchases and ending inventory
levels for the fiscal year. Actual annual inflation rates and inventory
balances as of the end of any fiscal year may differ from interim estimates.
Prior to fiscal year 2002, the Company used the Bureau of Labor Statistics
(BLS) producer price indices applied against inventory values to calculate
the value of inventory on a LIFO basis. In fiscal year 2002, the Company
applied internally developed indices that the Company believes more
consistently measure inflation or deflation in the components of its
merchandise (i.e., diamonds, gold and other metals and precious stones) and its
merchandise mix.

F-11



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##### Table of Contents



ZALE CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

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

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

Long-lived Assets and Goodwill.Long-lived assets are periodically
reviewed for impairment by comparing the carrying value of the assets with
their estimated fair values. If the evaluation indicates that the carrying
amount of the asset may not be recoverable, the potential impairment is
measured based on a projected discounted cashflow method, using a discount rate
that is considered to be commensurate with the risk inherent in the Companys
current business model. Assumptions are made with respect to cash flows
expected to be generated by the related assets based upon updated projections.
Any changes in key assumptions or market conditions could result in an
unanticipated impairment charge. For instance, in the event of a major market
downturn, individual stores may become unprofitable, which could result in a
write-down of the carrying value of the assets located in those stores. Any
impairment would be recognized in operating results if a permanent reduction
were to occur. See Property and Equipment in the Notes to Consolidated
Financial Statements, page F-18 for the impairment charges recorded in the
periods presented.

In accordance with Statement of Financial Accounting Standards (SFAS)
No. 142, Goodwill and Other Intangible Assets, the Company tests goodwill for
impairment annually, at the end of its second quarter, or more frequently if
events occur which indicate a potential reduction in the fair value of a
reporting units net assets below its carrying value. An impairment is deemed
to exist if the net book value of a reporting unit exceeds its estimated fair
value. In the second quarter of fiscal year 2003, the Company performed its
annual review for impairment of goodwill related to its Piercing Pagoda, Inc.,
Peoples Jewellers and other smaller acquisitions. The Company has concluded
that there is no evidence of impairment related to the goodwill of
approximately $57.8 million recorded for the Peoples acquisition and $5.0
million for other smaller acquisitions. To perform the impairment test for
Piercing Pagoda, the Company engaged an independent third party valuation firm.
This firm calculated the estimated fair value of Piercing Pagoda using the
expected present value of corresponding future cash flows and market values of
comparable businesses where available. The calculation indicated that the fair
value of Piercing Pagoda was lower than its carrying value, reflective of the
current market conditions and lower than expected performance. The Company
recorded a non-cash charge of $136.3 million in the second quarter of fiscal
year 2003, which is included as a component of operating earnings in the
Consolidated Statement of Operations, to reduce the carrying value of the
Piercing Pagoda goodwill to approximately $19.4 million.

Depreciation and Amortization.Depreciation and amortization are computed
using the straight-line method over the estimated useful lives of the assets or
remaining lease life, whichever is shorter. Estimated useful lives of the
assets range from three to twenty-seven 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 and amortized over their useful lives.

Excess
of Revalued Net Assets Over Stockholders Investment. The Company
adopted SFAS No. 141, Business Combinations, (SFAS 141) and SFAS No. 142
Goodwill and Other Intangible Assets (SFAS 142), in the first quarter of
fiscal year 2002. As a result, the Company recognized a cumulative effect of a
change in accounting

F-12



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##### Table of Contents



ZALE CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

principle of approximately $41 million credit in the first quarter of fiscal
year 2002 related to the write off of the Excess of Revalued Net Assets Over
Stockholders Investment. Prior to fiscal year 2002, the Company amortized the
Excess of Revalued Net Assets Over Stockholders Investment over fifteen years.
Amortization was $5.9 million for the year ended July 31, 2001.

Stock Based Compensation.The Company accounts for stock-based
compensation by applying Accounting Principles Board (APB) Opinion No. 25,
Accounting for Stock Issued to Employees, as allowed under SFAS No. 123,
Accounting for Stock-Based Compensation. Under APB No. 25, if the number of
options is fixed and the exercise price of employee stock options equals or
exceeds the market price of the underlying stock on the date of grant, no
compensation expense is recorded. Under the provision of the Companys equity
compensation plan, stock options cannot be granted at below market price.

The following table summarizes the pro-forma results as if the provisions
of SFAS No. 123, Accounting for Stock-Based Compensation had been used to
determine the compensation cost of the Stock Option Plan:

|                                                                                                                                            |                                               |   |                    |        |      |   |         |        |  |   |        |        | 
|------------------------------------------------------------------------------------------------------------------------------------------- | --------------------------------------------- | - | ------------------ | ------ | ---- | - | ------- | ------ |  | - | ------ | ------ | 
|                                                                                                                                            |                                               |   | Year Ended July 31
|                                                                                                                                            |                                               |   |                   
|                                                                                                                                            |                                               |   | 2003               |        | 2002 |   | 2001   
|                                                                                                                                            |                                               |   |                    |        |      |   |        
|Net (loss) earnings, as reported                                                                                                            |                                               | $ | (40,645            | )      |      | $ | 143,932 |        |  | $ | 82,048 |       
|Deduct: Total stock-based employee compensation
expense determined under fair value based
method for all awards, net of related tax
effects |                                               |   | (5,207             | )      |      |   | (6,158  | )      |  |   | (7,804 | )     
|                                                                                                                                            |                                               |   |                    |        |      |   |         |        |  |   |        |       
|Pro forma net (loss) earnings                                                                                                               |                                               | $ | (45,852            | )      |      | $ | 137,774 |        |  | $ | 74,244 |       
|                                                                                                                                            |                                               |   |                    |        |      |   |         |        |  |   |        |       
|(Loss) Earnings Per Common ShareBasic:                                                                                                     |                                               |   |                    |        |      |   |         |        |  |   |        |       
|                                                                                                                                            | (Loss) Earnings Per Common Share, as reported |   | $                  | (1.26  | )    |   | $       | 4.16   |  |   | $      | 2.37   | 
|                                                                                                                                            | (Loss) Earnings Per Common Share, pro forma   |   | $                  | (1.42  | )    |   | $       | 3.98   |  |   | $      | 2.15   | 
|(Loss) Earnings Per Common Share  Diluted:                                                                                                 |                                               |   |                    |        |      |   |         |        |  |   |        |       
|                                                                                                                                            | (Loss) Earnings Per Common Share, as reported |   | $                  | (1.26  | )    |   | $       | 4.13   |  |   | $      | 2.36   | 
|                                                                                                                                            | (Loss) Earnings Per Common Share, pro forma   |   | $                  | (1.42  | )    |   | $       | 3.95   |  |   | $      | 2.14   | 
|Weighted Average Number of Common Shares
Outstanding:                                                                                       |                                               |   |                    |        |      |   |         |        |  |   |        |       
|                                                                                                                                            | Basic                                         |   |                    | 32,264 |      |   |         | 34,589 |  |   |        | 34,575 | 
|                                                                                                                                            | Diluted                                       |   |                    | 32,264 |      |   |         | 34,846 |  |   |        | 34,751 | 

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 2003,
2002, and 2001 respectively: risk-free interest rate of 3.0 percent, 4.1
percent, and 4.9 percent, expected dividend yield of zero, expected lives of
five years, and expected volatility of 39.2 percent, 39.5 percent, and 38.9
percent. The weighted average fair value of options granted for fiscal years
2003, 2002 and 2001 is $17.05, $12.24, and $13.37, respectively.

F-13



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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, which is approximately ninety-five percent of total
revenues, 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. Total revenues
include amortized extended service agreements which are recognized over the
period the services are performed. Revenues also include premiums from the
Companys insurance business, principally related to credit insurance policies
sold to customers who purchase the Companys merchandise under the proprietary
credit program. Insurance premiums are recognized over the coverage period.

Credit
Insurance Operations. Insurance premium revenue from credit
insurance subsidiaries was $16.1 million, $18.3 million and $19.0 million for
the years ended July 31, 2003, 2002, and 2001, respectively. These revenues
are included in Total Revenues on the Consolidated Statement of Operations.
The associated cost of insurance operations was $8.2 million, $8.6 million and
$5.6 million for the years ended July 31, 2003, 2002 and 2001, respectively.

Advertising Expenses.Advertising expenses are 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 $64.0 million, $62.9 million and $78.5 million for the fiscal
years ended July 31, 2003, 2002 and 2001, respectively, net of amounts
contributed by vendors to the Company. The amounts of prepaid advertising at
July 31, 2003 and 2002, are $8.4 million and $8.0 million, respectively, and
are classified as components of other assets in the consolidated balance sheet.

Vendor
Allowances. The Company receives cash or allowances from
merchandise vendors primarily in connection with cooperative advertising
programs. The Company has agreements in place with each vendor setting forth
the specific conditions for each allowance or payment. The Company adopted EITF
02-16, Accounting by a Reseller (including a Retailer) for Cash Consideration
Received from a Vendor in fiscal year 2003, which is required to be applied to
new vendor arrangements entered into after January 1, 2003. The Company
generally enters into and renews existing cooperative advertising program
agreements with its vendors annually at the beginning of each fiscal year.
Accordingly, for fiscal year 2003, 2002 and 2001, qualifying vendor
reimbursements of costs incurred to advertise vendors products are recorded as
a reduction of advertising expense, which is a component of selling, general,
and administrative expenses.

Beginning in fiscal year 2004, upon the annual renewal of existing
agreements or the consummation of any new agreements, these vendor
reimbursements will be included as a reduction of the purchase cost of the
related inventory and flow through the retail inventory calculation as a
reduction in cost of sales when the inventory is sold.

Reclassifications.The classifications in use at July 31, 2003, have been
applied to the financial statements for July 31, 2002 and 2001.

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 (Loss) in the Consolidated Statements of Stockholders Investment.

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##### Table of Contents



ZALE CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (continued)

Derivative
Financial Instruments. The Company recognizes all derivative
instruments as either assets or liabilities in the statement of financial
position measured at fair value. The Company does not utilize derivative
financial instruments for trading or speculative purposes.

The Company enters into foreign currency forward exchange contracts solely
to reduce the effects of fluctuating foreign currency exchange rates. The
Company enters into forward exchange contracts with terms that are no longer
than twelve months. These contracts are used to hedge certain forecasted
inventory, advertising, and purchases relating to real estate activities
anticipated to be incurred each fiscal year, denominated in foreign currencies
for periods and amounts consistent with the Companys identified exposures. The
purpose of the hedging activities is to minimize the effect of foreign exchange
rate movements on cash flows. All foreign exchange contracts are denominated
in Canadian dollars and are with one financial institution rated as investment
grade by a major rating agency. No fees or up front payments are required when
using these foreign exchange contracts.

The Company enters into forward contracts for the purchase of gold in
order to reduce the effects of fluctuating gold prices on the cost of
inventory. The Company generally hedges certain planned inventory purchases
covering a designated period of no longer than twelve months. These contracts
are used to hedge forecasted inventory purchases of finished goods made of gold
for periods and amounts consistent with the Companys identified exposure. The
purpose of the hedging activities is to minimize the effect of gold price
movements on cash flows. All forward contracts are with one financial
institution rated as investment grade by a major rating agency. No fees or up
front payments are required when using these commodity forwards. These
contracts settle on a net basis.

The Company documents all relationships between hedging instruments and
hedged items, as well as its risk-management objective and strategy for
undertaking various hedge transactions. The Company also assesses, both at the
hedges inception and on an ongoing basis, whether the derivatives that are
used in hedging transactions are highly effective in offsetting changes in cash
flows and changes in expense relating to hedged items. When it is determined
that a derivative is not highly effective as a hedge or that it has ceased to
be a highly effective hedge, the Company discontinues hedge accounting
prospectively.

Changes in the fair value of derivatives that are designated and qualify
as cash flow hedges are recorded in Accumulated Other Comprehensive Income
(Loss) to the extent that they are effective. The amounts are relieved from
Other Comprehensive Income (Loss) during the same period the hedged transaction
is recorded in earnings. Any hedge ineffectiveness and changes in the fair
value of instruments that do not qualify as hedges are reported in current
period earnings.

As of July 31, 2003, the Company had $7.3 million of outstanding forward
contracts to purchase gold. The fair value of these gold contracts recorded in
the accompanying Consolidated Balance Sheet at July 31, 2003 is $210,200. The
gains and losses on forward contracts realized for the years ended July 31,
2003 and 2002, were immaterial to the Companys Consolidated Statement of
Operations. The Company estimates that the unrealized gains of $0.3 million
included in Accumulated Other Comprehensive Income (Loss) will be recognized
into earnings within seven months of the individual contract settlement date,
corresponding with the sale of the related inventory. The Company had no
foreign currency forward exchange contracts outstanding at July 31, 2003. As of
July 31, 2002, the Company had $1.4 million of foreign currency forward
exchange contracts outstanding. The fair value of these foreign currency
forward exchange contracts recorded on the accompanying Consolidated Balance
Sheet at July 31, 2002 was $829.

F-15



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##### Table of Contents



ZALE CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (continued)

Effect of a Change in Accounting Principle

On July 21, 2001, the Financial Accounting Standards Board issued
Statements of Financial Accounting Standards No. 141 (SFAS 141) Business
Combinations. SFAS 141 establishes specific criteria for the recognition of
intangible assets subsequent to their acquisition, including negative goodwill.
Negative goodwill related to future acquisitions should be recorded as an
extraordinary item. Upon adoption, existing negative goodwill (or excess of
revalued net assets over stockholders investment) should be written off as a
change in accounting principle. The Company adopted SFAS 141 in the first
quarter of fiscal year 2002. As a result, the Company recognized a cumulative
effect of a change in accounting principle of approximately $41.3 million, in
the first quarter of fiscal year 2002 related to the write off of the Excess of
Revalued Net Assets Over Stockholders Investment.

An additional result of the adoption of SFAS 141 and SFAS 142 in fiscal
year 2002 was a decrease in net amortization expense. A reconciliation for the
impact of the adoption of SFAS 141 and SFAS 142 to net income and earnings per
share is as follows:

|                                                     |  |                     |         |      |  |      |         |   |  |   |        |  
|---------------------------------------------------- |  | ------------------- | ------- | ---- |  | ---- | ------- | - |  | - | ------ | -
|                                                     |  | Year Ended July 31,
|                                                     |  |                    
|                                                     |  | 2003                |         | 2002 |  | 2001
|                                                     |  |                     |         |      |  |     
|Net (Loss) Earnings                                  |  | $                   | (40,645 | )    |  | $    | 143,932 |   |  | $ | 82,048 |  
|Add back: Goodwill Amortization                      |  |                     |        |      |  |      |        |   |  |   | 11,754 |  
|Subtract: Deferred Credit Amortization               |  |                     |        |      |  |      |        |   |  |   | (5,898 | )
|Subtract: Effect of a Change in Accounting Principle |  |                     |        |      |  |      | (41,287 | ) |  |   |       |  
|                                                     |  |                     |         |      |  |      |         |   |  |   |        |  
|Adjusted Net (Loss) Earnings                         |  | $                   | (40,645 | )    |  | $    | 102,645 |   |  | $ | 87,904 |  
|                                                     |  |                     |         |      |  |      |         |   |  |   |        |  
|(Loss) Earnings Per Common Share  Basic:            |  |                     |         |      |  |      |         |   |  |   |        |  
|Reported Net (Loss) Earnings                         |  | $                   | (1.26   | )    |  | $    | 4.16    |   |  | $ | 2.37   |  
|Goodwill Amortization                                |  |                     |        |      |  |      |        |   |  |   | 0.34   |  
|Deferred Credit Amortization                         |  |                     |        |      |  |      |        |   |  |   | (0.17  | )
|Effect of Change in Accounting Principle             |  |                     |        |      |  |      | (1.19   | ) |  |   |       |  
|                                                     |  |                     |         |      |  |      |         |   |  |   |        |  
|Adjusted Net (Loss) Earnings                         |  | $                   | (1.26   | )    |  | $    | 2.97    |   |  | $ | 2.54   |  
|                                                     |  |                     |         |      |  |      |         |   |  |   |        |  
|(Loss) Earnings Per Common Share  Diluted:          |  |                     |         |      |  |      |         |   |  |   |        |  
|Reported Net (Loss) Earnings                         |  | $                   | (1.26   | )    |  | $    | 4.13    |   |  | $ | 2.36   |  
|Goodwill Amortization                                |  |                     |        |      |  |      |        |   |  |   | 0.34   |  
|Deferred Credit Amortization                         |  |                     |        |      |  |      |        |   |  |   | (0.17  | )
|Effect of Change in Accounting Principle             |  |                     |        |      |  |      | (1.18   | ) |  |   |       |  
|                                                     |  |                     |         |      |  |      |         |   |  |   |        |  
|Adjusted Net (Loss) Earnings                         |  | $                   | (1.26   | )    |  | $    | 2.95    |   |  | $ | 2.53   |  
|                                                     |  |                     |         |      |  |      |         |   |  |   |        |  

F-16



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##### Table of Contents



ZALE CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (continued)

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, was classified as goodwill, and prior to
fiscal year 2002 was amortized on a straight line basis over twenty years.
However, the Company adopted SFAS 142 in the first quarter of fiscal year 2002.
As a result, goodwill related to the Companys acquisition of Piercing Pagoda
is no longer amortized, and instead is reviewed annually for impairment. See
Long-lived Assets and Goodwill in the Notes to Consolidated Financial
Statements on page F-12 for further details. Assets acquired and liabilities
assumed have been recorded at their estimated fair values.

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.

Merchandise Inventories

The Companys U.S. operations use the LIFO retail method of accounting for
inventory. The LIFO provision was $2.9 million, $1.4 million and $4.9 million
for the years ended July 31, 2003, 2002 and 2001, respectively. The cumulative
LIFO provision reflected on the Companys Balance Sheet was $19.0 million and
$16.1 million at July 31, 2003 and 2002, respectively. Domestic inventories on
a FIFO basis were $755.7 million and $739.8 million at July 31, 2003 and 2002,
respectively.

The Companys Canadian operations use the FIFO retail method of accounting
for inventory. Inventory, net of reserves, was approximately $62.0 million and
$58.6 million at July 31, 2003 and 2002, respectively.

Consigned inventory and related contingent obligations are not reflected
in the Companys financial statements. Consignment inventory historically
consists of test programs, merchandise at higher price points, or merchandise
that otherwise does not warrant the risk of ownership. Consignment merchandise
can be returned to the vendor at any time. 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. The Company maintained
consolidated consigned inventory at its retail locations of approximately
$170.8 million and $162.2 million at July 31, 2003 and 2002, respectively.

Prior to fiscal year 2002, the Company used the BLS producer price indices
applied against inventory values to calculate the value of inventory on a LIFO
basis. In fiscal year 2002, the Company applied internally developed indices
that the Company believes more consistently measures inflation or deflation in
the components of its merchandise (i.e., the proper weighting of diamonds, gold
and other metals and precious stones) and the Companys merchandise mix. The
Company believes the internally developed indices more accurately reflect
inflation or deflation in its own prices than the BLS producer price indices.
The impact on the individual prior years presented and the cumulative effect of
this change on earnings at the beginning of fiscal year 2002 was not
determinable. At the end of fiscal year 2002, the effect of using internal
indices instead of the BLSs producer price indices was to increase net income
by approximately $4.8 million, or $0.14 per share.

F-17



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##### Table of Contents



ZALE CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (continued)

Investments

Investments in debt and equity securities are reported as Other Assets in
the Consolidated Balance Sheet. Investments are recorded at fair value based
on quoted market prices. All long-term debt securities outstanding at July 31,
2003 will contractually mature within 1 to 29 years. Investments, principally
related to the Companys insurance subsidiaries as of July 31, 2003 and 2002
were as follows:

|                            |  |               |        |               |  |                        |        |            |  |   |        |  |  |   |        | 
|--------------------------- |  | ------------- | ------ | ------------- |  | ---------------------- | ------ | ---------- |  | - | ------ |  |  | - | ------ | 
|                            |  | July 31, 2003 |        | July 31, 2002
|                            |  |               |        |              
|                            |  | Cost          |        | Fair Value    |  | Cost                   |        | Fair Value
|                            |  |               |        |               |  |                        |        |           
|                            |  |               |        |               |  | (amounts in thousands) |        |            |  |  
|U.S. government obligations |  | $             | 15,782 |               |  | $                      | 16,286 |            |  | $ | 16,135 |  |  | $ | 17,142 | 
|Corporate bonds and notes   |  |               | 3,614  |               |  |                        | 3,825  |            |  |   | 4,906  |  |  |   | 5,133  | 
|Corporate equity
securities |  |               | 5,594  |               |  |                        | 4,978  |            |  |   | 5,271  |  |  |   | 4,378  | 
|                            |  |               |        |               |  |                        |        |            |  |   |        |  |  |   |        | 
|                            |  | $             | 24,990 |               |  | $                      | 25,089 |            |  | $ | 26,312 |  |  | $ | 26,653 | 
|                            |  |               |        |               |  |                        |        |            |  |   |        |  |  |   |        | 

All investments are classified as available for sale. At July 31, 2003
and 2002, the carrying value of investments included net unrealized gains of
$0.1 million and $0.3 million at July 31, 2003 and 2002, respectively, which
are included in other comprehensive income (loss). The net realized gain
(loss) on investments which totaled $0.3 million in fiscal year 2003, ($0.1)
million in fiscal year 2002 and $0.3 million in fiscal year 2001, were
determined on a specific identification basis. Investments with a carrying
value of $4.1 million were on deposit with various state insurance departments
at July 31, 2003 and 2002 as required by law.

Property And Equipment

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

|                                                |  |                        |          |               |  |   |          |  
|----------------------------------------------- |  | ---------------------- | -------- | ------------- |  | - | -------- | -
|                                                |  | July 31, 2003          |          | July 31, 2002
|                                                |  |                        |          |              
|                                                |  | (amounts in thousands)
|Land                                            |  | $                      | 881      |               |  | $ | 881      |  
|Building and Leasehold Improvements             |  |                        | 192,775  |               |  |   | 185,425  |  
|Furniture and Fixtures                          |  |                        | 332,439  |               |  |   | 312,463  |  
|Construction in Progress                        |  |                        | 12,177   |               |  |   | 9,089    |  
|                                                |  |                        |          |               |  |   |          |  
|Total Property and Equipment                    |  |                        | 538,272  |               |  |   | 507,858  |  
|Less: Accumulated Amortization and Depreciation |  |                        | (272,105 | )             |  |   | (223,420 | )
|                                                |  |                        |          |               |  |   |          |  
|Total Net Property and Equipment                |  | $                      | 266,167  |               |  | $ | 284,438  |  
|                                                |  |                        |          |               |  |   |          |  

Depreciation expense of $55.6 million, $58.3 million and $52.4 million
was recorded at July 31, 2003, 2002 and 2001. Property and equipment are
depreciated over the estimated useful lives of the assets. Useful lives for
buildings, leasehold improvements, and furniture and fixtures are 27 years, the
remaining term of the lease, and 3-12 years, respectively.

The Company recorded impairment charges of $1.3 million, $1.8 million, and
$0.4 million for the years ended July 31, 2003, 2002, and 2001, respectively,
related to unproductive assets. These impairment charges are included in
Selling, General, and Administrative Expenses and resulted from the Companys
ongoing process to evaluate the productivity of its asset base.

The Company currently owns a 73,000 square foot building in Bethlehem,
Pennsylvania that formerly served as Piercing Pagodas distribution center. The
Company plans to sell this building and it is currently holding it available
for sale. As of July 31, 2003, the carrying amount of this building is
approximately $7.0 million which represents the estimated fair value of the
asset. In fiscal year 2003, the Company recorded an impairment charge of
approximately $0.8 million to reflect the writedown to the estimated fair
value.

F-18



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##### Table of Contents



ZALE CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (continued)

Accounts Payable and Accrued Liabilities

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

|                                               |  |                        |         |               |  |   |         | 
|---------------------------------------------- |  | ---------------------- | ------- | ------------- |  | - | ------- | 
|                                               |  | July 31, 2003          |         | July 31, 2002
|                                               |  |                        |         |              
|                                               |  | (amounts in thousands)
|Accounts Payable                               |  | $                      | 149,285 |               |  | $ | 145,968 | 
|Accrued Payroll                                |  |                        | 31,267  |               |  |   | 28,304  | 
|Accrued Taxes                                  |  |                        | 27,265  |               |  |   | 51,278  | 
|Extended Warranty Deferred Revenue             |  |                        | 28,662  |               |  |   | 29,044  | 
|Accrued Rent                                   |  |                        | 24,597  |               |  |   | 25,067  | 
|Other Accruals                                 |  |                        | 46,699  |               |  |   | 52,002  | 
|                                               |  |                        |         |               |  |   |         | 
|Total Accounts Payable and Accrued
Liabilities |  | $                      | 307,775 |               |  | $ | 331,663 | 
|                                               |  |                        |         |               |  |   |         | 

Non-Current Liabilities

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 Citi Commerce
Solutions recognized as deferred income.

Deferred Credit.In connection with the sale of its customer receivables
in fiscal year 2000, the Company entered into a ten year merchant services
agreement whereby Citi will issue private label credit cards branded with
appropriate Company trademarks. Citi 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, 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 is recognized ratably over the term of the
agreement. Deferred credits of $29.3 million and $33.4 million are included in
the accompanying Consolidated Balance Sheet at July 31, 2003 and 2002,
respectively.

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##### Table of Contents



ZALE CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (continued)

Postretirement Benefits.The Company provides medical, dental, and vision
insurance benefits for all eligible retirees and spouses with benefits to the
latter continuing after the death of the retiree. In January 2002, the Company
amended its Retiree Medical Plan to limit retiree health coverage to only those
retirees who were already participants in the plan and to those otherwise
eligible employees who elected to retire prior to April 1, 2002. In January
2003, the Company amended the plan to set retiree rates in such a way that all
future cost increases are to be paid by the retirees.

Retiree health benefits will no longer be available to those current
employees who were previously in the eligible class of employees (i.e., those
hired prior to November 15, 1994, if they retired at age 55 or older with ten
or more years of continuous service). In fiscal year 2002, the Company
recorded a $3.5 million gain related to the curtailment of its Retiree Medical
Plan. In fiscal year 2003, 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 continued 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.

|                                        |  |                        |         |               |  |   |         |  
|--------------------------------------- |  | ---------------------- | ------- | ------------- |  | - | ------- | -
|                                        |  | July 31, 2003          |         | July 31, 2002
|                                        |  |                        |         |              
|                                        |  | (amounts in thousands)
|Change in Benefit Obligation:           |  |                        |         |               |  |   |         |  
|Benefit obligation at beginning of year |  | $                      | 8,991   |               |  | $ | 17,255  |  
|Service cost                            |  |                        |        |               |  |   | 193     |  
|Interest cost                           |  |                        | 508     |               |  |   | 899     |  
|Plan participant contributions          |  |                        | 1,292   |               |  |   | 1,113   |  
|Curtailments                            |  |                        |        |               |  |   | (8,423  | )
|Amendments                              |  |                        | (4,177  | )             |  |   |        |  
|Actuarial loss (gain)                   |  |                        | 1,237   |               |  |   | (236    | )
|Benefits Paid                           |  |                        | (2,106  | )             |  |   | (1,810  | )
|                                        |  |                        |         |               |  |   |         |  
|Benefit obligation at end of year       |  | $                      | 5,745   |               |  | $ | 8,991   |  
|                                        |  |                        |         |               |  |   |         |  
|Change in Plan Assets:                  |  |                        |         |               |  |   |         |  
|Market value at beginning of year       |  | $                      |        |               |  | $ |        |  
|Employer contributions                  |  |                        | 814     |               |  |   | 697     |  
|Plan participant contributions          |  |                        | 1,292   |               |  |   | 1,113   |  
|Benefit payments                        |  |                        | (2,106  | )             |  |   | (1,810  | )
|                                        |  |                        |         |               |  |   |         |  
|Market value at end of year             |  | $                      |        |               |  | $ |        |  
|                                        |  |                        |         |               |  |   |         |  
|Funded Status                           |  | $                      | (5,745  | )             |  | $ | (8,991  | )
|Unrecognized net actuarial gain         |  |                        | (5,664  | )             |  |   | (7,528  | )
|Unrecognized prior service cost         |  |                        | (4,072  | )             |  |   |        |  
|                                        |  |                        |         |               |  |   |         |  
|Accrued benefit                         |  | $                      | (15,481 | )             |  | $ | (16,519 | )
|                                        |  |                        |         |               |  |   |         |  

The weighted average assumption of the discount rate is 6.5 percent and
7.0 percent as of July 31, 2003 and 2002, respectively. The health care cost
trend rates were also reduced as of July 31, 2003 down to 0.0 percent, as
dictated by the plan design change. Because retiree contributions will now be
annually increased to shift all cost increases to participants, the expected
trend rate is now effectively 0.0 percent.

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##### Table of Contents



ZALE CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (continued)

Components of net periodic (benefit) cost:

|                                                   |  |                        |      |               |  |               |        |   |  |   |       |  
|-------------------------------------------------- |  | ---------------------- | ---- | ------------- |  | ------------- | ------ | - |  | - | ----- | -
|                                                   |  | July 31, 2003          |      | July 31, 2002 |  | July 31, 2001
|                                                   |  |                        |      |               |  |              
|                                                   |  | (amounts in thousands)
|Service Cost                                       |  | $                      |     |               |  | $             | 193    |   |  | $ | 332   |  
|Interest Cost                                      |  |                        | 508  |               |  |               | 899    |   |  |   | 1,113 |  
|Amortization of Prior Service Cost and Gain        |  |                        | (607 | )             |  |               | (177   | ) |  |   | (497  | )
|Settlement / Curtailment / Termination of
Benefits |  |                        |     |               |  |               | (4,117 | ) |  |   |      |  
|                                                   |  |                        |      |               |  |               |        |   |  |   |       |  
|Net Periodic (Benefit) Cost                        |  | $                      | (99  | )             |  | $             | (3,202 | ) |  | $ | 948   |  
|                                                   |  |                        |      |               |  |               |        |   |  |   |       |  

The plan amendment in January 2003 has effectively frozen the plan and
changes in the trend are no longer relevant. Claims experience will impact the
plan from year to year, but there should be no general change due to medical
trend rates.

Non-Qualified Retirement Plan

The Company has a Supplemental Executive Retirement Plan (the Plan).
The Plan provides 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.

Long-term Debt

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

|                           |  |                        |         |               |  |   |        | 
|-------------------------- |  | ---------------------- | ------- | ------------- |  | - | ------ | 
|                           |  | July 31, 2003          |         | July 31, 2002
|                           |  |                        |         |              
|                           |  | (amounts in thousands)
|Revolving Credit Agreement |  | $                      | 184,400 |               |  | $ |       | 
|Senior Notes               |  |                        |        |               |  |   | 86,749 | 
|                           |  |                        |         |               |  |   |        | 
|Total Long-Term Debt       |  | $                      | 184,400 |               |  | $ | 86,749 | 
|                           |  |                        |         |               |  |   |        | 

Payoff of Senior Notes.In the fourth quarter of fiscal year 2003, the
Company called and retired the remaining $87 million of its 8
1⁄2 percent
Senior Notes (the Senior Notes). The Company recognized a $5.9 million loss
related to this early retirement of debt.

Revolving Credit Agreement.The Company entered into a new revolving
credit facility (the Revolving Credit Agreement) on July 23, 2003, replacing
its existing $225 million facility. The Revolving Credit Agreement provides to
the Company and its operating subsidiary, Zale Delaware, Inc. up to $500
million in commitments by certain lenders, including a $20 million sublimit for
letters of credit. The Revolving Credit Agreement, which has a term of five
years, is primarily secured by the Companys U.S. merchandise inventory.

The revolving credit loans bear interest at a floating rate at either (i)
the applicable LIBOR Rate plus a margin equal to 1.75 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). The margin applicable to LIBOR Rates and letter of
credit commission rates will be automatically reduced or increased from time to
time based upon excess availability under the Revolving Credit Agreement. The
Company pays a commitment fee of 0.375 percent on the preceding months unused
commitment. 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, 2003, there was $184.4 million outstanding
under the Revolving Credit Agreement. The effective interest rate at July 31,
2003 was 4.0 percent. Based on the terms of the agreement, the Company had
approximately $295 million in available borrowings at July 31, 2003.

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ZALE CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (continued)

The Revolving Credit Agreement requires the Company to comply with certain
restrictive covenants including, among other things, limitations on
indebtedness, investments, liens, acquisitions, and asset sales. In addition,
if remaining borrowing availability under the facility is less than $75
million, the Company will be restricted in its ability to repurchase stock or
pay dividends. If remaining borrowing availability is less than $50 million,
the Company will be required to meet a minimum fixed charge coverage ratio. The
Company is currently in compliance with all of its obligations under the
Revolving Credit Agreement.

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 $2.1 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,  
|                   |                                      |   | 2003                   |         | 2002       |   | 2001      
|                   |                                      |   |                        |         |            |   |           
|                   |                                      |   | (amounts in thousands)
|Retail Space:      |                                      |   |                        |         |            |   |            |         |  |   |         |        
|                   | Minimum Rentals                      |   | $                      | 175,193 |            |   | $          | 169,274 |  |   | $       | 149,671 | 
|                   | Rentals Based on Sales               |   |                        | 10,767  |            |   |            | 13,335  |  |   |         | 15,135  | 
|                   |                                      |   |                        |         |            |   |            |         |  |   |         |         | 
|                   |                                      |   | 185,960                |         |            |   | 182,609    |         |  |   | 164,806 |        
|                   | Equipment and Corporate Headquarters |   |                        | 2,757   |            |   |            | 2,862   |  |   |         | 2,778   | 
|                   |                                      |   |                        |         |            |   |            |         |  |   |         |         | 
|Total Rent Expense |                                      | $ | 188,717                |         |            | $ | 185,471    |         |  | $ | 167,584 |        
|                   |                                      |   |                        |         |            |   |            |         |  |   |         |        

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, 2003, for all noncancelable
leases of ongoing operations were as follows: 2004  $167.3 million; 2005 
$151.6 million; 2006  $133.6 million; 2007  $115.7 million; 2008  $94.4
million; thereafter  $208.1 million; for a total of $870.7 million.

Interest

Interest expense for the fiscal years ended July 31, 2003, 2002 and 2001
was $7.7 million, $9.8 million and $11.0 million, respectively.

Interest income for the fiscal years ended July 31, 2003, 2002 and 2001
was $1.4 million, $2.0 million and $4.1 million, respectively.

The Company called and retired the remaining $87 million of the Senior
Notes. The Company recognized a $5.9 million loss related to this early
retirement of debt. This loss is reported as Cost of Early Retirement of Debt
in the Statement of Operations.

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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 of 35 percent
as follows:

|                                                                            |  |            |        |            |  |            |        |   |  |   |        |  
|--------------------------------------------------------------------------- |  | ---------- | ------ | ---------- |  | ---------- | ------ | - |  | - | ------ | -
|                                                                            |  | Year Ended |        | Year Ended |  | Year Ended
|                                                                            |  | July 31,   |        | July 31,   |  | July 31,  
|                                                                            |  | 2003       |        | 2002       |  | 2001      
|                                                                            |  |            |        |            |  |           
|Federal Income Tax Expense at Statutory Rate                                |  | $          | 5,143  |            |  | $          | 56,665 |   |  | $ | 46,689 |  
|Amortization of Excess of Revalued Net
Assets
Over Stockholders Investment |  |            |       |            |  |            |       |   |  |   | (2,064 | )
|Impairment of
Goodwill                                                      |  |            | 47,705 |            |  |            |       |   |  |   |       |  
|Goodwill
Amortization                                                       |  |            |       |            |  |            |       |   |  |   | 2,658  |  
|State Income Taxes, Net of Federal Income
Tax Benefit                       |  |            | 2,205  |            |  |            | 2,136  |   |  |   | 2,899  |  
|Other                                                                       |  |            | 287    |            |  |            | 455    |   |  |   | 1,166  |  
|                                                                            |  |            |        |            |  |            |        |   |  |   |        |  
|Total Income Tax
Expense                                                    |  | $          | 55,340 |            |  | $          | 59,256 |   |  | $ | 51,348 |  
|                                                                            |  |            |        |            |  |            |        |   |  |   |        |  
|Effective Income Tax
Rate                                                   |  |            | 376.7  | %(1)       |  |            | 36.6   | % |  |   | 38.5   | %
|                                                                            |  |            |        |            |  |            |        |   |  |   |        |  

(1)  For the year ended July 31, 2003, the effective income tax rate
excluding the effect of the goodwill impairment charge of $136.3 million is
36.7 percent.

|                           |                          |   |                        |        |            |   |            |        |  |   |        |        | 
|-------------------------- | ------------------------ | - | ---------------------- | ------ | ---------- | - | ---------- | ------ |  | - | ------ | ------ | 
|                           |                          |   | Year Ended             |        | Year Ended |   | Year Ended
|                           |                          |   | July 31,               |        | July 31,   |   | July 31,  
|                           |                          |   | 2003                   |        | 2002       |   | 2001      
|                           |                          |   |                        |        |            |   |           
|                           |                          |   | (amounts in thousands)
|Current Provision:         |                          |   |                        |        |            |   |            |        |  |   |        |       
|                           | Federal                  |   | $                      | 7,347  |            |   | $          | 41,693 |  |   | $      | 25,205 | 
|                           | Foreign                  |   |                        | 3,823  |            |   |            | 1,779  |  |   |        | 2,327  | 
|                           | State                    |   |                        | (2,116 | )          |   |            | 2,116  |  |   |        | 3,535  | 
|                           |                          |   |                        |        |            |   |            |        |  |   |        |        | 
|                           | Total Current Provision  |   |                        | 9,054  |            |   |            | 45,588 |  |   |        | 31,067 | 
|Deferred Provision:        |                          |   |                        |        |            |   |            |        |  |   |        |       
|                           | Federal                  |   |                        | 39,016 |            |   |            | 10,236 |  |   |        | 18,471 | 
|                           | Foreign                  |   |                        | 2,817  |            |   |            | 2,262  |  |   |        | 885    | 
|                           | State                    |   |                        | 4,453  |            |   |            | 1,170  |  |   |        | 925    | 
|                           |                          |   |                        |        |            |   |            |        |  |   |        |        | 
|                           | Total Deferred Provision |   |                        | 46,286 |            |   |            | 13,668 |  |   |        | 20,281 | 
|                           |                          |   |                        |        |            |   |            |        |  |   |        |        | 
|Total Income Tax Provision |                          | $ | 55,340                 |        |            | $ | 59,256     |        |  | $ | 51,348 |       
|                           |                          |   |                        |        |            |   |            |        |  |   |        |        | 

As of July 31, 2003, the Company has a tax net operating loss carryforward
(NOL) (after limitations) of $106.2 million. The utilization of this asset is
subject to limitations. The most restrictive is the Internal Revenue Code
Section 382 annual limitation of $19.5 million. The NOL carry forward can be
utilized through 2008.

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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, 2003 and 2002
are presented below.

|                                    |              |                                                          |        |                        |         |               |        |        |         |  
|----------------------------------- | ------------ | -------------------------------------------------------- | ------ | ---------------------- | ------- | ------------- | ------ | ------ | ------- | -
|                                    |              |                                                          |        | July 31, 2003          |         | July 31, 2002
|                                    |              |                                                          |        |                        |         |              
|                                    |              |                                                          |        | (amounts in thousands)
|Current Deferred Taxes:             |              |                                                          |        |                        |         |               |        |       
|                                    | Assets      |                                                          |        |                        |         |               |        |        |        
|                                    |              | Customer receivables                                     |        | $                      | 806     |               |        | $      | 993     |  
|                                    |              | Accrued liabilities                                      |        |                        | 29,465  |               |        |        | 35,443  |  
|                                    |              | State and local taxes                                    |        |                        | 4,879   |               |        |        | 4,303   |  
|                                    |              | Net operating loss carryforward                          |        |                        | 7,601   |               |        |        | 7,601   |  
|                                    |              | Other                                                    |        |                        | 1,876   |               |        |        | 1,811   |  
|                                    |              |                                                          |        |                        |         |               |        |       
|Total Assets                        |              |                                                          | 44,627 |                        |         |               | 50,151 |       
|                                    | Liabilities |                                                          |        |                        |         |               |        |        |        
|                                    |              | Merchandise inventories,
principally due to LIFO reserve |        |                        | (86,614 | )             |        |        | (70,818 | )
|                                    |              | Other                                                    |        |                        | (4,279  | )             |        |        | (849    | )
|                                    |              |                                                          |        |                        |         |               |        |        |         |  
|                                    |              | Deferred Current Tax Liability, Net                      |        | $                      | (46,266 | )             |        | $      | (21,516 | )
|                                    |              |                                                          |        |                        |         |               |        |       
|Non-Current Deferred Taxes:         |              |                                                          |        |                        |         |               |        |       
|                                    | Assets      |                                                          |        |                        |         |               |        |        |        
|                                    |              | Net operating loss carryforward                          |        |                        | 33,179  |               |        |        | 42,734  |  
|                                    |              | Postretirement benefits                                  |        |                        | 6,038   |               |        |        | 6,442   |  
|                                    |              | Accrued Liabilities                                      |        |                        | 9,781   |               |        |        | 11,412  |  
|                                    |              | Other                                                    |        |                        | 1,536   |               |        |        | 1,153   |  
|                                    |              |                                                          |        |                        |         |               |        |       
|                                    | Total Assets |                                                          |        | 50,534                 |         |               |        | 61,741 |        
|                                    |              | Liabilities                                             |        |                        |         |               |        |        |         |  
|                                    |              | Property and equipment                                   |        |                        | (20,619 | )             |        |        | (10,499 | )
|                                    |              | Goodwill                                                 |        |                        | (8,792  | )             |        |        | (8,226  | )
|                                    |              |                                                          |        |                        |         |               |        |        |         |  
|Deferred Non-Current Tax Asset, Net |              | $                                                        | 21,123 |                        |         | $             | 43,016 |       
|                                    |              |                                                          |        |                        |         |               |        |        |         |  

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, 2003 and 2002, respectively. The Company
believes that, as of July 31, 2003, the realization of the deferred income
tax asset is more likely than not.

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##### Table of Contents



ZALE CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (continued)

Capital Stock

Common Stock.At July 31, 2003 and 2002, 70,000,000 shares of common
stock, par value of $0.01 per share (Common Stock), were authorized, and
41,190,961 shares and 40,746,409 shares, respectively, were issued, of which
27,610,927 shares and 33,569,362 shares, respectively, were outstanding.

Preferred Stock.At July 31, 2003 and 2002, 5,000,000 shares of Preferred
Stock, par value of $0.01, were authorized. None were issued or outstanding.

Treasury Stock.The Company held 13,580,034 and 7,177,047 treasury shares
at July 31, 2003 and 2002, respectively.

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, could purchase up to an
aggregate of $50 million of its 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 year 2001.

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 and in accordance with the Companys usual
policies and applicable securities laws, could purchase throughout the fiscal
year, up to an aggregate of $50 million of its Common Stock on the open market.
Under this program, the Company repurchased 1.3 million shares at an aggregate
cost of $50 million in fiscal year 2002.

In July, 2002, 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, and in accordance with the Companys
usual policies and applicable securities laws, may purchase, up to an aggregate
of $50 million of its Common Stock on the open market through July 31, 2003.
Under this program, the Company purchased 0.2 million shares at an aggregate
cost of $4.4 million through July 31, 2002. In October 2002, the Company
completed this program, having repurchased 1.7 million shares at an aggregate
cost of $50 million under this program. The Company repurchased 1.5 million of
these shares, at an aggregate cost of $45.6 million, during the first quarter
of fiscal year 2003.

On March 18, 2003, 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 up to an aggregate of $50
million of its Common Stock on the open market. Under this program, the
Company purchased 209,000 shares at an aggregate cost of $7.5 million through
July 31, 2003.

On July 1, 2003, the Company entered into a modified Dutch Auction
tender offer (the Tender Offer) to purchase up to 6,400,000 shares of its
outstanding Common Stock at a price per share of not less than $42.00 nor in
excess of $48.00 per share, for an aggregate purchase price of up to $307.2
million. The Tender Offer enabled the Company to repurchase approximately 4.7
million shares of Common Stock at an aggregate cost of approximately $225
million.

On August 28, 2003, 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 up to an additional $100
million of its Common Stock. This action brings the Companys remaining
availability of the total authorization under its stock repurchase program to
approximately $142 million.

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##### Table of Contents



ZALE CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (continued)

Incentive Stock Plan.During the fiscal year ended July 31, 2003, the
Company had two stock incentive plans; the Zale Corporation Omnibus Stock
Incentive Plan (the Stock Incentive Plan) and the Zale Corporation Outside
Directors 1995 Stock Option Plan (the Directors Plan) . On July 30, 1993,
the Company adopted the Stock Incentive 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, including previously granted
shares, were available for grant under the Stock Incentive Plan to eligible
employees. The Stock Incentive Plan allowed for the granting of restricted
stock, stock options, stock bonuses and stock appreciation rights subject to
the provisions of the Stock Incentive Plan. Restricted Stock granted under the
Stock Incentive Plan vested ratably over a four to five year vesting period and
were non-transferable prior to vesting. Options granted under the Stock
Incentive Plan (i) were 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 Stock Incentive Plan expired in
accordance with its terms on July 30, 2003. The Board of Directors has adopted
the Zale Corporation 2003 Stock Incentive Plan (the 2003 Plan), which has
similar features to the Stock Incentive Plan, to replace the Stock Incentive
Plan. The 2003 Plan has been submitted for stockholder approval at the 2003
annual meeting of stockholders to authorize the issuance of up to 3,000,000
shares of Common Stock. The Directors Plan authorizes the Company to grant
Common Stock to non-employee directors at fair market value of the Companys
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 Directors 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 vested ratably on each of the anniversaries ranging from two to
four years from the date of grant and were subject to restrictions on their
sale or transfer. During July 2001, 250,000 shares of restricted common stock
were granted to a key employee, valued at $7.9 million as of the grant date,
and these shares 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. In fiscal year 2002, 200,000 restricted shares
were cancelled 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 $0.1 million, $1.9 million, and $0.7 million
for the twelve month periods ended July 31, 2003, 2002, and 2001 respectively.
Compensation expense is included in selling, general and administrative expense
in the accompanying Consolidated Statements of Operations.

Stock option transactions are summarized as follows:

|                               |  |        |           |             |  |        |           |             |  |             |           |             |  |      |             |      |  |      |             |        |  |        |             |        |  |                           |       |  |  |   |       |  |  |   |       | 
|------------------------------ |  | ------ | --------- | ----------- |  | ------ | --------- | ----------- |  | ----------- | --------- | ----------- |  | ---- | ----------- | ---- |  | ---- | ----------- | ------ |  | ------ | ----------- | ------ |  | ------------------------- | ----- |  |  | - | ----- |  |  | - | ----- | 
|                               |  |        |           |             |  |        |           |             |  |             |           |             |  |      |             |      |  |      |             |        |  |        |             |        |  | Weighted Average Exercise
|                               |  | Shares |           | Grant Price |  | Price 
|                               |  |       
|                               |  | Fiscal |           | Fiscal      |  | Fiscal |           |             |  |             |           |             |  |      |             |      |  |      |             | Fiscal |  | Fiscal |             | Fiscal
|                               |  | 2003   |           | 2002        |  | 2001   |           | Fiscal 2003 |  | Fiscal 2002 |           | Fiscal 2001 |  | 2003 |             | 2002 |  | 2001
|                               |  |        |           |             |  |        |           |             |  |             |           |             |  |      |             |      |  |     
|Outstanding,
beginning of year |  |        | 3,025,578 |             |  |        | 3,247,782 |             |  |             | 3,241,313 |             |  | $    | 9.00-45.56  |      |  | $    | 8.68-45.56  |        |  | $      | 8.68-45.56  |        |  | $                         | 34.35 |  |  | $ | 34.10 |  |  | $ | 34.70 | 
|Granted                        |  |        | 583,000   |             |  |        | 640,700   |             |  |             | 1,066,650 |             |  |      | 29.01-46.46 |      |  |      | 28.29-42.00 |        |  |        | 28.22-40.13 |        |  |                           | 44.21 |  |  |   | 30.04 |  |  |   | 31.82 | 
|Exercised                      |  |        | (443,552  | )           |  |        | (328,579  | )           |  |             | (485,156  | )           |  |      | 9.00-43.50  |      |  |      | 9.74-43.50  |        |  |        | 9.00-33.44  |        |  |                           | 33.65 |  |  |   | 24.47 |  |  |   | 25.44 | 
|Canceled                       |  |        | (376,900  | )           |  |        | (534,325  | )           |  |             | (575,025  | )           |  |      | 9.74-45.56  |      |  |      | 8.68-43.50  |        |  |        | 9.74-43.72  |        |  |                           | 37.43 |  |  |   | 33.79 |  |  |   | 40.54 | 
|                               |  |        |           |             |  |        |           |             |  |             |           |             |  |      |             |      |  |      |             |        |  |        |             |        |  |                           |       |  |  |   |       |  |  |   |       | 
|Outstanding, end of
year       |  |        | 2,788,126 |             |  |        | 3,025,578 |             |  |             | 3,247,782 |             |  | $    | 9.00-46.46  |      |  | $    | 9.00-45.56  |        |  | $      | 8.68-45.56  |        |  | $                         | 36.10 |  |  | $ | 34.35 |  |  | $ | 34.10 | 
|                               |  |        |           |             |  |        |           |             |  |             |           |             |  |      |             |      |  |      |             |        |  |        |             |        |  |                           |       |  |  |   |       |  |  |   |       | 

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##### Table of Contents



ZALE CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (continued)

The following table summarizes information about stock options outstanding at
July 31, 2003.

| |  |                     |       |                     |  |                |       |          |  |             |           |          |  |          |     |          |  |   |       |  |  |          |           |  |  |   |       | 
| |  | ------------------- | ----- | ------------------- |  | -------------- | ----- | -------- |  | ----------- | --------- | -------- |  | -------- | --- | -------- |  | - | ----- |  |  | -------- | --------- |  |  | - | ----- | 
| |  | 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   
| |  |                     |       |                     |  |                |       |          |  |             |           |         
| |  | $                   | 4.65  |                     |  | $              | 9.29  |          |  |             | 750       |          |  |          | 1.0 |          |  | $ | 9.00  |  |  |          | 750       |  |  | $ | 9.00  | 
| |  |                     | 9.29  |                     |  |                | 13.94 |          |  |             | 13,750    |          |  |          | 0.8 |          |  |   | 10.52 |  |  |          | 13,750    |  |  |   | 10.52 | 
| |  |                     | 13.94 |                     |  |                | 18.58 |          |  |             | 12,800    |          |  |          | 3.0 |          |  |   | 16.30 |  |  |          | 12,800    |  |  |   | 16.30 | 
| |  |                     | 18.58 |                     |  |                | 23.23 |          |  |             | 13,000    |          |  |          | 3.8 |          |  |   | 21.21 |  |  |          | 13,000    |  |  |   | 21.21 | 
| |  |                     | 23.23 |                     |  |                | 27.88 |          |  |             | 24,750    |          |  |          | 5.0 |          |  |   | 26.07 |  |  |          | 24,750    |  |  |   | 26.07 | 
| |  |                     | 27.88 |                     |  |                | 32.52 |          |  |             | 913,303   |          |  |          | 8.5 |          |  |   | 29.36 |  |  |          | 230,978   |  |  |   | 29.67 | 
| |  |                     | 32.52 |                     |  |                | 37.17 |          |  |             | 732,500   |          |  |          | 5.3 |          |  |   | 33.44 |  |  |          | 676,000   |  |  |   | 33.44 | 
| |  |                     | 37.17 |                     |  |                | 41.81 |          |  |             | 34,500    |          |  |          | 8.4 |          |  |   | 41.25 |  |  |          | 9,625     |  |  |   | 41.06 | 
| |  | $                   | 41.81 |                     |  | $              | 46.46 |          |  |             | 1,042,773 |          |  |          | 8.3 |          |  |   | 44.73 |  |  |          | 407,398   |  |  |   | 43.22 | 
| |  |                     |       |                     |  |                |       |          |  |             |           |          |  |          |     |          |  |   |       |  |  |          |           |  |  |   |       | 
| |  |                     |       |                     |  |                |       |          |  |             | 2,788,126 |          |  |          | 7.5 |          |  | $ | 36.10 |  |  |          | 1,389,051 |  |  | $ | 35.09 | 
| |  |                     |       |                     |  |                |       |          |  |             |           |          |  |          |     |          |  |   |       |  |  |          |           |  |  |   |       | 

As of July 31, 2003, 2002 and 2001, 1,389,051, 1,728,515, and 1,450,382,
of options outstanding were exercisable at a weighted average exercise price of
$35.09, $35.21, and $32.21, respectively.

(Loss) Earnings Per Common Share

Basic (loss) 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 issued by the Company represent the only dilutive effect reflected in
diluted weighted average shares. For the fiscal years ended July 31, 2003,
2002 and 2001, there were antidilutive common stock equivalents of 590,150,
865,825, and 1,846,613, respectively.

|                                                                 |  |                                                  |         |      |  |      |         |  |  |   |        | 
|---------------------------------------------------------------- |  | ------------------------------------------------ | ------- | ---- |  | ---- | ------- |  |  | - | ------ | 
|                                                                 |  | Years Ended July 31,                            
|                                                                 |  | 2003                                             |         | 2002 |  | 2001
|                                                                 |  |                                                  |         |      |  |     
|                                                                 |  | (amounts in thousands, except per share amounts)
|Net (loss) earnings available to stockholders                    |  | $                                                | (40,645 | )    |  | $    | 143,932 |  |  | $ | 82,048 | 
|Basic:                                                           |  |                                                  |         |      |  |      |         |  |  |   |        | 
|Weighted average number of common shares outstanding             |  |                                                  | 32,264  |      |  |      | 34,589  |  |  |   | 34,575 | 
|(Loss) earnings per common share  basic:                        |  |                                                  |         |      |  |      |         |  |  |   |        | 
|Before effect of change in accounting principle                  |  | $                                                | (1.26   | )    |  | $    | 2.97    |  |  | $ | 2.37   | 
|                                                                 |  |                                                  |         |      |  |      |         |  |  |   |        | 
|Net (loss) earnings per share                                    |  | $                                                | (1.26   | )    |  | $    | 4.16    |  |  | $ | 2.37   | 
|                                                                 |  |                                                  |         |      |  |      |         |  |  |   |        | 
|Diluted:                                                         |  |                                                  |         |      |  |      |         |  |  |   |        | 
|Weighted average number of common shares outstanding             |  |                                                  | 32,264  |      |  |      | 34,589  |  |  |   | 34,575 | 
|Effect of dilutive securities:                                   |  |                                                  |         |      |  |      |         |  |  |   |        | 
|Stock Options                                                    |  |                                                  |        |      |  |      | 257     |  |  |   | 176    | 
|Weighted average number of common shares
outstanding as adjusted |  |                                                  | 32,264  |      |  |      | 34,846  |  |  |   | 34,751 | 
|(Loss) earnings per common share  diluted:                      |  |                                                  |         |      |  |      |         |  |  |   |        | 
|Before effect of change in accounting principle                  |  | $                                                | (1.26   | )    |  | $    | 2.95    |  |  | $ | 2.36   | 
|                                                                 |  |                                                  |         |      |  |      |         |  |  |   |        | 
|Net (loss) earnings per share                                    |  | $                                                | (1.26   | )    |  | $    | 4.13    |  |  | $ | 2.36   | 
|                                                                 |  |                                                  |         |      |  |      |         |  |  |   |        | 

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##### Table of Contents



ZALE CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (continued)

Comprehensive Income (Loss)

Comprehensive income (loss) represents 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 (loss) are reported in the Consolidated Statements of
Stockholders Investment. Income taxes are generally not provided for foreign
currency translation adjustments, as such adjustments relate to permanent
investments in international subsidiaries.

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 principal brands. Revenues of international retail operations
represent approximately 6.8 percent, 6.7 percent, and 7.2 percent of the
Companys revenues for fiscal years 2003, 2002, and 2001 respectively. Net
property and equipment of international operations, represents approximately
7.5 percent and 5.9 percent of the Companys net property and equipment for
fiscal year 2003 and fiscal year 2002, respectively.

Special Inventory Charge

In February 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 in fiscal year 2001, the
Company recorded a special inventory 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 at the request of the Board of Directors, 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.

The Company extended to Mr. DiNicola a full recourse, $2.2 million loan,
bearing interest at a rate of 8.74 percent per annum, for the sole purpose of
allowing Mr. DiNicola to exercise options to purchase 125,000 shares of Common
Stock prior to expiration of the options. Pursuant to a pledge agreement, the
Company was granted a security interest in the 125,000 shares acquired by Mr.
DiNicola upon exercise of the option. On January 15, 2002, Mr. DiNicola sold
the shares, and repaid the entire outstanding principal balance on the loan.
In recognition of Mr. DiNicolas continued services to the Company following
his re-election as Chairman and Chief Executive Officer, effective February 21,
2001 through July 31, 2002, Mr. DiNicola received additional compensation in
the amount of the accrued interest under the loan.

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 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

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##### Table of Contents



ZALE CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (continued)

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, to facilitate Mr. DiNicolas relocation to Dallas following
his re-election as Chairman and Chief Executive Officer, the Company extended
to Mr. DiNicola a full recourse, $2.1 million loan, bearing interest at a rate
of 7.25 percent per annum, the proceeds of which were used by Mr. DiNicola to
purchase a home in Dallas, Texas. As security for repayment of the loan, the
Company had a first priority mortgage on the property. On July 16, 2002, Mr.
DiNicola repaid the entire outstanding principal balance on the loan, along
with all accrued interest.

Robert J. DiNicola retired as Chief Executive Officer at the end of fiscal
year 2002. In connection with his retirement, the Company agreed to pay
certain expenses on an ongoing basis including life insurance premiums,
relocation and medical costs totaling $0.8 million. He remains Chairman of the
Board in a non-executive role, and has entered into a consulting agreement with
the Company.

In addition, Alan P. Shor resigned as President and Chief Operating
Officer at the end of fiscal year 2002. In connection with his resignation,
the Company agreed to pay over a three year period certain benefits of
approximately $1.5 million consisting principally of an amount equivalent to
three years of salary and other related benefits, including accelerated vesting
of restricted stock. Mr. Shor also received accelerated vesting of certain
stock options.

Commitments and Contingencies

The Company is involved in various 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.

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 federal
anti-racketeering laws. During the first quarter of fiscal year 2003, the
Company reached an agreement with counsel for the plaintiff to settle the
actions. Preliminary court approval of the settlement agreement has been
granted, with final approval expected to occur in late November 2003.

On October 23, 2001 a plaintiff filed a complaint against Zale Corporation
and Zale Delaware, Inc. in the Superior Court of California, County of Los
Angeles, Central District. The complaint is a purported class action on behalf
of current and former salaried store managers and assistant store managers of
the Company in California. The complaint alleges that these individuals were
entitled to overtime pay and should not have been classified as exempt
employees under California law. During the third quarter of fiscal year 2003,
the Company reached an agreement with counsel for the plaintiff to settle the
action. Final approval of the settlement agreement was granted by the court on
July 24, 2003.

The Company has established reserves based on the current status of each
case.

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##### Table of Contents



ZALE CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (continued)

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, 2002, requires fixed payments totaling $11 million over a
36-month term plus a variable amount based on usage. The Company has an option
to extend the current agreement for two consecutive one year periods.

Guarantee Obligations

In November 2002, the Financial Accounting Standards Board issued
Interpretation No. 45 (FIN 45), Guarantors Accounting and Disclosure
Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of
Others. FIN 45 addresses the disclosures to be made by a guarantor in its
interim and annual financial statements about its obligations under guarantees,
and clarifies the requirements related to the recognition of a liability by a
guarantor for the obligations undertaken in issuing that guarantee. The
adoption of FIN 45 did not have an impact on the Companys statement of
financial position or results of operations. However, specific credit and
product warranty programs are subject to the following disclosure in interim
and annual financial statements.

Credit
Programs. Citi, a subsidiary of CitiGroup, provides financing to
the Companys customers through the Companys private label credit card
program, in exchange for payment by the Company of a merchant fee (subject to
periodic adjustment) based on a percentage of each credit card sale. The
receivables established through the issuance of credit by Citi are originated
and owned by Citi. As defined in the agreement with Citi, losses related to a
standard credit account (an account within the credit limit approved under
the original merchant agreement between the Company and Citi) are assumed
entirely by Citi without recourse to the Company, except where a Company
employee violates the credit procedures agreed to in the merchant agreement.

In an effort to better service customers, the Company and Citi developed
two programs that extend credit to qualifying customers beyond the standard
credit account. The incremental credit extension is at the Companys
discretion and is based upon either additional down payments made at the time
of sale or the total amount of the sale transaction. The Company bears a
portion of customer default losses as defined in the agreement with Citi
arising from these accounts.

Based on account balances for the shared risk programs as of July 31,
2003, the Companys maximum potential payment would be approximately $25
million if the entire portfolio defaulted. Based on historical performance,
losses in these portfolios absorbed by the Company have been approximately
$800,000 since August 2000. Prior to fiscal year 2003, the Company was liable
for all losses under these shared risk programs. Losses in fiscal year 2003,
under new terms with Citi that limit the Companys losses, were approximately
$110,000 through July 31, 2003. The reserve for both portfolios is
approximately $370,000, which the Company believes is adequate based on the
historical trend of actual losses. In April 2003, the Company and Citi
finalized an agreement that requires the Company to pledge collateral to Citi
in an interest bearing depository account that will fluctuate monthly based on
the account balances of the shared risk programs. The current collateral
balance as of July 31, 2003 is $5.0 million.

Product Warranty Programs.The Company sells extended service agreements
(ESA) to customers to cover sizing and breakage on certain products purchased
from the Company for a two-year period. The revenue on these agreements is
recognized over the period the services are performed. In addition to ESA, the
Company provides warranty services not covered by the extended service
agreements. These types of services cover repair work on certain diamond
merchandise sold as long as the customer follows certain inspection practices
over the time of ownership of the merchandise. The Company has established a
reserve for potential non-ESA warranty issues based on estimated expenses.

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##### Table of Contents



ZALE CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (continued)

The changes in the Companys product warranty liability for the reporting
periods is as follows:

|                                    |  |                        |         |               |  |               |         |   |  |   |         |  
|----------------------------------- |  | ---------------------- | ------- | ------------- |  | ------------- | ------- | - |  | - | ------- | -
|                                    |  | Year Ended            
|                                    |  |                       
|                                    |  | July 31, 2003          |         | July 31, 2002 |  | July 31, 2001
|                                    |  |                        |         |               |  |              
|                                    |  | (amounts in thousands)
|Beginning Balance                   |  | $                      | 32,541  |               |  | $             | 30,394  |   |  | $ | 27,578  |  
|Extended Warranty Sales             |  |                        | 38,866  |               |  |               | 35,000  |   |  |   | 27,831  |  
|Extended Warranty Income Recognized |  |                        | (39,247 | )             |  |               | (32,853 | ) |  |   | (25,015 | )
|                                    |  |                        |         |               |  |               |         |   |  |   |         |  
|Ending Balance                      |  | $                      | 32,160  |               |  | $             | 32,541  |   |  | $ | 30,394  |  
|                                    |  |                        |         |               |  |               |         |   |  |   |         |  

Benefit Plans

Defined Contribution Retirement Plan

At July 31, 2003, 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. Effective August 1, 2002, the maximum amount employees
can contribute was raised to thirty percent of their annual salary, subject to
Internal Revenue Service (IRS) limitations Through February 2002, the Company
matched one dollar in Common Stock for every dollar an employee contributes up
to four percent of annual compensation, subject to IRS limitations. Effective
March 1, 2002, the Company matches $0.50 in Common Stock for every dollar an
employee contributes up to four percent of annual compensation subject to IRS
limitations.

Through February 2002, matching contributions were made on a monthly
basis. Effective March 1, 2002, matching contributions are made on an annual
basis, and employees must be employed with the Company on the last day of the
plan year to receive the Company match contributions. Employees vest in the
Company match contribution immediately. The Companys provision for matching
contributions were $2.2 million, $3.2 million and $4.1 million for fiscal years
2003, 2002 and 2001, 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.

Financial Instruments

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

The carrying amount of the $86.7 million, Senior Notes approximates fair
value at July 31, 2002. For fiscal year 2003, the carrying amount of $184.4
million related to the new revolving credit facility approximates fair value at
July 31, 2003.

The investments of the Companys insurance subsidiaries, primarily stocks
and bonds in the amount of $25.1 million and $26.7 million, approximate market
value at July 31, 2003 and July 31, 2002 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.

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##### Table of Contents



ZALE CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (continued)

Concentrations of Credit Risk.As of July 31, 2003 and 2002, 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 $5.2 million, $5.9 million, and $2.4
million of jewelry merchandise during fiscal year 2003, 2002, and 2001,
respectively. The Company believes the terms were equivalent to those of
transactions with unrelated parties.

During fiscal year 2002 and 2001, the Company retained an outside firm to
perform certain executive search services for the Company. A member of the
Companys compensation committee and Board of Directors served as managing
partner of this firm. In exchange for executive search services, the firm
received fees of approximately $330,000 and $100,000 in fiscal years 2002 and
2001, respectively. The Company believes the terms were equivalent to those
transactions with unrelated parties.

In December 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 exercising 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. As of July 31, 2002, all outstanding loans with Mr. DiNicola
were repaid in full.

Effective March 27, 2001, the Company extended loans to Alan P. Shor, Mary
L. 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. These loans were repaid in full in fiscal
year 2002.

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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,
2003 and 2002 were as follows
(amounts in thousands except per share data):

|                                      |  |                            |         |           |  |                  |         |             |  |   |         |   |  |   |         |  
|------------------------------------- |  | -------------------------- | ------- | --------- |  | ---------------- | ------- | ----------- |  | - | ------- | - |  | - | ------- | -
|                                      |  |                            |         |           |  | Fiscal Year 2003 |         |             |  |  
|                                      |  |                            |         |           |  |                  |         |             |  |  
|                                      |  | For the Three Months Ended
|                                      |  |                           
|                                      |  | July 31,                   |         | April 30, |  | January 31,      |         | October 31,
|                                      |  | 2003                       |         | 2003      |  | 2003             |         | 2002       
|                                      |  |                            |         |           |  |                  |         |            
|Total
Revenues                        |  | $                          | 442,382 |           |  | $                | 449,383 |             |  | $ | 908,359 |   |  | $ | 412,117 |  
|Cost of
Sales                         |  |                            | 215,103 |           |  |                  | 220,106 |             |  |   | 461,472 |   |  |   | 204,349 |  
|Net Earnings (Loss)                   |  |                            | 2,933   |           |  |                  | 9,367   |             |  |   | (46,222 | ) |  |   | (6,723  | )
|Net earnings (loss) per diluted share |  | $                          | 0.09    |           |  | $                | 0.29    |             |  | $ | (1.44   | ) |  | $ | (0.20   | )

|                                                   |                                    |   |                            |      |           |   |                  |      |             |   |         |      |  |   |         |       |  
|-------------------------------------------------- | ---------------------------------- | - | -------------------------- | ---- | --------- | - | ---------------- | ---- | ----------- | - | ------- | ---- |  | - | ------- | ----- | -
|                                                   |                                    |   |                            |      |           |   | Fiscal Year 2002 |      |             |   |        
|                                                   |                                    |   |                            |      |           |   |                  |      |             |   |        
|                                                   |                                    |   | For the Three Months Ended
|                                                   |                                    |   |                           
|                                                   |                                    |   | July 31,                   |      | April 30, |   | January 31,      |      | October 31,
|                                                   |                                    |   | 2002                       |      | 2002      |   | 2002             |      | 2001       
|                                                   |                                    |   |                            |      |           |   |                  |      |            
|Total
Revenues                                     |                                    | $ | 435,566                    |      |           | $ | 449,150          |      |             | $ | 897,133 |      |  | $ | 409,878 |      
|Cost of Sales (1)                                  |                                    |   | 213,781                    |      |           |   | 218,502          |      |             |   | 451,379 |      |  |   | 199,391 |      
|Earnings (Loss) before effect of accounting change |                                    |   | 3,651                      |      |           |   | 7,649            |      |             |   | 94,995  |      |  |   | (3,650  | )    
|Net Earnings
(Loss)                                |                                    |   | 3,651                      |      |           |   | 7,649            |      |             |   | 94,995  |      |  |   | 37,637  |      
|Net earnings (loss) per diluted share:             |                                    |   |                            |      |           |   |                  |      |             |   |         |      |  |   |         |      
|                                                   | Before effect of accounting change |   | $                          | 0.11 |           |   | $                | 0.22 |             |   | $       | 2.70 |  |   | $       | (0.10 | )
|                                                   | Net earnings per share             |   | $                          | 0.11 |           |   | $                | 0.22 |             |   | $       | 2.70 |  |   | $       | 1.08  |  



| |                                                                                                                                                                                                                                                                                                                                                                                                                                                               
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | (1) In fiscal year 2002, the Company changed its method of determining
price indices used in the valuation of LIFO inventories. The effect of using
internal indices instead of the BLS producer price indices was to increase net
income by approximately $4.8 million. The impact on the individual prior years
and prior quarters presented and the cumulative effect of this change on
earnings at the beginning of fiscal year 2002 was not determinable.

F-33



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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 9th day of October, 2003.

ZALE CORPORATION

By: /s/ MARY L. FORTÉ

Mary L. FortéPresident
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/ MARY L. FORTÉ

Mary L. Forté                   |  | President,
Chief Executive Officer and Director
(principal executive officer of the
registrant)          |  | October 9, 2003
|                                                   |  |                                                                                                          |  |                
|/s/ SUE E. GOVE

Sue E. Gove                       |  | Executive Vice President and,
Chief Operating Officer                                                    |  | October 9, 2003
|                                                   |  |                                                                                                          |  |                
|/s/ MARK R. LENZ

Mark R. Lenz                     |  | Group Senior Vice President
and Chief Financial Officer,
(principal financial
officer of the registrant) |  | October 9, 2003
|                                                   |  |                                                                                                          |  |                
|/s/ CYNTHIA T. GORDON

Cynthia T. Gordon           |  | Senior Vice President, Controller
(principal accounting officer of the
registrant)                       |  | October 9, 2003
|                                                   |  |                                                                                                          |  |                
|/s/ ROBERT J. DINICOLA

Robert J. DiNicola         |  | Chairman of the Board                                                                                    |  | October 9, 2003
|                                                   |  |                                                                                                          |  |                
|/s/ GLEN ADAMS

Glen Adams                         |  | Director                                                                                                 |  | October 9, 2003
|                                                   |  |                                                                                                          |  |                
|/s/ A. DAVID BROWN

A. David Brown                 |  | Director                                                                                                 |  | October 9, 2003
|                                                   |  |                                                                                                          |  |                
|/s/ MARY E. BURTON

Mary E. Burton                 |  | Director                                                                                                 |  | October 9, 2003
|                                                   |  |                                                                                                          |  |                
|/s/ PETER P. COPSES

Peter P. Copses               |  | Director                                                                                                 |  | October 9, 2003
|                                                   |  |                                                                                                          |  |                
|/s/ RICHARD C. MARCUS

Richard C. Marcus           |  | Director                                                                                                 |  | October 9, 2003
|                                                   |  |                                                                                                          |  |                
|/s/ CHARLES H. PISTOR, JR.

Charles H. Pistor, Jr. |  | Director                                                                                                 |  | October 9, 2003
|                                                   |  |                                                                                                          |  |                
|/s/ ANDREW H. TISCH

Andrew H. Tisch               |  | Director                                                                                                 |  | October 9, 2003

39



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##### Table of Contents



|               |  |                                                                                                   
|-------------- |  | --------------------------------------------------------------------------------------------------
|Exhibit Number |  | Description of Exhibit                                                                            
|               |  |                                                                                                   
|4.1            |  | Revolving Credit Agreement, dated as of July 23, 2003.                                            
|               |  |                                                                                                   
|4.2            |  | Security Agreement of Revolving Credit Agreement, dated as of July 23, 2003.                      
|               |  |                                                                                                   
|10.4           |  | Zale Corporation 2003 Stock Option Plan.                                                          
|               |  |                                                                                                   
|10.12          |  | Employment Agreement dated as of August 1, 2003 between Zale Corporation and Mark R. Lenz.        
|               |  |                                                                                                   
|10.13          |  | Employment Agreement dated as of February 28, 2003, between Zale Corporation and Pamela
J. Romano.
|               |  |                                                                                                   
|10.14          |  | Zale Corporation Executive Bonus Plan.                                                            
|               |  |                                                                                                   
|14             |  | Code of Ethics.                                                                                   
|               |  |                                                                                                   
|21             |  | Subsidiaries of the registrant.                                                                   
|               |  |                                                                                                   
|23.1           |  | Consent of KPMG LLP.                                                                              
|               |  |                                                                                                   
|31.1           |  | Rule 13a-14(a) Certification of Chief Executive Officer.                                          
|               |  |                                                                                                   
|31.2           |  | Rule 13a-14(a) Certification of Chief Financial Officer.                                          
|               |  |                                                                                                   
|32.1           |  | Section 1350 Certification of Chief Executive Officer.                                            
|               |  |                                                                                                   
|32.2           |  | Section 1350 Certification of Chief Financial Officer.                                            
|               |  |                                                                                                   
|99.1           |  | Audit Committee Charter.                                                                          
|               |  |                                                                                                   
|99.2           |  | Compensation Committee Charter.                                                                   
|               |  |                                                                                                   
|99.3           |  | Nominating/Corporate Governance Committee Charter.                                                

The above list reflects all exhibits filed herewith. See Item 16 for
a complete list of the Companys exhibits, including exhibits
incorporated by reference from previous filings.

40