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UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 Form 10-K For the fiscal year ended July 31, 2004 Zale Corporation A Delaware Corporation
IRS Employer Identification No. 75-0675400
SEC File Number 1-04129 901 W. Walnut Hill Lane
Irving, Texas 75038-1003
(972) 580-4000 Zale Corporations Common Stock, par value $.01 per share, is registered
pursuant to Section 12 (b) of the Act. Zale Corporation (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, and (2) has been subject to such
filing requirements for the past 90 days. Disclosure of the delinquent filers pursuant to Item 405 of Regulation S-K
is contained in a definitive proxy statement, portions of which are
incorporated by reference in Part III of this Form 10-K. The aggregate market value of Zale Corporations Common Stock (based upon
the closing sales price quoted on the New York Stock Exchange) held by
non-affiliates as of September 24, 2004 was $1.4 billion. As of September 24,
2004, 51,839,768 shares of Zale Corporations Common Stock were outstanding.
For this purpose, directors and officers have been assumed to be affiliates. Zale Corporation is an accelerated filer. DOCUMENTS INCORPORATED BY REFERENCE. Portions of Zale Corporations Proxy Statement for the 2004 Annual Meeting
of Stockholders to be held on November 12, 2004 are incorporated by reference
into Part III.




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TABLE OF CONTENTS  PART IITEM 1. BUSINESSITEM 2. PROPERTIESITEM 3. LEGAL PROCEEDINGSITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERSPART IIITEM 5. MARKET FOR THE REGISTRANTS COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIESITEM 6. SELECTED FINANCIAL DATAITEM 7. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONSITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISKITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATAITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS AND FINANCIAL DISCLOSUREITEM 9A. CONTROLS AND PROCEDURESITEM 9B. OTHER INFORMATIONPART IIIITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANTITEM 11. EXECUTIVE COMPENSATIONITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERSITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONSITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICESPART IVITEM 15. EXHIBITS, FINANCIAL STATEMENTS SCHEDULES AND REPORTS ON FORM 8-KMANAGEMENTS REPORTREPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRMCONSOLIDATED STATEMENTS OF OPERATIONSCONSOLIDATED BALANCE SHEETSCONSOLIDATED STATEMENTS OF CASH FLOWSCONSOLIDATED STATEMENTS OF STOCKHOLDERS INVESTMENTNOTES TO CONSOLIDATED FINANCIAL STATEMENTSSIGNATURESForm of Stock Option Award AgreementForm of Restricted Stock Award Agreement2nd Lease Amendment to Lease AgreementForm of Change of Control AgreementSubsidiaries of the RegistrantConsent of KPMG LLPRule 13a-14(a) Certification of CEORule 13a-14(a) Certification of CFOSection 1350 Certification of CEOSection 1350 Certification of CFOAudit Committee CharterCompensation Committee CharterNominating/Corporate Governance Committe Charter    Table of Contents  
 PART I 
 ITEM 1. BUSINESS General Zale Corporation, through its wholly owned subsidiaries (the Company),
is the largest and most diversified specialty retailer of fine jewelry in North
America. At July 31, 2004, the Company operated 2,234 specialty retail jewelry
stores and kiosks located mainly in shopping malls throughout the United States
of America (U.S.), Canada and Puerto Rico. The Company primarily operates
under seven brands, each targeted to reach a distinct customer. Zales Jewelers®
is the Companys national brand in the U.S. which provides traditional
moderately priced jewelry to a broad range of customers. Zales Jewelers has
extended the reach of its brand to the internet shopper through its e-commerce
site, Zales.com.The Company has further leveraged the brand strength through
Zales Fine Jewelry Outlet (formerly, Zales the Diamond Store Outlet), which
focuses on the brand conscious, value-oriented shopper in outlet malls and
neighborhood power centers. Peoples Jewellers®, the Companys national brand in
Canada, offers traditional moderately priced jewelry to customers throughout
Canada. Gordons Jewelers® in the U.S., and Mappins Jewellers® 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 jewelry stores that are considered among the finest
luxury jewelry stores in their markets, offering designer jewelry and watches
to attract more affluent customers. Piercing Pagoda® reaches the opening price
point fine jewelry customer primarily through mall-based kiosks. During the fiscal year ended July 31, 2004 (fiscal year 2004), the
Company generated $2.3 billion of net revenues. The Company believes it is
well-positioned to compete in the approximately $45 billion, highly fragmented
retail jewelry industry, leveraging its established brand names, economies of
scale and geographic and demographic diversity. The Company has 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
creatively designed 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 2004, the Company continued execution of its strategic plan
to increase brand differentiation, strengthen its infrastructure and position
the business to take advantage of identified long- term growth opportunities.
Key areas addressed by the strategy are improvements to the Companys supply
chain, which includes the creation of an internal sourcing and production
organization, the implementation of a real estate growth strategy, the building
of a more targeted and customer-focused marketing plan, the development of a
human resources vision and the establishment of a long-term information
technology direction. 2




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The Company believes its brand management strategy, which focuses on
aligning each brands product offerings and marketing stance with its
appropriate customer segment further differentiates its brands and provides
opportunity to capture market share. In fiscal year 2004, the Company
continued to capitalize on these strengths and maximize its opportunities
during the key gift-giving periods. Supply chain improvements were instrumental to the Companys success in
fiscal year 2004. A centralized product sourcing organization was established
to coordinate the purchase and assembly of cut and polished diamond solitaire
product. In the fall of fiscal year 2004, the Company began to assemble
solitaire rings, pendants and earrings for its Canadian brands. Direct
sourcing of these solitaire products has improved gross margins as well as
increased revenues, and was expanded to include certain domestic brands during
late fiscal year 2004. In the fiscal year ended July 31, 2005 (fiscal year
2005), the Company expects to increase production supplying both Gordons
Jewelers and Zales Fine Jewelry Outlet (Zales Outlet) with significant
portions of their solitaire needs. The Company also invested in a new
manufacturing system to support its diamond solitaire direct sourcing and
assembly initiative. This investment in increased production capacity should
enable the Company to handle the product demands of all brands. In addition to
the purchase and assembly of diamond solitaire products, direct sourcing from
overseas vendors also was identified as an opportunity for Piercing Pagoda to
be more up-to-the-moment with respect to fashion trends while reducing product
cost. In fiscal year 2004, the success of Piercing Pagodas direct sourcing
initiatives was critical to the Companys earnings improvement. The Company
expects direct sourcing to contribute additional improvements in merchandise
margin, strengthen the supply chain and allow the Company to be more flexible
and competitive in merchandising certain items over the next several years.
Direct sourcing contributed 50 basis points of gross margin improvement for
fiscal year 2004. Setting in motion the Companys long-term supply chain improvements, the
Company relocated its Piercing Pagoda distribution center to Dallas last
summer. The new facility was integral in supporting Piercing Pagodas strong
performance by shipping 47 percent more units than the same period last year,
while reducing overall unit cost significantly. Future plans include opening a
new integrated Canadian distribution and assembly center. The Company launched its growth strategy in fiscal year 2004 with projects
initiated to allow a more rapid expansion of its off-mall presence in fiscal
year 2005. At the center of the growth plans is Zales Fine Jewelry Outlet.
Expansion into value-oriented shopping centers with recognizable tenants such
as Bed Bath & Beyond, Office Depot, Target and Kohls is a natural extension of
the business that will continue leveraging the Zales brand, provide additional
flexibility to enter new markets and drive further traffic from a customer not
currently served. The target customer is seeking convenience and a full
service jewelry experience from a trusted brand. The plan includes opening 50
Zales Outlet stores in fiscal year 2005. The Company plans to further expand its off-mall presence with an urban
strategy to extend the reach of the Companys most established brand, Zales
Jewelers. A few years ago, the Company entered New York City with six Zales
stores, which provided the opportunity to gain market knowledge and fine tune
merchandise assortments. The Company believes over time, the New York City
market could reach $100 million in revenue. By increasing Zales presence in
New York City, the Company believes it will have the scale to capitalize its
marketing strengths more effectively and serve a customer that is very brand
loyal. Zales Jewelers growth potential also includes establishing a presence in
life-style centers across the country. The Company is currently testing this
format as the Company looks to leverage one of the most recognized brands in
jewelry. Additional growth vehicles include expansion of Piercing Pagoda in the
U.S. and introduction into Canada of a smaller cart version of the Piercing
Pagoda kiosk under the brand name Peoples II, which will leverage the product
strategies of Piercing Pagoda and the brand strength of the Companys Canadian
business. The Company intends to open up to 100 mall carts under the name
Peoples II during fiscal year 2005. The Company plans to open approximately 85 new stores, principally under
the brand names Zales Fine Jewelry Outlet and Zales Jewelers, and 50 Piercing
Pagoda kiosks for which it expects to incur an aggregate of approximately $32
million in capital expenditures during fiscal year 2005. The Company also 3




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plans to refurbish, remodel or relocate approximately 220 stores and
kiosks at a cost of approximately $24 million during fiscal year 2005. In fiscal year 2004, the Company also dedicated resources to improving the
effectiveness of its marketing function. The Company believes that knowledge
of its different types of customers and their behaviors has improved the
decision making capabilities with respect to its media buys and the message it
delivers to existing and potential customers. This increased awareness has
compelled the Company to further evolve the positioning of its key brands. This
knowledge, along with the Companys widely differentiated portfolio of brands,
allows it to meet the needs of the jewelry-buying consumer on a more personal
basis. These needs vary in importance depending on the person. Accordingly,
the communication strategy utilized for each brand will vary as well. Each
brand will emphasize different features  giving each brand a distinct look,
style and feel. The Companys goal is to establish predictive customer data to maximize
the effectiveness of its marketing efforts to its existing 25 million name
customer base, and target new opportunities to market its jewelry products to
individuals demonstrating a high propensity to respond. The database, combined
with improved statistical modeling capabilities, allows the Company to
interpret the overall brand message into resonant direct mail communications.
The Company is continuing to build upon these efforts through an initiative
called Personal Dynamic Marketing. The goal is to combine demographics,
lifestyle characteristics and transaction history into customized
communications to customers. Additionally the development and utilization of
proprietary clientele development systems is allowing the Company to place a
personal touch on these relationship efforts. Investments in Company infrastructure include the development of a
long-term human resource vision. At the center of this vision is an investment
in an integrated human resource and payroll information system to be
implemented in fiscal year 2005. The system is designed to provide on-line
employee access, eliminate manual processes, and provide detailed data analysis
to managers, allowing the Company to continuously enhance productivity.
Organizational improvements in fiscal year 2004 included a renewed focus on new
hire selection techniques and processes. Training and recruiting processes
were redesigned to promote management development across all areas of the
organization and improve quality and consistency across the brands. Centers of
Excellence in Training and Recruiting were established during the past year to
support these efforts. Integral to the training designed in fiscal year 2004 were programs
designed to strengthen management development. The development programs
consisted of sessions on communication, networking, interviewing, time
management, team building and coaching. The goal is to fine-tune the managers
skills and enhance their performance while ultimately better meeting the needs
of customers. The Company further supported the development of product knowledge of its
managers and sales associates through targeted training programs focused on
diamonds and precious gemstones. At the center of this effort is an arrangement
with the Diamond Council of America (DCA) to include training for key
managers and sales associates to increase their expertise in diamonds and
colored stones. Additionally, the Company has a well-developed buyer training
program to develop and train new buyers on merchandise and Company standards. The Company has also established a long-term information technology
strategy that links the Companys business needs with its technology efforts
and investments. The Company is committed to making the appropriate system
investments that allow it to adapt to new technologies, gain efficiencies and
achieve a competitive business advantage. The overall objective of these
efforts is to provide core capabilities and enable the business to grow. During
fiscal year 2004, the focus included support for direct sourcing, database
marketing and clientele development, enhancing the total marketing focus on the
customer, and the technology link to support the human resources strategy. In
fiscal year 2004, point-of-sale system upgrades included improved transaction
time with the Companys credit providers and benefiting customers through
reduced wait times. Additionally, store connectivity provides all stores with
on-line access, email availability, and more efficient store processes. As the Company moves into fiscal year 2005, it plans to increase its focus
on enhancing the store experience. The Company will be identifying the needs of
its sales associates and the desires of its 4




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customers with a focus on increasing transaction speed and enhancing
accessibility while improving performance. Current Year Stock Repurchase Plan.On August 5, 2004, 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, could purchase
up to an additional $50 million of its Common Stock. 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, could purchase up to an additional $100
million of its Common Stock. This approval, combined with repurchase
authorizations existing at the time, made possible the Companys repurchase of
a total of approximately $142 million worth of its Common Stock. As of July 31,
2004, the Company had purchased approximately 2.8 million shares at an
aggregate cost of $142 million, which completed its authorization under the
program. Stock Split. On May 18, 2004, the Company announced its Board of Directors
had approved a two-for-one split of the Common Stock. The stock split was
affected by issuing an additional share of Common Stock for each outstanding
share. The additional shares were distributed June 8, 2004, to shareholders of
record at the close of business on May 28, 2004. Accordingly, the Company
restated its earnings (loss) per share calculations, and reclassified amounts
between Common Stock and additional paid-in-capital to reflect the impact of
the stock split for all periods presented. In accounting for the stock split,
16.3 million shares of treasury stock were deemed reissued and an additional
9.6 million shares were issued. As the treasury shares that were reissued as
part of the stock split had been repurchased by the Company during the current
and previous fiscal years, treasury stock has only been reclassified to show
the effect of the stock split as of July 31, 2004. Industry and Competition The U.S. retail jewelry industrys sales were approximately $45 billion in
2004. Specialty retail jewelry stores (such as the Company) account for
approximately 60 percent of sales in 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 2004. 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 comprised 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 24 percent of the market. The
largest jewelry retailer is believed to be Wal-Mart Stores, Inc., which
includes a wide ranging assortment of costume jewelry, followed by the Company.
The Company is the largest specialty retail jewelry chain in North America,
with approximately eight percent of the U.S. 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. Jewelry retailing is highly competitive. 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, on-line 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 and/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. 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 ability to offer private label
credit card 5




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programs to customers wishing to finance their purchases. The Companys success
is also dependent on its ability to both 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 retail jewelry
industry. 6




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Operations The Company operates under seven principal brands. The following table
presents total revenues, average sales per location and the number of locations
for Zales, Zales Outlet, Gordons, Bailey Banks & Biddle, Peoples (including
Mappins stores), and Piercing Pagoda for the periods indicated. Year Ended July 31,2004
    
    2003
    
    2002Total Revenues (in thousands)Zales (includingZales.com)
    
    $
    1,070,576
    
    
    $
    1,040,537
    
    
    $
    1,004,223Zales Outlet
    
    
    137,613
    
    
    
    119,270
    
    
    
    112,366Gordons
    
    
    313,881
    
    
    
    314,345
    
    
    
    321,120Bailey Banks & Biddle
    
    
    326,086
    
    
    
    314,886
    
    
    
    315,002Peoples (a)
    
    
    174,058
    
    
    
    150,416
    
    
    
    147,466Piercing Pagoda
    
    
    269,660
    
    
    
    256,665
    
    
    
    273,225Insurance Revenues
    
    
    12,566
    
    
    
    16,122
    
    
    
    18,325$
    2,304,440
    
    
    $
    2,212,241
    
    
    $
    2,191,727Average sales per location (b)Zales
    
    $
    1,390,000
    
    
    $
    1,369,000
    
    
    $
    1,316,000Zales Outlet
    
    
    1,287,000
    
    
    
    1,261,000
    
    
    
    1,294,000Gordons
    
    
    1,101,000
    
    
    
    1,084,000
    
    
    
    1,063,000Bailey Banks & Biddle
    
    
    2,848,000
    
    
    
    2,702,000
    
    
    
    2,614,000Peoples
    
    
    1,041,000
    
    
    
    878,000
    
    
    
    856,000Piercing Pagoda
    
    
    339,000
    
    
    
    322,000
    
    
    
    312,000Locations opened during periodZales
    
    
    9
    
    
    
    13
    
    
    
    18Zales Outlet
    
    
    25
    
    
    
    4
    
    
    
    10Gordons
    
    
    9
    
    
    
    1
    
    
    
    2Bailey Banks & Biddle
    
    
    0
    
    
    
    1
    
    
    
    6Peoples
    
    
    5
    
    
    
    3
    
    
    
    4Piercing Pagoda
    
    
    24
    
    
    
    15
    
    
    
    872
    
    
    
    37
    
    
    
    48Locations closed during periodZales
    
    
    7
    
    
    
    15
    
    
    
    11Zales Outlet
    
    
    0
    
    
    
    0
    
    
    
    1Gordons
    
    
    9
    
    
    
    12
    
    
    
    6Bailey Banks & Biddle
    
    
    8
    
    
    
    5
    
    
    
    6Peoples
    
    
    9
    
    
    
    7
    
    
    
    5Piercing Pagoda
    
    
    39
    
    
    
    59
    
    
    
    6872
    
    
    
    98
    
    
    
    97Total LocationsZales
    
    
    757
    
    
    
    755
    
    
    
    757Zales Outlet
    
    
    121
    
    
    
    96
    
    
    
    92Gordons
    
    
    287
    
    
    
    287
    
    
    
    298Bailey Banks & Biddle
    
    
    108
    
    
    
    116
    
    
    
    120Peoples
    
    
    163
    
    
    
    167
    
    
    
    171Piercing Pagoda
    
    
    798
    
    
    
    813
    
    
    
    8572,234
    
    
    
    2,234
    
    
    
    2,295
  (a)
    
    Reflects all revenue from Canadian operations, which constitutes all
foreign operations of the Company. Long-lived assets from foreign
operations totaled approximately $23.2 million at July 31, 2004.(b)
    
    Based on merchandise sales for locations open a full twelve months during
the respective year. 7




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Zales Jewelers Zales, the Companys national flagship and the nations largest specialty
retail jeweler, is a leading brand name in jewelry retailing in the U.S. At
July 31, 2004, Zales had 757 stores in 50 states and Puerto Rico. Zales
average store size is 1,600 square feet, and the average selling price per
transaction totals $367. The Zales brand accounted for $1.1 billion or 47
percent of the Companys total revenues in fiscal year 2004. Zales merchandise selection is generally standardized across the nation
and targets customers representing a cross-section of mainstream America. In
fiscal year 2004, bridal merchandise represented 43 percent of merchandise
sales, while fashion jewelry and watches comprised the remaining 57 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 80
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 as well as its
key item strategy to drive sales during 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 fiscal year 2004, Zales introduced the Zales
Signature Collection, round and princess cut solitaire jewelry representing the
highest quality within the classic looks of the merchandise assortment. In
addition to the solitaires, the selection includes matching wedding bands and a
three stone collection. Together, the Zales Signature Collection and the Zales
Diamond, a proprietary stone introduced in 2002, offer the customer either a
combination of high standards in cut, color and clarity or the uniqueness of a
specialty cut. 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
events such as the Rockefeller Center Christmas Tree Lighting. Zales serves
the Internet customer through its e-commerce site, Zales.com, which accounted
for less than one percent of the Companys total revenues in fiscal year 2004
(see ZLC Directon page 11 for further discussion). Zales Fine Jewelry Outlet At July 31, 2004, the Company operated 121 Zales Fine Jewelry Outlet
stores in 35 states and Puerto Rico. The average store size is 2,400 square
feet, and the average transaction totals $349. Zales Outlet accounted for 6
percent of the Companys total revenues in fiscal year 2004. Zales Outlet
benefits from Zales brand recognition and national advertising programs. The outlet concept has evolved into one of the strongest concepts in
retail shopping today, featuring top brands in every major jewelry category.
The merchandise assortment in a typical Zales Outlet store caters to the brand
conscious and value-oriented female shopper, offering 20-70 percent off
traditional retail prices every day. 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 growth opportunity for Zales Outlet in the coming years
is expansion into power strip shopping centers. Such centers are
value-oriented and characterized by their convenience to the suburban customer
and such recognizable co-tenants as Bed Bath & Beyond, Office Depot, Target,
and Kohls. Although Zales Outlet was established as an extension of the Zales brand
and capitalizes on Zales national advertising and brand recognition, Zales
Outlet has built its own customer base, outside of the traditional Zales
customer. Zales Outlet offers its own unique product line and promotional
efforts geared specifically to the outlet consumer. In addition to fashion
forward styles 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 available only through Zales Outlet. Also, Zales
Outlets special collection of Exceptional Values offers good value on
best-selling items in each merchandise category. 8




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Gordons Jewelers Gordons is positioned as the Companys major regional brand. As of July
31, 2004, Gordons had 287 stores in 34 states and Puerto Rico. Average store
size is 1,500 square feet and the average transaction totals $411. Total
revenue at Gordons accounted for 14 percent of the Companys total revenues in
fiscal year 2004. The Company is continuing steps to differentiate the Gordons image from
that of other moderate jewelers, including store remodeling and improved
merchandise and marketing with a focus on leveraging its solid bridal business
and market position as the relationship expert. Gordons strives to distinguish itself by understanding local and regional
differences to tailor its assortments. By versioning its merchandise by
location, Gordons can meet each customers needs and desires. Gordons offers
a broad range of merchandise, such as diamond solitaires, jewelry set in
platinum and semi-precious gems. Additionally, Gordons has a larger and more
developed bridal business than the Companys other brands (46%) which reflects
its unique relationship with its customer. Gordons introduced the Gordons
Diamond, which is exclusive to Gordons, in the fiscal year ended July 31,
2003 (fiscal year 2003).  The Gordons Diamond collection was expanded to
also include a three-stone ring. In fiscal year 2005, this collection will
further be enhanced by the addition of a princess cut solitaire. Gordons utilizes a tailored approach in its marketing. Gordons
advertising consists primarily of television and direct mail. The marketing
will continue to evolve capitalizing upon the opportunity created by the bridal
business to establish Gordons as the relationship expert, a warm, friendly
place to obtain knowledgeable guidance on a significant jewelry purchase. Bailey Banks & Biddle Fine Jewelers For 172 years, Bailey Banks & Biddle has combined classic jewelry with
contemporary designs, offering a compelling shopping environment for the
high-end luxury consumer. Bailey Banks & Biddle locations are among the
pre-eminent stores in their markets. They carry both exclusive and recognized
branded and designer merchandise selections to appeal to the more affluent
customer. The Bailey Banks & Biddle merchandise assortments are carefully
selected to provide treasures that will be appreciated for generations with a
focus on diamonds, precious gemstones and gold jewelry, complemented by an
extensive assortment of prestige watch brands and giftware. At July 31, 2004, Bailey Banks & Biddle operated 108 upscale jewelry
stores in 31 states and Puerto Rico. The Company also utilizes the trade name
Zell Bros.® for one location operated by the Bailey Banks & Biddle brand.
Average store size is 3,700 square feet and the average transaction totals
$1,290. Total revenue at Bailey Banks & Biddle accounted for 14 percent of the
Companys total revenues in fiscal year 2004. Bailey Banks & Biddle has a large customer base and prospects with upscale
direct-mail catalogs and invitations to special events, enabling the stores to
focus on specific products tailored for specific customers. In fiscal year
2004, Bailey Banks & Biddle introduced a new branding campaign designed to
expand its increased brand awareness with a significant presence in nationally
distributed and high profile magazines such as Town & Country, Architectural
Digest, Departures, InStyle, Vogue, and W. In fiscal year 2005, Bailey Banks & Biddle expects to utilize targeted
direct mail and an extensive magazine campaign to further expand its customer
base. Bailey Banks & Biddle also plans to continue to utilize exclusive
private label merchandise, especially in markets which carry fewer branded
products, to provide unique assortments and compelling offerings. Extensive
ongoing training campaigns were developed in fiscal year 2004 that are expected
to enhance the shopping experiences for Bailey Banks & Biddle customers. In
fiscal year 2005, Bailey Banks & Biddle will continue to differentiate itself
as a premium jewelry store in key markets through site redesign. The Houston
Galleria opened as the brands flagship store in August 2004. Similar
renovations will follow in King of Prussia, Pennsylvania and Palm Beach
Gardens, Florida. 9




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Zale Canada Zale Canada operates 163 stores in nine provinces across Canada and enjoys
the largest market share of any jewelry retailer in Canada. The stores have an
average transaction totaling $280 and an average store size of 1,600 square
feet. Zale Canada accounted for 8 percent of the Companys total revenues in
fiscal year 2004. The organization operates under two banners, Peoples Jewellers and Mappins
Jewellers. 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 and 59. Using the trademark Peoples, the Diamond Store
in Canada, Peoples emphasizes its diamond business while also offering a wide
selection of gold jewelry, gemstone jewelry and watches. Due to the similarity
in marketing and store designs, Peoples Jewellers is able to leverage
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 in the Peoples
marketing campaign. Peoples also produces a seasonal bridal book, which is
mailed to customers twice a year. In fiscal year 2005, Peoples plans to leverage its brand strength and the
merchandise successes of Piercing Pagoda, with the opening of approximately 100
mall carts under the name Peoples II. Peoples II will be stocked primarily with
such merchandise as Italian charms, earrings, and body jewelry targeted at a
younger, fashion-forward customer. Mappins Jewellers continues to be a strong second brand in Canada.
Building on a history dating from 1936, Mappins is recognized as a jeweler
catering to the upscale 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 At the entry-level price point, Piercing Pagoda targets a young,
fashion-forward customer. Piercing Pagoda offers an extensive collection of
popularly priced bracelets, earrings, charms, rings, and 14 karat and 10 karat
gold chains, as well as a selection of silver and diamond jewelry, all in basic
styles at moderate prices. In addition, trained associates perform ear
piercing services on site. At July 31, 2004, Piercing Pagoda operated 798
locations in 42 states and Puerto Rico, under the names Piercing Pagoda, Plum
Gold, Silver and Gold Connection, and Piercing Pagoda+. Piercing Pagodas sales
represented 12 percent of the Companys total revenues in fiscal year 2004. Piercing Pagoda locations are generally located in high traffic concourses
of regional shopping malls. The kiosk locations average 200 square feet in size
and are easily accessible and visible within malls. In fiscal year 2004,
Piercing Pagodas average transaction totaled $36. The kiosks focus on the
opening price point customer. In fiscal year 2005, Piercing Pagoda plans to continue its expanded focus
on the key strategies it implemented during fiscal year 2004. Such initiatives
included an expanded offering of lower price point merchandise and
fashion-focused items including charms, earrings and body jewelry.
Additionally, increased assortments of silver, stainless steel and diamond
accent products are aimed at offsetting the decline in demand for gold
products. Piercing Pagoda will use its scale to create a competitive advantage
by expanding direct sourcing opportunities, which proved successful at
improving gross margin in fiscal year 2004. The Company will continue the
expansion of the updated kiosk design introduced in fiscal year 2004. The new
look, now implemented in approximately 165 locations, allows for greater
merchandise capacity and is expected to improve productivity. 10




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ZLC Direct For the on-line customer, the Company offers Zales.com. This e-commerce
site takes advantage of the recognized brand name and marketing power of Zales
Jewelers. During fiscal year 2004, Zales.comwas honored by an internet trade
magazine, Internet Retailer,as one of the Top 50 Internet Retailing Web Sites.
The magazine evaluated each candidate based on detailed knowledge of its
customers, how the web fits into its retailing strategy and its continual
improvement of the on-line shopping experience. The Company remains committed
to providing its customers with superior service and the best shopping
experience regardless of the channel they choose to shop. In fiscal year 2005,
the Company plans to launch a second brand e-commerce site under the Bailey
Banks & Biddle banner. This e-commerce site will leverage the Companys
existing e-commerce infrastructure, but be appropriately tailored to the luxury
jewelry customer in creative appeal and merchandise content. 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,
has certain discontinued business that it continues to run off. Credit
insurance operations are dependent on Company retail sales through its private
label credit cards. In fiscal year 2004, 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 $12.6 million, $16.1 million, and
$18.3 million are included in total revenues for fiscal years ended July 31,
2004, 2003 and 2002, respectively. Store Operations The Companys stores are designed to differentiate its brands, create an
attractive environment, make shopping convenient and enjoyable, and maximize
operating efficiencies. The Company focuses on store layout, particularly in
areas such as lighting, choice of materials and arrangement of display cases to
maximize merchandise presentation. Promotional displays are changed
periodically to provide variety 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, distribution
and payroll are consolidated at the corporate level in an effort to maintain
low operating costs at the store level. Each store offers standard warranties
and return policies, and provides extended warranty coverage that may be
purchased at the customers option.  In order to facilitate sales, stores will hold merchandise in layaway, generally requiring a
deposit of not less than 20% percent at the inception of the layaway transaction.  Stores on occasion utilize fully-paid
layaway transactions for other purposes, such as to obtain sale prices for customers in advance of an anticipated sales event.
Although not material to the financial statements, the Company is aware that, on limited occasions, store personnel have allowed
customers to leave with the merchandise recorded as a fully-paid layaway prior to the sale event to satisfy the customer.  The Company
is in the process of curtailing such activity. The Company has implemented inventory control systems, extensive security
systems and loss prevention procedures to maintain low inventory losses. In
fiscal year 2004, the Company continued to experience improvements with respect
to its internal 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. 11




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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 in-store communications and
service. The goal is to service the customer from the first sale by
maintaining a customer connection through client services. The Company has a
consolidated customer service call center to more effectively address customer
phone calls at lower aggregate cost. The Company increased the level and frequency of its employee training
programs in fiscal year 2004, particularly with store managers and key sales
associates. The Company also included training in sales techniques for new
employees, on-the-job training for all store personnel and management training
for store managers. Under the banner of Zale Corporation University, the
Company offers training to employees at every level of the organization. Purchasing and Inventory The Company purchases the majority 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 Companys headquarters. The Company currently purchases
the majority of 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 has
historically consisted of test programs, merchandise at higher price points or
merchandise that otherwise does not warrant the risk of ownership. Consignment
merchandise can be returned to the vendor at any time. The Company had
approximately $162 million and $171 million of consignment inventory on hand at
July 31, 2004 and 2003, respectively. During fiscal years 2004 and 2003, the
Company purchased approximately 30 percent and 33 percent, respectively, of its
merchandise from its top five vendors, including more than 11 percent from its
top vendor in fiscal year 2004. 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
activity 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
fiscal year 2004, the Company entered into foreign currency forward exchange
contracts to minimize the market risk from currency exchange rate exposure,
primarily associated with its Canadian brand, Peoples Jewellers. These
contracts are used to hedge certain forecasted inventory, advertising, and
purchases relating to capital investments anticipated to be incurred during the
fiscal year, denominated in foreign currencies for periods and amounts
consistent with the Companys identified exposures. In addition, the Company
entered into forward contracts for the purchase of some of its 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 could be affected by
industry-wide fluctuations in the prices of diamonds, gold, and other metals
and stones. The supply and prices of diamonds in the principal world markets
are significantly influenced by a single entity, the Diamond Trading Company,
which has traditionally controlled the marketing of a substantial majority of
the worlds supply of diamonds and sells rough diamonds to worldwide diamond
cutters at prices determined in its sole discretion. The availability of
diamonds to the Diamond Trading Company and 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 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. Within the jewelry industry 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 12




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the exclusion from the supply chain 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 credit
programs under its private label credit card program. Approximately 40 percent
and 42 percent, respectively, of the Companys U.S. total sales excluding
Piercing Pagoda, which does not offer proprietary credit, were generated by
proprietary credit cards in fiscal years 2004 and 2003. The Companys Canadian
propriety credit card sales represented approximately 27 percent of total sales
for both respective time periods. In fiscal year 2004, the Company expanded its proprietary credit offerings
to include Same As Cash options, as well as continued offerings of revolving
and interest free programs, all of which allowed the sales personnel to provide
the customer additional financing options . 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, Same as Cash). In the fiscal year ended July
31, 2001 (fiscal year 2001), the Company converted its Canadian private label
credit agreement to Citi Commerce Solutions Canada. Employees As of July 31, 2004, 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 temporary employees
during each Holiday season. 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 generating a proportionally greater
percentage of annual sales, earnings from operations and cash flow than the
other three quarters. Management expects such seasonality to continue. Information Technology The Companys technology 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); (v) customer care and (vi) 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
accurate 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 increasing the merchants ability to be responsive to
changes in customer behavior. The Company is also improving the connectivity
between stores and the Companys corporate headquarters to enhance operating
efficiencies and speed of transmission. 13




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The Companys information technology systems and processes allow
management to monitor, review and control operational performance on a daily,
monthly, quarterly and annual basis for each store and each transaction. Senior
management can review and analyze activity by store, amount of sale, terms of
sale or employees who sell the merchandise. 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. The Company believes that by outsourcing this portion of its
information technology systems it will continue to achieve additional
efficiencies and allow the Company to focus its resources on developing and
enhancing strategic initiatives. The Company has historically upgraded, and expects to continue to upgrade,
its information systems to improve operations and support future growth. The
Company estimates it will make capital expenditures of approximately $11
million in fiscal year 2005 for enhancements to its information systems and
infrastructure. Fiscal year 2005 expenditures will include: implementation of a
new human resource and payroll system designed to significantly streamline the
data capture processing and utilization of payroll and employee life-cycle
information, several technology infrastructure projects and the launch of the
Bailey Banks & Biddle e-commerce site. 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 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. The Company is subject to
federal and state regulations requiring retailers offering merchandise at
promotional prices to offer the merchandise at regular or original prices for
stated periods of time. Additionally, the Company is subject to certain
truth-in-advertising and various other laws, including consumer protection
regulations that regulate retailers generally and/or the promotion and sale of
jewelry in particular. The Company monitors changes in those laws and believes
that it is in material compliance with applicable laws with respect to such
practices. 14




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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 of 1934, as amended
(the Exchange Act) (Forms 3, 4 and 5), on the Companys website at
http://www.zalecorp.com, under the heading Shareholder Information-SEC
Filings. 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 as well as, 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, under the
heading Corporate Governance. 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 web site at http://www.zalecorp.com, under the
heading Corporate Governance-Code of Business Conduct and Ethics. Waivers of
the Code will be disclosed in a SEC filing on Form 8-K. 15




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Cautionary Notice Regarding Forward-Looking Statements The Company makes forward-looking statements in this Annual Report on Form
10-K and in other reports the Company files with the SEC. In addition, members
of the Companys senior management may make forward-looking statements orally
in presentations to analysts, investors, the media and others. Forward-looking
statements include statements regarding the Companys objectives and
expectations with respect to sales and earnings, merchandising and marketing
strategies, store renovation, remodeling and expansion, inventory management
and performance, liquidity and cash flows, capital structure, capital
expenditures, development of its information technology plan and related
management information systems, e-commerce initiatives, human resource initiatives and other statements
regarding the Companys plans and objectives. In addition, the words
anticipate, estimate, project, intend, expect, believe, forecast,
can, could, should, will, may, or similar expressions may identify
forward looking statements, but some of these statements may use other
phrasing. These forward-looking statements are intended to relay the Companys
expectations about the future, and speak only as of the date they are made.
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. 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. Some of these factors are described
below. Many of these factors, both described and not described, are beyond the
Companys control. If the general economy performs poorly, discretionary spending on goods that
are, or are perceived to be, luxuries may not grow and may even decrease. Jewelry purchases are discretionary and may be affected by adverse trends
in the general economy (and consumer perceptions of those trends). In
addition, a number of other factors affecting disposable consumer income such
as employment, wages and salaries, business conditions, credit availability and
taxation policies, for the economy as a whole and in regional and local markets
where the Company operates, can impact sales and earnings. The concentration of a substantial portion of the Companys sales in three,
relatively brief selling seasons means that the Companys performance is more
susceptible to disruptions. A substantial portion of the Companys sales are derived from three
selling seasons  Holiday (Christmas), Valentines Day, and Mothers Day. Because of the
briefness of these three selling seasons, the opportunity for sales to recover
in the event of a disruption or other difficulty is limited, and the impact of
disruptions and difficulties can be significant. For instance, adverse
weather (such as a blizzard), a significant interruption in the receipt of
products (whether because of vendor or other product problems), or a sharp
decline in mall traffic occurring during one of these selling seasons, could
materially impact sales for the affected season and, because of the importance
of each of these selling seasons, could materially impact overall sales and
earnings. Most of the Companys sales are of products that include diamonds, precious
metals and other commodities, and fluctuations in the availability and pricing
of commodities could impact the Companys ability to obtain and produce
products at favorable prices. The supply and price of diamonds in the principal world markets are
significantly influenced by a single entity, which has traditionally controlled
the marketing of a substantial majority of the worlds supply of diamonds and
sells rough diamonds to worldwide diamond cutters at prices determined in its
sole discretion. The availability of diamonds also is somewhat dependent on
the political conditions in diamond-producing countries and on continuing
supply of arrangements for raw diamonds. Any sustained interruption in this
supply could have an adverse affect on the Company. The Company also is affected by fluctuations in the price of diamonds,
gold and other commodities. The Company historically has engaged in only a
limited amount of hedging against fluctuations in the costs of gold. A
significant change in prices of key commodities could adversely affect 16




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the Companys business by reducing operating margins or decreasing
consumer demand if retail prices are increased significantly. The Companys sales are dependent upon mall traffic. The Companys stores and kiosks are located primarily in shopping malls
throughout the United States, Canada and Puerto Rico. The Companys success is
in part dependent upon the continued popularity of malls as a shopping
destination and the ability of malls, their tenants and other mall attractions
to generate customer traffic. Accordingly, a significant decline in this
popularity, especially if it is sustained, would substantially harm the
Companys sales and earnings. The Company operates in a highly competitive industry. The retail jewelry business is highly competitive, and the Company
competes with nationally recognized jewelry chains as well as a large number of
independent regional and local jewelry retailers and other types of retailers
who sell jewelry and gift items, such as department stores, mass merchandisers
and catalog showrooms. The Company also is beginning to compete with internet
sellers of jewelry. Because of the breadth and depth of this competition, the
Company constantly is under competitive pressure that both constrains pricing
and requires extensive merchandising efforts in order for the Company to remain
competitive. Any failure by the Company to manage its inventory effectively will negatively
impact sales and earnings. The Company purchases much of its inventory well in advance of each
selling season. In the event the Company misjudges consumer preferences or
demand, the Company will experience lower sales than expected and will have
excessive inventory that may need to be written down in value or sold at prices
that are less than expected. Because of the Companys dependence upon a small number of landlords for a
substantial number of the Companys locations, any significant erosion of the
Companys relationships with those landlords would negatively impact the
Companys ability to obtain and retain store locations. The Company is significantly dependent on its ability to operate stores in
desirable locations with capital investment and lease costs that allow the
Company to earn a reasonable return on its locations. The Company depends on
the leasing market and its landlords to determine supply, demand, lease cost
and operating costs and conditions. The Company cannot be certain as to when
or whether desirable store locations will become or remain available to the
Company at reasonable lease and operating costs. Further, several large
landlords dominate the ownership of prime malls, and the Company is dependent
upon maintaining good relations with those landlords in order to obtain and
retain store locations on optimal terms. From time-to-time the Company does
have disagreements with its landlords and a significant disagreement if not resolved, could have an adverse impact on the Company. Changes in regulatory requirements relating to the extension of credit may
increase the cost of or adversely affect the Companys operations. 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 aggregate
amount of finance charges that may be charged by a credit provider. Any change
in the regulation of credit (including changes is the application of current
laws) which would materially limit the availability of credit to the Companys
customer base could adversely affect the Companys sales and earnings. 17




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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. The Companys agreement with Citi, through which Citi provides financing
for the Companys
customers to purchase merchandise through private label credit cards,
enhances the Companys ability to provide consumer credit and write credit
insurance. Any disruption in, or change to, this agreement could have an
adverse effect on the Company, especially to the extent that it materially
limits credit availability to the Companys customer base. Acquisitions involve special risks, including the possibility that the Company
may not be able to integrate acquisitions into its existing operations. The Company has made significant acquisitions in the past and may in the
future make additional acquisitions. Difficulty integrating an acquisition
into the Companys existing infrastructure and operations may cause the Company
to fail to realize expected return on investment through revenue increases, cost savings, increases in
geographic or product presence and customer reach, and/or other projected
benefits from the acquisition. Additionally, attractive acquisition
opportunities may not be available at the time or pursuant to terms acceptable
to the Company. 18




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ITEM 2. PROPERTIES The Company leases a 430,000 square foot corporate headquarters facility,
which lease extends through 2018. The facility is located in Las Colinas, a
planned business development in Irving, Texas, near the Dallas/Fort Worth
International Airport. The Company leases approximately 40,000 square feet of
warehouse space that in June 2003, was subleased to a third party through the
remainder of the lease term, which extends through March 2009. Another 73,000
square foot building owned by the Company located in Bethlehem, Pennsylvania
served as the primary distribution center for Piercing Pagoda. The Company
plans to sell this building and is currently holding it available for sale. On
August 31, 2004, the Company sold a 69,000 square foot building located
adjacent to the Bethlehem property that was previously used for additional
distribution and warehousing functions at Piercing Pagoda. The Company leases a
7,400 square foot distribution and warehousing facility in Toronto, Ontario,
Canada for Peoples Jewellers. This lease extends to October 2005. The Company
intends to expand its Canadian distribution operations in late fiscal year
2005, which could result in relocation of this facility. 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 in term 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 Company leases 19 percent of its store and kiosk locations from Simon
Property Group and 13 percent of its store and kiosk locations from General
Growth Management, Inc. Otherwise, the Company has no relationship with any
lessor relating to 10 percent or more of its store and kiosk locations. The following table indicates the expiration dates of the current terms of
the Companys leases as of July 31, 2004: PercentageTerm Expires
    
    Stores
    
    Kiosks
    
    Other
    
    Total
    
    Of Total2005 and prior
    
    
    207
    
    
    
    340
    
    
    
    3
    
    
    
    550
    
    
    
    24.4
    %2006
    
    
    165
    
    
    
    186
    
    
    
    4
    
    
    
    355
    
    
    
    15.8
    %2007
    
    
    188
    
    
    
    97
    
    
    
    3
    
    
    
    288
    
    
    
    12.8
    %2008
    
    
    181
    
    
    
    104
    
    
    
    1
    
    
    
    286
    
    
    
    12.7
    %2009 and thereafter
    
    
    719
    
    
    
    47
    
    
    
    7
    
    
    
    773
    
    
    
    34.3
    %Total number of leases
    
    
    1,460
    
    
    
    774
    
    
    
    18
    
    
    
    2,252
    
    
    
    100.0
    %
 Management believes substantially all of the store leases expiring in
fiscal year 2005 that it wishes to renew (including leases which expired
earlier and are currently being operated under month-to-month extensions) will
be renewed on terms not materially less favorable to the Company than the terms
of the expiring leases. Management believes its facilities are suitable and
adequate for the Companys business as presently conducted. 
 ITEM 3. LEGAL PROCEEDINGS The Company is involved in 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. 
 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, 2004. 19




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##### Table of Contents



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 his or her successor is elected and qualified, or
until his or her earlier resignation, removal from office or death. Name
    
    Age
    
    PositionExecutive Officers:Mary L. Forté
    
    
    53
    
    
    President, Chief Executive Officer and DirectorSue E. Gove
    
    
    46
    
    
    Executive Vice President, Chief Operating Officer and DirectorMark R. Lenz
    
    
    48
    
    
    Group Senior Vice President, Chief Financial OfficerPamela J. Romano
    
    
    46
    
    
    Group Senior Vice President and President, Zales JewelersGregory Humenesky
    
    
    53
    
    
    Senior Vice President, Human ResourcesKey Employees:Charles E. Fieramosca
    
    
    56
    
    
    Senior Vice President and President, Bailey Banks & Biddle Fine
JewelersFrank C. Mroczka
    
    
    46
    
    
    Senior Vice President and President, Gordons JewelersPaul G. Leonard
    
    
    49
    
    
    Senior Vice President and President, Piercing PagodaJohn A. Zimmermann
    
    
    45
    
    
    Senior Vice President and President, Peoples JewellersNancy O. Skinner
    
    
    54
    
    
    Senior Vice President and President, Zales Fine Jewelry OutletAshlee Aldridge
    
    
    35
    
    
    Senior Vice President, Chief Information OfficerCynthia T. Gordon
    
    
    40
    
    
    Senior Vice President, ControllerStephen C. Massanelli
    
    
    48
    
    
    Senior Vice President, Real EstateErvin G. Polze
    
    
    52
    
    
    Senior Vice President, Support OperationsBernard M. Sensale, Jr
    
    
    42
    
    
    Senior Vice President, MarketingGeorge J. Slicho
    
    
    55
    
    
    Senior Vice President, Loss PreventionStephen L. Strong
    
    
    44
    
    
    Senior Vice President, Executive
Vice President, Store Operations, Zales JewelersCharleen R. Wuellner
    
    
    53
    
    
    Senior Vice President, President, Corporate MerchandisingHilary Molay
    
    
    50
    
    
    Vice President, General Counsel and 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 Jewelers, 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 Federated Department
Store. From July 1989 to July 1991, Ms. Forté was Vice President of Richs
Department Stores, Housewares Division. In addition to the above, Ms. Forté has
an additional 14 years of retailing and merchandising experience with Macys,
The May Department Stores Company, Inc. and Federated Department Stores. 20




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##### Table of Contents



Ms. Sue E. Govewas appointed Chief Operating Officer effective August 1,
2002 and appointed to the Board of Directors effective September 23, 2004. She
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 capacities until her appointment to Vice President in 1989.
Prior to joining the Company, Ms. Gove was an accountant at Data General
Corporation. 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.
Prior to joining the Company, Ms. Romano held various merchandising positions
with Macys. Mr. Gregory Humeneskywas promoted to 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. 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 served in numerous
positions 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 for the Company. 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 at Federated Department Stores, where he served as Divisional Vice
President for Womens Fashion Accessories for The Bon Marché. 21




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##### Table of Contents



Ms. Nancy O. Skinnerwas promoted to Senior Vice President and President
of Zales Fine Jewelry Outlet in August 2003. Ms. Skinner served as Vice
President and Senior Vice President of Merchandising, Zales Fine Jewelry Outlet
from April 2001 to July 2003. From May 1998 to April 2001, Ms. Skinner was a
Diamond Buyer for Zales Fine Jewelry 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. Ashlee Aldridgewas promoted to Senior Vice President, Chief
Information Officer in May 2004. Ms. Aldridge joined the Company in October
2003 as Vice President of Strategic Development. Prior to joining the
Company, Ms. Aldridge served in various positions in the internal
audit division of Deloitte & Touche in Dallas, Texas from June 1999
to September 2003. Ms. Cynthia T. Gordonwas promoted to 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. Stephen C. Massanelliwas appointed Senior Vice President, Real Estate
in May 2004. Mr. Massanelli joined the Company in June 1997 as Senior Vice
President, Treasurer. From 1993 to 1997, Mr. Massanelli was a principal and
member of the Board of Directors of The Treadstone Group, Inc., a private
merchant banking organization in Dallas. Prior to 1993, Mr. Massanelli served
in various financial roles at 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 capacities until his appointment to Vice
President in March 1988. Prior to 1983, Mr. Polze served in accounting roles
with Continental Emsco, a division of LTV Corporation and in the audit division
of Arthur Young, LLP in Dallas, Texas. Mr. Bernard M. Sensale, Jr.was 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 the Company in 1995
as Vice President of Marketing & Planning for Bailey Banks & Biddle. Prior to
joining the Company, Mr. Sensale was Vice President, General Merchandise
Manager for Ames Department Stores. Mr. George J. Slichowas promoted to the position of Senior Vice
President, Loss Prevention in November 2000. Mr. Slicho began his career with
the Company in March 1991 as Vice President of Loss Prevention. Prior to
joining the Company, Mr. Slicho held various positions in corporate security,
including Vice President of Loss Prevention and Audit for P.A. Bergner &
Company. In addition, Mr. Slicho served as a special agent in various field
offices of the Federal Bureau of Investigation. Mr. 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. 22




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##### Table of Contents



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
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
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., Trial Attorney, U.S.
Department of Justice, and Judicial Law Clerk, Court of Appeals of Maryland. 23




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##### Table of Contents



PART II 
  ITEM 5.
    MARKET FOR THE REGISTRANTS COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES 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. The market prices set forth below have
been adjusted to give retroactive effect to the Companys two-for-one stock
split completed on June 8, 2004. 2004
    
    2003High
    
    Low
    
    High
    
    LowFirst
    
    $
    26.03
    
    
    $
    22.05
    
    
    $
    16.33
    
    
    $
    13.25Second
    
    
    28.05
    
    
    
    25.14
    
    
    
    18.86
    
    
    
    14.33Third
    
    
    31.30
    
    
    
    26.85
    
    
    
    17.50
    
    
    
    14.18Fourth
    
    
    28.58
    
    
    
    25.12
    
    
    
    24.34
    
    
    
    17.03
 As of September 24, 2004, the outstanding shares of Common Stock were held
by approximately 651 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 or repurchase its Common Stock if borrowing availability under its
$500 million revolving credit facility (the Revolving Credit Agreement) is
less than $75 million. At July 31, 2004, the Company had borrowing availability
under the Revolving Credit Agreement of approximately $302.5 million. See
Managements Discussion and Analysis of Financial Condition and Results
Operations  Liquidity and Capital Resources and Notes to the Consolidated
Financial Statements  Long Term Debt. 24




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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 fiscal years ended July 31, 2004, 2003, 2002, 2001, and 2000 have
been derived from the Companys audited Consolidated Financial Statements. Year Ended July 31,2004
    
    2003
    
    2002
    
    2001
    
    2000(amounts in thousands, except per share amounts)Total revenues (a)
    
    $
    2,304,440
    
    
    $
    2,212,241
    
    
    $
    2,191,727
    
    
    $
    2,087,199
    
    
    $
    1,834,090Costs and expenses:Cost of sales (b)
    
    
    1,122,946
    
    
    
    1,101,030
    
    
    
    1,083,053
    
    
    
    1,034,913
    
    
    
    930,826Special Inventory Charge
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    25,236
    
    
    
    Selling, General and
Administrative expenses
    
    
    942,796
    
    
    
    884,069
    
    
    
    873,265
    
    
    
    818,205
    
    
    
    644,487Cost of insurance operations
    
    
    5,963
    
    
    
    8,228
    
    
    
    8,620
    
    
    
    5,589
    
    
    
    5,928Depreciation and amortization
Expense
    
    
    56,381
    
    
    
    55,690
    
    
    
    58,340
    
    
    
    58,290
    
    
    
    42,431Impairment of Goodwill
    
    
    
    
    
    
    136,300
    
    
    
    
    
    
    
    
    
    
    
    Unusual items (c)
    
    
    
    
    
    
    
    
    
    
    (1,202
    )
    
    
    4,713
    
    
    
    Operating earnings
    
    
    176,354
    
    
    
    26,924
    
    
    
    169,651
    
    
    
    140,253
    
    
    
    210,418Interest expense, net
    
    
    7,528
    
    
    
    6,319
    
    
    
    7,750
    
    
    
    6,857
    
    
    
    32,178Costs of Early Retirement of Debt
    
    
    
    
    
    
    5,910
    
    
    
    
    
    
    
    
    
    
    
    Earnings before income
taxes
    
    
    168,826
    
    
    
    14,695
    
    
    
    161,901
    
    
    
    133,396
    
    
    
    178,240Income taxes
    
    
    62,353
    
    
    
    55,340
    
    
    
    59,256
    
    
    
    51,348
    
    
    
    66,726Earnings (loss) before effect of
accounting change
    
    
    106,473
    
    
    
    (40,645
    )
    
    
    102,645
    
    
    
    82,048
    
    
    
    111,514Effect of change in accounting principle (d)
    
    
    
    
    
    
    
    
    
    
    (41,287
    )
    
    
    
    
    
    
    Net earnings (loss)
    
    $
    106,473
    
    
    $
    (40,645
    )
    
    $
    143,932
    
    
    $
    82,048
    
    
    $
    111,514Earnings (Loss) Per Common Share 
Basic:Before effect of change in
accounting principle
    
    $
    2.02
    
    
    $
    (0.63
    )
    
    $
    1.48
    
    
    $
    1.19
    
    
    $
    1.58Net Earnings (Loss) Per Share
    
    $
    2.02
    
    
    $
    (0.63
    )
    
    $
    2.08
    
    
    $
    1.19
    
    
    $
    1.58Earnings (Loss) Per Common Share 
Diluted:Before effect of change in
accounting principle
    
    $
    1.99
    
    
    $
    (0.63
    )
    
    $
    1.47
    
    
    $
    1.18
    
    
    $
    1.55Net Earnings (Loss) Per Share
    
    $
    1.99
    
    
    $
    (0.63
    )
    
    $
    2.07
    
    
    $
    1.18
    
    
    $
    1.55Weighted average number of common shares
outstanding: (e)Basic
    
    
    52,650
    
    
    
    64,528
    
    
    
    69,178
    
    
    
    69,150
    
    
    
    70,652Diluted
    
    
    53,519
    
    
    
    64,528
    
    
    
    69,692
    
    
    
    69,502
    
    
    
    71,766Balance Sheet Data:Working capital
    
    $
    582,888
    
    
    $
    532,443
    
    
    $
    561,939
    
    
    $
    512,418
    
    
    $
    651,505Total assets
    
    
    1,342,084
    
    
    
    1,294,106
    
    
    
    1,489,265
    
    
    
    1,408,029
    
    
    
    1,384,961Long-Term Debt
    
    
    197,500
    
    
    
    184,400
    
    
    
    86,749
    
    
    
    109,463
    
    
    
    109,369Total stockholders investment
    
    $
    726,114
    
    
    $
    652,323
    
    
    $
    939,807
    
    
    $
    840,563
    
    
    $
    781,777
  (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).(e)
    
    Outstanding share amounts have been adjusted to give retroactive effect to
a two-for-one stock split completed on June 8, 2004.Note: 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. 25




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##### Table of Contents



ITEM 7. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS With respect to forward-looking statements made in this Managements
Discussion and Analysis of Financial Condition and Results of Operations see
Business  Cautionary Notice Regarding Forward-Looking Statements. Executive Overview The Company is the largest and most diversified specialty retailer of fine
jewelry in North America. At July 31, 2004, the Company operated 2,234
specialty retail jewelry stores and kiosks located primarily in shopping malls
throughout the United States of America, Canada and Puerto Rico. The Company
primarily operates under seven brands, each targeted to reach a distinct
customer as described below:  
    
    Zales Jewelers (including Zales.com), the Companys national brand
in the United States of America provides traditional, moderately priced
jewelry to a broad range of customers.  
    
    Zales Fine Jewelry Outlet, (formerly Zales the Diamond Store
Outlet) focuses on the brand conscious, value-oriented shopper in
outlet malls and value-oriented neighborhood power centers.  
    
    Peoples Jewellers, the Companys national brand in Canada offers
traditional moderately priced jewelry to customers throughout Canada.  
    
    Gordons Jewelers targets the moderate and more discerning customer
with merchandise assortments designed to promote slightly higher priced
purchases and specifically caters to the bridal customer.  
    
    Mappins Jewellers in Canada targets the moderate and more
discerning customer with merchandise assortments designed to promote
slightly higher priced purchases.  
    
    Bailey Banks & Biddle Fine Jewelers operates jewelry stores that
are considered among the finest luxury jewelry stores in their markets,
offering designer jewelry and branded watches to attract more affluent
customers.  
    
    Piercing Pagoda reaches the opening price point fine jewelry
customer primarily through mall based kiosks. Company highlights for fiscal year 2004 include:  
    
    Achieved $2.3 billion in net revenues.  
    
    Established a centralized product sourcing organization to
coordinate the purchase and assembly of core diamond products.  
    
    Initiated direct sourcing efforts from overseas vendors to improve
product pricing and fashion orientation.  
    
    Implemented an expanded real estate strategy encompassing an
off-mall roll-out through Zales Fine Jewelry Outlet and a renewed urban
strategy in New York City for Zales Jewelers.  
    
    Enhanced database marketing capabilities to continue to improve the
effectiveness of its marketing function. Key Strategies for fiscal year 2004, which will continue to impact fiscal year 2005 include:  
    
    Internal sourcing and production  
    
    Real estate growth strategy  
    
    Targeted and customer focused marketing plan  
    
    A human resource vision  
    
    A long-term information technology direction See Part I. Item 1. Business for more detailed information regarding the
above Executive Summary. 26




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##### Table of Contents



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 31,2004
    
    2003
    
    2002Total Revenues
    
    
    100.0
    %
    
    
    100.0
    %
    
    
    100.0
    %Cost of Sales
    
    
    48.7
    
    
    
    49.8
    
    
    
    49.4Selling, General and Administrative Expenses
    
    
    40.9
    
    
    
    39.9
    
    
    
    39.8Cost of Insurance Operations
    
    
    0.3
    
    
    
    0.4
    
    
    
    0.4Depreciation and Amortization Expense
    
    
    2.5
    
    
    
    2.5
    
    
    
    2.7Impairment of Goodwill
    
    
    
    
    
    
    6.2
    
    
    
    Unusual Items
    
    
    
    
    
    
    
    
    
    
    Operating Earnings
    
    
    7.6
    
    
    
    1.2
    
    
    
    7.7Interest Expense, Net
    
    
    0.3
    
    
    
    0.3
    
    
    
    0.3Costs of Early Retirement of Debt
    
    
    
    
    
    
    0.2
    
    
    
    Earnings Before Income Taxes
    
    
    7.3
    
    
    
    0.7
    
    
    
    7.4Income Taxes
    
    
    2.7
    
    
    
    2.5
    
    
    
    2.7Earnings (Loss) Before Effect of Accounting Change
    
    
    4.6
    
    
    
    (1.8
    )
    
    
    4.7Effect of a Change in Accounting for the Write
Off of the Excess of Revalued Net Assets Over
Stockholders Investment
    
    
    
    
    
    
    
    
    
    
    (1.9
    )Net Earnings (Loss)
    
    
    4.6
    %
    
    
    (1.8
    )%
    
    
    6.6
    %
 Year Ended July 31, 2004 Compared to Year Ended July 31, 2003 Total Revenues.Total revenues for fiscal year 2004 were $2.304 billion,
an increase of 4.2 percent over total revenues for the prior fiscal year.
During fiscal year 2004, the Company opened 48 new stores and closed 33 stores.
In addition, the Company opened 24 kiosks and closed 39 kiosks during fiscal
year 2004. Comparable store sales increased 3.9 percent for the fiscal year as
compared to the prior fiscal year. Comparable store sales exclude amortization
of extended service agreements and include sales for those stores in their
thirteenth full month of operation. Total revenues include insurance premium
revenue for credit insurance operations of $12.6 million and $16.1 million,
respectively, for the fiscal years ending July 31, 2004 and 2003. The continued development of the core bridal business, which included the
launch of the Zales Signature collection and the expansion of Italian charms
and body jewelry in Piercing Pagoda, contributed to the total revenue increase. For the current fiscal year, all brands had positive comparable store
sales with Bailey Banks & Biddle in the luxury market and Piercing Pagoda in
the opening price point segment with the most positive results. Cost of Sales. Cost of sales as a percentage of revenues was 48.7 percent
for the fiscal year 2004, a decrease of 1.1 percentage points over last fiscal
year. The cost of sales decrease was primarily driven by the Companys direct
sourcing initiatives, which contributed 0.5 percentage points. In addition, the
receipt of cash consideration from vendors, which was previously recorded as a
reduction to selling, general and administrative expense (SG&A), is now
recorded as a reduction of inventory costs, contributed 0.5 percentage points. The Companys LIFO inventory provision was $2.1 million and $2.9 million
for the fiscal years ended July 31, 2004 and 2003, respectively. Selling General and Administrative Expenses.Selling, General, and
Administrative Expenses (SG&A) totaled $943 million, an increase of 6.7
percent over last fiscal year. As a percent of revenues, SG&A was 40.9 percent
for fiscal year 2004 compared to 39.9 percent for fiscal year 2003. The
increase as 27




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##### Table of Contents



a percentage of total revenues is primarily due to the
reclassification of cash consideration from vendors, which was previously
recorded as a reduction to SG&A to a reduction of inventory costs in accordance
with EITF 02-16, which represented an increase of approximately 0.8 percentage
points. Cost of Insurance Operations.The cost of insurance operations was $6.0
million, a decrease of 27.5 percent. As a percentage of revenues, cost of
insurance operations was slightly lower at 0.3 percent for the current fiscal
year, as compared to prior year at 0.4 percent. Depreciation and Amortization Expense.Depreciation and Amortization
Expense was $56.4 million, an increase of 1.2 percent, primarily due to the
purchase of new assets for new store openings, renovations, and refurbishments. Interest Expense, Net.Interest Expense, Net was $7.5 million and $6.3
million respectively for the fiscal years ended July 31, 2004 and 2003. The
increase of approximately $1.2 million is primarily a result of higher
outstanding debt balance during fiscal year 2004 resulting from the Companys
tender offer executed in July 2003. Income Taxes.The income tax provision for the fiscal years ended July 31,
2004 and 2003 was $62.3 million and $55.3 million, respectively, reflecting an
effective tax rate of 36.9 percent and 36.7 percent (excluding goodwill
impairment of $136.3 million recorded in the second quarter of the fiscal year
2003). 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, 2004, the
Company had a remaining NOL (after limitations) of $78.7 million. 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 exclude amortization of extended service agreements and
include sales for those stores in their thirteenth full month of operation.
Total revenues include insurance premium revenue for credit insurance
operations of $16.1 million and $18.3 million, respectively, for the fiscal
years ending July 31, 2003 and 2002. 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 Companys
brands, Zales Jewelers, Peoples Jewellers, and Bailey Banks & Biddle had a
positive performance that offset the negative performance of the other brands,
primarily Piercing Pagoda. Piercing Pagoda showed improvements in the fourth
quarter of fiscal year 2003 primarily due to the expansion of lower price point
merchandise, such as charms and body jewelry. Cost of Sales. Cost of sales as a percentage of revenues was 49.8 percent
for fiscal year 2003, an increase of 0.4 percentage points over fiscal year
2002. 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 inventory provision was $2.9 million and $1.4 million,
respectively, for the fiscal years ended July 31, 2003 and 2002. Selling, General and Administrative Expenses.Selling, General, and
Administrative Expenses (SG&A) were $884.1 million, an increase of 1.2
percent over fiscal year 2002. As a percent of revenues, SG&A was slightly
higher at 39.9 percent for fiscal year 2003 compared to 39.8 percent for fiscal
year 28




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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 fiscal year 2003,
as well as fiscal year 2002. 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 have been
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
one other smaller acquisition. The Company concluded that there was no
evidence of impairment related to the Goodwill of approximately $57.8 million
recorded for the Peoples acquisition and $5.0 million for one other smaller
acquisition. 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 was
included as a component of operating earnings in the 2003 consolidated
statement of operations, to reduce the carrying value of the Piercing Pagoda
goodwill to approximately $19.4 million for fiscal year 2003. 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, was 376.6 percent. The Company did 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. 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. 29




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Liquidity and Capital Resources The Companys cash requirements consist primarily of funding inventory
growth, capital expenditures primarily for new store growth and renovations of
the existing portfolio, upgrades to its management information systems and debt
service. As of July 31, 2004, the Company had cash and cash equivalents of
$63.1 million, of which approximately $5.5 million is restricted due to an
agreement with Citi Commerce Solutions (Citi), a subsidiary of Citigroup.
This agreement requires the Company to pledge an amount as collateral to Citi
in the form of an interest-bearing depository account that will fluctuate
monthly based on the account balances of the shared risk credit 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, 2004 and the
three months ended January 31, 2003, 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. Cash Flow Activities Net cash provided by operating activities was $178.1 million, $164.8
million and $178.9 million for fiscal years 2004, 2003, and 2002, respectively.
In fiscal year 2004, the increase in cash provided by operating activities was
primarily due to the increase in earnings offset by the change in accounts
payable and inventories. There has been an increase of approximately $24
million in owned merchandise inventories at July 31, 2004 compared to the
balance at July 31, 2003. In fiscal year 2003, the net cash provided by
operating activities decreased from that of the prior year primarily due to the
change in accounts payable and inventory. Net cash used in investing activities was $60.0 million in fiscal year
2004, related to capital expenditures for new store openings, renovations and
refurbishments and net purchases of investments. Net cash used in investing
activities was $42.4 million in fiscal year 2003, mainly from capital
expenditure for new store openings and renovations. In fiscal year 2002, net
cash used in investing activities was $54.9 million, primarily from capital
expenditures for new store openings and renovations. Net cash used in financing activities was $90.7 million in fiscal year
2004, primarily related to the repurchase of approximately 2.8 million shares
of Common Stock offset slightly by borrowings under the new revolving credit
facility. Net cash used in financing activities was $172.5 million in fiscal
year 2003, principally related to the called and retired Senior Notes and the
repurchase of approximately 6.4 million shares of Common Stock, offset by
borrowing under the new revolving credit facility. 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 it incurred an $0.8 million loss
on retirement of debt. Finance Arrangements The Company entered into the Revolving Credit Agreement on July 23, 2003,
replacing its existing $225 million facility. The Revolving Credit Agreement
provides 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 loans made under the Revolving Credit Agreement bear interest at a
floating rate at either (i) the applicable LIBO Rate plus the applicable
margin, or (ii) the Base Rate plus the applicable margin. The margin
applicable to LIBOR based loans and standby letter of credit commission rates
will be automatically reduced or increased from time to time based upon excess
borrowing availability under the Revolving Credit Agreement. The Company pays a
commitment fee quarterly of .375 percent on the preceding months unused
commitment. The Company and its subsidiaries may repay the revolving credit
loans outstanding under the Revolving Credit Agreement at any time without
penalty prior to the maturity date. At July 31, 2004, there was $197.5 million
in borrowings outstanding under the Revolving Credit Agreement and the Company
had approximately $302.5 million in available borrowings. At July 31, 2004, 30




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##### Table of Contents



the applicable margin for LIBOR based loans was 1.50 percent and the applicable
margin for Base Rate loans was 0 percent. Under the Revolving Credit Agreement, 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 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. The Company is currently in compliance with all of its obligations
under the Revolving Credit Agreement. Capital Growth During the year ended July 31, 2004, the Company made $60.8 million of
capital expenditures, a portion of which was used to open 72 new stores and
kiosks and to remodel, relocate or refurbish other locations. The Company plans
to open 85 new stores, principally under the brand names Zales Jewelers and
Zales Fine Jewelry Outlet and 50 new kiosks, for which it expects to incur
approximately $32 million in capital expenditures during fiscal year 2005.
During fiscal year 2005, the Company anticipates spending approximately $24
million to remodel, relocate or refurbish 220 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
approximately $11 million during fiscal year 2005 for enhancements to its
management information systems and infrastructure expansion. In total, the
Company anticipates making $80 million of capital expenditures during fiscal
year 2005. Other Activities Affecting Liquidity  
    
    Stock Repurchase Plan On August 5, 2004, 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 could purchase up to an additional $50
million of its Common Stock. 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, could purchase up to an additional $100
million of its Common Stock. This approval, combined with repurchase
authorizations existing at the time, made possible the Companys repurchase of
a total of approximately $142 million worth of its Common Stock. As of July 31,
2004, the Company had purchased approximately 2.8 million shares at an
aggregate cost of $142 million, which completed its authorization under the
program. 31




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##### Table of Contents




    
    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 2004 was approximately $10.7 million. As of July 31, 2004, the
Company had a NOL (after limitations) of $78.7 million, which represents
up to $30.7 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 Aggregate information about the Companys contractual obligations as of
July, 31, 2004 is presented in the following table. Payments Due by PeriodLess
    
    
    
    
    
    
    
    
    
    MoreContractual Cash
    
    
    
    
    
    than
    
    1-3
    
    4-5
    
    thanObligations ($ in millions)
    
    Total
    
    1 Year
    
    Years
    
    Years
    
    5 Years
    
    OtherLong-Term Debt (a)
    
    $
    198
    
    
    
    
    
    
    
    
    
    
    $
    198
    
    
    
    
    
    
    
    Operating Leases (b)
    
    
    907
    
    
    
    173
    
    
    
    289
    
    
    
    206
    
    
    
    239
    
    
    
    Operation Services
Agreement (c)
    
    
    4
    
    
    
    4
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Other Long-term Liabilities (d)
    
    
    22
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    22Total
    
    $
    1,131
    
    
    $
    177
    
    
    $
    289
    
    
    $
    404
    
    
    $
    239
    
    
    $
    22
  (a)
    
    Long-term obligations relate to principal payments due under the
Companys Revolving Credit Agreement. (See Notes to Consolidated Financial
Statement-Long-Term Debt for further discussion).(b)
    
    Operating lease obligations relate to minimum payments due under store
lease agreements. (See Notes to Consolidated Financial Statements-Lease
Commitments for further discussion).(c)
    
    Operation Services Agreement relates to the contract with a third party
for the management of the Companys mainframe processing operations (See
Item 1. Business, Information Technology for further discussion).(d)
    
    Other long-term liabilities reflect future payments relating to the
Companys Post Retirement Benefits Plan. (See Notes to Consolidated
Financial Statements-Post Retirement Benefits for further discussion) and
loss reserves related to credit insurance. The Company has reflected these
payments under Other, as the timing of these future payments is
dependent on the actual processing of the claims.(e)
    
    Not included in the above table is the long-term portion ($21 million) of
the incentive payment received from Citi Commerce Solutions of $41.8
million. The incentive is amortized over the life of the contract and is
included in long-term liabilities on the accompanying Consolidated Balance
Sheet but does not impact cash payments in future periods. (See Notes to
Consolidated Financial Statements-Deferred Credit for further discussion).(f)
    
    Not included in the table above as purchase obligations are the Companys
ordinary course purchase orders for merchandise and obligations under
employment agreements.  
    
    Off-Balance Sheet ArrangementsCiti Commerce Solutions (Citi), a subsidiary of Citi Group, 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 contract 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 32




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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, 2004,
the Companys maximum potential payment would be approximately $30 million
if the entire portfolio defaulted. Under the shared risk programs, the
Company incurred approximately $362,000 of losses for the twelve months
ended July 31, 2004. As of July 31, 2004, the reserve for both portfolios is
approximately $861,000 which the Company believes is adequate based on the
historical trend of actual losses. As part of the shared risk programs, the
Company is required to pledge collateral to Citi in the form of 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, 2004 is approximately $5.5 million. Management believes that operating cash flow and amounts available under
the Revolving Credit Agreement should be sufficient to fund the Companys
current operations, debt service and currently anticipated capital expenditure
requirements for the foreseeable future. New Accounting Pronouncements 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 June 15, 2003. The Company adopted EITF 00-21 for the first quarter of
fiscal year 2004. The adoption of EITF 00-21 had no impact on its financial
position, results of operations or cash flows. In December 2003, SFAS 132, Employers Disclosures about Pensions and
other Post Retirement Benefits was revised (SFAS 132R). This statement
amends APB Opinion No. 28, Interim Financial Reporting to require
interim-period disclosure of the components of net periodic benefit cost and
the amounts of contributions and projected contributions to fund post
retirement benefit plans, if significantly different from prior period. The
interim-period disclosures requirements are effective for interim periods
beginning December 15, 2003. The Company does not expect SFAS 132R to require
any additional disclosure. In December 2003, the Securities and Exchange Commission (SEC) issued
Staff Accounting Bulletin No. 104 (SAB 104) Revenue Recognition. SAB 104
revises, clarifies or rescinds portions of Staff Accounting Bulletin No. 101
Revenue Recognition in Financial Statements. The adoption of SAB 104 had no
impact on the Companys financial position, results of operations or cash
flows. 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. Current market trends indicate rising diamond prices. If such
trends continue, the companys LIFO provision could be impacted. The Company
currently hedges a portion of its gold purchases through forward contracts.
There is no assurance that inflation will not materially affect the Company in
the future. 33




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Critical Accounting Policies and Estimates The preparation of financial statements and related disclosures in
conformity with accounting principles generally accepted in the U.S. 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,
tax, and contingencies. Estimates and assumptions are reviewed periodically and
the effects of revisions are reflected in the consolidated financial statements
in the period they are determined to be necessary. Management believes the following 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 and Mappins Jewellers of Canada is
valued using the first-in, first-out (FIFO) retail inventory method. Under
the retail method, inventory is segregated into categories of merchandise with
similar characteristics at its current 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.
The Company applies 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 U.S.
Bureau of Labor Statistics (BLS) producer price indices or other published
indices. 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 once annually for all store locations and for
the distribution centers. The shrinkage rate from the most recent physical
inventory, in combination with historical experience, 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 cash flow 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. 34




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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
2004, the Company performed its annual review for impairment of goodwill
related to its Piercing Pagoda Inc., Peoples Jewellers and one other smaller
acquisition. The Company concluded that there was no evidence of impairment
related to the goodwill of approximately $19.4 million for Piercing Pagoda,
$61.2 million recorded for the Peoples acquisition and $5.0 million for one
other smaller acquisition. In the second quarter of fiscal year 2003, the
Company did conclude 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. 104
Revenue Recognition. Revenue related to merchandise sales, which is
approximately 95 percent of total revenues, is recognized at the time of the
sale, reduced by a provision for 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 that are
recognized over the two year period in proportion to the costs expected to be
incurred in performing services under the agreements. Revenues also include
premiums from the Companys insurance businesses, 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. 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, 2004, the realization of its gross
deferred tax assets is more likely than not, and thus there was no valuation
reserve recorded. 35




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##### Table of Contents



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. The investments of the Companys insurance subsidiaries, primarily stocks
and bonds, had an approximate market value at July 31, 2004 of $24 million. Based on the Companys market risk-sensitive instruments (including
variable rate debt) outstanding at July 31, 2004, 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. 36




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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 2004, 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, 2004) Contract
    
    Fine Troy
    
    Contract Gold
    
    Fair MarketCommodity
    
    Settlement Date
    
    Ounces of Gold
    
    Price Per Ounce
    
    ValueGold
    
    08-06-04
    
    
    400
    
    
    $
    397.650
    
    
    $
    (2,623
    )Gold
    
    08-06-04
    
    
    185
    
    
    
    386.525
    
    
    
    845Gold
    
    08-06-04
    
    
    215
    
    
    
    386.395
    
    
    
    1,010Gold
    
    08-20-04
    
    
    400
    
    
    
    397.880
    
    
    
    (2,629
    )Gold
    
    08-20-04
    
    
    190
    
    
    
    386.750
    
    
    
    866Gold
    
    08-20-04
    
    
    210
    
    
    
    386.620
    
    
    
    984Gold
    
    09-07-04
    
    
    633
    
    
    
    398.177
    
    
    
    (4,146
    )Gold
    
    09-07-04
    
    
    200
    
    
    
    387.035
    
    
    
    918Gold
    
    09-07-04
    
    
    434
    
    
    
    386.910
    
    
    
    2,047Gold
    
    09-21-04
    
    
    634
    
    
    
    398.407
    
    
    
    (4,152
    )Gold
    
    09-21-04
    
    
    200
    
    
    
    387.260
    
    
    
    919Gold
    
    09-21-04
    
    
    433
    
    
    
    387.135
    
    
    
    2,045Gold
    
    10-07-04
    
    
    1,619
    
    
    
    398.670
    
    
    
    (10,510
    )Gold
    
    10-07-04
    
    
    400
    
    
    
    387.520
    
    
    
    1,863Gold
    
    10-07-04
    
    
    1,220
    
    
    
    387.390
    
    
    
    5,842Gold
    
    10-21-04
    
    
    1,620
    
    
    
    398.901
    
    
    
    (10,496
    )Gold
    
    10-21-04
    
    
    400
    
    
    
    387.745
    
    
    
    1,871Gold
    
    10-21-04
    
    
    1,219
    
    
    
    387.615
    
    
    
    5,859Gold
    
    11-08-04
    
    
    1,477
    
    
    
    399.197
    
    
    
    (9,359
    )Gold
    
    11-08-04
    
    
    300
    
    
    
    388.050
    
    
    
    1,443Gold
    
    11-08-04
    
    
    1,178
    
    
    
    387.905
    
    
    
    5,838Gold
    
    11-22-04
    
    
    1,478
    
    
    
    399.427
    
    
    
    (9,321
    )Gold
    
    11-22-04
    
    
    300
    
    
    
    388.255
    
    
    
    1,460Gold
    
    11-22-04
    
    
    1,177
    
    
    
    388.130
    
    
    
    5,874Gold
    
    12-07-04
    
    
    224
    
    
    
    399.674
    
    
    
    (1,369
    )Gold
    
    12-07-04
    
    
    225
    
    
    
    388.370
    
    
    
    1,169Gold
    
    12-21-04
    
    
    225
    
    
    
    399.905
    
    
    
    (1,364
    )Gold
    
    12-21-04
    
    
    224
    
    
    
    388.595
    
    
    
    1,175Gold
    
    01-07-05
    
    
    124
    
    
    
    388.865
    
    
    
    659Gold
    
    01-21-05
    
    
    124
    
    
    
    389.090
    
    
    
    666
 The Company generally enters into forward gold purchase contracts with
maturity dates of not longer than twelve months. 37




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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 exchange contracts. In fiscal year 2004,
the Company entered into foreign currency exchange contracts to reduce the
effect of fluctuating Canadian currency exchange rates. The table below
provides information about the companys derivative financial instruments that
are sensitive to Canadian currency exchange rates. Foreign Exchange Contracts(As of July 31, 2004) Contract
    
    Contract
    
    ContractCurrency
    
    Settlement Date
    
    Amount
    
    Exchange Rate
    
    Fair Market ValueUSD
    
    08-04
    
    $
    1,211,000
    
    
    
    1.322
    
    
    $
    11,612USD
    
    09-04
    
    
    721,000
    
    
    
    1.324
    
    
    
    6,203
 Energy ContractIn fiscal year 2003, 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. 38




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##### Table of Contents



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: PageIndex
    
    NumberManagements Report
    
    
    F-2Report of Independent Registered Public Accounting Firm
    
    
    F-3Consolidated Statements of Operations
    
    
    F-4Consolidated Balance Sheets
    
    
    F-5Consolidated Statements of Cash Flows
    
    
    F-6Consolidated Statements of Stockholders Investment
    
    
    F-8Notes to Consolidated Financial Statements
    
    
    F-10
 
 ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS AND FINANCIAL DISCLOSURE Not applicable 
 ITEM 9A. 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 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 9B. OTHER INFORMATION Not applicable 
 PART III 
 ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT 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 2004
Annual Meeting of Stockholders is incorporated herein by reference. In
addition, the information set forth under Executive Officers and Key Employees
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 2004 Annual
Meeting of Stockholders is incorporated herein by reference. 39




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##### Table of Contents



ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS 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 2004 Annual Meeting of Stockholders is incorporated herein by
reference. 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, 2004. Equity Compensation Plan Information Number of securitiesWeighted-
    
    remaining available for futureNumber of securities to
    
    average exercise
    
    issuance under equitybe issued upon exercise
    
    price of
    
    compensation plansof outstanding options
    
    outstanding
    
    (excluding securities reflectedPlan Category
    
    (1), (3)
    
    options
    
    in 1st column) (2), (3)Equity
compensation
plans approved
by security
holders
    
    
    3,922,132
    
    
    $
    20.81
    
    
    
    5,328,100Equity
compensation
plans not
approved by
security
holders
    
    
    
    
    
    
    
    
    
    
    Total
    
    
    3,922,132
    
    
    $
    20.81
    
    
    
    5,328,100
  (1)
    
    Includes securities to be issued upon the exercise of outstanding options
under the Zale Corporation Omnibus Stock Incentive Plan, the Zale
Corporation 2003 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 and the Zale
Corporation 2003 Stock Incentive Plan.  (3)
    
    The number of shares to be issued upon exercise of outstanding options
and the number of securities available for future issuance under the
equity compensation plans were proportionally adjusted to give effect to
the Companys two-for-one stock split completed on June 8, 2004. 
 ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS Not applicable 
 ITEM 14. 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 2004 Annual
Meeting of Stockholders is incorporated herein by reference. 40




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##### Table of Contents



PART IV 
 ITEM 15. 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. 41




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##### Table of Contents



3. Exhibits Each management contract or compensation plan required to be filed as an
exhibit is identified by an asterisk (*). The filings referencedfor incorporation by reference areZale Corporation filings (File No.Exhibit Number
    
    Description of Exhibit
    
    1-04129) unless otherwise noted3.1
    
    Restated Certificate of Incorporation of Zale Corporation
    
    October 31, 2001 Form 10-Q,
Exhibit 3.13.2
    
    Bylaws of Zale Corporation
    
    July 31, 2000 Form 10-K,
Exhibit 3.24.1
    
    Revolving Credit Agreement, dated as of July 23, 2003
    
    July 31, 2003 Form 10-K,
Exhibit 4.110.1a*
    
    Zale Corporation Savings and Investment Plan
    
    July 31, 2000 Form 11-K,
Exhibit 9910.1b*
    
    Amendment to Zale Corporation Savings and Investment Plan
    
    July 31, 2001 Form 11-K,
Exhibit 9910.2*
    
    Form of Indemnification Agreement between Zale
Corporation and its directors
    
    July 31, 1995 Form 10-K
Exhibit 10.210.3*
    
    Zale Corporation Omnibus Stock Incentive Plan
    
    July 31, 2000 Form 10-K,
Exhibit 10.3a10.4a*
    
    Zale Corporation 2003 Stock Incentive Plan
    
    July 31, 2003 Form 10-K,
Exhibit 10.410.4b
    
    Form of Stock Option Award
Agreement
    
    Filed herewith.10.4c
    
    Form of Restricted Stock Award
Agreement
    
    Filed herewith.10.5*
    
    Outside Directors 1995 Stock Option Plan
    
    July 31, 2001 Form 10-K,
Exhibit 10.3c10.6a*
    
    Executive Severance Plan
    
    Form S-1 (Reg. No. 33-27225),
Exhibit 10.2310.6b*
    
    Amendment to Executive Severance Plan
    
    July 31, 1996 Form 10-K,
Exhibit 10.8a10.7a
    
    Lease Agreement for Corporate Headquarters
    
    July 31, 1996 Form 10-K,
Exhibit 10.11
 42




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##### Table of Contents



The filings referencedfor incorporation by reference areZale Corporation filings (File No.Exhibit Number
    
    Description of Exhibit
    
    1-04129) unless otherwise noted10.7b
    
    First Amendment to Lease Agreement for Corporate
Headquarters
    
    July 31, 1996 Form 10-K,
Exhibit 10.11a10.7c
    
    Second Amendment to Lease Agreement for Corporate
Headquarters
    
    Filed herewith.10.8*
    
    Employment Agreement with Mary L.
Forté, dated as of
August 1, 2002
    
    July 31, 2002 Form 10-K,
Exhibit 10.910.9*
    
    Employment Agreement with Sue E. Gove, dated as of August
1, 2002
    
    July 31, 2002 Form 10-K,
Exhibit 10.1010.10*
    
    Employment Agreement with Mark R. Lenz dated as of
August 1, 2003
    
    July 31, 2003 Form 10-K,
Exhibit 10.1210.11*
    
    Employment Agreement with Pamela J. Romano dated as of
February 28, 2003
    
    July 31, 2003 Form 10-K,
Exhibit 10.1310.12*
    
    Zale Corporation Executive Bonus Plan
    
    July 31, 2003 Form 10-K,
Exhibit 10.1510.13
    
    Amendment to Citibank USA, N.A. Agreement, dated as of
April 4, 2003
    
    April 30, 2003 Form 10-Q,
Exhibit 99.210.14*
    
    Form of Change of Control Agreement of Senior Vice
Presidents without separate employment agreements
    
    Filed herewith.14
    
    Code of Ethics
    
    July 31, 2003 Form 10-K,
Exhibit 1421
    
    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.99.1
    
    Audit Committee Charter
    
    Filed herewith.99.2
    
    Compensation Committee Charter
    
    Filed herewith.99.3
    
    Nominating/Corporate Governance Committee Charter
    
    Filed herewith.
 43




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##### Table of Contents



4. Reports on Form 8-K  1)
    
    On May 6, 2004, the Company filed a Current Report on Form 8-K under Item
12, Results of Operation and Financial Condition to furnish a press
release reporting its sales results for the third quarter ended April 30,
2004.2)
    
    On May 18, 2004, the Company filed a Current Report on Form 8-K under
Item 12, Results of Operation and Financial Condition to furnish a press
release reporting its financial results for the third quarter ended April
30, 2004. 44




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##### Table of Contents



INDEX TO CONSOLIDATED FINANCIAL STATEMENTS PageManagements Report
    
    
    F-2Report of Independent Registered Public Accounting Firm
    
    
    F-3Consolidated Statements of Operations
    
    
    F-4Consolidated Balance Sheets
    
    
    F-5Consolidated Statements of Cash Flows
    
    
    F-6Consolidated Statements of Stockholders Investment
    
    
    F-8Notes to Consolidated Financial Statements
    
    
    F-10
 F- 1




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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, 2004 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. LenzPresident, Chief Executive Officer
    
    Group Senior Vice President,and Director
    
    Chief Financial OfficerOctober 12, 2004
    
    October 12, 2004
 F- 2




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##### Table of Contents



REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM To the Stockholders and Board of Directors of Zale Corporation: We have audited the accompanying consolidated balance sheets of Zale
Corporation and subsidiaries as of July 31, 2004 and 2003, and the related
consolidated statements of operations, stockholders investment and cash flows
for each of the years in the three-year period ended July 31, 2004. These
consolidated financial statements are the responsibility of the Companys
management. Our responsibility is to express an opinion on these consolidated
financial statements based on our audits. We conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we
plan and perform the audit to obtain reasonable assurance about whether the
financial statements are free of material misstatement. An audit includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the financial statements. An audit also includes assessing the accounting
principles used and significant estimates made by management, as well as
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of Zale Corporation
and subsidiaries as of July 31, 2004 and 2003, and the results of their
operations and their cash flows for each of the years in the three-year period
ended July 31, 2004, in conformity with U.S. generally accepted accounting
principles. KPMG LLP
Dallas, Texas
August 30, 2004 F- 3




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##### Table of Contents



ZALE CORPORATION AND SUBSIDIARIES 
 CONSOLIDATED STATEMENTS OF OPERATIONS (amounts in thousands, except per share amounts)
 Year Ended
    
    Year Ended
    
    Year EndedJuly 31,
    
    July 31,
    
    July 31,2004
    
    2003
    
    2002Total Revenue
    
    $
    2,304,440
    
    
    $
    2,212,241
    
    
    $
    2,191,727Cost and Expenses:Cost of Sales
    
    
    1,122,946
    
    
    
    1,101,030
    
    
    
    1,083,053Selling, General and Administrative Expenses
    
    
    942,796
    
    
    
    884,069
    
    
    
    873,265Cost of Insurance Operations
    
    
    5,963
    
    
    
    8,228
    
    
    
    8,620Depreciation and Amortization Expense
    
    
    56,381
    
    
    
    55,690
    
    
    
    58,340Impairment of Goodwill
    
    
    
    
    
    
    136,300
    
    
    
    Unusual Item-Executive Transaction
    
    
    
    
    
    
    
    
    
    
    2,300Unusual Item-Retiree Medical Curtailment
    
    
    
    
    
    
    
    
    
    
    (3,502
    )Operating Earnings
    
    
    176,354
    
    
    
    26,924
    
    
    
    169,651Interest Expense, Net
    
    
    7,528
    
    
    
    6,319
    
    
    
    7,750Cost of Early Retirement of Debt
    
    
    
    
    
    
    5,910
    
    
    
    Earnings Before Income Taxes
    
    
    168,826
    
    
    
    14,695
    
    
    
    161,901Income Taxes
    
    
    62,353
    
    
    
    55,340
    
    
    
    59,256Earnings (Loss) Before Effect of Accounting
Change
    
    
    106,473
    
    
    
    (40,645
    )
    
    
    102,645Effect of a Change in Accounting for the Write-Off of
the Excess of Revalued Net Assets over Stockholders
Investment
    
    
    
    
    
    
    
    
    
    
    (41,287
    )Net Earnings (Loss)
    
    $
    106,473
    
    
    $
    (40,645
    )
    
    $
    143,932Earnings (Loss) Per Common Share-Basic:Before Effect of Change in AccountingPrinciple
    
    $
    2.02
    
    
    $
    (.63
    )
    
    $
    1.48Net Earnings (Loss) Per Share
    
    $
    2.02
    
    
    $
    (.63
    )
    
    $
    2.08Earnings (Loss) Per Common Share-Diluted:Before Effect of Change in AccountingPrinciple
    
    $
    1.99
    
    
    $
    (.63
    )
    
    $
    1.47Net Earnings (Loss) Per Share
    
    $
    1.99
    
    
    $
    (.63
    )
    
    $
    2.07Weighted Average Number of Common Shares and Common Share
Equivalents Outstanding:Basic
    
    
    52,650
    
    
    
    64,528
    
    
    
    69,178Diluted
    
    
    53,519
    
    
    
    64,528
    
    
    
    69,692
 See Notes to the Consolidated Financial Statements. F- 4




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ZALE CORPORATION AND SUBSIDIARIES 
 CONSOLIDATED BALANCE SHEETS (amounts in thousands, except per share amounts)
 July 31, 2004
    
    July 31, 2003ASSETSCurrent Assets:Cash and Cash Equivalents
    
    $
    63,124
    
    
    $
    35,273Merchandise Inventories
    
    
    826,824
    
    
    
    798,761Other Current Assets
    
    
    63,956
    
    
    
    52,450Total Current Assets
    
    
    953,904
    
    
    
    886,484Property and Equipment, Net
    
    
    266,688
    
    
    
    266,167Goodwill, Net
    
    
    85,583
    
    
    
    82,199Other Assets
    
    
    35,909
    
    
    
    38,133Deferred Tax Asset, Net
    
    
    
    
    
    
    21,123Total Assets
    
    $
    1,342,084
    
    
    $
    1,294,106LIABILITIES AND STOCKHOLDERS INVESTMENTCurrent Liabilities:Accounts Payable and Accrued Liabilities
    
    $
    319,599
    
    
    $
    307,775Deferred Tax Liability, Net
    
    
    51,417
    
    
    
    46,266Total Current Liabilities
    
    
    371,016
    
    
    
    354,041Non-current Liabilities
    
    
    42,486
    
    
    
    103,342Deferred Tax Liability, Net
    
    
    4,968
    
    
    
    Long-term Debt
    
    
    197,500
    
    
    
    184,400Commitments and ContingenciesStockholders Investment:Preferred Stock (Par value $0.01, 5,000 shares authorized)
    
    
    
    
    
    
    Common Stock (Par value $0.01, 70,000 shares authorized,
52,110 and 55,222 shares issued and outstanding as
of July 31, 2004 and 2003, respectively.)
    
    
    521
    
    
    
    552Additional Paid-In Capital
    
    
    63,661
    
    
    
    566,552Accumulated Other Comprehensive Income
    
    
    13,470
    
    
    
    6,834Accumulated Earnings
    
    
    648,462
    
    
    
    589,122Deferred Compensation
    
    
    
    
    
    
    726,114
    
    
    
    1,163,060Treasury Stock
    
    
    
    
    
    
    (510,737
    )Total Stockholders Investment
    
    
    726,114
    
    
    
    652,323Total Liabilities and Stockholders Investment
    
    $
    1,342,084
    
    
    $
    1,294,106
 See Notes to the Consolidated Financial Statements. F- 5




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##### Table of Contents



ZALE CORPORATION AND SUBSIDIARIES 
 CONSOLIDATED STATEMENTS OF CASH FLOWS (amounts in thousands)
 Year Ended
    
    Year Ended
    
    Year EndedJuly 31,
    
    July 31,
    
    July 31,2004
    
    2003
    
    2002Net Cash Flows from Operating Activities:Net earnings (loss)
    
    $
    106,473
    
    
    $
    (40,645
    )
    
    $
    143,932Adjustments to reconcile net earnings (loss)
to net cash provided by operating activities:Depreciation and amortization expense
    
    
    56,381
    
    
    
    55,690
    
    
    
    58,340Amortization of long-term debt issue costs
    
    
    1,329
    
    
    
    463
    
    
    
    447Deferred compensation expense
    
    
    
    
    
    
    115
    
    
    
    1,916Impairment of Goodwill
    
    
    
    
    
    
    136,300
    
    
    
    Impairment of Fixed Assets
    
    
    2,627
    
    
    
    2,092
    
    
    
    1,788Loss from dispositions of property & equipment
    
    
    2,429
    
    
    
    6,194
    
    
    
    3,908Deferred taxes
    
    
    30,976
    
    
    
    46,286
    
    
    
    13,668Tax benefit associated with stock option exercises
    
    
    7,955
    
    
    
    2,292
    
    
    
    1,537Effect 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:Merchandise inventories
    
    
    (24,431
    )
    
    
    (9,073
    )
    
    
    (60,940
    )Other current assets
    
    
    (11,150
    )
    
    
    2,419
    
    
    
    9,092Other assets
    
    
    (315
    )
    
    
    (5,114
    )
    
    
    2,009Accounts payable and accrued liabilities
    
    
    12,113
    
    
    
    (26,011
    )
    
    
    53,409Non-current liabilities
    
    
    (6,309
    )
    
    
    (6,188
    )
    
    
    (5,402
    )Net Cash Provided by Operating Activities
    
    
    178,078
    
    
    
    164,820
    
    
    
    178,915Net Cash Flows from Investing Activities:Additions to property and equipment
    
    
    (60,788
    )
    
    
    (43,579
    )
    
    
    (54,159
    )Purchase of available for sale investments
    
    
    (4,980
    )
    
    
    (12,964
    )
    
    
    (8,197
    )Proceeds from sale of available for sale investments
    
    
    5,751
    
    
    
    14,190
    
    
    
    7,471Net Cash Used in Investing Activities
    
    
    (60,017
    )
    
    
    (42,353
    )
    
    
    (54,885
    )Net Cash Flows from Financing Activities:Payments on revolving credit agreement
    
    
    (704,300
    )
    
    
    (169,154
    )
    
    
    (239,747
    )Borrowings under revolving credit agreement
    
    
    717,400
    
    
    
    353,554
    
    
    
    230,281Senior notes repurchase
    
    
    
    
    
    
    (86,787
    )
    
    
    (12,735
    )Proceeds from exercise of stock options
    
    
    39,565
    
    
    
    14,711
    
    
    
    8,213Loan origination costs on new revolving credit agreement
    
    
    
    
    
    
    (6,563
    )
    
    
    Purchase of common stock
    
    
    (143,358
    )
    
    
    (278,236
    )
    
    
    (54,399
    )Net Cash Used in Financing Activities
    
    
    (90,693
    )
    
    
    (172,475
    )
    
    
    (68,387
    )Effect of Exchange Rate Changes on Cash
    
    
    483
    
    
    
    394
    
    
    
    (146
    )Net Increase (Decrease) in Cash and Cash Equivalents
    
    
    27,851
    
    
    
    (49,614
    )
    
    
    55,497Cash and Cash Equivalents at Beginning of Period
    
    
    35,273
    
    
    
    84,887
    
    
    
    29,390Cash and Cash Equivalents at End of Period
    
    $
    63,124
    
    
    $
    35,273
    
    
    $
    84,887
 See Notes to 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 EndedJuly 31, 2004
    
    July 31, 2003
    
    July 31, 2002Supplemental cash flow information:Interest paid
    
    $
    5,559
    
    
    $
    9,767
    
    
    $
    9,667Interest received
    
    $
    409
    
    
    $
    1,368
    
    
    $
    2,141Income taxes paid (net of refunds received)
    
    $
    19,914
    
    
    $
    33,302
    
    
    $
    14,543
 See Notes to the Consolidated Financial Statements. F- 7




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##### Table of Contents



ZALE CORPORATION AND SUBSIDIARIES 
 CONSOLIDATED STATEMENTS OF STOCKHOLDERS INVESTMENT (amounts in thousands)
 AccumulatedNumber of
    
    
    
    
    
    Additional
    
    OtherCommon Shares
    
    Common
    
    Paid-In
    
    ComprehensiveOutstanding
    
    Stock
    
    Capital
    
    Income (Loss)Balance July 31, 2001
    
    
    69,630
    
    
    $
    696
    
    
    $
    539,612
    
    
    $
    (2,355
    )Net Earnings
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Unrealized Loss on Securities, net
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (626
    )Unrealized Gain on Derivatives
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1Cumulative 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
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Effect of Stock Split
    
    
    (1,246
    )
    
    
    (28
    )
    
    
    28
    
    
    
    Balance July 31, 2002
    
    
    67,138
    
    
    $
    671
    
    
    $
    549,584
    
    
    $
    (6,559
    )Net Earnings
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Unrealized Loss on Securities, net
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (243
    )Unrealized Gain on Derivatives
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    259Cumulative Translation Adjustments
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    13,377Exercise 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
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Effect of Stock Split
    
    
    (5,958
    )
    
    
    (127
    )
    
    
    127
    
    
    
    Balance July 31, 2003
    
    
    55,222
    
    
    $
    552
    
    
    $
    566,552
    
    
    $
    6,834Net Earnings
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Unrealized Loss on Securities, net
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (163
    )Release of Pre-Bankruptcy Tax Reserve
    
    
    
    
    
    
    
    
    
    
    54,547
    
    
    
    Unrealized Loss on Derivatives
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (292
    )Cumulative Translation Adjustments
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    7,091Exercise of Stock Options, including related
tax benefit
    
    
    1,202
    
    
    
    13
    
    
    
    47,506
    
    
    
    Purchase of Common Stock
    
    
    (2,762
    )
    
    
    
    
    
    
    
    
    
    
    Contribution to 401(k) plan
    
    
    
    
    
    
    
    
    
    
    302
    
    
    
    Restricted Stock Issued
    
    
    75
    
    
    
    
    
    
    
    
    
    
    
    Effect of Stock Split
    
    
    (1,627
    )
    
    
    (44
    )
    
    
    (605,246
    )
    
    
    Balance July 31, 2004
    
    
    52,110
    
    
    $
    521
    
    
    $
    63,661
    
    
    $
    13,470
 See Notes to the Consolidated Financial Statements. F- 8




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##### Table of Contents



ZALE CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF STOCKHOLDERS INVESTMENT  (continued)
(amounts in thousands) Accumulated
    
    Deferred
    
    Treasury
    
    Total
    
    ComprehensiveEarnings
    
    Compensation
    
    Stock
    
    Investment
    
    Income (Loss)Balance July 31, 2001
    
    $
    485,835
    
    
    $
    (8,253
    )
    
    $
    (174,972
    )
    
    $
    840,563
    
    
    $
    79,282Net Earnings
    
    
    143,932
    
    
    
    
    
    
    
    
    
    
    
    143,932
    
    
    
    143,932Unrealized Loss on Securities, net
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (626
    )
    
    
    (626
    )Unrealized Gain on Derivatives
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1
    
    
    
    1Cumulative 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, Issued/Cancelled
    
    
    
    
    
    
    6,218
    
    
    
    (6,218
    )
    
    
    
    
    
    
    Deferred Compensation Amortization
    
    
    
    
    
    
    1,920
    
    
    
    
    
    
    
    1,920
    
    
    
    Effect of Stock Split
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Balance July 31, 2002
    
    $
    629,767
    
    
    $
    (115
    )
    
    $
    (233,541
    )
    
    $
    939,807
    
    
    $
    139,728Net Earnings
    
    
    (40,645
    )
    
    
    
    
    
    
    
    
    
    
    (40,645
    )
    
    
    (40,645
    )Unrealized Loss On Securities, net
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (243
    )
    
    
    (243
    )Unrealized Gain on Derivatives
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    259
    
    
    
    259Cumulative Translation Adjustments
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    13,377
    
    
    
    13,377Exercise 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
    
    
    
    Effect of Stock Split
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Balance July 31, 2003
    
    $
    589,122
    
    
    $
    
    
    
    $
    (510,737
    )
    
    $
    652,323
    
    
    $
    (27,252
    )Net Earnings
    
    
    106,473
    
    
    
    
    
    
    
    
    
    
    
    106,473
    
    
    
    106,473Unrealized Loss on Securities, net
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (163
    )
    
    
    (163
    )Release of Pre-Bankruptcy Tax Reserve
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    54,547
    
    
    
    Unrealized Loss on Derivatives
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (292
    )
    
    
    (292
    )Cumulative Translation Adjustments
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    7,091
    
    
    
    7,091Exercise of Stock Options, including
related tax benefit
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    47,519
    
    
    
    Purchase of Common Stock
    
    
    
    
    
    
    
    
    
    
    (143,358
    )
    
    
    (143,358
    )
    
    
    Contribution to 401(k) plan
    
    
    
    
    
    
    
    
    
    
    1,672
    
    
    
    1,974
    
    
    
    Restricted Stock Issued
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Effect of Stock Split
    
    
    (47,133
    )
    
    
    
    
    
    
    652,423
    
    
    
    
    
    
    
    Balance July 31, 2004
    
    $
    648,462
    
    
    $
    
    
    
    $
    
    
    
    $
    726,114
    
    
    $
    113,109
 See Notes to the Consolidated Financial Statements. F- 9




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##### Table of Contents



ZALE CORPORATION AND SUBSIDIARIES 
 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Summary of Significant Accounting Policies Nature of Operations.Zale Corporation, through its wholly owned
subsidiaries (collectively, the Company), is the largest and most diversified
specialty retailer of fine jewelry in North America. At July 31, 2004, the
Company operated 2,234 specialty retail jewelry stores and kiosks located
primarily in shopping malls throughout the United States of America, Canada and
Puerto Rico. The Company primarily operates under seven 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 the internet
shopper through its e-commerce site, Zales.com. The Company has furthered
leveraged the brand strength through Zales Fine Jewelry Outlet (formerly Zales
the Diamond Store Outlet) which focuses on the brand conscious, value-oriented
shopper in outlet malls and value oriented neighborhood power 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 of America, and Mappins Jewellers 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 jewelry stores that are considered among the finest luxury jewelry
stores in their markets, offering designer jewelry and watches to attract more
affluent customers. Piercing Pagoda reaches the opening price point fine
jewelry customer primarily through mall based kiosks. The accompanying Consolidated Financial Statements are those of the
Company as of and for the twelve month periods ended July 31, 2004, and July
31, 2003. The Company consolidates substantially all of its United States
(U.S.) operations into Zale Delaware, Inc. (ZDel), a wholly owned
subsidiary of Zale Corporation. ZDel is the parent company for several
subsidiaries, including three that are engaged primarily in providing credit
insurance to credit customers of the Company. The Company consolidates its
Canadian retail operations into Zale International, Inc., which is a wholly
owned subsidiary of Zale Corporation. All significant intercompany
transactions have been eliminated. Use of Estimates.The preparation of financial statements 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, 2004 includes restricted
cash of $5.5 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 U.S. inventories represent finished goods
which are valued using the LIFO retail inventory method. Merchandise inventory
of Peoples Jewellers and Mappins Jewellers of Canada is valued using the
first-in, first-out (FIFO) retail inventory method. Under the retail method,
inventory is segregated into categories of merchandise with similar
characteristics at its current 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. F- 10




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##### Table of Contents



ZALE CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) 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. Beginning in fiscal year 2002, the
Company applies 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 than the BLS producer indices or other published indices. 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 once annually for all store locations
and for the distribution centers. The shrinkage rate from the most recent
physical inventory, in combination with historical experience, 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 cash flow 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 herein on page F-18 for
the impairment charges recorded in the periods presented. In accordance with SFAS No. 142, Goodwill and Other Intangible Assets
(SFAS No. 142) 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 2004, the Company performed its annual review for impairment of
goodwill related to its Piercing Pagoda Inc., Peoples Jewellers and one other
smaller acquisition. The Company concluded that there was no evidence of
impairment related to the goodwill of approximately $19.4 million for Piercing
Pagoda, $61.2 million recorded for the Peoples acquisition and $5.0 million
for one other smaller acquisition. In the second quarter of fiscal year 2003,
the Company concluded 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
as of July 31, 2003. 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 twelve years. F- 11




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##### Table of Contents



ZALE CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) 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 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. Stock Based Compensation.The Company accounts for its Stock Option and
Employee Stock Purchase Plans under the recognition and measurement principles
of Accounting Principles Board (APB) Opinion No. 25, Accounting for Stock
Issued to Employees, and related interpretations. 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 plans, stock options cannot be granted at below
market price. The following table illustrates the effect on net earnings (loss) and
earnings (loss) per share if the Company had applied the fair value recognition
provisions of Statement of Financial Accounting Standards (SFAS) No. 123,
Accounting for Stock-Based Compensation, and as allowed by SFAS 148,
Accounting for Stock-Based Compensation-Transition and Disclosure-An Amendment
of SFAS No.123 to stock based employee compensation. Year Ended July 312004
    
    2003
    
    2002(amounts in thousands)Net earnings (loss), as reported
    
    $
    106,473
    
    
    $
    (40,645
    )
    
    $
    143,932Deduct: Total stock-based employee compensation
expense determined under fair value based
method for all awards, net of related tax
effects
    
    
    (6,205
    )
    
    
    (5,207
    )
    
    
    (6,158
    )Pro forma net earnings (loss)
    
    $
    100,268
    
    
    $
    (45,852
    )
    
    $
    137,774Earnings (Loss) Per Common ShareBasic:Earnings (Loss) Per Common Share, as reported
    
    $
    2.02
    
    
    $
    (.63
    )
    
    $
    2.08Earnings (Loss) Per Common Share, pro forma
    
    $
    1.90
    
    
    $
    (.71
    )
    
    $
    1.99Earnings (Loss) Per Common Share  Diluted:Earnings (Loss) Per Common Share, as reported
    
    $
    1.99
    
    
    $
    (.63
    )
    
    $
    2.07Earnings (Loss) Per Common Share, pro forma
    
    $
    1.87
    
    
    $
    (.71
    )
    
    $
    1.98Weighted Average Number of Common Shares
Outstanding:Basic
    
    
    52,650
    
    
    
    64,528
    
    
    
    69,178Diluted
    
    
    53,519
    
    
    
    64,528
    
    
    
    69,692
 F- 12




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##### Table of Contents



ZALE CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (continued) 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 2004,
2003, and 2002, respectively: risk-free interest rate of 3.6 percent, 3.0
percent, and 3.9 percent, expected dividend yield of zero (all three fiscal
years), expected life of five years (all three fiscal years), and expected
volatility of 40.2 percent, 38.8 percent, and 39.9 percent. The weighted
average fair value of options granted for fiscal years 2004, 2003 and 2002 is
$10.93, $8.57, and $6.12, respectively. Revenue Recognition.The Company recognizes revenue in accordance with the
Securities and Exchange Commissions Staff Accounting Bulletin No. 104,
Revenue Recognition (SAB 104). 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 and are recognized over the two-year period in proportion to the
costs expected to be incurred in performing services under the agreements.
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 $12.6 million, $16.1 million and $18.3 million for
the fiscal years ended July 31, 2004, 2003, and 2002, respectively. These
revenues are included in total revenues on the accompanying consolidated
statement of operations. The associated cost of insurance operations was $6.0
million, $8.2 million and $8.6 million for the fiscal years ended July 31,
2004, 2003 and 2002, respectively. Advertising Expenses.Advertising expenses are charged against operations
when incurred and are a component of selling, general and administrative
expense in the accompanying consolidated statements of operations. Amounts
charged against operations were $83.7 million, $64.0 million and $62.9 million
for the fiscal years ended July 31, 2004, 2003 and 2002, respectively, net of
amounts contributed by vendors to the Company. In fiscal year 2004, the
Company adopted EITF 02-16 which resulted in a reclassification of amounts
previously recorded as reductions to advertising expense to reductions of
inventory costs (See Notes to Consolidated Financial Statements  Vendor
Allowances for further detail). The amounts of prepaid advertising at July 31,
2004 and 2003, are $12.9 million and $8.4 million, respectively, and are
classified as components of other assets in the accompanying consolidated
balance sheets. Vendor Allowances.The Company receives cash or allowances from
merchandise vendors primarily in connection with cooperative advertising
programs and reimbursements for markdowns taken to sell the vendors products.
The Company has agreements in place with each vendor setting forth the specific
conditions for each allowance or payment. The majority of these agreements are
entered into or renewed annually at the beginning of each fiscal year. 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 was
required to be applied to new vendor arrangements entered into after January 1,
2003. Accordingly, for fiscal years 2004 and 2003, qualifying vendor
reimbursements of costs incurred to specifically advertise vendors products
are recorded as a reduction of advertising expense, which is a component of
selling, general, and administrative expenses. For fiscal year 2004, $18.7
million of vendor arrangements, which would have been recorded in SG&A prior to
the adoption of EITF 02-16 were recorded as a reduction to the cost of the
product purchased. F- 13




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##### Table of Contents



ZALE CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) Beginning in fiscal year 2004, upon the annual renewal of existing
agreements or the creation of any new agreements, certain of these vendor
reimbursements have been included as a reduction of cost of sales when the
inventory is sold. The table below shows the accounting impact of cash
consideration received for cooperative advertising agreements resulting in
changes to cost of sales and SG&A. Twelve Months EndedJuly 31,2004
    
    2003(amounts in thousands)Cost of sales
    
    $
    (10,659
    )
    
    $
    SG&A
    
    $
    (14,792
    )
    
    $
    (34,116
    )
 Reclassifications.The classifications in use at July 31, 2004 have been
applied to the financial statements for July 31, 2003 and 2002. 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 accompanying consolidated statements of stockholders
investment. 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 currently 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 currently 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. F- 14




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##### Table of Contents



ZALE CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (continued) 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, 2004, the Company had $6.9 million of outstanding forward
contracts to purchase gold. The fair value of these gold contracts recorded in
the accompanying consolidated balance sheets at July 31,
2004 is $6.9 million. The gains and losses on forward contracts realized for
the fiscal years ended July 31, 2004 and 2003 were immaterial to the Companys
consolidated statement of operations. The Company had no foreign currency
forward exchange contracts outstanding at July 31, 2003. As of July 31, 2004,
the Company has $1.9 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,
2004, was $1.9 million. The estimated unrealized gains and losses as of July
31, 2004 included in Accumulated Other Comprehensive Income (Loss) for both the
gold forward contracts and the currency forward exchange contracts were
immaterial. 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 SFAS
141. 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 EndedJuly 31,2002(amounts in thousands)Net Earnings
    
    $
    143,932Subtract: Effect of a Change in Accounting Principle
    
    
    (41,287
    )Adjusted Net Earnings
    
    $
    102,645Earnings Per Common Share  Basic:Reported Net Earnings
    
    $
    2.08Effect of Change in Accounting Principle
    
    
    (0.60
    )Adjusted Net Earnings
    
    $
    1.48Earnings Per Common Share  Diluted:Reported Net Earnings
    
    $
    2.07Effect of Change in Accounting Principle
    
    
    (0.59
    )Adjusted Net Earnings
    
    $
    1.48
 F- 16




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##### Table of Contents



ZALE CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (continued) Merchandise Inventories The Companys U.S. operations use the LIFO retail method of accounting for
inventory. The LIFO provision was $2.1 million, $2.9 million and $1.4 million
for the years ended July 31, 2004, 2003 and 2002, respectively. The cumulative
LIFO provision reflected on the accompanying consolidated balance sheets was
$21.2 million and $19.0 million at July 31, 2004 and 2003, respectively.
Domestic inventories on a FIFO basis were $779.8 million and $755.7 million at
July 31, 2004 and 2003, respectively. The Companys Canadian operations use the FIFO retail method of accounting
for inventory. Inventory, net of reserves, was approximately $68.2 million and
$62.0 million at July 31, 2004 and 2003, respectively. Consigned inventory and related contingent obligations are not reflected
in the Companys consolidated financial statements. Consignment inventory has
historically consisted of test programs, merchandise at higher price points, or
merchandise that otherwise does not warrant the risk of 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 $161.5 million and $170.8 million at July 31, 2004 and 2003,
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. Beginning in fiscal year 2002, the Company applies 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 producer price indices was to
increase net income by approximately $4.8 million, or $0.14 per share. Investments Investments in debt and equity securities are reported as Other Assets in
the accompanying consolidated balance sheets. Investments are recorded at fair
value based on quoted market prices. All long-term debt securities outstanding
at July 31, 2004 will contractually mature within 1 to 29 years. Investments,
principally related to the Companys insurance subsidiaries as of July 31, 2004
and 2003 were as follows: July 31, 2004
    
    July 31, 2003Cost
    
    Fair Value
    
    Cost
    
    Fair Value(amounts in thousands)U.S. government obligations
    
    $
    14,882
    
    
    $
    15,115
    
    
    $
    15,782
    
    
    $
    16,286Corporate bonds and notes
    
    
    5,188
    
    
    
    5,289
    
    
    
    3,614
    
    
    
    3,825Corporate equity
securities
    
    
    4,211
    
    
    
    3,814
    
    
    
    5,594
    
    
    
    4,978$
    24,281
    
    
    $
    24,218
    
    
    $
    24,990
    
    
    $
    25,089
 F- 17




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##### Table of Contents



ZALE CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (continued) All investments are classified as available for sale. At July 31, 2004
and 2003, the carrying value of investments included net unrealized loss of
($0.1) million and net unrealized gains of $0.1 million at July 31, 2004 and
2003, respectively, which are included in other comprehensive income (loss).
The net realized gain (loss) on investments which totaled $0.3 million in
fiscal year 2004, $0.3 million in fiscal year 2003 and ($0.1) million in fiscal
year 2002, 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, 2004 and 2003 as required by law. Property And Equipment The Companys property and equipment consists of the following: July 31, 2004
    
    July 31, 2003(amounts in thousands)Building and Leasehold Improvements
    
    $
    209,738
    
    
    $
    193,656Furniture and Fixtures
    
    
    359,894
    
    
    
    332,439Construction in Progress
    
    
    15,824
    
    
    
    12,177Total Property and Equipment
    
    
    585,456
    
    
    
    538,272Less: Accumulated Amortization and Depreciation
    
    
    (318,768
    )
    
    
    (272,105
    )Total Net Property and Equipment
    
    $
    266,688
    
    
    $
    266,167
 Depreciation expense of $56.4 million, $55.7 million and $58.3 million,
respectively, was recorded at July 31, 2004, 2003 and 2002. Property and
equipment are depreciated over the estimated useful lives of the assets. Useful
lives for leasehold improvements and furniture and fixtures are the remaining
term of the lease and 3-12 years, respectively. The Company recorded impairment charges of $0.9 million, $1.3 million, and
$1.8 million for the fiscal years ended July 31, 2004, 2003, and 2002,
respectively, related to unproductive assets. These impairment charges are
included in SG&A and resulted from the Companys ongoing process to evaluate
the productivity of its asset base. On August 31, 2004, the Company sold a 69,000 square foot building in
Bethlehem, Pennsylvania that was previously used for additional distribution
and warehousing functions at Piercing Pagoda. In fiscal year 2003, the Company
recorded an impairment charge of approximately $0.8 million to reflect the
write-down to the estimated fair value. In fiscal year 2004, the Company
recorded an impairment charge of approximately $1.8 million to reflect the
write-down to the estimated fair value. As of July 31, 2004, the carrying
amount of the remaining building in Bethlehem, Pennsylvania owned by the
Company is approximately $2.8 million, which represents the estimated fair
value of the asset. The Company plans to sell this building and is currently
holding it available for sale. Accounts Payable and Accrued Liabilities The Companys accounts payable and accrued liabilities consist of the
following: July 31, 2004
    
    July 31, 2003(amounts in thousands)Accounts Payable
    
    $
    138,800
    
    
    $
    149,285Accrued Payroll
    
    
    42,596
    
    
    
    31,267Accrued Taxes
    
    
    31,529
    
    
    
    27,265Extended Warranty Deferred Revenue
    
    
    28,146
    
    
    
    28,662Accrued Rent
    
    
    31,337
    
    
    
    24,597Other Accruals
    
    
    47,191
    
    
    
    46,699Total Accounts Payable and Accrued
Liabilities
    
    $
    319,599
    
    
    $
    307,775
 F- 18




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##### Table of Contents



ZALE CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (continued) 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 described below,
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 accompanying 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 $25.1 million and $29.3 million are included
in the accompanying consolidated balance sheets at July 31, 2004, and 2003,
respectively. The long-term portion of the deferred credits is $20.9 million
and $25.1 million at July 31, 2004 and 2003, respectively. Tax Contingencies.At July 31, 2003, the Company had a reserve balance of
$54.7 million in non- current liabilities for tax contingencies related to
pre-bankruptcy income tax issues. As of July 31, 2004, the Company resolved all
such issues with the Internal Revenue Service (IRS). Therefore, the Company
reversed this reserve to additional paid-in-capital as of July 31, 2004. F- 19




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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 are no longer 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 2004, 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 SG&A in the accompanying consolidated
statements of operations over an employees active career on an accrual basis.
The Company funds actual claims as they occur. July 31, 2004
    
    July 31, 2003(amounts in thousands)Change in Benefit Obligation:Benefit obligation at beginning of year
    
    $
    5,745
    
    
    $
    8,991Service cost
    
    
    
    
    
    
    Interest cost
    
    
    349
    
    
    
    508Plan participant contributions
    
    
    1,272
    
    
    
    1,292Curtailments
    
    
    
    
    
    
    Amendments
    
    
    
    
    
    
    (4,177
    )Actuarial loss (gain)
    
    
    (50
    )
    
    
    1,237Benefits Paid
    
    
    (2,333
    )
    
    
    (2,106
    )Benefit obligation at end of year
    
    $
    4,983
    
    
    $
    5,745Change in Plan Assets:Market value at beginning of year
    
    $
    
    
    
    $
    Employer contributions
    
    
    1,061
    
    
    
    814Plan participant contributions
    
    
    1,272
    
    
    
    1,292Benefit payments
    
    
    (2,333
    )
    
    
    (2,106
    )Market value at end of year
    
    $
    
    
    
    $
    Funded Status
    
    $
    (4,983
    )
    
    $
    (5,745
    )Unrecognized net actuarial gain
    
    
    (5,304
    )
    
    
    (5,664
    )Unrecognized prior service cost
    
    
    (3,756
    )
    
    
    (4,072
    )Accrued benefit
    
    $
    (14,043
    )
    
    $
    (15,481
    )
 The weighted average assumption of the discount rate is 6.0 percent and
6.5 percent as of July 31, 2004 and 2003, respectively. The health care cost
trend rates remain as of July 31, 2004 at 0.0 percent, as dictated by the plan
design change in January 2003. Because retiree contributions will now be
annually increased to shift all cost increases to participants, the expected
health care cost trend rate is not relevant. F- 20




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##### Table of Contents



ZALE CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (continued)   July 31, 2004
    
    July 31, 2003
    
    July 31, 2002(amounts in thousands)Service Cost
    
    $
    
    
    
    $
    
    
    
    $
    193Interest Cost
    
    
    349
    
    
    
    508
    
    
    
    899Amortization of Prior Service Cost and Gain
    
    
    (726
    )
    
    
    (607
    )
    
    
    (177
    )Settlement / Curtailment / Termination of
Benefits
    
    
    
    
    
    
    
    
    
    
    (4,117
    )Net Periodic (Benefit) Cost
    
    $
    (377
    )
    
    $
    (99
    )
    
    $
    (3,202
    )
 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 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. 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
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 loans made under the Revolving Credit Agreement bear interest at a
floating rate at either (i) the applicable LIBO Rate plus the applicable
margin, or (ii) the Base Rate plus the applicable margin. The margin
applicable to LIBOR based loans and standby letter of credit commission rates
will be automatically reduced or increased from time to time based upon excess
borrowing availability under the Revolving Credit Agreement. The Company pays a
commitment fee quarterly of .375 percent on the preceding months unused
commitment. The Company and its subsidiaries may repay the revolving credit
loans outstanding under the Revolving Credit Agreement at any time without
penalty prior to the maturity date. At July 31, 2004 and 2003, there was $197.5
million and $184.4 million outstanding, respectively, under the Revolving
Credit Agreement. The effective interest rate at July 31, 2004 was 2.88 percent
with the applicable margin for LIBOR based loans at 1.50 percent and the
applicable margin for Base Rate loans at 0 percent. Based on the terms of the
Revolving Credit Agreement, the Company had approximately $302.5 million in
available borrowings at July 31, 2004. F- 21




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##### Table of Contents



ZALE CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (continued) At any time, if remaining borrowing availability under the Revolving
Credit Agreement falls below $75 million, the Company will be restricted in its
ability to repurchase stock or pay dividends. If remaining borrowing
availability falls below $50 million, the Company will be required to meet a
minimum fixed charge coverage ratio. 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. 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. In fiscal
year 2004, the Company amended and extended its corporate headquarters lease
for thirteen and three-fourth years beginning in July 2004. Lease incentives of
$1.7 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 EndedJuly 31,
    
    July 31,
    
    July 31,2004
    
    2003
    
    2002(amounts in thousands)Retail Space:Minimum Rentals
    
    $
    182,520
    
    
    $
    175,193
    
    
    $
    169,274Rentals Based on Sales
    
    
    12,212
    
    
    
    10,767
    
    
    
    13,335194,732
    
    
    
    185,960
    
    
    
    182,609Equipment and Corporate Headquarters
    
    
    2,823
    
    
    
    2,757
    
    
    
    2,862Total Rent Expense
    
    $
    197,555
    
    
    $
    188,717
    
    
    $
    185,471
 Rent expense is included in SG&A 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, 2004, for all noncancelable
leases of ongoing operations were as follows: 2005 
$173.2 million; 2006 
$154.0 million; 2007  $134.9 million; 2008 
$112.9 million; 2009  93.5
million thereafter$238.7 million; for a total of $907.2 million. Interest Interest expense for the fiscal years ended July 31, 2004, 2003 and 2002
was $8.3 million, $7.7 million and $9.8 million, respectively. Interest income for the fiscal years ended July 31, 2004, 2003 and 2002
was $.8 million, $1.4 million and $2.0 million, respectively. In fiscal year 2003, 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 accompanying consolidated statements of operations. F- 22




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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 EndedJuly 31,
    
    July 31,
    
    
    
    
    
    July 31,2004
    
    2003
    
    
    
    
    
    2002(amounts in thousands)Federal Income Tax Expense at Statutory Rate
    
    $
    59,089
    
    
    $
    5,143
    
    
    
    
    
    
    $
    56,665Impairment of
Goodwill
    
    
    
    
    
    
    47,705
    
    
    
    
    
    
    
    State Income Taxes, Net of Federal Income
Tax
Benefit
    
    
    2,657
    
    
    
    2,205
    
    
    
    
    
    
    
    2,136Other
    
    
    607
    
    
    
    287
    
    
    
    
    
    
    
    455Total Income Tax
Expense
    
    $
    62,353
    
    
    $
    55,340
    
    
    
    
    
    
    $
    59,256Effective Income Tax
Rate
    
    
    36.9
    %
    
    
    376.7
    %(1)
    
    
    
    
    
    
    36.6
    %
 (1)    For the fiscal 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 EndedJuly 31,
    
    July 31,
    
    July 31,2004
    
    2003
    
    2002(amounts in thousands)Current Provision:Federal
    
    $
    29,375
    
    
    $
    7,347
    
    
    $
    41,693Foreign
    
    
    1,786
    
    
    
    3,823
    
    
    
    1,779State
    
    
    216
    
    
    
    (2,116
    )
    
    
    2,116Total Current Provision
    
    
    31,377
    
    
    
    9,054
    
    
    
    45,588Deferred Provision:Federal
    
    
    22,768
    
    
    
    39,016
    
    
    
    10,236Foreign
    
    
    5,606
    
    
    
    2,817
    
    
    
    2,262State
    
    
    2,602
    
    
    
    4,453
    
    
    
    1,170Total Deferred Provision
    
    
    30,976
    
    
    
    46,286
    
    
    
    13,668Total Income Tax Provision
    
    $
    62,353
    
    
    $
    55,340
    
    
    $
    59,256
 As of July 31, 2004, the Company has a tax net operating loss carryforward
(NOL) (after limitations) of $78.7 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. F- 23




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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, 2004 and 2003
are presented below. July 31, 2004
    
    July 31, 2003(amounts in thousands)Current Deferred Taxes:Assets Customer receivables
    
    $
    642
    
    
    $
    806Accrued liabilities
    
    
    37,866
    
    
    
    22,915State and local
taxes
    
    
    4,152
    
    
    
    4,879Net operating loss carryforward
    
    
    7,601
    
    
    
    7,601Inventory reserves
    
    
    9,163
    
    
    
    8,426Total Assets
    
    
    59,424
    
    
    
    44,627LiabilitiesMerchandise inventories, principally due to
LIFO reserve
    
    
    (102,586
    )
    
    
    (86,614
    )Accrued liabilities
    
    
    (8,255
    )
    
    
    (4,279
    )Deferred Current Tax Liability, Net
    
    $
    (51,417
    )
    
    $
    (46,266
    )Non-Current Deferred Taxes:AssetsNet operating loss carryforward
    
    
    23,061
    
    
    
    33,179Postretirement benefits
    
    
    5,477
    
    
    
    6,038Accrued liabilities
    
    
    9,678
    
    
    
    9,781Other
    
    
    4,905
    
    
    
    1,536Total Assets
    
    
    43,121
    
    
    
    50,534LiabilitiesProperty and equipment
    
    
    (36,188
    )
    
    
    (20,619
    )Other
    
    
    (881
    )
    
    
    Goodwill
    
    
    (11,020
    )
    
    
    (8,792
    )Deferred Non-Current Tax (Liability)/Asset,
Net
    
    $
    (4,968
    )
    
    $
    21,123
 A valuation allowance must be provided when it is more likely than not
that the deferred income tax asset will not be realized. The Company believes
that, as of July 31, 2004 and 2003, the realization of its gross deferred
income tax assets is more likely than not, and thus, there was no valuation
reserve recorded. F- 24




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##### Table of Contents



ZALE CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (continued) Capital Stock The following disclosures, with respect to Capital Stock, have been
restated to reflect the impact of the two-for-one stock split of the
outstanding Common Stock for all periods presented. Common Stock.At July 31, 2004 and 2003, 70,000,000 shares of common
stock, par value of $0.01 per share (Common Stock), were authorized, and
52,109,590 shares and 55,221,854 shares, respectively, were issued and
outstanding. Stock Split.On May 18, 2004, the Company announced its Board of Directors
had approved a two-for-one split of the Common Stock. The stock split was
effected by issuing an additional share of common stock for each outstanding
share of that common stock. The additional shares were distributed June 8, 2004
to shareholders of record at the close of business on May 28, 2004. Accordingly
the Company has restated its earnings (loss) per share calculations, as well as
reclassified amounts between Common Stock and additional-paid-in-capital to
reflect the impact of the stock split of the outstanding Common Stock for all
periods presented. In accounting for the stock split, 16.3 million shares of
treasury stock were deemed reissued and an additional 9.6 million shares were
issued. As the treasury shares that were reissued as part of the stock split
had been purchased by the Company during the current and previous fiscal years,
treasury stock has only been reclassified to show the effect of the stock split
as of July 31, 2004. Preferred Stock.At July 31, 2004 and 2003, 5,000,000 shares of Preferred
Stock, par value of $0.01, were authorized. None was issued or outstanding. Treasury Stock.The Company held 13,580,034 treasury shares at July 31,
2003. The Company reissued these shares and additional shares repurchased in
fiscal year 2004 in connection with the two-for-one stock split and at July 31,
2004, held no treasury shares. 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 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 at managements discretion, 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, 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 3.4 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 at managements discretion, 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. Under this program, the
Company purchased 0.2 million shares at an aggregate cost of $7.5 million
through July 31, 2003. F- 25




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##### Table of Contents



ZALE CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (continued) On July 1, 2003, the Company entered into a modified Dutch Auction
tender offer (the Tender Offer) to purchase up to 6.4 million shares of its
outstanding Common Stock at a price per share of not less than $21.00 nor in
excess of $24.00 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 at managements discretion and in accordance with the Companys usual
policies and applicable securities laws could purchase up to an additional $100
million of its Common Stock. This approval, combined with existing repurchase
authorizations existing at the time, made possible the Companys repurchase of
a total of approximately $142 million worth of its Common Stock. As of July 31,
2004, the Company had purchased approximately 2.8 million shares at an
aggregate cost of $142 million which completed its authorization under the
program. On August 5, 2004, the Company announced that its Board of Directors had
approved a stock repurchase program pursuant to which the Company, from time to
time at managements discretion, and in accordance with the Companys usual
policies and applicable securities laws, could purchase up to an additional $50
million of its Common Stock. F- 26




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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, 2004, the
Company had three stock incentive plans under which there were outstanding
awards: the Zale Corporation Omnibus Stock Incentive Plan (the Omnibus Plan),
the Zale Corporation Outside Directors 1995 Stock Option Plan (the Directors
Plan), and the Zale Corporation 2003 Stock Incentive Plan (the 2003 Stock
Incentive Plan). The Omnibus Plan expired with respect to new grants on July
30, 2003, and was replaced by the 2003 Stock Incentive Plan, which was approved
in November 2003. The 2003 Stock Incentive Plan was designed 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 6,000,000 shares of Common Stock, including previously
granted shares, are available for grant under the 2003 Stock Incentive Plan to
eligible employees. The 2003 Stock Incentive Plan allows for the granting of
restricted stock, stock options, stock bonuses and stock appreciation rights
subject to the provisions of the 2003 Stock Incentive Plan. Restricted Stock
granted under the 2003 Stock Incentive Plan vests on the third anniversary of
the grant date and is non-transferable prior to vesting. Options granted under
the 2003 Stock Incentive Plan (i) are 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 Directors Plan authorizes
the Company to grant options 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 600,000. During February 1999, 361,384 shares of restricted Common Stock were
granted to certain key employees. The restricted shares were valued in the
aggregate 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,
500,000 shares of restricted Common Stock valued at $7.9 million as of the
grant date were granted to a key employee, and 100,000 of these shares vested
on the first anniversary of the grant date. In fiscal year 2001, 51,924
restricted shares were cancelled and returned to treasury stock due to the
resignation of an executive. In fiscal year 2002, 400,000 restricted shares
were cancelled due to the resignation of an executive. In July 2004, 75,300
shares of restricted Common Stock valued at approximately $2 million as of the
grant date were granted to certain key employees. These shares vest on the
third anniversary of the grant date and are subject to restrictions on sale or
transfer. The total cost of restricted Common Stock is amortized to income as
compensation expense ratably over the vesting period and amounted to $0-
million, $0.1 million, and $1.9 million for the twelve month periods ended July
31, 2004, 2003, and 2002 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 ExerciseShares
    
    Grant Price
    
    PriceFiscal
    
    Fiscal
    
    FiscalFiscal 2004
    
    Fiscal 2003
    
    Fiscal 2002
    
    Fiscal 2004
    
    Fiscal 2003
    
    Fiscal 2002
    
    2004
    
    2003
    
    2002Outstanding,
beginning of year
    
    
    5,578,852
    
    
    
    6,050,906
    
    
    
    6,495,164
    
    
    $
    4.50-23.23
    
    
    $
    4.50-22.78
    
    
    $
    4.50-22.78
    
    
    $
    18.05
    
    
    $
    17.17
    
    
    $
    17.05Granted
    
    
    813,600
    
    
    
    1,169,000
    
    
    
    1,281,400
    
    
    
    23.94-29.57
    
    
    
    14.50-23.23
    
    
    
    14.15-21.00
    
    
    
    27.32
    
    
    
    22.10
    
    
    
    15.02Exercised
    
    
    (2,336,370
    )
    
    
    (887,104
    )
    
    
    (657,158
    )
    
    
    4.50-21.75
    
    
    
    4.50-21.75
    
    
    
    4.87-21.75
    
    
    
    16.68
    
    
    
    16.83
    
    
    
    12.24Canceled
    
    
    (133,950
    )
    
    
    (753,950
    )
    
    
    (1,068,500
    )
    
    
    4.50-26.55
    
    
    
    4.87-22.78
    
    
    
    4.87-21.75
    
    
    
    17.65
    
    
    
    18.71
    
    
    
    16.90Outstanding, end of
year
    
    
    3,922,132
    
    
    
    5,578,852
    
    
    
    6,050,906
    
    
    $
    10.91-29.57
    
    
    $
    4.50-23.23
    
    
    $
    4.50-22.78
    
    
    $
    20.81
    
    
    $
    18.05
    
    
    $
    17.17
 F- 27




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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, 2004, including the effect of the two-for-one stock split effective
June 8, 2004. Options Outstanding
    
    Options ExercisableWeighted
    
    Weighted
    
    
    
    
    
    WeightedAverage
    
    Average
    
    
    
    
    
    AverageRange of Exercise
    
    Number
    
    Remaining Life
    
    Exercise
    
    Number
    
    ExercisePrices
    
    Outstanding
    
    (Years)
    
    Price
    
    Exercisable
    
    Price$
    8.87
    
    
    $
    11.83
    
    
    
    10,800
    
    
    
    3.0
    
    
    $
    10.91
    
    
    
    10,800
    
    
    $
    10.9111.83
    
    
    
    14.78
    
    
    
    924,752
    
    
    
    7.8
    
    
    
    14.21
    
    
    
    292,252
    
    
    
    14.1814.78
    
    
    
    17.74
    
    
    
    412,804
    
    
    
    6.4
    
    
    
    16.13
    
    
    
    202,479
    
    
    
    16.1917.74
    
    
    
    20.70
    
    
    
    14,750
    
    
    
    7.4
    
    
    
    20.30
    
    
    
    5,750
    
    
    
    20.6120.70
    
    
    
    23.65
    
    
    
    1,755,426
    
    
    
    7.6
    
    
    
    22.47
    
    
    
    943,176
    
    
    
    21.9923.65
    
    
    
    26.61
    
    
    
    61,500
    
    
    
    7.8
    
    
    
    26.02
    
    
    
    
    
    
    
    0.00$
    26.61
    
    
    $
    29.57
    
    
    
    742,100
    
    
    
    9.9
    
    
    
    27.44
    
    
    
    
    
    
    
    0.003,922,132
    
    
    
    7.9
    
    
    $
    20.81
    
    
    
    1,457,457
    
    
    $
    19.52
 As of July 31, 2004, 2003 and 2002, 1,457,457, 2,777,702, and 3,456,781 of
options outstanding were exercisable at a weighted average exercise price of
$19.52, $17.55, and $17.60, respectively. Earnings (Loss) Per Common Share Basic earnings (loss) per common 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 common 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. After giving effect to
the stock split, for the fiscal years ended July 31, 2004, 2003 and 2002, there
were antidilutive Common Stock equivalents of 26,530, 1,180,299, and 1,731,651,
respectively. Years Ended July 31,2004
    
    2003
    
    2002(amounts in thousands, except per share amounts)Net earnings (loss) available to stockholders
    
    $
    106,473
    
    
    $
    (40,645
    )
    
    $
    143,932Basic:Weighted average number of common shares outstanding
    
    
    52,650
    
    
    
    64,528
    
    
    
    69,178Earnings (loss) per common share  basic:Before effect of change in accounting principle
    
    $
    2.02
    
    
    $
    (0.63
    )
    
    $
    1.48Net earnings (loss) per share
    
    $
    2.02
    
    
    $
    (0.63
    )
    
    $
    2.08Diluted:Weighted average number of common shares outstanding
    
    
    52,650
    
    
    
    64,528
    
    
    
    69,178Effect of dilutive securities:Stock Options
    
    
    869
    
    
    
    
    
    
    
    513Weighted average number of common shares
outstanding as adjusted
    
    
    53,519
    
    
    
    64,528
    
    
    
    69,692Earnings (Loss) per common share  diluted:Before effect of change in accounting principle
    
    $
    1.99
    
    
    $
    (0.63
    )
    
    $
    1.47Net earnings (loss) per share
    
    $
    1.99
    
    
    $
    (0.63
    )
    
    $
    2.07
 F- 28




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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 accompanying 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 seven principal brands. Revenues of international retail operations
represent approximately 7.5 percent, 6.8 percent, and 6.7 percent of the
Companys revenues for fiscal years 2004, 2003, and 2002 respectively. Net
property and equipment of international operations, represents approximately
8.7 percent and 7.5 percent of the Companys net property and equipment for
fiscal year 2004 and fiscal year 2003, respectively. 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. 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. F- 29




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##### Table of Contents



ZALE CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (continued) 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. 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 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,
2004, the Companys maximum potential payment would be approximately $30
million if the entire portfolio defaulted. Under the shared risk programs, the
Company incurred approximately $362,000 in losses for the fiscal year ended
July 31, 2004. The reserve for both portfolios is approximately $861,000 which
the Company believes is adequate based on the historical trend of actual
losses. The Company is required to pledge collateral to Citi in the form of an
interest bearing depository account that will fluctuate monthly based on the
account balances of the shared risk credit programs. The current collateral
balance as of July 31, 2004 is $5.5 million. Product Warranty Programs.The Company sells extended service agreements
(ESA) to customers to cover sizing and breakage for a two-year period on
certain products purchased from the Company. The revenue on these agreements
is recognized over the two-year period in proportion to the costs expected to
be incurred in performing services under the agreements. In addition to ESA,
the Company provides warranty services that cover diamond replacement costs 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
primarily on historical experience of actual expenses. F- 30




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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 EndedJuly 31, 2004
    
    July 31, 2003
    
    July 31, 2002(amounts in thousands)Beginning Balance
    
    $
    32,160
    
    
    $
    32,541
    
    
    $
    30,394Extended Service Agreements Sold
    
    
    50,183
    
    
    
    38,866
    
    
    
    35,000Extended Service Agreements
Revenue Recognized
    
    
    (50,549
    )
    
    
    (39,247
    )
    
    
    (32,853
    )Ending Balance
    
    $
    31,794
    
    
    $
    32,160
    
    
    $
    32,541
 Benefit Plans Defined Contribution Retirement Plan The Company maintains 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 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 $2.7 million, $2.2 million and $3.2 million for fiscal years
2004, 2003 and 2002, respectively. Financial Instruments As cash and short-term cash investments, trade payables and certain other
short-term financial instruments are all short-term in nature, their carrying
amount approximates fair value. For fiscal year 2004, the carrying amount of $197.5 million related to the
Revolving Credit Agreement approximates fair value at July 31, 2004. The investments of the Companys insurance subsidiaries, primarily stocks
and bonds in the amount of $24.3 million and $25.1 million, approximate market
value at July 31, 2004 and July 31, 2003 respectively and are reflected in
Other Assets on the accompanying consolidated balance sheets. Investments are
classified as available for sale and are carried at fair value. F- 31




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ZALE CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (continued) Concentrations of Business and Credit Risk.During fiscal years 2004 and 2003,
the Company purchased approximately 30 percent and 33 percent, respectively, of
its merchandise from its top five vendors, including more than 11 percent from
its top vendor in fiscal year 2004. 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
supply arrangements could be established. As of July 31, 2004 and 2003, the
Company had no significant concentrations of credit risk. Related-Party Transactions During fiscal year 2002, the Company retained an outside firm to perform
certain executive search services for the Company. One of the Companys
directors served as managing partner of this firm. In exchange for executive
search services, the firm received fees of approximately $330,000 in fiscal
year 2002. 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. In January 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 reelection 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 this loan. Also, in April 2001, the Company extended a $2.1 million,
three year interest bearing loan at 7.25 percent to Mr. DiNicola for the
purpose of purchasing a home. In July 2002, Mr. DiNicola repaid the outstanding
principal balance on this loan, along with all accrued interest. F- 32




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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 fiscal years ended July
31, 2004 and 2003 were as follows (amounts in thousands except per share data): Fiscal Year 2004For the Three Months EndedJuly 31,
    
    April 30,
    
    January 31,
    
    October 31,2004
    
    2004
    
    2004
    
    2003Total
Revenues
    
    $
    455,598
    
    
    $
    483,175
    
    
    $
    949,023
    
    
    $
    416,644Cost of
Sales
    
    
    214,518
    
    
    
    232,802
    
    
    
    469,936
    
    
    
    205,690Net Earnings (Loss)
    
    
    6,894
    
    
    
    11,528
    
    
    
    97,295
    
    
    
    (9,244
    )Net earnings (loss) per diluted share
    
    $
    0.13
    
    
    $
    0.22
    
    
    $
    1.83
    
    
    $
    (0.17
    )
 Fiscal Year 2003For the Three Months EndedJuly 31,
    
    April 30,
    
    January 31,
    
    October 31,2003
    
    2003
    
    2003
    
    2002Total
Revenues
    
    $
    442,382
    
    
    $
    449,383
    
    
    $
    908,359
    
    
    $
    412,117Cost of Sales
    
    
    215,103
    
    
    
    220,106
    
    
    
    461,472
    
    
    
    204,349Net Earnings (Loss)
    
    
    2,933
    
    
    
    9,367
    
    
    
    (46,222
    )
    
    
    (6,723
    )Net earnings (loss) per diluted share
    
    $
    0.05
    
    
    $
    0.15
    
    
    $
    (0.72
    )
    
    $
    (0.10
    )
 F- 33




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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 12th day of October, 2004. ZALE CORPORATIONBy:
    
    /s/ MARY L. FORTÉMary L. FortéPresident
and Chief Executive Officer
 KNOW ALL MEN BY THESE PRESENTS, that each person whose signature
appears below constitutes and appoints Mary L. Forté and Sue E. Gove, and
each of them, as his or her true and lawful attorneys-in-fact and agents,
with full powers and substitution and resubstitution for him or her, in
his or her name place and stead, in any and all capacities, to sign any
and all amendments to this Annual Report on Form 10-K, and to file the
same, with all exhibits thereto, and other documents in connection
therewith, with the Securities and Exchange Commission, granting unto said
attorneys-in-fact and agents full power and authority to do perform each
and every act and thing requisite and necessary to be done in and about
the premises as fully and to all intents and purposes as he or she might
or could do in person, hereby ratifying and confirming all that said
attorneys-in-fact and agents may lawfully do or cause to be done by virtue
hereof. Pursuant to the requirements of the Securities Exchange Act of 1934,
this report has been signed below by the following persons on behalf of
the registrant and in the capacities and on the dates indicated. Signature
    
    Title
    
    Date/s/ MARY L. FORTÉ
    
    President,
    
    October 12, 2004Mary L. Forté
    
    Chief Executive Officer and Director
(principal executive officer of the
registrant)/s/ SUE E. GOVE
    
    Executive Vice President,
    
    October 12, 2004Sue E. Gove
    
    Chief Operating Officer and Director/s/ MARK R. LENZ

Mark R. Lenz
    
    Group Senior Vice President
and Chief Financial Officer,
(principal financial
officer of the registrant )
    
    October 12, 2004/s/ CYNTHIA T. GORDON

Cynthia T. Gordon
    
    Senior Vice President, Controller
(principal accounting officer of the
registrant)
    
    October 12, 2004/s/ RICHARD C. MARCUS
    
    Chairman of the Board
    
    October 12, 2004Richard C. Marcus/s/ J. GLEN ADAMS
    
    Director
    
    October 12, 2004J. Glen Adams/s/ A. DAVID BROWN
    
    Director
    
    October 12, 2004A. David Brown/s/ MARY E. BURTON
    
    Director
    
    October 12, 2004Mary E. Burton/s/ JOHN B. LOWE, JR.
    
    Director
    
    October 12, 2004John B. Lowe, Jr./s/ THOMAS C. SHULL
    
    Director
    
    October 12, 2004Thomas C. Shull/s/ DAVID M. SZYMANSKI
    
    Director
    
    October 12, 2004David M. Szymanski




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Exhibit Number
    
    Description of Exhibit10.4b
    
    Form of Stock Option Award Agreement.10.4c
    
    Form of Restricted Stock Award Agreement.10.7c
    
    Second Lease Amendment to Lease Agreement for Corporate Headquarters.10.14
    
    Form of Change of Control Agreement of Senior Vice Presidents
without separate employment agreements.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 15 for a
complete list of the Companys exhibits, including exhibits incorporated
by reference from previous filings.