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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
 Washington, D.C. 20549
 Form 10-K
 For the fiscal year ended July 31, 2006
 Zale Corporation
 
 
      DOCUMENTS INCORPORATED BY REFERENCE.




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TABLE OF CONTENTS  PART IITEM 1. BUSINESSITEM 1A. RISK FACTORSITEM 1B. UNRESOLVED STAFF COMMENTSITEM 2. PROPERTIESITEM 3. LEGAL PROCEEDINGSITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERSITEM 4A. EXECUTIVE OFFICERS AND KEY EMPLOYEES OF THE REGISTRANTPART 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-KAmendment to the Revolving Credit AgreementSavings and Investment Plan as Amended2003 Stock Incentive Plan as AmendedOutside Directors' 2005 Stock Incentive Plan as AmendedSupplemental Executive Retirement Plan as AmendedEmployment Agreement - Mary E. BurtonEmployment Agreement - Gilbert P. HollanderEmployment Agreement - Frank C. MroczkaZale Corporation Bonus PlanBase SalariesSubsidiariesConsent of KPMG LLPCertification of Chief Executive OfficerCertification of Chief Financial OfficerCertification of Chief Executive OfficerCertification of Chief Financial OfficerCompensation Committee Charter    Table of Contents  
 PART I
 
 ITEM 1. BUSINESS
 General
  www.zalecorp.com.
  Business Segments
  Fine Jewelry
 zales.com. baileybanksandbiddle.com Ò
 Zale North America
  Zales Jewelers.
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zales.com
 Peoples
Jewellers and Mappins Jewellers.
  Zales Outlet
    Gordons Jewelers
  - 2 -




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Bailey Banks & Biddle Fine Jewelers
    Kiosk Jewelry
     All Other
  - 3 -




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Business Developments
         Business Initiatives and Strategy
 Regain Market Share
  - 4 -




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Improve Gross Margin
      - 5 -




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Invest in People
   Current Year Capital
   Industry and Competition
   United
States Census Bureau
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Operations by Brand
  Year Ended July 31, 20062006
    
    
    2005
    
    
    2004Total Revenues (in thousands)Zales (including ZLC Direct)
    
    $
    1,092,625
    
    
    $
    1,079,230
    
    
    $
    1,070,576Zales Outlet
    
    
    177,736
    
    
    
    166,000
    
    
    
    137,613Gordons
    
    
    339,510
    
    
    
    324,854
    
    
    
    313,881Bailey Banks & Biddle (a)
    
    
    309,311
    
    
    
    320,869
    
    
    
    326,086Peoples (b)
    
    
    229,574
    
    
    
    198,308
    
    
    
    174,058Piercing Pagoda
    
    
    268,936
    
    
    
    274,296
    
    
    
    269,660Peoples II
    
    
    7,683
    
    
    
    6,601
    
    
    
    Insurance Revenues/Other
    
    
    13,602
    
    
    
    12,908
    
    
    
    12,566$
    2,438,977
    
    
    $
    2,383,066
    
    
    $
    2,304,440Average Sales Per Location (c)Zales
    
    $
    1,383,000
    
    
    $
    1,366,000
    
    
    $
    1,390,000Zales Outlet
    
    
    1,360,000
    
    
    
    1,249,000
    
    
    
    1,287,000Gordons
    
    
    1,200,000
    
    
    
    1,112,000
    
    
    
    1,101,000Bailey Banks & Biddle
    
    
    3,738,000
    
    
    
    3,474,000
    
    
    
    2,848,000Peoples
    
    
    1,397,000
    
    
    
    1,140,000
    
    
    
    1,041,000Piercing Pagoda
    
    
    332,000
    
    
    
    343,000
    
    
    
    339,000Peoples II
    
    
    82,000
    
    
    
    100,000
    
    
    
    
 Locations By BrandLocations Opened During
    
    Locations Closed During
    
    Locations at End ofPeriod
    
    Period
    
    PeriodYear Ended July 31, 2006Zales (d)
    
    
    24
    
    
    
    20
    
    
    
    784Zales Outlet (d)
    
    
    7
    
    
    
    1
    
    
    
    131Gordons
    
    
    17
    
    
    
    11
    
    
    
    293Bailey Banks & Biddle
    
    
    1
    
    
    
    32
    
    
    
    73Peoples
    
    
    7
    
    
    
    
    
    
    
    175Piercing Pagoda
    
    
    38
    
    
    
    33
    
    
    
    817Peoples II
    
    
    16
    
    
    
    9
    
    
    
    76Master Jewelry Repair
    
    
    3
    
    
    
    3
    
    
    
    113
    
    
    
    109
    
    
    
    2,349Year Ended July 31, 2005Zales
    
    
    24
    
    
    
    14
    
    
    
    767Zales Outlet
    
    
    18
    
    
    
    1
    
    
    
    138Gordons
    
    
    13
    
    
    
    13
    
    
    
    287Bailey Banks & Biddle
    
    
    
    
    
    
    4
    
    
    
    104Peoples
    
    
    6
    
    
    
    1
    
    
    
    168Piercing Pagoda
    
    
    50
    
    
    
    36
    
    
    
    812Peoples II
    
    
    71
    
    
    
    2
    
    
    
    69Master Jewelry Repair
    
    
    
    
    
    
    
    
    
    
    182
    
    
    
    71
    
    
    
    2,345Year Ended July 31, 2004Zales
    
    
    9
    
    
    
    7
    
    
    
    757Zales Outlet
    
    
    25
    
    
    
    
    
    
    
    121Gordons
    
    
    9
    
    
    
    9
    
    
    
    287Bailey Banks & Biddle
    
    
    
    
    
    
    8
    
    
    
    108Peoples
    
    
    5
    
    
    
    9
    
    
    
    163Piercing Pagoda
    
    
    24
    
    
    
    39
    
    
    
    798Peoples II
    
    
    
    
    
    
    
    
    
    
    Master Jewelry Repair
    
    
    
    
    
    
    
    
    
    
    72
    
    
    
    72
    
    
    
    2,234
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(a)
    
    Includes revenues of $24.3 million, $49.8 million, and $48.1 million for fiscal years
2006, 2005, and 2004, respectively, related to the Bailey Banks & Biddle store closings in the
second quarter of fiscal year 2006.(b)
    
    Peoples (including Mappins) and Peoples II reflects all revenue from Canadian
operations, which constitutes all our foreign operations. Long-lived assets from foreign
operations totaled approximately $29.3 million, $27.6 million, and $23.2 million at July 31,
2006, 2005, and 2004, respectively.(c)
    
    Based on merchandise sales for locations open a full twelve months during the
applicable year.(d)
    
    In fiscal year 2006, the total locations at the end of the period reflect 13 stores
that were moved from the Zales Outlet brand to the Zales brand. Business Segment Data
  Store Operations
      Purchasing and Inventory
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Proprietary Credit
    - 9 -




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Employees
  Seasonality
  Information Technology
     Regulation
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Available Information
 www.zalecorp.com www.sec.gov.
 www.zalecorp.com
 www.zalecorp.com
 
 ITEM 1A. RISK FACTORS
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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.
  The concentration of a substantial portion of our sales in three relatively brief selling periods
means that our performance is more susceptible to disruptions.
  Most of our sales are of products that include diamonds, precious metals and other commodities, and
fluctuations in the availability and pricing of commodities could impact our ability to obtain and
produce products at favorable prices.
   Our sales are dependent upon mall traffic.
  We operate in a highly competitive and fragmented industry.
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Any failure by us to manage our inventory effectively will negatively impact sales and earnings.
  Because of our dependence upon a small concentrated number of landlords for a substantial number of
our locations, any significant erosion of our relationships with those landlords would negatively
impact our ability to obtain and retain store locations.
  Changes in regulatory requirements relating to the extension of credit may increase the cost of or
adversely affect our operations.
  Any disruption in, or changes to, our private label credit card arrangement with Citi may adversely
affect our ability to provide consumer credit and write credit insurance.
  Acquisitions involve special risk, including the possibility that we may be unable to integrate new
acquisitions into our existing operations.
  We recently appointed a new CEO, who may initiate strategies or other changes in store levels,
expenses, staffing, and related matters.
  
 ITEM 1B. UNRESOLVED STAFF COMMENTS
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ITEM 2. PROPERTIES
     Percentage ofTerm Expires
    
    Stores
    
    Kiosks
    
    Other (1)
    
    Total
    
    Total2007 and prior
    
    
    369
    
    
    
    389
    
    
    
    1
    
    
    
    759
    
    
    
    32.1
    %2008
    
    
    155
    
    
    
    171
    
    
    
    1
    
    
    
    327
    
    
    
    13.9
    %2009
    
    
    153
    
    
    
    121
    
    
    
    2
    
    
    
    276
    
    
    
    11.7
    %2010
    
    
    156
    
    
    
    134
    
    
    
    2
    
    
    
    292
    
    
    
    12.4
    %2011 and thereafter
    
    
    623
    
    
    
    78
    
    
    
    5
    
    
    
    706
    
    
    
    29.9
    %Total number of leases
    
    
    1,456
    
    
    
    893
    
    
    
    11
    
    
    
    2,360
    
    
    
    100.0
    %
 
 (1)
    
    Other includes warehouse, distribution, storage facilities, and four locations that are
either not yet opened, or are locations that have been closed but are still under lease
obligations.  
 ITEM 3. LEGAL PROCEEDINGS
  SEC Investigation.
 Securities
and ERISA Litigation. Levy v. Zale Corp.,
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Agoos v. Zale Corp., Pipefitters Local No. 636 Defined Benefit
Plan v. Zale Corp., Chester v. Zale Corp., Salvato v. Zale Corp., Connell v. Zale Corp., Levy, Agoos, Chester Salvato Connell
 Levy, Agoos, Pipefitters and Chester Salvato Connell Salvato Connell
 
 ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
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ITEM 4A. EXECUTIVE OFFICERS AND KEY EMPLOYEES OF THE REGISTRANT
  Name
    
    Age
    
    PositionExecutive Officers:Mary E. Burton
    
    
    54
    
    
    President, Chief Executive Officer and DirectorGeorge R. Mihalko, Jr.
    
    
    51
    
    
    Acting Chief Administrative Officer, Acting Chief Financial
Officer and DirectorJohn A. Zimmermann
    
    
    47
    
    
    Group President and President, Zale North AmericaGilbert P. Hollander
    
    
    53
    
    
    Group Senior Vice President and President, Corporate
Sourcing/Piercing PagodaFrank C. Mroczka
    
    
    48
    
    
    Senior Vice President and President, Gordons JewelersKey Employees:Mary Ann Doran
    
    
    50
    
    
    Senior Vice President, Human ResourcesCharles E. Fieramosca
    
    
    58
    
    
    Senior Vice President and President, Bailey Banks & Biddle Fine
JewelersCynthia T. Gordon
    
    
    42
    
    
    Senior Vice President, ControllerSteven Larkin
    
    
    48
    
    
    Senior Vice President, E-CommerceStephen C. Massanelli
    
    
    50
    
    
    Senior Vice President, Real EstateSusann C. Mayo
    
    
    54
    
    
    Senior Vice President, Supply ChainHilary Molay
    
    
    52
    
    
    Senior Vice President, General Counsel and SecretaryNancy O. Skinner
    
    
    56
    
    
    Senior Vice President and President, Zales the Diamond Store
OutletGeorge J. Slicho
    
    
    57
    
    
    Senior Vice President, Loss PreventionMark A. Stone
    
    
    48
    
    
    Senior Vice President, Chief Information Officer
 Executive Officers
  Ms. Mary E. Burton
 Mr. George R. Mihalko, Jr. .
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Mr. John A. Zimmermann
 Mr. Gilbert P. Hollander
 Mr. Frank C. Mroczka
 Mr. Rodney Carter
 Key Employees
 Ms. Mary Ann Doran
 Mr. Charles E. Fieramosca
 Ms. Cynthia T. Gordon
 Mr. Steven Larkin
 Mr. Stephen C. Massanelli
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Ms. Susann C. Mayo
 Ms. Hilary Molay
 Ms. Nancy O. Skinner
 Mr. George J. Slicho
 Mr. Mark A. Stone
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PART II
 
 ITEM 5.
    
    MARKET FOR THE REGISTRANTS COMMON EQUITY, RELATED
STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
  2006
    
    2005High
    
    Low
    
    High
    
    LowFirst
    
    $
    34.42
    
    
    $
    25.62
    
    
    $
    29.17
    
    
    $
    24.59Second
    
    $
    29.95
    
    
    $
    24.28
    
    
    $
    31.25
    
    
    $
    25.50Third
    
    $
    28.61
    
    
    $
    23.54
    
    
    $
    30.96
    
    
    $
    26.15Fourth
    
    $
    27.75
    
    
    $
    21.01
    
    
    $
    34.28
    
    
    $
    26.95
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ITEM 6. SELECTED FINANCIAL DATA
  Year Ended July 31,2006
    
    
    2005
    
    
    2004
    
    
    2003
    
    
    2002(amounts in thousands, except per share amounts)Total revenues (a)
    
    $
    2,438,977
    
    
    $
    2,383,066
    
    
    $
    2,304,440
    
    
    $
    2,212,241
    
    
    $
    2,191,727Costs and expenses:Cost of sales (b)
    
    
    1,215,636
    
    
    
    1,157,226
    
    
    
    1,122,946
    
    
    
    1,101,030
    
    
    
    1,083,053Selling, General and Administrative expenses (c)
    
    
    1,087,458
    
    
    
    982,113
    
    
    
    942,796
    
    
    
    884,069
    
    
    
    873,265Cost of insurance operations
    
    
    6,699
    
    
    
    6,084
    
    
    
    5,963
    
    
    
    8,228
    
    
    
    8,620Depreciation and amortization expense
    
    
    59,771
    
    
    
    59,840
    
    
    
    56,381
    
    
    
    55,690
    
    
    
    58,340Impairment of Goodwill
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    136,300
    
    
    
    Executive transactions
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    2,298Retiree medical plan termination/curtailment
    
    
    (13,403
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (3,500
    )Derivatives
(Gains)/Losses
    
    
    1,681
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Operating earnings
    
    
    81,135
    
    
    
    177,803
    
    
    
    176,354
    
    
    
    26,924
    
    
    
    169,651Interest expense, net
    
    
    11,185
    
    
    
    7,725
    
    
    
    7,528
    
    
    
    6,319
    
    
    
    7,750Costs of Early Retirement of Debt
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    5,910
    
    
    
    Earnings before income taxes
    
    
    69,950
    
    
    
    170,078
    
    
    
    168,826
    
    
    
    14,695
    
    
    
    161,901Income taxes (d)
    
    
    16,328
    
    
    
    63,303
    
    
    
    62,353
    
    
    
    55,340
    
    
    
    59,256Earnings (loss) before effect of
accounting change
    
    
    53,622
    
    
    
    106,775
    
    
    
    106,473
    
    
    
    (40,645
    )
    
    
    102,645Effect of change in accounting principle (e)
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (41,287
    )Net earnings (loss)
    
    $
    53,622
    
    
    $
    106,775
    
    
    $
    106,473
    
    
    $
    (40,645
    )
    
    $
    143,932Earnings (Loss) Per Common Share:Basic:Before effect of change in accounting principle
    
    $
    1.10
    
    
    $
    2.08
    
    
    $
    2.02
    
    
    
    ($0.63
    )
    
    $
    1.48Net Earnings (Loss) Per Share
    
    $
    1.10
    
    
    $
    2.08
    
    
    $
    2.02
    
    
    
    ($0.63
    )
    
    $
    2.08Earnings (Loss) Per Common Share:Diluted:Before effect of change in accounting principle
    
    $
    1.09
    
    
    $
    2.05
    
    
    $
    1.99
    
    
    
    ($0.63
    )
    
    $
    1.47Net Earnings (Loss) Per Share
    
    $
    1.09
    
    
    $
    2.05
    
    
    $
    1.99
    
    
    
    ($0.63
    )
    
    $
    2.07Weighted average number of common shares
outstanding (f):Basic
    
    
    48,808
    
    
    
    51,280
    
    
    
    52,650
    
    
    
    64,528
    
    
    
    69,178Diluted
    
    
    49,211
    
    
    
    51,975
    
    
    
    53,519
    
    
    
    64,528
    
    
    
    69,692Balance Sheet Data:Working capital
    
    $
    646,115
    
    
    $
    611,561
    
    
    $
    582,888
    
    
    $
    532,443
    
    
    $
    561,939Total assets
    
    
    1,462,568
    
    
    
    1,380,900
    
    
    
    1,342,084
    
    
    
    1,294,106
    
    
    
    1,489,265Long-Term Debt
    
    
    202,813
    
    
    
    129,800
    
    
    
    197,500
    
    
    
    184,400
    
    
    
    86,749Total stockholders investment
    
    $
    801,249
    
    
    $
    817,588
    
    
    $
    726,114
    
    
    $
    652,323
    
    
    $
    939,807
 
 (a)
    
    Total revenues include $24.3 million, $49.8 million, $48.1 million, $46.3 million, and $46.0
million for fiscal years 2006, 2005, 2004, 2003, and 2002, respectively, of revenues generated
in the closed Bailey Banks & Biddle stores.(b)
    
    In fiscal year 2006, cost of sales includes charges of $26.9 million related to the
accelerated markdown of discontinued merchandise and $21.4 million related to closing certain
Bailey Banks & Biddle stores (including a $6.2 million charge on inventory).(c)
    
    In fiscal year 2006, SG&A includes (1) $12.1 million in executive severance costs, (2) $28.0
million related to Bailey Banks & Biddle store closings, (3) $5.2 million related to adoption
of SFAS 123(R), (4) $5.3 million related to termination of an IT initiative, and (5) $4.6
million related to asset impairment charges. - 20 -




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(d)
    
    Income taxes in fiscal year 2006 decreased primarily due to lower earnings, tax benefits
related to the AJCA repatriation and reduced tax rates in Canada.(e)
    
    Fiscal year 2002 reflects a change in accounting principle for the write-off of the excess of
revalued net assets over stockholders equity (negative goodwill).(f)
    
    Outstanding share amounts have been adjusted to give retroactive effect to a two-for-one
stock split completed on June 8, 2004. - 21 -




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Segment Data
 Selected Financial Data by Segment
 Year Ended July 31,2006
    
    
    2005
    
    
    2004
    
    
    2003
    
    
    2002(amounts in thousands, except per share amounts)RevenuesFine Jewelry (a)
    
    $
    2,149,217
    
    
    $
    2,089,261
    
    
    $
    2,022,214
    
    
    $
    1,939,454
    
    
    $
    1,900,177Kiosk (b)
    
    
    276,619
    
    
    
    280,897
    
    
    
    269,660
    
    
    
    256,665
    
    
    
    273,225All Other
    
    
    13,141
    
    
    
    12,908
    
    
    
    12,566
    
    
    
    16,122
    
    
    
    18,325Total Revenues
    
    $
    2,438,977
    
    
    $
    2,383,066
    
    
    $
    2,304,440
    
    
    $
    2,212,241
    
    
    $
    2,191,727Depreciation & Amortization ExpenseFine Jewelry
    
    $
    43,273
    
    
    $
    44,410
    
    
    $
    41,757
    
    
    $
    40,915
    
    
    $
    40,453Kiosk
    
    
    5,571
    
    
    
    4,708
    
    
    
    4,199
    
    
    
    4,653
    
    
    
    5,618All Other
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Unallocated
    
    
    10,927
    
    
    
    10,722
    
    
    
    10,425
    
    
    
    10,122
    
    
    
    12,269Total Depreciation & Amortization Expense
    
    $
    59,771
    
    
    $
    59,840
    
    
    $
    56,381
    
    
    $
    55,690
    
    
    $
    58,340Operating Earnings (Loss)Fine Jewelry
    
    $
    108,082
    
    
    $
    147,414
    
    
    $
    153,739
    
    
    $
    151,650
    
    
    $
    145,816Kiosk (c)
    
    
    20,402
    
    
    
    29,030
    
    
    
    25,951
    
    
    
    (125,629
    )
    
    
    20,335All Other
    
    
    6,443
    
    
    
    6,824
    
    
    
    6,603
    
    
    
    7,894
    
    
    
    9,705Unallocated (d)
    
    
    (53,792
    )
    
    
    (5,465
    )
    
    
    (9,939
    )
    
    
    (6,991
    )
    
    
    (6,205
    )Total Operating Earnings
    
    $
    81,135
    
    
    $
    177,803
    
    
    $
    176,354
    
    
    $
    26,924
    
    
    $
    169,651Assets (e)Fine Jewelry (f)
    
    $
    1,119,679
    
    
    $
    1,103,142
    
    
    $
    1,055,755
    
    
    $
    1,036,080
    
    
    $
    1,022,790Kiosk (g)
    
    
    124,415
    
    
    
    117,125
    
    
    
    111,238
    
    
    
    96,485
    
    
    
    238,048All Other
    
    
    39,261
    
    
    
    35,670
    
    
    
    37,737
    
    
    
    38,217
    
    
    
    38,788Unallocated
    
    
    179,213
    
    
    
    124,963
    
    
    
    137,354
    
    
    
    123,324
    
    
    
    189,639Total Assets
    
    $
    1,462,568
    
    
    $
    1,380,900
    
    
    $
    1,342,084
    
    
    $
    1,294,106
    
    
    $
    1,489,265Capital ExpendituresFine Jewelry
    
    $
    54,942
    
    
    $
    59,587
    
    
    $
    42,535
    
    
    $
    27,064
    
    
    $
    41,602Kiosk
    
    
    7,750
    
    
    
    8,650
    
    
    
    6,038
    
    
    
    6,383
    
    
    
    3,644All Other
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Unallocated
    
    
    20,026
    
    
    
    14,887
    
    
    
    12,215
    
    
    
    10,132
    
    
    
    8,913Total Capital
    
    $
    82,718
    
    
    $
    83,124
    
    
    $
    60,788
    
    
    $
    43,579
    
    
    $
    54,159
 
 (a)
    
    Includes $229.6, $198.3, $174.1, $150.4 and $147.5 million in fiscal years 2006, 2005,
2004, 2003, and 2002, respectively, related to foreign operations.(b)
    
    Includes $7.7 and $6.6 million in fiscal years 2006 and 2005, respectively, related to
foreign operations. There were no foreign operations in the segment prior to fiscal year 2005.(c)
    
    Includes impairment of goodwill of $136.3 million in fiscal year 2003.(d)
    
    Fiscal year 2006 includes $36.7 million related to the special charge, $13.4 million benefit
related to the settlement of certain retirement plan obligations, $12.1 million for executive
severance, $5.3 million related to share-based compensation expense, and $2.4 million related
to accrued percentage rent. Also, includes $70.9, $71.0, $65.9, $63.3, and $61.1 million in
fiscal years 2006, 2005, 2004, 2003, and 2002, respectively, to offset internal carrying costs
charged to the segments.(e)
    
    Assets allocated to segments include fixed assets, inventories and goodwill. Unallocated
assets include cash, prepaid assets such as rent, corporate office improvements, and
technology infrastructure.(f)
    
    Includes $28.8, $27.2, $23.2, $20.0, and $16.9 million of fixed assets in fiscal years 2006,
2005, 2004, 2003, and 2002, respectively, related to foreign operations.(g)
    
    Includes $466,000 and $390,000 of fixed assets in fiscal years 2006 and 2005, respectively,
related to foreign operations. There were no foreign operations in the segment prior to fiscal
year 2005. NOTE:
    
    The segments are not organized based on product differences or geographic areas
and, accordingly, it is not practicable to report revenues based on such
organization.
 - 22 -




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##### Table of Contents



ITEM 7.
    
    MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
  Executive Overview
           - 23 -




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##### Table of Contents




    
    Expanded internally purchased and assembled product for Zales Jewelers, Gordons
Jewelers, Peoples Jewellers, and Zales the Diamond Store Outlet
    
    Implemented new Human Resources management solution, including payroll services solution
    
    Completed test/pilot of new point of sale system
    
    Closed 32 Bailey Banks & Biddle stores that did not fit the business model
  
    
    Increase market share through improved assortment and execution in the Zales brand
    
    Improve margin by expanding direct sourcing of diamonds for the Zales brand as well as
Peoples, Gordons, and Outlet
    
    Retain and attract key employees through competitive compensation, training, resources,
and support
   
    
    Zales Jewelers (including zales.com), our national brand in the U.S., provides
moderately priced jewelry to a broad range of customers
    
    Zales Outlet caters to the slightly higher-income female self purchaser in malls and
neighborhood power centers
    
    Gordons Jewelers is a regional jeweler focusing on customer driven assortments
    
    Bailey Banks & Biddle Fine Jewelers (including baileybanksandbiddle.com)operates
jewelry stores that are considered among the finest luxury jewelry stores in their
markets, offering designer jewelry and prestige watches to attract more affluent customers
    
    Peoples Jewellers and Mappins Jewellers are two of the most recognized brand names in
Canada, providing moderately priced jewelry to a wide variety of Canadian customers
   Results of Operations
  Year Ended July 31, 20062006
    
    2005
    
    2004Total Revenues
    
    
    100.0
    %
    
    
    100.0
    %
    
    
    100.0
    %Cost of Sales (a)
    
    
    49.8
    
    
    
    48.6
    
    
    
    48.7Selling, General and Administrative
Expenses (b)
    
    
    44.6
    
    
    
    41.2
    
    
    
    40.9Cost of Insurance Operations
    
    
    0.3
    
    
    
    0.3
    
    
    
    0.3Depreciation and Amortization Expense
    
    
    2.5
    
    
    
    2.5
    
    
    
    2.5Benefit from Settlement of
Retirement Benefit Obligation
    
    
    (0.6
    )
    
    
    
    
    
    
    Derivatives
(Gains)/Losses
    
    
    0.1
    
    
    
    
    
    
    
    Operating Earnings
    
    
    3.3
    
    
    
    7.4
    
    
    
    7.6Interest Expense, Net
    
    
    0.4
    
    
    
    0.3
    
    
    
    0.3Earnings Before Income Taxes
    
    
    2.9
    
    
    
    7.1
    
    
    
    7.3Income Taxes (c)
    
    
    0.7
    
    
    
    2.6
    
    
    
    2.7Net Earnings
    
    
    2.2
    %
    
    
    4.5
    %
    
    
    4.6
    %
 - 24 -




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##### Table of Contents



(a)
    
    The cost of sales increase is primarily due to a special charge of 110 basis points
related to the accelerated markdown of discontinued merchandise and a 10 basis points charge
related to closing certain Bailey Banks & Biddle stores.(b)
    
    The increase in SG&A in fiscal year 2006 is primarily related to executive severance costs
(50 basis points), Bailey Banks & Biddle store closings (120 basis points), adoption of SFAS
123(R) (20 basis points), termination of an IT initiative (20 basis points), and asset
impairment charges (20 basis points), and incremental store operating costs.(c)
    
    Income taxes decreased in fiscal year 2006 primarily due to tax benefits related to the
repatriation of Canadian revenues pursuant to the American Jobs Creation Act of 2004, and
Canadian earnings. Bailey Banks & Biddle Store Closings.
 American
Jobs Creation Act.
 Year Ended July 31, 2006 Compared to Year Ended July 31, 2005
 Total Revenues .
    - 25 -




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##### Table of Contents



Cost of Sales.
   Selling, General and Administrative Expenses .
 Depreciation and Amortization Expense .
 Settlement of Retirement Plan Obligations .
 Derivatives
(Gains)/Losses.
  Interest Expense .
 - 26 -




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##### Table of Contents



Income Taxes .
  Year Ended July 31, 2005 Compared to Year Ended July 31, 2004
 Total Revenues .
     Cost of Sales .
  Selling General and Administrative Expenses.
 - 27 -




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##### Table of Contents



Depreciation and Amortization Expense.
 Income Taxes.
 Liquidity and Capital Resources
      Cash Flow Activities
   - 28 -




---



##### Table of Contents



Finance Arrangements
 Revolving Credit Agreement.
     - 29 -




---



##### Table of Contents



Capital Growth
  Other Activities Affecting Liquidity
 Stock Repurchase Plan.
  Off-Balance Sheet Arrangements .
   Net Operating Losses.
 - 30 -




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##### Table of Contents



Contractual Obligations .
 Payments Due by PeriodContractual Cash Obligations
    
    
    
    
    
    Less than 1
    
    
    
    
    
    
    
    
    
    
    More than 5($ in millions) (f, g)
    
    Total
    
    
    Year
    
    
    1 - 3 Years
    
    
    4 - 5 Years
    
    
    Years
    
    
    OtherLong-Term Debt (a)
    
    $
    203
    
    
    $
    
    
    
    $
    203
    
    
    $
    
    
    
    $
    
    
    
    
    Operating Leases (b)
    
    
    1,026
    
    
    
    198
    
    
    
    318
    
    
    
    228
    
    
    
    282
    
    
    
    Operation Services Agreement (c)
    
    
    26
    
    
    
    5
    
    
    
    13
    
    
    
    8
    
    
    
    
    
    
    
    Severance (d)
    
    
    12
    
    
    
    12
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Other Long-Term Liabilities (e)
    
    
    8
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    8Total
    
    $
    1,275
    
    
    $
    215
    
    
    $
    534
    
    
    $
    236
    
    
    $
    282
    
    
    
    8
 
 (a)
    
    Long-term debt relates to principal payments due under our Revolving Credit Agreement. This
amount does not reflect any interest, which would be based on the current effective rate,
which was 6.47 percent at July 31, 2006 and assuming no prepayments.(b)
    
    Operating lease obligations relate to minimum payments due under store lease agreements. Most
of the store operating leases provide for the payment of base rentals plus real estate taxes,
insurance, common area maintenance fees and merchant association dues. For fiscal year 2006,
these costs represented approximately 20 percent of fixed rent payments. (See Notes to
Consolidated Financial Statements-Lease Commitments for further discussion).(c)
    
    We have an operations services agreement with a third party for the management of our
mainframe processing operations, client server systems, Local Area Network operations, Wide
Area Network management and e-commerce hosting. The current agreement is effective August 1,
2005 (see Notes to Consolidated Financial Statements  Commitments and Contingencies for
further discussion).(d)
    
    Executive Severance reflects the contractual cash and equities obligations primarily
resulting from the resignation of the Chief Executive Officer ($8.5 million) and the Chief
Operating Officer ($3.6 million).(e)
    
    Other long-term liabilities reflect loss reserves related to credit insurance. We have
reflected these payments under Other, as the timing of these future payments is dependent on
the actual processing of the claims.(f)
    
    Not included in the above table is the long-term portion ($12.5 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).(g)
    
    Not included in the table above as purchase obligations are our obligations under employment
agreements and ordinary course purchase orders for merchandise and obligations, including
certain merchandise on memo for which we may have a contingent liability to purchase certain
items if they do not sell through. New Accounting Pronouncement
 FASB Interpretation No. 48.
 - 31 -




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Inflation
  Critical Accounting Policies and Estimates
   Merchandise Inventories .
    - 32 -




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##### Table of Contents



Long-lived Assets and Goodwill.
  Revenue Recognition.
 Other Reserves.
  - 33 -




---



##### Table of Contents



Other Matters
 SEC Investigation.
 Securities and ERISA Litigation. Levy v. Zale Corp., Agoos v. Zale Corp., Pipefitters Local No. 636 Defined Benefit
Plan v. Zale Corp., Chester v. Zale Corp., Salvato v. Zale Corp., Connell v. Zale Corp., Levy, Agoos, Chester Salvato Connell
 Levy, Agoos, Pipefitters and Chester Salvato Connell Salvato Connell
 Executive
Changes.
      - 34 -




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##### Table of Contents



Special Charge.
 Bailey Banks & Biddle Store Closings.
 American Jobs Creation Act.
 Texas Margin Tax .
  - 35 -




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##### Table of Contents



ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
     Commodity Risk.
  .
    - 36 -




---



##### Table of Contents



Foreign Currency Contracts .
  - 37 -




---



##### Table of Contents



ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
  PageIndex
    
    NumberManagements Report on Internal Control Over Financial Reporting
    
    F-2Report of Independent Registered Public Accounting Firm
    
    F-3Report of Independent Registered Public Accounting Firm
    
    F-5Consolidated Statements of Operations
    
    F-6Consolidated Balance Sheets
    
    F-7Consolidated Statements of Cash Flows
    
    F-8Consolidated Statements of Stockholders Investment
    
    F-9Notes to Consolidated Financial Statements
    
    F-11
 
 ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS AND FINANCIAL
DISCLOSURE
  
 ITEM 9A. CONTROLS AND PROCEDURES
 Disclosure Controls and Procedures
  Internal Control Over Financial Reporting
   
 ITEM 9B. OTHER INFORMATION
 Summary of Mary E. Burton Employment Agreement
  - 38 -




---



##### Table of Contents



Summary of Frank C. Mroczka Employment Agreement
    - 39 -




---



##### Table of Contents



PART III
 
 ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
  
 ITEM 11. EXECUTIVE COMPENSATION
  
 ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND
MANAGEMENT AND RELATED STOCKHOLDER MATTERS
  Equity Compensation Plan Information
  Equity Compensation Plan Information
 Number of shares of
    
    
    
    
    
    
    Number of shares of common stockcommon stock to be
    
    
    
    
    
    
    remaining available for future issuanceissued upon exercise of
    
    
    Weighted - average
    
    
    under equity compensation plansoutstanding options
    
    
    exercise price of
    
    
    (excluding shares reflected in 1stPlan Category
    
    (1), (3)
    
    
    outstanding options
    
    
    column) (2), (3)Equity compensation
plans approved by
stockholders
    
    
    3,121,744
    
    
    $
    23.80
    
    
    
    4,261,248Equity compensation
plans not approved
by stockholders
    
    
    
    
    
    
    
    
    
    
    Total
    
    
    3,121,744
    
    
    $
    23.80
    
    
    
    4,261,248
 
 (1)
    
    Includes shares of common stock to be issued upon the exercise of outstanding options
under the Zale Corporation Omnibus Stock Incentive Plan, the Zale Corporation 2003 Stock
Incentive Plan, the Zale Corporation Outside Directors 1995 Stock Option Plan, and the Zale
Corporation Outside Directors 2005 Stock Incentive Plan, as amended.(2)
    
    Includes shares of common stock available for future issuance under the Zale Corporation 2003
Stock Incentive Plan as amended, and the Zale Corporation Outsider Directors 2005 Stock
Incentive Plan, as amended.(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 our two-for-one stock split completed on June 8,
2004. - 40 -




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##### Table of Contents



ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
  
 ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES
  - 41 -




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##### Table of Contents



PART IV
 
 ITEM 15. EXHIBITS, FINANCIAL STATEMENTS SCHEDULES AND REPORTS ON FORM 8-K
  1. Financial Statements
  2. Index to Financial Statement Schedules
  3. Exhibits
  The filings referencedfor incorporation by reference are ZaleExhibit
    
    
    
    Corporation filings (File No. 1-04129) unlessNumber
    
    Description of Exhibit
    
    otherwise noted3.1a
    
    Restated Certificate of Incorporation of Zale Corporation
    
    October 31, 2001 Form 10-Q,
Exhibit 3.13.1b
    
    Certificate of Amendment to Restated Certificate of
Incorporation of Zale Corporation
    
    October 31, 2004 Form
10-Q, Exhibit 3.13.2
    
    Bylaws of Zale Corporation
    
    July 31, 2000 Form 10-K,
Exhibit 3.24.1a
    
    Revolving Credit Agreement, dated as of July 23, 2003
    
    July 31, 2003 Form 10-K,
Exhibit 4.14.1b
    
    Amendment to Revolving Credit Agreement, dated as of
December 10, 2004
    
    December 10, 2004 Form
8-K, Exhibit 99.14.1c
    
    Amendment to Revolving Credit
Agreement dated as of
January 17, 2006
    
    Filed herewith10.1
    
    Zale Corporation Savings and Investment Plan, as amended
    
    Filed herewith10.2*
    
    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, as amended
    
    Filed herewith10.4b*
    
    Form of Incentive Stock Option Award Agreement
    
    July 31, 2004 Form 10-K,
Exhibit 10.4b
 - 42 -




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##### Table of Contents



The filings referencedfor incorporation by reference are ZaleExhibit
    
    
    
    Corporation filings (File No. 1-04129) unlessNumber
    
    Description of Exhibit
    
    otherwise noted10.4c
    
    Form of Non-qualified Stock Option Award Agreement
    
    August 31, 2006 Form 8-K,
Exhibit 10.110.4d*
    
    Form of Restricted Stock Award Agreement
    
    July 31, 2004 Form 10-K,
Exhibit 10.4c10.4e
    
    Form of Time-Vesting Restricted Stock Unit Award Agreement
    
    November 17, 2005 Form
8-K, Exhibit 10.510.4f
    
    Form of Performance-Based Restricted Stock Unit Award
Agreement
    
    November 17, 2005 Form
8-K, Exhibit 10.610.5*
    
    Outside Directors 1995 Stock Option Plan
    
    July 31, 2001 Form 10-K,
Exhibit 10.3c10.6a*
    
    Zale Corporation Outside Directors 2005 Stock Incentive
Plan, as amended
    
    Filed herewith10.6b
    
    Form of Stock Option Award Agreement
    
    November 17, 2005 Form
8-K, Exhibit 10.210.6c*
    
    Form of Restricted Stock Award Agreement
    
    November 17, 2005 Form
8-K, Exhibit 10.310.7a*
    
    Executive Severance Plan
    
    Form S-1 (Reg. No.
33-27225), Exhibit 10.2310.7b*
    
    Amendment to Executive Severance Plan
    
    July 31, 1996 Form 10-K,
Exhibit 10.8a10.8
    
    Supplemental Executive Retirement Plan, as amended
    
    Filed herewith10.9a
    
    Lease Agreement for Corporate Headquarters
    
    July 31, 1996 Form 10-K,
Exhibit 10.1110.9b
    
    First Amendment to Lease Agreement for Corporate
Headquarters
    
    July 31, 1996 Form 10-K,
Exhibit 10.11a10.9c
    
    Second Amendment to Lease Agreement for Corporate
Headquarters
    
    July 31, 2004 Form 10-K,
Exhibit 10.7c10.10*
    
    Employment Agreement with
Mary E. Burton, dated as of October 12, 2006
    
    Filed herewith10.11*
    
    Terms of Employment Arrangement with George R. Mihalko
    
    August 10, 2006 Form 8-K,
Exhibit 10.110.12*
    
    Employment Agreement with John A. Zimmermann, dated as of
March 31, 2006
    
    April 6, 2006 Form 8-K,
Exhibit 10.1
 - 43 -




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##### Table of Contents



The filings referencedfor incorporation by reference are ZaleExhibit
    
    
    
    Corporation filings (File No. 1-04129) unlessNumber
    
    Description of Exhibit
    
    otherwise noted10.13*
    
    Employment Agreement with Gilbert P. Hollander, dated as
of January 5, 2005
    
    Filed herewith10.14*
    
    Employment Agreement with Frank C. Mroczka, dated as of
August 1, 2006
    
    Filed herewith10.15*
    
    Employment Agreement with Mary L. Forté, dated as of
September 21, 2005
    
    September 27, 2005 Form
8-K, Exhibit 10.110.16*
    
    Employment Agreement with Sue E. Gove, dated as of
September 21, 2005
    
    September 27, 2005 Form
8-K, Exhibit 10.210.17*
    
    Employment Agreement with Mark R. Lenz dated as of
August 1, 2003
    
    July 31, 2003 Form 10-K,
Exhibit 10.1210.18*#
    
    Zale Corporation Bonus Plan
    
    Filed herewith10.19
    
    Amendment to Citibank USA, N.A. Agreement, dated as of
April 4, 2003
    
    April 30, 2003 Form 10-Q,
Exhibit 99.210.20*
    
    Form of Change of Control Agreement of Senior Vice
Presidents without separate employment agreements
    
    July 31, 2004 Form 10-K,
Exhibit 10.1410.21*
    
    Base Salaries of Named Executive Officers
    
    Filed herewith10.22*
    
    Summary of Non-Employee Director Compensation
    
    June 1, 2006 Form 8-K,
Exhibit 10.110.23
    
    Master Agreement for Information Technology Services
between Zale Delaware, Inc. and ACS Commercial Solutions,
Inc., dated as of August 1, 2005
    
    July 31, 2005 Form 10-K,
Exhibit 10.1814
    
    Code of Ethics
    
    July 31, 2003 Form 10-K,
Exhibit 1421
    
    Subsidiaries of the Registrant
    
    Filed herewith23.1
    
    Consent of KPMG LLP
    
    Filed herewith31.1
    
    Rule 13a-14(a) Certification of Chief Executive Officer
    
    Filed herewith31.2
    
    Rule 13a-14(a) Certification of Chief Financial Officer
    
    Filed herewith32.1
    
    Section 1350 Certification of Chief Executive Officer
    
    Filed herewith32.2
    
    Section 1350 Certification of Chief Financial Officer
    
    Filed herewith99.1
    
    Audit Committee Charter
    
    July 31, 2004 Form
10-K, Exhibit 99.199.2
    
    Compensation Committee Charter
    
    Filed herewith99.3
    
    Nominating/Corporate Governance Committee Charter
    
    July 31, 2004 Form
10-K, Exhibit 99.3
 
 #
    
    Zale Corporation has requested
confidential treatment for certain portions of this document pursuant
to an application sent to the SEC. The Company has omitted such
portions from this filing and filed them separately with the SEC. - 44 -




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##### Table of Contents



INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
 PageManagements Report on Internal Control Over Financial Reporting
    
    F-2Report of Independent Registered Public Accounting Firm
    
    F-3Report of Independent Registered Public Accounting Firm
    
    F-5Consolidated Statements of Operations
    
    F-6Consolidated Balance Sheets
    
    F-7Consolidated Statements of Cash Flows
    
    F-8Consolidated Statements of Stockholders Investments
    
    F-9Notes to Consolidated Financial Statements
    
    F-11
 F - 1




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##### Table of Contents



MANAGEMENTS REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING
    Internal Control 
Integrated Framework.
 Accounting for Derivative Instruments and
Hedging Activities
   Mary E. Burton
    
    George R. Mihalko, Jr.President, Chief Executive Officer
    
    Chief Financial Officer,and Director
    
    Chief Administrative Officer andDirectorOctober 12, 2006
    
    October 12, 2006
 F - 2




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##### Table of Contents



REPORT
OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
 
 Internal Control  Integrated Framework
    F-3




---



##### Table of Contents



Accounting for Derivative Instruments and Hedging Activities
  Internal Control  Integrated Framework Internal Control  Integrated
Framework
  
 F-4




---



##### Table of Contents



REPORT
OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
 
    Internal Control  Integrated
Framework
 Share Based Payment
  
 F-5




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##### Table of Contents



ZALE
CORPORATION AND SUBSIDIARIES
 CONSOLIDATED STATEMENTS OF OPERATIONS
(amounts in thousands, except per share amounts)
 Year Ended July 31,2006
    
    
    2005
    
    
    2004Total Revenue
    
    $
    2,438,977
    
    
    $
    2,383,066
    
    
    $
    2,304,440Cost and Expenses:Cost of Sales
    
    
    1,215,636
    
    
    
    1,157,226
    
    
    
    1,122,946Selling, General and Administrative Expenses
    
    
    1,087,458
    
    
    
    982,113
    
    
    
    942,796Cost of Insurance Operations
    
    
    6,699
    
    
    
    6,084
    
    
    
    5,963Depreciation and Amortization Expense
    
    
    59,771
    
    
    
    59,840
    
    
    
    56,381Benefit from Settlement of Retirement Plan
    
    
    (13,403
    )
    
    
    
    
    
    
    Derivatives
(Gains)/Losses
    
    
    1,681
    
    
    
    
    
    
    
    Operating Earnings
    
    
    81,135
    
    
    
    177,803
    
    
    
    176,354Interest Expense, Net
    
    
    11,185
    
    
    
    7,725
    
    
    
    7,528Earnings Before Income Taxes
    
    
    69,950
    
    
    
    170,078
    
    
    
    168,826Income Taxes
    
    
    16,328
    
    
    
    63,303
    
    
    
    62,353Net Earnings
    
    $
    53,622
    
    
    $
    106,775
    
    
    $
    106,473Earnings Per Common Share-Basic:Net Earnings Per Share
    
    $
    1.10
    
    
    $
    2.08
    
    
    $
    2.02Earnings Per Common Share-Diluted:Net Earnings Per share
    
    $
    1.09
    
    
    $
    2.05
    
    
    $
    1.99Weighted Average Number of Common Shares
Outstanding:Basic
    
    
    48,808
    
    
    
    51,280
    
    
    
    52,650Diluted
    
    
    49,211
    
    
    
    51,975
    
    
    
    53,519
  F - 6




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##### Table of Contents



ZALE
CORPORATION AND SUBSIDIARIES
 CONSOLIDATED BALANCE SHEETS
 (amounts in thousands, except per share amounts)
 July 31, 2006
    
    
    July 31, 2005ASSETSCurrent Assets:Cash and Cash Equivalents
    
    $
    42,594
    
    
    $
    55,446Merchandise Inventories
    
    
    903,294
    
    
    
    853,580Other Current Assets
    
    
    103,356
    
    
    
    64,042Total Current Assets
    
    $
    1,049,244
    
    
    $
    973,068Property and Equipment, Net
    
    
    283,721
    
    
    
    282,033Goodwill, Net
    
    
    96,339
    
    
    
    90,774Other Assets
    
    
    33,264
    
    
    
    35,025Total Assets
    
    $
    1,462,568
    
    
    $
    1,380,900LIABILITIES AND STOCKHOLDERS INVESTMENTCurrent Liabilities:Accounts Payable and Accrued Liabilities
    
    $
    341,182
    
    
    $
    296,309Deferred Tax Liability, Net
    
    
    61,947
    
    
    
    65,198Total Current Liabilities
    
    $
    403,129
    
    
    $
    361,507Non-current Liabilities
    
    
    20,105
    
    
    
    37,325Non-current Tax Liability, Net
    
    
    3,768
    
    
    
    5,008Long-term Debt
    
    
    202,813
    
    
    
    129,800Long-term Accrued Rent
    
    
    31,504
    
    
    
    29,672Stockholders Investment:Common Stock (Par value $0.01 per share, 150,000 and 150,000 shares
authorized, 53,646 and 53,056 shares issued and 48,174 and
51,239 outstanding as of July 31, 2006 and 2005, respectively)
    
    $
    482
    
    
    $
    513Additional Paid-In Capital
    
    
    110,105
    
    
    
    88,988Accumulated Other Comprehensive Income
    
    
    33,564
    
    
    
    24,119Accumulated Earnings
    
    
    808,859
    
    
    
    755,237Deferred Compensation
    
    
    (1,761
    )
    
    
    (1,269
    )951,249
    
    
    
    867,588Treasury Stock
    
    
    (150,000
    )
    
    
    (50,000
    )Total Stockholders Investment
    
    
    801,249
    
    
    
    817,588Total Liabilities and Stockholders Investment
    
    $
    1,462,568
    
    
    $
    1,380,900
  F - 7




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##### Table of Contents



ZALE
CORPORATION AND SUBSIDIARIES
 CONSOLIDATED STATEMENTS OF CASH FLOWS
(amounts in thousands)
 Year Ended
    
    
    Year Ended
    
    
    Year EndedJuly 31, 2006
    
    
    July 31, 2005
    
    
    July 31, 2004Net Cash Flows from Operating Activities:Net earnings
    
    $
    53,622
    
    
    $
    106,775
    
    
    $
    106,473Adjustments to reconcile net earnings
to net cash provided by operating activities:Depreciation and amortization expense
    
    
    59,771
    
    
    
    59,840
    
    
    
    56,381Amortization of long-term debt issue costs
    
    
    2,311
    
    
    
    1,306
    
    
    
    1,329Repatriation impact on tax provision
    
    
    (11,904
    )
    
    
    
    
    
    
    Deferred taxes (excluding repatriation impact)
    
    
    1,542
    
    
    
    12,993
    
    
    
    30,976Loss on dispositions of property & equipment
    
    
    4,346
    
    
    
    4,388
    
    
    
    2,429Impairment of fixed assets
    
    
    19,123
    
    
    
    1,497
    
    
    
    2,627Stock compensation expense
    
    
    1,893
    
    
    
    6,325
    
    
    
    7,955Retiree medical plan termination impact
    
    
    (13,403
    )
    
    
    
    
    
    
    Derivatives
(Gains)/Losses
    
    
    1,681
    
    
    
    
    
    
    
    Changes in assets and liabilities:Merchandise inventories
    
    
    (43,629
    )
    
    
    (20,968
    )
    
    
    (24,431
    )Other current assets
    
    
    (27,704
    )
    
    
    261
    
    
    
    (11,150
    )Other assets
    
    
    (2,047
    )
    
    
    (2,194
    )
    
    
    (315
    )Accounts payable and accrued liabilities
    
    
    38,033
    
    
    
    3,216
    
    
    
    12,113Non-current liabilities
    
    
    (3,817
    )
    
    
    (5,161
    )
    
    
    (6,309
    )Net Cash Provided by Operating Activities
    
    
    79,818
    
    
    
    168,278
    
    
    
    178,078Net Cash Flows from Investing Activities:Additions to property and equipment
    
    
    (82,718
    )
    
    
    (83,124
    )
    
    
    (60,788
    )Proceeds from sales of fixed assets
    
    
    
    
    
    
    3,971
    
    
    
    Purchase of available for sale investments
    
    
    (2,149
    )
    
    
    (3,480
    )
    
    
    (4,980
    )Proceeds from sales of available for sale investments
    
    
    3,311
    
    
    
    4,440
    
    
    
    5,751Net Cash Used in Investing Activities
    
    
    (81,556
    )
    
    
    (78,193
    )
    
    
    (60,017
    )Net Cash Flows from Financing Activities:Borrowings under revolving credit agreement
    
    
    1,125,613
    
    
    
    1,388,900
    
    
    
    717,400Payments on revolving credit agreement
    
    
    (1,052,600
    )
    
    
    (1,456,600
    )
    
    
    (704,300
    )Proceeds from exercise of stock options
    
    
    10,669
    
    
    
    17,725
    
    
    
    39,565Excess tax benefit on stock options exercised
    
    
    3,380
    
    
    
    
    
    
    
    Purchase of common stock
    
    
    (100,000
    )
    
    
    (50,000
    )
    
    
    (143,358
    )Net Cash Used in Financing Activities
    
    
    (12,938
    )
    
    
    (99,975
    )
    
    
    (90,693
    )Effect of Exchange Rate Changes on Cash
    
    
    1,824
    
    
    
    2,212
    
    
    
    483Net Increase (Decrease) in Cash and Cash Equivalents
    
    
    (12,852
    )
    
    
    (7,678
    )
    
    
    27,851Cash and Cash Equivalents at Beginning of Period
    
    
    55,446
    
    
    
    63,124
    
    
    
    35,273Cash and Cash Equivalents at End of Period
    
    $
    42,594
    
    
    $
    55,446
    
    
    $
    63,124Supplemental cash flow information:Interest paid
    
    $
    10,650
    
    
    $
    6,602
    
    
    $
    5,559Interest received
    
    $
    525
    
    
    $
    644
    
    
    $
    409Income taxes paid (net refunds received)
    
    $
    61,917
    
    
    $
    31,110
    
    
    $
    19,914
  F - 8




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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, 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
    
    
    $
    13,470Net Earnings
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Unrealized Loss on Securities, net
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (474
    )Unrealized Loss on Derivatives
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (338
    )Cumulative Translation Adjustments
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    11,461Exercise of Stock Options, including
related tax benefit
    
    
    946
    
    
    
    10
    
    
    
    23,380
    
    
    
    Purchase of Common Stock
    
    
    (1,812
    )
    
    
    (18
    )
    
    
    18
    
    
    
    Restricted Stock Issued/Cancelled
    
    
    (5
    )
    
    
    
    
    
    
    1,929
    
    
    
    Deferred Compensation Amortization
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Balance July 31, 2005
    
    
    51,239
    
    
    $
    513
    
    
    $
    88,988
    
    
    $
    24,119Net Earnings
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Unrealized Loss on Securities, net
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (434
    )Unrealized
Gain on Derivatives
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    370Cumulative Translation Adjustments
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    11,259Deferred Other Comprehensive Income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (1,750
    )Exercise of Stock Options, including
related tax benefit
    
    
    579
    
    
    
    5
    
    
    
    11,541
    
    
    
    Purchase of Common Stock
    
    
    (3,717
    )
    
    
    (38
    )
    
    
    38
    
    
    
    Restricted Stock Issued/Cancelled
    
    
    73
    
    
    
    2
    
    
    
    4,954
    
    
    
    Deferred Compensation Amortization
    
    
    
    
    
    
    
    
    
    
    (689
    )
    
    
    Stock Compensation Expense
    
    
    
    
    
    
    
    
    
    
    5,273
    
    
    
    Balance July 31, 2006
    
    
    48,174
    
    
    $
    482
    
    
    $
    110,105
    
    
    $
    33,564
  F - 9




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##### Table of Contents



ZALE
CORPORATION AND SUBSIDIARIES
 CONSOLIDATED STATEMENTS OF STOCKHOLDERS INVESTMENT (continued)
(amounts in thousands)
 Accumulated
    
    
    Deferred
    
    
    Treasury
    
    
    Total
    
    
    ComprehensiveEarnings
    
    
    Compensation
    
    
    Stock
    
    
    Investment
    
    
    IncomeBalance 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
    
    
    $
    113,109Net Earnings
    
    
    106,775
    
    
    
    
    
    
    
    
    
    
    
    106,775
    
    
    
    106,775Unrealized Loss on Securities, net
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (474
    )
    
    
    (474
    )Unrealized
Loss on Derivatives
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (338
    )
    
    
    (338
    )Cumulative Translation Adjustments
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    11,461
    
    
    
    11,461Exercise of Stock Options, including
related tax benefit
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    23,390
    
    
    
    Purchase of Common Stock
    
    
    
    
    
    
    
    
    
    
    (50,000
    )
    
    
    (50,000
    )
    
    
    Restricted Stock Issued/Cancelled
    
    
    
    
    
    
    (1,929
    )
    
    
    
    
    
    
    
    
    
    
    Deferred Compensation Amortization
    
    
    
    
    
    
    660
    
    
    
    
    
    
    
    660
    
    
    
    Balance July 31, 2005
    
    $
    755,237
    
    
    $
    (1,269
    )
    
    $
    (50,000
    )
    
    $
    817,588
    
    
    $
    117,424Net Earnings
    
    
    53,622
    
    
    
    
    
    
    
    
    
    
    
    53,622
    
    
    
    53,622Unrealized Loss on Securities, net
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (434
    )
    
    
    (434
    )Unrealized
Gain on Derivatives
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    370
    
    
    
    370Cumulative Translation Adjustments
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    11,259
    
    
    
    11,259Deferred Other Comprehensive Income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (1,750
    )
    
    
    (1,750
    )Exercise of Stock Options, including
related tax benefit
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    11,546
    
    
    
    Purchase of Common Stock
    
    
    
    
    
    
    
    
    
    
    (100,000
    )
    
    
    (100,000
    )
    
    
    Restricted Stock Issued/Cancelled
    
    
    
    
    
    
    (4,997
    )
    
    
    
    
    
    
    (41
    )
    
    
    Deferred Compensation Amortization
    
    
    
    
    
    
    4,505
    
    
    
    
    
    
    
    3,816
    
    
    
    Stock Compensation Expense
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    5,273
    
    
    
    Balance July 31, 2006
    
    $
    808,859
    
    
    $
    (1,761
    )
    
    $
    (150,000
    )
    
    $
    801,249
    
    
    $
    63,067
  F - 10




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##### Table of Contents



ZALE
CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 Basis of Presentation
  ® zales.com. ® ® baileybanksandbiddle.com Ò ®
 ® ®
  Summary of Significant Accounting Policies
 Use of Estimates.
 F - 11




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##### Table of Contents



ZALE
CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
 Cash and Cash Equivalents.
 Merchandise Inventories.
    Long-lived Assets and Goodwill .
  F - 12




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##### Table of Contents



ZALE
CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
  Cost of Sales
 Selling, General and Administrative Expenses.
 Operating
Leases.
 Depreciation and Amortization.
  Stock Based Compensation.
   F - 13




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##### Table of Contents



ZALE
CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
 Stock Based Compensation (continued)
  Year Ended July 312005
    
    
    2004amounts in thousands exceptper share amountsNet earnings, as reported
    
    $
    106,775
    
    
    $
    106,473Add: Restricted stock which is included in net
earnings, net of related tax effects
    
    
    414
    
    
    
    Deduct: Total stock-based employee compensation
expense determined under fair value based method for
all awards, net of related tax effects
    
    
    6,509
    
    
    
    6,205Pro forma net earnings
    
    $
    100,680
    
    
    $
    100,268Earnings Per Common Share-Basic:Earnings Per Common Share, as reported
    
    $
    2.08
    
    
    $
    2.02Earnings Per Common Share, pro forma
    
    $
    1.96
    
    
    $
    1.90Earnings Per Common Share  Diluted:Earnings Per Common Share, as reported
    
    $
    2.05
    
    
    $
    1.99Earnings Per Common Share, pro forma
    
    $
    1.94
    
    
    $
    1.87Weighted Average Number of Common Shares Outstanding:Basic
    
    
    51,280
    
    
    
    52,650Diluted
    
    
    51,975
    
    
    
    53,519
 Revenue Recognition.
 F - 14




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##### Table of Contents



ZALE
CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
 Credit Insurance Operations .
  Advertising Expenses.
 Vendor Allowances .
 Foreign Currency.
 Derivative Financial Instruments .
  .
    F - 15




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##### Table of Contents



ZALE
CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
 Reclassifications.
 Merchandise Inventories
    Investments
   July 31, 2006
    
    
    July 31, 2005Cost
    
    
    Fair Value
    
    
    Cost
    
    
    Fair Value(amounts in thousands)U.S. government obligations
    
    $
    14,249
    
    
    $
    13,770
    
    
    $
    14,085
    
    
    $
    14,036Corporate bonds and notes
    
    
    4,153
    
    
    
    4,076
    
    
    
    5,047
    
    
    
    5,071Corporate equity securities
    
    
    3,826
    
    
    
    4,102
    
    
    
    4,373
    
    
    
    4,533$
    22,228
    
    
    $
    21,948
    
    
    $
    23,505
    
    
    $
    23,640
 F - 16




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##### Table of Contents



ZALE
CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
  Property And Equipment
  July 31, 2006
    
    
    July 31, 2005(amounts in thousands)Building and Leasehold Improvements
    
    $
    245,343
    
    
    $
    231,274Furniture and Fixtures
    
    
    414,833
    
    
    
    399,583Construction in Progress
    
    
    18,108
    
    
    
    17,722Total Property and Equipment
    
    
    678,284
    
    
    
    648,579Less: Accumulated Amortization and Depreciation
    
    
    (394,563
    )
    
    
    (366,546
    )Total Net Property and Equipment
    
    $
    283,721
    
    
    $
    282,033
   Accounts Payable and Accrued Liabilities
  July 31, 2006
    
    
    July 31, 2005(amounts in thousands)Accounts Payable
    
    $
    174,581
    
    
    $
    133,300Accrued Payroll
    
    
    41,507
    
    
    
    37,882Accrued Taxes
    
    
    26,549
    
    
    
    49,466Extended Service Agreement Deferred Revenue
    
    
    27,480
    
    
    
    24,617Accrued Rent
    
    
    17,713
    
    
    
    12,156Other Accruals (a)
    
    
    53,352
    
    
    
    38,888Total Accounts Payable and Accrued Liabilities
    
    $
    341,182
    
    
    $
    296,309
 
 a)
    
    Other Accruals include cash layaway sales in the amount of
$5.7 million and $5.8
million for fiscal years 2006 and 2005, respectively. Non-Current Liabilities
  F - 17




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##### Table of Contents



ZALE
CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
 Deferred Credit.
 Post-retirement Benefits.
 F - 18




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##### Table of Contents



ZALE
CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
 Postretirement Benefits (continued)
 July 31, 2006
    
    
    July 31, 2005(amounts in thousands)Change in Benefit Obligation:Benefit obligation at beginning of year
    
    $
    3,612
    
    
    $
    4,983Interest cost
    
    
    120
    
    
    
    280Plan participant contributions
    
    
    
    
    
    
    1,217Curtailments
    
    
    (3,292
    )
    
    
    Actuarial loss (gain)
    
    
    (440
    )
    
    
    (921
    )Benefits Paid
    
    
    
    
    
    
    (1,947
    )Benefit Obligation at end of year
    
    $
    
    
    
    $
    3,612Change in Plan Assets:Market value at beginning of year
    
    $
    
    
    
    $
    Employer contributions
    
    
    157
    
    
    
    730Plan participant contributions
    
    
    1,142
    
    
    
    1,217Benefit payments
    
    
    (1,299
    )
    
    
    (1,947
    )Market value at end of year
    
    $
    
    
    
    $
    Beginning of fiscal year assumptions (for Annual
Expense) Discount Rate
    
    
    5.89
    %
    
    
    6.00
    %End of fiscal year assumptions (for Year-End
Benefit Obligation) Discount Rate
    
    
    N/A
    
    
    
    5.21
    %Projected Cash Flows:Net ContributionsCurrent Fiscal Year
    
    $
    157
    
    
    $
    730Fiscal Year + 1
    
    
    
    
    
    
    425Net Benefit PaymentsCurrent Fiscal Year
    
    $
    157
    
    
    $
    730Fiscal Year + 1
    
    
    
    
    
    
    425Fiscal Year + 2
    
    
    
    
    
    
    386Fiscal Year + 3
    
    
    
    
    
    
    361Fiscal Year + 4
    
    
    
    
    
    
    341Fiscal Year + 5
    
    
    
    
    
    
    323Sum of next 5 fiscal years
    
    
    
    
    
    
    1,306Reconciliation of Funded Status:Benefit Obligation
    
    $
    
    
    
    $
    (3,612
    )Unrecognized net actuarial gain
    
    
    
    
    
    
    (5,821
    )Unrecognized prior service cost
    
    
    
    
    
    
    (3,440
    )Net Amount Recognized
    
    $
    
    
    
    $
    (12,873
    )Development of Accrued Benefit Cost:Accrued last year
    
    $
    (12,873
    )
    
    $
    (14,043
    )Plus: Net employer contributions last year
    
    
    157
    
    
    
    730Plus: Net periodic benefit income expense last year
    
    
    313
    
    
    
    440Less: Benefit from settlement of retirement
benefits obligation
    
    
    12,403
    
    
    
    Accrued balance at end of year
    
    $
    
    
    
    $
    (12,873
    )
 F - 19




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##### Table of Contents



ZALE
CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
   Year EndedJuly 31, 2006
    
    
    July 31, 2005
    
    
    July 31, 2004(amounts in thousands)Service Cost
    
    $
    
    
    
    $
    
    
    
    $
    Interest Cost
    
    
    120
    
    
    
    280
    
    
    
    349Amortization of Prior Cost and Gain
    
    
    (433
    )
    
    
    (720
    )
    
    
    (726
    )Settlement/Curtailment/Termination of Benefits
    
    
    (13,403
    )
    
    
    
    
    
    
    Net Periodic (Benefit) Cost
    
    $
    (13,716
    )
    
    $
    (440
    )
    
    $
    (377
    )
 Non-Qualified Retirement Plan
  Long-Term Debt
 Revolving Credit Agreement.
  F - 20




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##### Table of Contents



ZALE
CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
    Lease Commitments
  Year EndedJuly 31, 2006
    
    
    July 31, 2005
    
    
    July 31, 2004(amounts in thousands)Retail Space:Minimum Rentals
    
    $
    228,363
    
    
    $
    196,647
    
    
    $
    182,520Rentals Based on Sales
    
    
    13,359
    
    
    
    11,589
    
    
    
    12,212241,722
    
    
    
    208,236
    
    
    
    194,732Equipment and Corporate Headquarters
    
    
    3,576
    
    
    
    1,773
    
    
    
    2,823Total Rent Expense
    
    $
    245,298
    
    
    $
    210,009
    
    
    $
    197,555
   F - 21




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##### Table of Contents



ZALE
CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
  Minimum
Rent Commitments
(amounts in thousands)2007
    
    $
    197,9542008
    
    
    170,3962009
    
    
    147,7502010
    
    
    127,2642011
    
    
    101,205Thereafter
    
    
    282,162Total
    
    $
    1,026,730
 Interest
   Income Taxes
  Year EndedJuly 31, 2006
    
    
    July 31, 2005
    
    
    July 31, 2004(amounts in thousands)Federal Income Tax Expense at Statutory Rate
    
    $
    24,483
    
    
    $
    59,527
    
    
    $
    59,089State Income Taxes, Net of Federal Income Tax
Benefit
    
    
    1,666
    
    
    
    2,634
    
    
    
    2,657Tax on Repatriation of Foreign Items (1)
    
    
    (6,762
    )
    
    
    
    
    
    
    Canadian Rate Changes (2)
    
    
    (1,908
    )
    
    
    
    
    
    
    Foreign Tax Credits (3)
    
    
    (1,400
    )
    
    
    
    
    
    
    Other
    
    
    249
    
    
    
    1,142
    
    
    
    607Total Income Tax Expense
    
    $
    16,328
    
    
    $
    63,303
    
    
    $
    62,353Effective Income Tax Rate
    
    
    23.3
    %
    
    
    37.2
    %
    
    
    36.9
    %
 
 (1)
    
    During fiscal year 2006, we repatriated $47.6 million under section 965 of the
AJCA, realizing an income tax benefit of $11.9 million. Additionally, management is not certain
all future foreign earnings will be permanently reinvested outside the U.S.; therefore, a $5.1
million liability related to the potential income tax on the remaining undistributed earnings
offsets the benefit under section 965.(2)
    
    During fiscal year 2006, Canada enacted new tax rates. The decrease in the
revised tax rates resulted in an income tax benefit of approximately $1.9 million.(3)
    
    During fiscal year 2006, we realized $1.4 million of additional foreign tax
credits. F - 22




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##### Table of Contents



ZALE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
 Year EndedJuly 31, 2006
    
    
    July 31, 2005
    
    
    July 31, 2004(amounts in thousands)Current Provision:Federal
    
    $
    10,598
    
    
    $
    36,771
    
    
    $
    29,375Foreign
    
    
    9,283
    
    
    
    9,015
    
    
    
    1,786State
    
    
    3,535
    
    
    
    4,524
    
    
    
    216Total Current Provision
    
    
    23,416
    
    
    
    50,310
    
    
    
    31,377Deferred Provision:Federal
    
    
    (3,550
    )
    
    
    14,154
    
    
    
    22,768Foreign
    
    
    (2,178
    )
    
    
    (286
    )
    
    
    5,606State
    
    
    (1,360
    )
    
    
    (875
    )
    
    
    2,602Total Deferred Provision
    
    
    (7,088
    )
    
    
    12,993
    
    
    
    30,976Total Income Tax Provision
    
    $
    16,328
    
    
    $
    63,303
    
    
    $
    62,353
  F - 23




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##### Table of Contents



ZALE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
  Year EndedJuly 31, 2006
    
    
    July 31, 2005(amounts in thousands)Current Deferred Taxes:Assets Customer receivables
    
    $
    292
    
    
    $
    467Accrued liabilities
    
    
    26,087
    
    
    
    22,044Net operating loss carryforward
    
    
    6,821
    
    
    
    6,821Inventory reserves
    
    
    20,738
    
    
    
    10,766Other
    
    
    1,377
    
    
    
    2,078Total Assets
    
    
    55,315
    
    
    
    42,176Liabilities Merchandise inventories, principally due to LIFO reserve
    
    
    (107,431
    )
    
    
    (98,453
    )Accrued liabilities
    
    
    (9,831
    )
    
    
    (8,921
    )Deferred Current Tax Liability, Net
    
    $
    (61,947
    )
    
    $
    (65,198
    )Non-Current Deferred Taxes:Assets Net operating loss carryforward
    
    $
    7,176
    
    
    $
    13,749Postretirement benefits
    
    
    875
    
    
    
    5,020Accrued liabilities
    
    
    15,416
    
    
    
    16,405State and local taxes
    
    
    8,420
    
    
    
    9,784Investments
    
    
    3,286
    
    
    
    3,286Other
    
    
    2,104
    
    
    
    5,408Total Assets
    
    
    37,277
    
    
    
    53,652Liabilities Property and
equipment
    
    
    (20,020
    )
    
    
    (36,126
    )Other
    
    
    (2,511
    )
    
    
    (1,380
    )Undistributed Earnings
    
    
    (6,106
    )
    
    
    (8,629
    )Goodwill
    
    
    (12,408
    )
    
    
    (12,525
    )Deferred Non-Current Tax (Liability), Net
    
    $
    (3,768
    )
    
    $
    (5,008
    )
  F - 24




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##### Table of Contents



ZALE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
 Capital Stock
 Common Stock.
 Stock Split.
 Preferred Stock.
 Treasury Stock.
  Incentive Stock Plan.
  F - 25




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##### Table of Contents



ZALE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
     Fiscal Year2006
    
    2005
    
    2004Volatility
    
    
    33.2
    %
    
    
    37.8
    %
    
    
    40.2
    %Risk-free Interest Rate
    
    
    4.3
    %
    
    
    3.7
    %
    
    
    3.6
    %Expected lives (years)
    
    
    5.0
    
    
    
    5.0
    
    
    
    5.0Fair value per option granted
    
    $
    9.37
    
    
    $
    10.74
    
    
    $
    10.93
  Shares
    
    
    Grant Price
    
    
    Weighted Average PriceFiscal 2006
    
    
    Fiscal 2005
    
    
    Fiscal 2004
    
    
    Fiscal 2006
    
    
    Fiscal 2005
    
    
    Fiscal 2004
    
    
    Fiscal 2006
    
    
    Fiscal 2005
    
    
    Fiscal 2004Outstanding, beginning of year
    
    
    2,871,360
    
    
    
    3,922,132
    
    
    
    5,578,852
    
    
    $
    13.11-30.65
    
    
    $
    10.91-29.57
    
    
    $
    4.50-23.23
    
    
    $
    21.74
    
    
    $
    20.81
    
    
    $
    18.05Granted
    
    
    1,243,000
    
    
    
    128,250
    
    
    
    813,600
    
    
    
    22.89-34.00
    
    
    
    25.50-30.65
    
    
    
    23.94-29.57
    
    
    
    26.85
    
    
    
    27.13
    
    
    
    27.13Exercised
    
    
    (579,254
    )
    
    
    (946,209
    )
    
    
    (2,336,370
    )
    
    
    14.11-27.44
    
    
    
    10.91-26.70
    
    
    
    4.50-21.75
    
    
    
    18.42
    
    
    
    18.54
    
    
    
    16.68Cancelled
    
    
    (413,362
    )
    
    
    (232,813
    )
    
    
    (133,950
    )
    
    
    14.15-34.00
    
    
    
    14.15-30.03
    
    
    
    4.50-26.55
    
    
    
    26.17
    
    
    
    22.00
    
    
    
    17.65Outstanding, end of year
    
    
    3,121,744
    
    
    
    2,871,360
    
    
    
    3,922,132
    
    
    $
    13.11-30.65
    
    
    $
    13.11-30.65
    
    
    $
    10.91-29.57
    
    
    $
    23.80
    
    
    $
    21.74
    
    
    $
    20.81
 F - 26




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##### Table of Contents



ZALE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
  Options Outstanding
    
    
    Options ExercisableWeighted AverageRange of Exercise
    
    
    Number
    
    
    Remaining Contractual
    
    
    Weighted Average
    
    
    Aggregate
    
    
    Number
    
    
    Weighted Average
    
    
    AggregatePrices
    
    
    Outstanding
    
    
    Term(Years)
    
    
    Exercise Price
    
    
    Intrinsic Value
    
    
    Exercisable
    
    
    Exercise Price
    
    
    Intrinsic Value$
    10.20
    
    
    $
    13.60
    
    
    
    2,500
    
    
    
    2.3
    
    
    $
    13.11
    
    
    
    
    
    
    
    2,500
    
    
    $
    13.1113.60
    
    
    
    17.00
    
    
    
    490,770
    
    
    
    4.7
    
    
    
    14.49
    
    
    
    
    
    
    
    477,770
    
    
    
    14.4917.00
    
    
    
    20.40
    
    
    
    3,000
    
    
    
    4.1
    
    
    
    17.38
    
    
    
    
    
    
    
    3,000
    
    
    
    17.3820.40
    
    
    
    23.80
    
    
    
    902,599
    
    
    
    5.8
    
    
    
    22.82
    
    
    
    
    
    
    
    768,099
    
    
    
    22.7523.80
    
    
    
    27.20
    
    
    
    432,600
    
    
    
    9.2
    
    
    
    25.38
    
    
    
    
    
    
    
    40,375
    
    
    
    26.1227.20
    
    
    
    30.60
    
    
    
    1,289,275
    
    
    
    8.5
    
    
    
    27.54
    
    
    
    
    
    
    
    586,825
    
    
    
    27.51$
    30.60
    
    
    $
    34.00
    
    
    
    1,000
    
    
    
    8.4
    
    
    
    30.65
    
    
    
    
    
    
    
    250
    
    
    
    30.653,121,744
    
    
    
    7.2
    
    
    $
    23.80
    
    
    $
    7,803,033
    
    
    
    1,878,819
    
    
    $
    22.19
    
    
    $
    7,224,959
   Shares Units
    
    
    PriceFY 2006
    
    
    FY 2005
    
    
    FY 2004
    
    
    FY 2006
    
    
    FY 2005
    
    
    FY 2004Non-vested Outstanding at Beginning of Year
    
    
    70,300
    
    
    
    75,300
    
    
    
    
    
    
    $
    27.44
    
    
    $
    27.44
    
    
    $
    Granted, Incentive Plan Performance-based Units
    
    
    107,200
    
    
    
    
    
    
    
    
    
    
    
    27.03
    
    
    
    
    
    
    
    Granted, Incentive Plan and 2005 Directors Plan Shares
    
    
    18,627
    
    
    
    
    
    
    
    75,300
    
    
    
    25.97
    
    
    
    
    
    
    
    27.44Granted, Incentive Plan Time-vested Units
    
    
    140,700
    
    
    
    
    
    
    
    
    
    
    
    24.27
    
    
    
    
    
    
    
    Canceled, Incentive Plan Time-vested Units
    
    
    19,700
    
    
    
    
    
    
    
    
    
    
    
    27.03
    
    
    
    
    
    
    
    Canceled, Incentive Plan Performance-based Units
    
    
    19,700
    
    
    
    
    
    
    
    
    
    
    
    27.03
    
    
    
    
    
    
    
    Canceled, Incentive Plan and 2005 Directors Plan Shares
    
    
    17,300
    
    
    
    5,000
    
    
    
    
    
    
    
    27.40
    
    
    
    27.44
    
    
    
    Vested, Incentive Plan Shares
    
    
    45,127
    
    
    
    
    
    
    
    
    
    
    
    26.93
    
    
    
    
    
    
    
    Vested, Incentive Plan Time-vested Units
    
    
    40,000
    
    
    
    
    
    
    
    
    
    
    
    27.03
    
    
    
    
    
    
    
    Vested, Incentive Plan Performance-based Units
    
    
    40,000
    
    
    
    
    
    
    
    
    
    
    
    27.03
    
    
    
    
    
    
    
    Non-vested Outstanding at End of Year
    
    
    155,000
    
    
    
    70,300
    
    
    
    75,300
    
    
    $
    24.18
    
    
    $
    27.44
    
    
    $
    27.44
  F - 27




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##### Table of Contents



ZALE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
 Earnings Per Common Share
  Year Ended July 312006
    
    
    2005
    
    
    2004(amounts in thousands, except per share annum)Net earnings available to stockholders
    
    $
    53,622
    
    
    $
    106,775
    
    
    $
    106,473Basic:Weighted average number of common shares outstanding
    
    
    48,808
    
    
    
    51,280
    
    
    
    52,650Net earnings per share  basic
    
    $
    1.10
    
    
    $
    2.08
    
    
    $
    2.02Diluted:Basic weighted average number of common shares outstanding
    
    
    48,808
    
    
    
    51,280
    
    
    
    52,650Effect of dilutive stock options:Stock options
    
    
    403
    
    
    
    695
    
    
    
    869Diluted weighted average number of common shares outstanding as adjusted
    
    
    49,211
    
    
    
    51,975
    
    
    
    53,519Net earnings per share  diluted
    
    $
    1.09
    
    
    $
    2.05
    
    
    $
    1.99
 Comprehensive Income
  Segments
  ® ®
 F - 28




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##### Table of Contents



ZALE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
    Year Ended July 31Selected Financial Data by Segment
    
    2006
    
    
    2005
    
    
    2004(amounts in thousands, except per share amounts)Revenues:Fine Jewelry (a)
    
    $
    2,149,217
    
    
    $
    2,089,261
    
    
    $
    2,022,214Kiosk (b)
    
    
    276,619
    
    
    
    280,897
    
    
    
    269,660All Other
    
    
    13,141
    
    
    
    12,908
    
    
    
    12,566Total Revenues
    
    $
    2,438,977
    
    
    $
    2,383,066
    
    
    $
    2,304,440Depreciation & Amortization ExpenseFine Jewelry
    
    $
    43,273
    
    
    $
    44,410
    
    
    $
    41,757Kiosk
    
    
    5,571
    
    
    
    4,708
    
    
    
    4,199All Other
    
    
    
    
    
    
    
    
    
    
    Unallocated
    
    
    10,927
    
    
    
    10,722
    
    
    
    10,425Total Depreciation & Amortization Expense
    
    $
    59,771
    
    
    $
    59,840
    
    
    $
    56,381Operating Earnings (Loss)Fine Jewelry
    
    $
    108,082
    
    
    $
    147,414
    
    
    $
    153,739Kiosk
    
    
    20,402
    
    
    
    29,030
    
    
    
    25,951All Other
    
    
    6,443
    
    
    
    6,824
    
    
    
    6,603Unallocated (c)
    
    
    (53,792
    )
    
    
    (5,465
    )
    
    
    (9,939
    )Total Operating Earnings
    
    $
    81,135
    
    
    $
    177,803
    
    
    $
    176,354Assets (d)Fine Jewelry (e)
    
    $
    1,119,679
    
    
    $
    1,103,142
    
    
    $
    1,055,755Kiosk (f)
    
    
    124,415
    
    
    
    117,125
    
    
    
    111,238All Other
    
    
    39,261
    
    
    
    35,670
    
    
    
    37,737Unallocated
    
    
    179,213
    
    
    
    124,963
    
    
    
    137,354Total Assets
    
    $
    1,462,568
    
    
    $
    1,380,900
    
    
    $
    1,342,084Capital ExpendituresFine Jewelry
    
    $
    54,942
    
    
    $
    59,587
    
    
    $
    42,535Kiosk
    
    
    7,750
    
    
    
    8,650
    
    
    
    6,038All Other
    
    
    
    
    
    
    
    
    
    
    Unallocated
    
    
    20,026
    
    
    
    14,887
    
    
    
    12,215Total Capital
    
    $
    82,718
    
    
    $
    83,124
    
    
    $
    60,788
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##### Table of Contents



ZALE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
 
 (a)
    
    Includes $229.6, $198.3 and $174.1 million in fiscal years 2006, 2005, and 2004,
respectively, related to foreign operations.(b)
    
    Includes $7.7 and $6.6 million in fiscal years 2006 and 2005, respectively, related to
foreign operations. There were no foreign operations in this segment prior to fiscal year
2005.(c)
    
    Includes $36.7 million related to the special charge, $13.4 million benefit related to the
settlement of certain retirement plan obligations, $12.1 million for executive severance, $5.3
million related to share-based compensation expense and $2.4 million related to accrued
percentage rent. Also, includes $70.9, $71.0, and $65.9 million
in fiscal years 2005, 2004,
and 2003, respectively, to offset internal carrying costs charged to the segments.(d)
    
    Assets allocated to segments include fixed assets, inventories and goodwill. Unallocated
assets include cash, prepaid assets such as rent, corporate office improvements, and
technology infrastructure.(e)
    
    Includes $28.8, $27.2 and $23.2 million of fixed assets
in fiscal years 2006, 2005 and 2004,
respectively, related to foreign operations.(f)
    
    Includes $466,000 and $390,000 of fixed assets in fiscal years 2006 and 2005, respectively,
related to foreign operations. There were no foreign operations in this segment prior to
fiscal year 2005. Commitments and Contingencies
  New Accounting Pronouncements
 FASB Interpretation No. 48.
 Guarantee Obligations
  Credit Programs.
  F - 30




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##### Table of Contents



ZALE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
   Product Warranty Programs.
  Year EndedJuly 31, 2006
    
    
    July 31, 2005
    
    
    July 31, 2004(amounts in thousands)Beginning Balance
    
    $
    28,264
    
    
    $
    31,794
    
    
    $
    32,160Extended Service Agreements Sold
    
    
    77,586
    
    
    
    59,415
    
    
    
    50,183Extended Service Agreements Revenue Recognized
    
    
    (74,066
    )
    
    
    (62,945
    )
    
    
    (50,549
    )Ending Balance
    
    $
    31,784
    
    
    $
    28,264
    
    
    $
    31,794
 Benefit Plans
   Financial Instruments
    F - 31




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##### Table of Contents



ZALE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
  Concentrations of Business and Credit Risk.
 Subsequent Event.
 Other Matters
 SEC Investigation.
 Litigation.
 Executive
Changes.
     F - 32




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##### Table of Contents



ZALE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
 Bailey Banks & Biddle Store Closings.
 A merican Jobs Creation Act.
 Texas Margin Tax .
  Quarterly Results of Operations (Unaudited)
  Fiscal Year 2006For the Three Months EndedJuly 31, 2006
    
    April 30, 2006
    
    January 31, 2006
    
    October 31, 2005Total Revenues
    
    $
    490,695
    
    
    $
    526,895
    
    
    $
    993,749
    
    
    $
    427,639Cost of Sales
    
    
    257,370
    
    
    
    254,361
    
    
    
    495,094
    
    
    
    208,812Net Earnings (Loss)
    
    
    (27,362
    )
    
    
    16,831
    
    
    
    87,815
    
    
    
    (23,661
    )Net Earnings (Loss) per diluted share
    
    $
    (0.57
    )
    
    $
    0.35
    
    
    $
    1.78
    
    
    $
    (0.47
    )
 Fiscal Year 2005For the Three Months EndedJuly 31, 2005
    
    April 30, 2005
    
    January 31, 2005
    
    October 31, 2004Total Revenues
    
    $
    472,343
    
    
    $
    515,618
    
    
    $
    972,332
    
    
    $
    422,773Cost of Sales
    
    
    225,566
    
    
    
    246,151
    
    
    
    480,229
    
    
    
    205,280Net Earnings (Loss)
    
    
    4,053
    
    
    
    14,456
    
    
    
    99,197
    
    
    
    (10,933
    )Net Earnings (Loss) per diluted share
    
    $
    0.08
    
    
    $
    0.28
    
    
    $
    1.91
    
    
    $
    (0.21
    )
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##### Table of Contents



ZALE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
 SIGNATURES
 th
 ZALE CORPORATIONBy:
    /s/ Mary E. BurtonMary E. BurtonPresident and Chief Executive Officer   Signature
    
    Title
    
    Date/s/ Mary E. Burton
    
    President, Chief Executive OfficerMary E. Burton
    
    and Director (principal executive
officer of the registrant)
    
    October 12, 2006/s/ George R. Mihalko, Jr.
    
    Chief Administrative Officer, ChiefGeorge Mihalko
    
    Financial Officer and Director
(principal financial officer of the
registrant)
    
    October 12, 2006/s/ Cynthia T. Gordon
    
    Senior Vice President, ControllerCynthia T. Gordon
    
    (principal accounting officer of the
registrant)
    
    October 12, 2006/s/ Richard C. Marcus
    
    Chairman of the Board
    
    October 12, 2006Richard C. Marcus/s/ J. Glen Adams
    
    Director
    
    October 12, 2006J. Glen Adams/s/ John B. Lowe, Jr.
    
    Director
    
    October 12, 2006John B. Lowe, Jr./s/ Thomas C. Shull
    
    Director
    
    October 12, 2006Thomas C. Shull/s/ David M. Szymanski
    
    Director
    
    October 12, 2006David M. Szymanski
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##### Table of Contents



ZALE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
 ExhibitNumber
    
    Description of Exhibit4.1c
    
    Amendment to the Revolving Credit Agreement, dated as of January 17, 200610.1
    
    Zale Corporation Savings and Investment Plan, as amended10.4a
    
    Zale Corporation 2003 Stock Incentive Plan, as amended10.6a
    
    Zale Corporation Outside Directors 2005 Stock Incentive Plan, as amended10.8
    
    Supplemental Executive Retirement Plan, as amended10.10
    
    Employment Agreement with
Mary E. Burton10.13
    
    Employment Agreement with Gilbert P. Hollander10.14
    
    Employment Agreement with Frank C. Mroczka10.18
    
    Zale Corporation Bonus Plan10.21
    
    Base Salaries of Named Executive Officers21
    
    Subsidiaries of the Registrant23.1
    
    Consent of KPMG LLP31.1
    
    Rule 13a-14(a) Certification of Chief Executive Officer31.2
    
    Rule 13a-14(a) Certification of Chief Financial Officer32.1
    
    Section 1350 Certification of Chief Executive Officer32.2
    
    Section 1350 Certification of Chief Financial Officer99.2
    
    Compensation Committee Charter
  F - 35