ZALE CORP - 10-Q Quarterly Report

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q


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

For the quarterly period ended April 30, 2003


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

For the transition period from to

Commission file number 001-04129

ZALE CORPORATION

(Exact name of registrant as specified in its charter)


Delaware		75-0675400
(State or other jurisdiction of		(I.R.S. Employer
incorporation or organization)		Identification No.)

901 W. Walnut Hill Lane, Irving, Texas		75038-1003
(Address of principal executive offices)		(Zip Code)

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

None
(Former name, former address and former
fiscal year, if changed since last report)

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

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

APPLICABLE ONLY TO CORPORATE ISSUERS:

As of May 28, 2003, 32,031,311 shares of the registrant’s common stock were outstanding.

TABLE OF CONTENTS


Part I. Financial Information
	Item 1. Financial Statements
		CONSOLIDATED STATEMENTS OF OPERATIONS
		CONSOLIDATED BALANCE SHEETS
		CONSOLIDATED STATEMENTS OF CASH FLOWS
		NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS (unaudited)
	Item 2. ZALE CORPORATION AND SUBSIDIARIES MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
	Item 3. Quantitative and Qualitative Disclosures About Market Risk
	Item 4. Controls and Procedures
Part II. Other Information
	Item 1. Legal Proceedings
	Item 6. Exhibits and Reports on Form 8-K
SIGNATURE
CERTIFICATIONS
EXHIBIT INDEX
EX-99.1 Amended/Restated Revolving Credit Agrmt.
EX-99.2 Amendment to Citibank USA, N.A. Agreement

ZALE CORPORATION AND SUBSIDIARIES

Index


		Page

Part I	Financial Information:
Item 1.	Financial Statements
	Consolidated Statements of Operations	3
	Consolidated Balance Sheets	4
	Consolidated Statements of Cash Flows	5
	Notes to Unaudited Interim Consolidated Financial Statements	6
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	23
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	31
Item 4.	Controls and Procedures	31
Part II	Other Information:
Item 1.	Legal Proceedings	32
Item 6.	Exhibits and Reports on Form 8-K	32
Signature		33
Certifications		34

Part I. Financial Information

Item 1. Financial Statements

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


		Three Months Ended				Nine Months Ended
		April 30,				April 30,

		2003		2002		2003			2002

Total Revenues		$	449,383	$	449,150	$	1,769,859		$	1,756,161
Costs and Expenses:
	Cost of Sales		220,107		218,502		885,927			869,272
	Selling, General and Administrative Expenses		197,010		200,216		683,298			678,212
	Cost of Insurance Operations		2,000		2,356		6,412			6,058
	Depreciation and Amortization Expense		13,820		14,520		41,772			43,802
	Impairment of Goodwill		—		—		136,300			—
	Unusual Item – Retiree Medical Curtailment Gain		—		—		—			(3,502	)

Operating Earnings			16,446		13,556		16,150			162,319
Interest Expense, Net			1,578		1,425		5,274			5,335

Earnings Before Income Taxes			14,868		12,131		10,876			156,984
Income Taxes			5,501		4,481		54,455			57,989

Earnings (Loss) Before Effect of Accounting Change			9,367		7,650		(43,579	)		98,995
Effect of a Change in Accounting for the Write Off of the Excess of Revalued Net Assets Over Stockholders’ Investment			—		—		—			(41,287	)

Net Earnings (Loss)		$	9,367	$	7,650	$	(43,579	)	$	140,282

Earnings Per Common Share – Basic:
	Before effect of change in accounting principle	$	0.29	$	0.22	$	(1.35	)	$	2.85
	Net Earnings (Loss) Per Share	$	0.29	$	0.22	$	(1.35	)	$	4.03
Earnings Per Common Share – Diluted:
	Before effect of change in accounting principle	$	0.29	$	0.22	$	(1.35	)	$	2.83
	Net Earnings (Loss) Per Share	$	0.29	$	0.22	$	(1.35	)	$	4.00
Weighted Average Number of Common Shares Outstanding:
	Basic		32,075		34,678		32,376			34,783
	Diluted		32,172		35,049		32,376			35,036

See Notes to Unaudited Interim Consolidated Financial Statements.

ZALE CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(unaudited)
(amounts in thousands)


		April 30,			July 31,			April 30,
		2003			2002			2002

ASSETS
Current Assets:
	Cash and Cash Equivalents	$	172,655		$	84,887		$	148,610
	Merchandise Inventories		813,066			782,316			794,770
	Other Current Assets		57,082			47,915			51,477

Total Current Assets			1,042,803			915,118			994,857
Property and Equipment, Net			268,133			284,438			290,761
Goodwill, Net			81,141			212,039			216,206
Other Assets			32,671			34,654			33,204
Deferred Tax Asset, Net			31,334			31,604			40,139

Total Assets		$	1,456,082		$	1,477,853		$	1,575,167

LIABILITIES AND STOCKHOLDERS’ INVESTMENT
Current Liabilities:
	Accounts Payable and Accrued Liabilities	$	392,685		$	331,663		$	398,281
	Deferred Tax Liability, Net		9,974			10,104			18,953

Total Current Liabilities			402,659			341,767			417,234
Non-current Liabilities			104,971			109,530			111,353
Long-term Debt			86,780			86,749			99,700
Commitments and Contingencies			—			—			—
Stockholders’ Investment:
	Preferred Stock		—			—			—
	Common Stock		407			407			406
	Additional Paid-In Capital		550,074			549,848			547,218
	Accumulated Other Comprehensive Income (Loss)		5,098			(6,559	)		(5,199	)
	Accumulated Earnings		586,188			629,767			626,117
	Deferred Compensation		—			(115	)		(6,779	)

			1,141,767			1,173,348			1,161,763
	Treasury Stock		(280,095	)		(233,541	)		(214,883	)

Total Stockholders’ Investment			861,672			939,807			946,880

Total Liabilities and Stockholders’ Investment		$	1,456,082		$	1,477,853		$	1,575,167

See Notes to Unaudited Interim Consolidated Financial Statements.

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


		Nine Months Ended			Nine Months Ended
		April 30,			April 30,
		2003			2002

Net Cash Flows from Operating Activities:
Net (loss) earnings		$	(43,579	)	$	140,282
Adjustments to reconcile net (loss) earnings to net cash provided by operating activities:
	Depreciation and amortization expense		42,110			44,187
	Deferred taxes		140			10,403
	Deferred compensation expense		115			1,470
	Impairment of goodwill		136,300			—
	Impairment of fixed assets		1,697			—
	Effect of change in accounting principle for the write-off of negative goodwill		—			(41,287	)
	Retiree medical curtailment gain		—			(3,502	)
Change in assets and liabilities:
	Merchandise inventories		(24,585	)		(72,809	)
	Other current assets		(8,840	)		5,603
	Other assets		455			(804	)
	Accounts payable and accrued liabilities		59,454			121,901
	Noncurrent liabilities		(4,559	)		(3,579	)

Net Cash Provided by Operating Activities			158,708			201,865

Net Cash Flows from Investing Activities:
Additions to property and equipment			(26,705	)		(41,218	)
Dispositions of property and equipment			1,320			2,693
Purchase of Available-For-Sale investments			(10,557	)		(4,870	)
Proceeds from sale of Available-For-Sale investments			11,887			5,258

Net Cash Used in Investing Activities			(24,055	)		(38,137	)

Net Cash Flows from Financing Activities:
Payments on revolving credit agreement			(166,649	)		(239,769	)
Borrowings under revolving credit agreement			166,649			230,203
Proceeds from exercise of stock options			380			7,119
Purchase of common stock			(47,594	)		(41,959	)

Net Cash Used in Financing Activities			(47,214	)		(44,406	)

Effect of Exchange Rate Changes on Cash			329			(102	)
Net Increase in Cash and Cash Equivalents			87,768			119,220
Cash and Cash Equivalents at Beginning of Period		$	84,887		$	29,390

Cash and Cash Equivalents at End of Period		$	172,655		$	148,610

Supplemental cash flow information:
Interest paid		$	7,766		$	8,655
Interest received		$	970		$	1,660
Income taxes paid (net of refunds received)		$	6,280		$	(5,011	)

See Notes to Unaudited Interim Consolidated Financial Statements.

ZALE CORPORATION AND SUBSIDIARIES
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS (unaudited)

BASIS OF PRESENTATION

Zale Corporation, along with its wholly owned subsidiaries (the “Company”), is the largest specialty retailer of fine jewelry in North America. At April 30, 2003, the Company operated 2,264 specialty retail jewelry stores and kiosks located primarily in shopping malls throughout the United States, Canada and Puerto Rico. The Company principally operates under six brands, each targeted to reach a distinct customer. Zales Jewelers® is the Company’s national brand, which provides traditional, moderately priced jewelry to a broad range of customers. Zales Jewelers has extended the reach of its brand to Zales the Diamond Store Outlet® and Zales.com. Zales the Diamond Store Outlet focuses on the brand conscious, value oriented shopper, offering jewelry at discounts off everyday retail prices in outlet centers. Peoples Jewellers®, the Company’s national brand in Canada, offers traditional, moderately priced jewelry to customers throughout Canada. Gordon’s Jewelers® in the United States, and Mappins Jewelers® in Canada, offer contemporary jewelry merchandise designed to attract slightly higher purchases. Bailey Banks & Biddle Fine Jewelers® operates upscale jewelry stores that are considered among the finest jewelry stores in their markets, offering designer merchandise to more affluent customers. Piercing Pagoda® reaches the opening price point jewelry customer primarily through mall-based kiosks.

The accompanying Interim Consolidated Financial Statements are those of the Company as of and for the three month and nine month periods ended April 30, 2003 and 2002. The Company consolidates substantially all of its U.S. operations into Zale Delaware, Inc. (“ZDel”), a wholly owned subsidiary of Zale Corporation. ZDel is the parent company for several subsidiaries, including three that are engaged primarily in providing credit insurance to credit customers of the Company. The Company consolidates its Canadian retail operations into Zale International, Inc., which is a wholly owned subsidiary of Zale Corporation. All significant intercompany transactions have been eliminated. The accompanying Interim Consolidated Financial Statements should be read in conjunction with the audited Consolidated Financial Statements and related notes thereto included in the Company’s Annual Report on Form 10-K for the fiscal year ended July 31, 2002. The classifications in use at April 30, 2003, have been applied to the financial statements for July 31, 2002, and April 30, 2002.

The accompanying Interim Consolidated Financial Statements are unaudited and have been prepared by the Company in accordance with accounting principles generally accepted in the United States for interim financial information. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. In management’s opinion, all material adjustments and disclosures necessary for a fair presentation have been made. The July 31, 2002 financial information has been derived from the audited consolidated financial statements, and related notes thereto, included in the Company’s Annual Report on Form 10-K for the fiscal year ended July 31, 2002.

The results of operations for the three and nine month periods ended April 30, 2003, and 2002, are not indicative of the operating results for the full fiscal years due to the seasonal nature of the Company’s business. Seasonal fluctuations in retail sales historically have resulted in higher earnings in the quarter of the fiscal year that includes the holiday selling season.

ZALE CORPORATION AND SUBSIDIARIES
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS (unaudited) – (continued)

EARNINGS PER COMMON SHARE

Basic earnings per share is computed by dividing income available to common shareholders by the weighted average number of common shares outstanding for the reporting period. Diluted earnings per share reflects the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock. Outstanding stock options issued by the Company represent the only dilutive effect reflected in diluted weighted average shares. There were antidilutive common stock equivalents of 1,569,500 and 917,250 outstanding for the three months ended April 30, 2003 and April 30, 2002, respectively. There were antidilutive common stock equivalents of 1,891,904 and 880,039 outstanding for the nine months ended April 30, 2003 and April 30, 2002, respectively. The antidilutive common stock equivalents are disregarded for purposes of the calculation below.


	Three Months Ended				Nine Months Ended
	April 30,				April 30,

	2003		2002		2003			2002

	(amounts in thousands, except per share amounts)
Earnings (loss) before effect of accounting change	$	9,367	$	7,650	$	(43,579	)	$	98,995
Net earnings (loss) available to shareholders		9,367		7,650		(43,579	)		140,282
Basic:
Weighted average number of common shares outstanding		32,075		34,678		32,376			34,783
Earnings (loss) per share before effect of accounting change	$	0.29	$	0.22	$	(1.35	)	$	2.85

Net earnings (loss) per common share – basic	$	0.29	$	0.22	$	(1.35	)	$	4.03

Diluted:
Weighted average number of common shares outstanding		32,075		34,678		32,376			34,783
Effect of dilutive stock options		97		371		—			253

Weighted average number of common shares outstanding as adjusted		32,172		35,049		32,376			35,036
Earnings (loss) per share before effect of accounting change	$	0.29	$	0.22	$	(1.35	)	$	2.83

Net earnings (loss) per common share – diluted	$	0.29	$	0.22	$	(1.35	)	$	4.00

ZALE CORPORATION AND SUBSIDIARIES
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS (unaudited)– (continued)

STOCK REPURCHASE PLAN

On March 18, 2003, the Company announced that its Board of Directors had approved a stock repurchase program pursuant to which the Company, from time to time, and at management’s discretion may purchase up to an aggregate of $50 million of Zale Corporation common stock on the open market. Under this program, the Company purchased 58,000 shares at an aggregate cost of $2.0 million through April 30, 2003.

In July 2002, the Company announced that its Board of Directors had approved a stock repurchase program pursuant to which the Company repurchased 1.7 million shares at a cost of $50 million to complete this program.

STOCK BASED COMPENSATION

The Company accounts for its Stock Option and Employee Stock Purchase Plans under the recognition and measurement principles of APB Opinion No. 25, “Accounting for Stock Issued to Employees”, and related interpretations. The following table illustrates the effect on net income and earnings per share if the Company had applied the fair value recognition provisions of SFAS No. 123, “Accounting for Stock-Based Compensation,” to stock-based employee compensation.


		Three Months Ended						Nine Months Ended
		April 30,						April 30,

		2003			2002			2003			2002

		(amounts in thousands, except per share amounts)
Net income (loss), as reported		$	9,367		$	7,650		$	(43,579	)	$	140,282
Deduct: Total stock-based employee compensation expense determined under fair value based method for all awards, net of related tax effects			(1,204	)		(1,611	)		(3,692	)		(4,648	)

Pro forma net income (loss)		$	8,163		$	6,039		$	(47,271	)	$	135,634

Earnings (Loss) Per Common Share – Basic:
	Earnings (Loss) Per Common Share, as reported	$	0.29		$	0.22		$	(1.35	)	$	4.03
	Earnings (Loss) Per Common Share, pro forma	$	0.25		$	0.17		$	(1.46	)	$	3.90
Earnings (Loss) Per Common Share – Diluted:
	Earnings (Loss) Per Common Share, as reported	$	0.29		$	0.22		$	(1.35	)	$	4.00
	Earnings (Loss) Per Common Share, pro forma	$	0.25		$	0.17		$	(1.46	)	$	3.87
Weighted Average Number of Common Shares Outstanding:
	Basic		32,075			34,678			32,376			34,783
	Diluted		32,172			35,049			32,376			35,036

ZALE CORPORATION AND SUBSIDIARIES
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS (unaudited)– (continued)

COMPREHENSIVE INCOME

Comprehensive income (loss) is defined as the change in equity during a period from transactions and other events, except those resulting from investments by and distributions to stockholders. The components of comprehensive income (loss) for the three and nine month periods ended April 30, 2003 and 2002, are as follows:


		Three Months Ended						Nine Months Ended
		April 30,						April 30,

		2003			2002			2003			2002

		(amounts in thousands)
Net Earnings (Loss)		$	9,367		$	7,650		$	(43,579	)	$	140,282
Other Comprehensive Income (Loss):
	Increase (decrease) in unrealized gain on investment securities, net		578			(181	)		(136	)		(380	)
	(Decrease) increase in unrealized gain on derivative instruments		(168	)		(74	)		245			—
	Increase in unrealized loss on derivative instruments		—			—			—			(48	)
	Cumulative translation adjustments		7,621			1,677			11,548			(2,416	)

Total Comprehensive Income (Loss)		$	17,398		$	9,072		$	(31,922	)	$	137,438

LONG-TERM DEBT

In order to support the Company’s growth plans and seasonal borrowing needs, the Company maintains an unsecured Revolving Credit Agreement. The Revolving Credit Agreement provides for (i) a U.S. Revolving Credit facility, in the aggregate principal amount of up to $215 million in commitments by certain U.S. lenders, including a $10 million sublimit for letters of credit, and (ii) a separate Canadian Revolving Credit facility, which provides for Canadian Dollar denominated loans in the aggregate principal amount of up to a U.S. Dollar equivalent of $10 million in commitments by a Canadian lender. The total amount of commitments under the Revolving Credit Agreement to the Company and its subsidiaries is approximately $225 million, and the facility expires in 2005. Under the Revolving Credit Agreement the Company may, subject to approval of the U.S. Agent or the Canadian Agent, as the case may be, increase the total U.S. commitment to $285 million and the Canadian commitment to a U.S. dollar equivalent of $25 million, provided that the commitments together do not exceed a U.S. Dollar equivalent of $300 million. The increase can come from within or outside the bank group.

The revolving credit loans bear interest at floating rates as follows: (A) loans outstanding under the U.S. Revolving Credit facility bear interest, at the Company’s option, at either (i) the applicable Eurodollar Rate plus a margin equal to 1.00 percent (subject to adjustment), or (ii) the Base Rate (which is the higher of the annual rate of interest announced from time to time by the agent bank under the Revolving Credit Agreement as its base rate or 1.00 percent plus the Federal Funds Effective Rate); and (B) loans outstanding under the Canadian Revolving Credit facility bear interest, at the Company’s option, at either (i) a Bankers’ Acceptance Discount Rate (which varies depending upon whether the Canadian Lender is a bank named under Schedule I or II to the Bank Act (Canada) or neither) plus a margin equal to 1.00 percent (subject to adjustment), or (ii) the annual rate of interest announced from time to time by the Canadian agent bank under the Revolving Credit Agreement as its “prime rate” for commercial loans in Canadian Dollars to borrowers in Canada. At April 30, 2003, there were no outstanding amounts under the U.S. Revolving Credit or the Canadian Revolving Credit facility. The Revolving Credit Agreement contains certain restrictive covenants, which, among other restrictions, imposes limitations on indebtedness, investments, capital expenditures, and other distributions (including repurchases of the Company’s common stock). The Company is currently in compliance with all of its obligations under the Revolving Credit Agreement.

ZALE CORPORATION AND SUBSIDIARIES
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS (unaudited)– (continued)

The impairment charge of $136.3 million resulting from the valuation of the carrying value of the Piercing Pagoda goodwill resulted in a limitation on the Company’s ability to make distributions under the Revolving Credit Agreement. In March 2003, the Company elected to amend the Revolving Credit Agreement to adjust the basis of the floating interest rates and redefine limitations on capital expenditures and other distributions (as discussed above).

In 1997, the Company issued $100 million of 8½ percent Senior Notes due in 2007. In fiscal year 2002, the Company repurchased $13 million of the Senior Notes. The Senior Notes are unsecured and are guaranteed by ZDel. The indenture relating to the Senior Notes contains restrictive covenants including but not limited to limitations on indebtedness, dividends and other restricted payments (including repurchases of the Company’s common stock), transactions with affiliates, liens and disposition of proceeds of asset sales, among others. The Company is currently in compliance with all of its obligations under the Senior Notes.

DERIVATIVE FINANCIAL INSTRUMENTS

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

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

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

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

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

ZALE CORPORATION AND SUBSIDIARIES
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS (unaudited)– (continued)

As of April 30, 2003, the Company had $3.9 million of outstanding forward contracts to purchase gold. The fair value of these gold contracts recorded in the accompanying Consolidated Balance Sheet at April 30, 2003 is $49,900. The gains and losses on forward contracts realized for the three and nine month periods ended April 30, 2003 and 2002, were immaterial to the Company’s Consolidated Statement of Operations. The Company estimates that the unrealized gains of $0.2 million included in Accumulated Other Comprehensive Income (Loss) will be recognized into earnings within seven months of the individual contract settlement date, corresponding with the sale of the related inventory. The Company had no foreign currency forward contracts outstanding at April 30, 2003. As of April 30, 2002, the Company had $5.0 million of foreign currency forward exchange contracts outstanding. The fair value of these foreign currency forward exchange contracts recorded on the accompanying Consolidated Balance Sheet at April 30, 2002 was ($48,200).

COMMITMENTS AND CONTINGENCIES

The Company is involved in various legal actions and claims arising in the ordinary course of business. The Company currently believes that such litigation and claims, both individually and in the aggregate, will be resolved without material effect on the Company’s financial position or results of operations. However, litigation involves an element of uncertainty. Future developments could result in significant changes in litigation reserves and costs.

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

On October 23, 2001, a plaintiff filed a complaint against Zale Corporation and Zale Delaware, Inc. in the Superior Court of California, County of Los Angeles, Central District. The complaint is a purported class action on behalf of current and former salaried store managers and assistant store managers of the Company in California. The complaint alleged that these individuals were entitled to overtime pay and should not have been classified as exempt employees under California law. Plaintiff sought recovery of overtime pay, declaratory relief and attorneys’ fees. The Company has reached an agreement with counsel for the plaintiff to settle the action. The settlement is subject to the approval of the court.

The Company has established reserves based on the current status of each case. Certification of the matters as class actions could result in adjustments to the reserves.

ZALE CORPORATION AND SUBSIDIARIES
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS (unaudited)– (continued)

GOODWILL

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

In accordance with SFAS No. 142, “Goodwill and Other Intangible Assets”, the Company tests goodwill for impairment annually, at the end of its second quarter, or more frequently if events occur which indicate a potential reduction in the fair value of a reporting unit’s net assets below its carrying value. An impairment is deemed to exist if the net book value of a reporting unit exceeds its estimated fair value. In the second quarter of fiscal year 2003, the Company performed its annual review for impairment of goodwill related to its Piercing Pagoda, Inc., People’s Jewellers and other smaller acquisitions. The Company has concluded that there is no evidence of impairment related to the goodwill of approximately $56.7 million recorded for the People’s acquisition and $5 million for other smaller acquisitions. To perform the impairment test for Piercing Pagoda, the Company engaged an independent third party valuation firm. This firm calculated the estimated fair value of Piercing Pagoda. The calculation indicated that the fair value of Piercing Pagoda was lower than its carrying value, reflective of the current market conditions and lower than expected performance. The Company recorded a non-cash charge of $136.3 million in the second quarter of fiscal year 2003, which is included as a component of operating earnings in the Consolidated Statement of Operations, to reduce the carrying value of the Piercing Pagoda goodwill to approximately $19 million. This impairment charge, being non-cash in nature, does not directly affect the Company’s liquidity, although the Company is currently limited under the terms of the indenture for its Senior Notes in its ability to make certain future discretionary payments, such as repurchasing stock, until it accumulates future earnings or modifies the agreements.

FINANCIAL ACCOUNTING PRONOUNCEMENTS

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

ZALE CORPORATION AND SUBSIDIARIES
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS (unaudited) – (continued)

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

GUARANTEE OBLIGATIONS

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

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

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

Based on account balances for the shared risk programs as of April 30, 2003, the Company’s maximum potential payment would be approximately $25 million if the entire portfolio defaulted. Based on historical performance, losses in these portfolios absorbed by the Company have been less than $800,000 since August 2000. Prior to fiscal year 2003, the Company was liable for all losses under these shared risk programs. Losses in fiscal year 2003 under new terms with Citi that limit the Company’s losses were less than $40,000 through April 30, 2003. The reserve for both portfolios is approximately $710,000, which the Company believes is adequate based on the historical trend of actual losses. In April 2003, the Company and Citi finalized an agreement that requires the Company to pledge an amount of $4.7 million as collateral to Citi in an interest bearing depository account that will fluctuate monthly based on the account balances of the shared risk programs.

ZALE CORPORATION AND SUBSIDIARIES
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS (unaudited) – (continued)

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

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


	Three Months Ended						Nine Months Ended
	April 30,						April 30,

	2003			2002			2003			2002

	(amounts in thousands)
Beginning Balance	$	34,716		$	34,189		$	32,541		$	30,394
Extended Warranty Sales		8,279			7,544			31,052			27,813
Extended Warranty Income Recognized		(9,106	)		(8,140	)		(29,704	)		(24,614	)

Ending Balance	$	33,889		$	33,593		$	33,889		$	33,593

SUPPLEMENTAL CONDENSED CONSOLIDATING FINANCIAL INFORMATION

The Company has outstanding $87 million in aggregate principal amount of 8½ percent Senior Notes due in 2007. The Company’s payment obligations under the Senior Notes are guaranteed by ZDel (the “Guarantor Subsidiary”). Separate financial statements of the Guarantor Subsidiary are not presented because the Company’s management has determined that they would not be material to investors. The following supplemental financial information sets forth, on an unconsolidated basis, statements of operations, balance sheets, and statements of cash flow information for the Company (“Parent Company Only”), for the Guarantor Subsidiary and for the Company’s other subsidiaries (the “Non-Guarantor Subsidiaries”). The supplemental financial information reflects the investments of the Company and the Guarantor Subsidiary in the Guarantor and Non-Guarantor Subsidiaries using the equity method of accounting. Certain reclassifications have been made to provide for uniform disclosure of all periods presented. These reclassifications are not material.

ZALE CORPORATION AND SUBSIDIARIES
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS (unaudited)—(continued)
SUPPLEMENTAL CONDENSED CONSOLIDATING FINANCIAL INFORMATION—(continued)

SUPPLEMENTAL CONDENSED CONSOLIDATING STATEMENT OF OPERATIONS

Three Months Ended April 30, 2003
(unaudited)
(amounts in thousands)


	Parent
	Company			Guarantor			Non-Guarantor
	Only			Subsidiary			Subsidiaries			Eliminations			Consolidated

Total Revenues	$	—		$	406,716		$	42,667		$	—		$	449,383
Total Costs and Expenses:
Cost of Sales		—			200,120			19,987			—			220,107
Selling, General and Administrative Expenses		38			180,653			16,319			—			197,010
Cost of Insurance Operations		—			(4	)		2,004			—			2,000
Depreciation and Amortization Expense		—			12,749			1,071			—			13,820

Operating (Loss) Earnings		(38	)		13,198			3,286			—			16,446
Interest Expense, Net		(13,348	)		14,935			(9	)		—			1,578

Earnings (Loss) Before Income Taxes		13,310			(1,737	)		3,295			—			14,868
Income Taxes		4,923			(645	)		1,223			—			5,501

Earnings (Loss) Before Equity in Earnings of Subsidiaries		8,387			(1,092	)		2,072			—			9,367
Equity in Earnings of Subsidiaries		980			1,642			—			(2,622	)		—

Net Earnings (Loss)	$	9,367		$	550		$	2,072		$	(2,622	)	$	9,367

ZALE CORPORATION AND SUBSIDIARIES
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS (unaudited)—(continued)
SUPPLEMENTAL CONDENSED CONSOLIDATING FINANCIAL INFORMATION—(continued)

SUPPLEMENTAL CONDENSED CONSOLIDATING STATEMENT OF OPERATIONS

Three Months Ended April 30, 2002
(unaudited)
(amounts in thousands)


	Parent
	Company			Guarantor			Non-Guarantor
	Only			Subsidiary			Subsidiaries			Eliminations			Consolidated

Total Revenues	$	—		$	406,953		$	42,197		$	—		$	449,150
Total Costs and Expenses:
Cost of Sales		—			198,974			19,528			—			218,502
Selling, General and Administrative Expenses		38			183,452			16,726			—			200,216
Cost of Insurance Operations		—			—			2,356			—			2,356
Depreciation and Amortization Expense		—			13,546			974			—			14,520

Operating (Loss) Earnings		(38	)		10,981			2,613			—			13,556
Interest Expense, Net		(13,348	)		14,815			(42	)		—			1,425

Earnings (Loss) Before Income Taxes		13,310			(3,834	)		2,655			—			12,131
Income Taxes		4,917			(1,418	)		982			—			4,481

Earnings (Loss) Before Equity in Earnings of Subsidiaries		8,393			(2,416	)		1,673			—			7,650
Equity in Earnings of Subsidiaries		(743	)		2,156			—			(1,413	)		—

Net Earnings (Loss)	$	7,650		$	(260	)	$	1,673		$	(1,413	)	$	7,650

ZALE CORPORATION AND SUBSIDIARIES
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS (unaudited)—(continued)
SUPPLEMENTAL CONDENSED CONSOLIDATING FINANCIAL INFORMATION—(continued)

SUPPLEMENTAL CONDENSED CONSOLIDATING STATEMENT OF OPERATIONS

Nine Months Ended April 30, 2003
(unaudited)
(amounts in thousands)


	Parent
	Company			Guarantor			Non-Guarantor
	Only			Subsidiary			Subsidiaries		Eliminations		Consolidated

Total Revenues	$	—		$	1,604,180		$	165,679	$	—	$	1,769,859
Total Costs and Expenses:
Cost of Sales		—			805,227			80,700		—		885,927
Selling, General and Administrative Expenses		113			629,241			53,944		—		683,298
Cost of Insurance Operations		—			(2	)		6,414		—		6,412
Depreciation and Amortization Expense		—			38,582			3,190		—		41,772
Impairment of Goodwill		—			136,300			—		—		136,300

Operating (Loss) Earnings		(113	)		(5,168	)		21,431		—		16,150
Interest Expense, Net		(40,044	)		45,224			94		—		5,274

Earnings (Loss) Before Income Taxes		39,931			(50,392	)		21,337		—		10,876
Income Taxes		14,774			31,785			7,896		—		54,455

Earnings (Loss) Before Equity in Earnings of Subsidiaries		25,157			(82,177	)		13,441		—		(43,579	)
Equity in Earnings of Subsidiaries		(68,736	)		6,434			—		62,302		—

Net (Loss) Earnings	$	(43,579	)	$	(75,743	)	$	13,441	$	62,302	$	(43,579	)

ZALE CORPORATION AND SUBSIDIARIES
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS (unaudited)—(continued)
SUPPLEMENTAL CONDENSED CONSOLIDATING FINANCIAL INFORMATION —(continued)

SUPPLEMENTAL CONDENSED CONSOLIDATING STATEMENT OF OPERATIONS

Nine Months Ended April 30, 2002
(unaudited)
(amounts in thousands)


	Parent						Non-
	Company			Guarantor			Guarantor
	Only			Subsidiary			Subsidiaries			Eliminations			Consolidated

Total Revenues	$	—		$	1,594,422		$	161,739		$	—		$	1,756,161
Total Costs and Expenses:
Cost of Sales		—			790,123			79,149			—			869,272
Selling, General and Administrative Expenses		113			624,585			53,514			—			678,212
Cost of Insurance Operations		—			—			6,058			—			6,058
Depreciation and Amortization Expense		—			40,739			3,063			—			43,802
Unusual Item-Retiree Medical Curtailment Gain		—			(3,502	)		—			—			(3,502	)

Operating (Loss) Earnings		(113	)		142,477			19,955			—			162,319
Interest Expense, Net		(40,044	)		45,399			(20	)		—			5,335

Earnings (Loss) Before Income Taxes		39,931			97,078			19,975			—			156,984
Income Taxes		14,751			35,859			7,379			—			57,989

Earnings Before Effect of Accounting Change		25,180			61,219			12,596			—			98,995
Effect of a Change in Accounting for the Write off of the Excess of Revalued Net Assets Over Stockholders’ Investment		—			(41,287	)		—			—			(41,287	)

Earnings Before Equity in Earnings of Subsidiaries		25,180			102,506			12,596			—			140,282
Equity in Earnings of Subsidiaries		115,102			7,483			—			(122,585	)		—

Net Earnings	$	140,282		$	109,989		$	12,596		$	(122,585	)	$	140,282

ZALE CORPORATION AND SUBSIDIARIES
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS (unaudited)—(continued)
SUPPLEMENTAL CONDENSED CONSOLIDATING FINANCIAL INFORMATION—(continued)

SUPPLEMENTAL CONDENSED CONSOLIDATING BALANCE SHEET

April 30, 2003
(unaudited)
(amounts in thousands)


		Parent
		Company		Guarantor			Non-Guarantor
		Only		Subsidiary			Subsidiaries			Eliminations			Consolidated

ASSETS
Current Assets:
	Cash and Cash Equivalents	$	—	$	149,184		$	23,471		$	—		$	172,655
	Merchandise Inventories		—		735,120			77,946			—			813,066
	Other Current Assets		—		46,719			10,363			—			57,082

Total Current Assets			—		931,023			111,780			—			1,042,803

Investment in Subsidiaries			19,705		65,515			—			(85,220	)		—
Property and Equipment, Net			—		244,296			23,837			—			268,133
Intercompany Receivable			913,935		—			1,114			(915,049	)		—
Goodwill, Net			—		24,394			56,747			—			81,141
Other Assets			—		2,782			29,889			—			32,671
Deferred Tax Assets, Net			1,446		32,730			(2,842	)		—			31,334

Total Assets		$	935,086	$	1,300,740		$	220,525		$	(1,000,269	)	$	1,456,082

LIABILITIES AND STOCKHOLDERS’ INVESTMENT
Current Liabilities:
	Accounts Payable and Accrued Liabilities	$	2,338	$	364,125		$	26,222		$	—		$	392,685
	Deferred Tax Liability, Net		646		10,694			(1,366	)		—			9,974

Total Current Liabilities			2,984		374,819			24,856			—			402,659

Non-current Liabilities			—		97,118			7,853			—			104,971
Intercompany Payable			—		910,321			5,096			(915,417	)		—
Long-term Debt			86,780		—			—			—			86,780
Total Stockholders’ Investment			845,322		(81,518	)		182,720			(84,852	)		861,672

Total Liabilities and Stockholders’ Investment		$	935,086	$	1,300,740		$	220,525		$	(1,000,269	)	$	1,456,082

ZALE CORPORATION AND SUBSIDIARIES
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS (unaudited)—(continued)
SUPPLEMENTAL CONDENSED CONSOLIDATING FINANCIAL INFORMATION—(continued)

SUPPLEMENTAL CONDENSED CONSOLIDATING BALANCE SHEET

July 31, 2002
(unaudited)
(amounts in thousands)


		Parent
		Company		Guarantor		Non-Guarantor
		Only		Subsidiary		Subsidiaries			Eliminations			Consolidated

ASSETS
Current Assets:
	Cash and Cash Equivalents	$	662	$	67,157	$	17,068		$	—		$	84,887
	Merchandise Inventories		—		709,728		72,588			—			782,316
	Other Current Assets		—		41,129		6,786			—			47,915

Total Current Assets			662		818,014		96,442			—			915,118

Investment in Subsidiaries			123,378		63,581		—			(186,959	)		—
Property and Equipment, Net			—		263,364		21,074			—			284,438
Intercompany Receivable			890,671		—		3,561			(894,232	)		—
Goodwill, Net			—		160,694		51,345			—			212,039
Other Assets			—		2,486		32,168			—			34,654
Deferred Tax Assets, Net			1,446		32,730		(2,572	)		—			31,604

Total Assets		$	1,016,157	$	1,340,869	$	202,018		$	(1,081,191	)	$	1,477,853

LIABILITIES AND STOCKHOLDERS’ INVESTMENT
Current Liabilities:
	Accounts Payable and Accrued Liabilities	$	4,924	$	302,754	$	23,985		$	—		$	331,663
	Deferred Tax Liability, Net		646		10,694		(1,236	)		—			10,104

Total Current Liabilities			5,570		313,448		22,749			—			341,767

Non-current Liabilities			—		101,009		8,521			—			109,530
Intercompany Payable			—		886,082		8,136			(894,218	)		—
Long-term Debt			86,749		—		—			—			86,749
Total Stockholders’ Investment			923,838		40,330		162,612			(186,973	)		939,807

Total Liabilities and Stockholders’ Investment		$	1,016,157	$	1,340,869	$	202,018		$	(1,081,191	)	$	1,477,853

ZALE CORPORATION AND SUBSIDIARIES
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS (unaudited)— (continued)
SUPPLEMENTAL CONDENSED CONSOLIDATING FINANCIAL INFORMATION— (continued)

SUPPLEMENTAL CONDENSED CONSOLIDATING STATEMENT OF CASH FLOWS

Nine Months Ended April 30, 2003
(unaudited)
(amounts in thousands)


	Parent
	Company			Guarantor			Non-Guarantor
	Only			Subsidiary			Subsidiaries			Eliminations			Consolidated

Net Cash Provided by (Used in) Operating Activities	$	46,552		$	104,654		$	11,865		$	(4,363	)	$	158,708
Net Cash Flows from Investing Activities:
Additions to property and equipment		—			(23,876	)		(2,829	)		—			(26,705	)
Dispositions of property and equipment		—			1,249			71			—			1,320
Purchase of available for sale investments		—			—			(10,557	)		—			(10,557	)
Proceeds from sale of available for sale investments		—			—			11,887			—			11,887

Net Cash Used in Investing Activities		—			(22,627	)		(1,428	)		—			(24,055	)

Net Cash Flows from Financing Activities:
Payments on revolving credit agreement		—			(128,800	)		(37,849	)		—			(166,649	)
Borrowings under revolving credit agreement		—			128,800			37,849			—			166,649
Proceeds from exercise of stock options		380			—			—			—			380
Purchase of common stock		(47,594	)		—			—			—			(47,594	)
Dividends paid		—			—			(4,363	)		4,363			—

Net Cash (Used in) Provided by Financing Activities		(47,214	)		—			(4,363	)		4,363			(47,214	)

Effect of Exchange Rate Changes on Cash		—			—			329			—			329
Net (Decrease) Increase in Cash and Cash Equivalents		(662	)		82,027			6,403			—			87,768
Cash and Cash Equivalents at Beginning of Period		662			67,157			17,068			—			84,887

Cash and Cash Equivalents at End of Period	$	—		$	149,184		$	23,471		$	—		$	172,655

ZALE CORPORATION AND SUBSIDIARIES
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS (unaudited)- (continued)
SUPPLEMENTAL CONDENSED CONSOLIDATING FINANCIAL INFORMATION- (continued)

SUPPLEMENTAL CONDENSED CONSOLIDATING STATEMENT OF CASH FLOWS

Nine Months Ended April 30, 2002
(unaudited)
(amounts in thousands)


	Parent
	Company			Guarantor			Non-Guarantor
	Only			Subsidiary			Subsidiaries			Eliminations			Consolidated

Net Cash Provided by (Used in) Operating Activities	$	34,840		$	150,003		$	19,549		$	(2,527	)	$	201,865
Net Cash Flows from Investing Activities:
Additions to property and equipment		—			(36,543	)		(4,675	)		—			(41,218	)
Dispositions of property and equipment		—			2,592			101			—			2,693
Purchase of available for sale investments		—			—			(4,870	)		—			(4,870	)
Proceeds from sale of available for sale investments		—			—			5,258			—			5,258

Net Cash Used in Investing Activities		—			(33,951	)		(4,186	)		—			(38,137	)

Net Cash Flows from Financing Activities:
Payments on revolving credit agreement		—			(219,300	)		(20,469	)		—			(239,769	)
Borrowings under revolving credit agreement		—			219,300			10,903			—			230,203
Proceeds from exercise of stock options		7,119			—			—			—			7,119
Purchase of common stock		(41,959	)		—			—			—			(41,959	)
Dividends paid		—			—			(2,527	)		2,527			—

Net Cash (Used in) Provided by Financing Activities		(34,840	)		—			(12,093	)		2,527			(44,406	)

Effect of Exchange Rate Changes on Cash		—			—			(102	)		—			(102	)
Net Increase in Cash and Cash Equivalents		—			116,052			3,168			—			119,220
Cash and Cash Equivalents at Beginning of Period		—			11,440			17,950			—			29,390

Cash and Cash Equivalents at End of Period	$	—		$	127,492		$	21,118		$	—		$	148,610

Item 2.
ZALE CORPORATION AND SUBSIDIARIES MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

This discussion and analysis should be read in conjunction with the unaudited Consolidated Financial Statements of the Company (and the related notes thereto) included elsewhere in this report and the Company’s Annual Report and Form 10-K for the fiscal year ended July 31, 2002.

Results of Operations

The following table sets forth certain financial information from the Company’s unaudited Consolidated Statements of Operations expressed as a percentage of total revenues.


	Three Months Ended						Nine Months Ended
	April 30,						April 30,

	2003			2002			2003			2002

Total Revenues		100.0	%		100.0	%		100.0	%		100.0	%
Cost of Sales		49.0			48.7			50.0			49.5
Selling, General and Administrative Expenses		43.8			44.6			38.6			38.6
Cost of Insurance Operations		0.4			0.5			0.4			0.4
Depreciation and Amortization Expense		3.1			3.2			2.4			2.5
Impairment of Goodwill		—			—			7.7			—
Unusual Item-Retiree Medical Curtailment Gain		—			—			—			(0.2	)

Operating Earnings		3.7			3.0			0.9			9.2
Interest Expense, Net		0.4			0.3			0.3			0.3

Earnings Before Income Taxes		3.3			2.7			0.6			8.9
Income Taxes		1.2			1.0			3.1			3.3

Earnings (Loss) Before Effect of Accounting Change		2.1			1.7			(2.5	)		5.6
Effect of Change in Accounting for the Write Off of the Excess of Revalued Net Assets over Stockholder’s Investment		—			—			—			(2.4	)

Net Earnings (Loss)		2.1	%		1.7	%		(2.5	%)		8.0	%

Three Months Ended April 30, 2003 Compared to Three Months Ended April 30, 2002

Total Revenues. Total Revenues for the three months ended April 30, 2003 were $449.4 million, an increase of 0.1 percent over total revenues of $449.2 million for the same period in the prior year. During the period, the Company opened 4 new stores and closed 29 stores, 18 of which were part of the kiosk business. Comparable store sales increased 0.3 percent in the three months ended April 30, 2003 over the same period in the prior year. Comparable store sales include sales for those stores that were in operation for a full 12-month period in both the current year and prior year. Total Revenues include insurance premium revenues for credit insurance operations of $3.9 million and $4.8 million for the three months ended April 30, 2003, and 2002, respectively.

The revenue increase is primarily due to the continued strength of the solitaire and bridal categories. In addition to heart-related items for Valentine’s Day, proprietary diamonds, three stone jewelry in a wide assortment of shapes and sizes, and white metals continued to be the Company’s best sellers.

Despite the volatility of the external environment, the moderate brands and high-end business had a positive performance that offset the negative trend of the kiosk business. The kiosk’s brand performance continued to be challenging primarily due to decreases in mall traffic and teen spending.

Cost of Sales. Cost of Sales as a percentage of revenues was 49.0 for the three months ended April 30, 2003, an increase of 0.3 percentage points over the same period in the prior year. The cost of sales increase was driven primarily by the continued shift in the merchandise mix to bridal and solitaire categories, which traditionally have lower margins. This increase was partially offset by improved inventory shrink results due to operating initiatives strengthening the management of inventory.

The Company’s LIFO provision was $0.8 million and $0.6 million for the three months ended April 30, 2003 and 2002, respectively. As stated in Critical Accounting Policies and Estimates in the Company’s Form 10-K for the fiscal year ended July 31, 2002, and the Notes to the Consolidated Financial Statements, the quarterly LIFO calculation requires estimates of inflation trends, purchases and ending inventory levels for the total fiscal year. Actual inflation rates and inventory balances as of July 31, 2003 may be different than interim estimates.

Selling, General and Administrative Expenses. Selling, General and Administrative (“SG&A”) expenses were $197.0 million, a decrease of 1.6 percent. As a percent of revenues, SG&A decreased to 43.8 percent of revenues for the three months ended April 30, 2003, from 44.6 percent of revenues for the three months ended April 30, 2002. This decrease is primarily due to lower corporate expenses resulting from cost saving initiatives. SG&A spending was reduced where appropriate given sales trends.

Cost of Insurance Operations. The Cost of Insurance Operations was $2.0 million, a decrease of 15.0 percent. As a percent of revenues, Cost of Insurance Operations is 0.4 percent of revenues, a decrease of 0.1 percentage points over the same period in the prior year.

Depreciation and Amortization Expense. Depreciation and Amortization Expense was $13.8 million, a decrease of 4.8 percent primarily due to reduced capital expenditures over the past two years. Older assets are being retired or have been fully depreciated.

Interest Expense, Net. Interest Expense, Net was $1.6 million, an increase of 10.7 percent. The increase is due to lower earnings on investment rates and a reduction in capitalized interest due to reduced capital expenditures.

Income Taxes. The Income Tax provision for the three month periods ended April 30, 2003 and 2002 was $5.5 million and $4.5 million, respectively, reflecting an effective tax rate of 37.0 percent (excluding the goodwill impairment charge of $136.3 million) and 36.9 percent, respectively. The Company may realize a cash benefit from utilization of tax net operating loss carryforward (“NOL”) (after limitations) against current and future tax liabilities. As of April 30, 2003, the Company had remaining NOL (after limitations) of approximately $111.0 million. The Company will not recognize a tax benefit associated with the writedown of Piercing Pagoda goodwill since the original acquisition was a nontaxable business combination for which the goodwill is not deductible for tax purposes.

Nine Months Ended April 30, 2003 Compared to Nine Months Ended April 30, 2002

Total Revenues. Total Revenues for the nine months ended April 30, 2003 remained flat at $1.8 billion, over total revenues for the same period in the prior year. Comparable store sales increased 0.6 percent in the nine months ended April 30, 2003 over the same period in the prior year. Comparable store sales include sales for those stores that were in operation for a full 12-month period in both the current year and prior year. Total Revenues include insurance premium revenues for credit insurance operations of $12.4 million and $13.8 million for the nine months ended April 30, 2003 and 2002, respectively.

The revenue increase is primarily due to the continued strength of the solitaire and bridal categories. In addition to heart related items for Valentine’s Day, proprietary diamonds, three stone jewelry in a wide assortment of shapes and sizes, and white metals continued to be the Company’s best sellers. These items contributed to the improvement in the average check over the prior year.

Despite the volatility of the external environment, the moderate brands and high-end business had a stronger performance that offset the negative trend of the kiosk business. The kiosk brand’s performance continued to be challenging due to decreases in mall traffic and teen spending, as well as a merchandising strategy during the holidays that did not meet expectations.

Cost of Sales. Cost of Sales as a percentage of total revenues was 50.0 percent for the nine month period ending April 30, 2003, an increase of 0.5 percentage points over the same period in the prior year.

The cost of sales increase was driven primarily by higher promotional markdowns, especially in the kiosk business. Additionally, a continued shift in the merchandise mix to bridal and solitaire categories, which traditionally have lower margins, contributed to the increase in the cost of sales. This increase was partially offset by improved inventory shrink results due to operating initiatives strengthening the management of inventory.

The Company’s LIFO provision was $3.5 million and $4.3 million for the nine months ended April 30, 2003 and 2002, respectively. As stated in Critical Accounting Policies and Estimates in the Company’s Form 10-K for the fiscal year ended July 31, 2002, and the Notes to the Consolidated Financial Statements, the quarterly LIFO calculation requires estimates of inflation trends, purchases and ending inventory levels for the total fiscal year. Actual inflation rates and inventory balances as of July 31, 2003 may be different than interim estimates.

Selling, General and Administrative Expenses. Selling, General and Administrative Expenses (“SG&A”) were $683.3 million, an increase of 1.0 percent. As a percent of revenues, SG&A remained consistent at 38.6 percent of revenues for the nine month period ending April 30, 2003, compared to the same period in the prior year.

Cost of Insurance Operations. The Cost of Insurance Operations was $6.4 million, an increase of 5.8 percent. As a percent of revenues, Cost of Insurance Operations was 0.4 and 0.3 percent of revenues for the nine months ended April 30, 2003 and 2002, respectively.

Depreciation and Amortization Expense. Depreciation and Amortization Expense was $41.8 million, a decrease of 4.6 percent, primarily due to reduced capital expenditures over the past two years. Older assets are being retired or have been fully depreciated.

Impairment of Goodwill. In accordance with SFAS No. 142, “Goodwill and Other Intangible Assets”, the Company tests goodwill for impairment annually, at the end of its second quarter, or more frequently if events occur which indicate a potential reduction in the fair value of a reporting unit’s net assets below its carrying value. An impairment is deemed to exist if the net book value of a reporting unit exceeds its estimated fair value. In the second quarter of fiscal year 2003, the Company performed its annual review for impairment of goodwill related to its Piercing Pagoda, Inc., People’s Jewellers and other smaller acquisitions. The Company has concluded that there is no evidence of impairment related to the goodwill of approximately $56.7 million recorded for the People’s acquisition and $5 million for other smaller acquisitions. To perform the impairment test for Piercing Pagoda, the Company engaged an independent third party valuation firm. This firm calculated the estimated fair value of Piercing Pagoda. The calculation indicated that the fair value of Piercing Pagoda was lower than its carrying value, reflective of the current market conditions and lower than expected performance. The Company recorded a non-cash charge of $136.3 million in the second quarter of fiscal year 2003, which is included as a component of operating earnings in the Consolidated Statement of Operations, to reduce the carrying value of the Piercing Pagoda goodwill to approximately $19 million. This impairment charge, being non-cash in nature, does not directly affect the Company’s liquidity, although the Company is currently limited under the terms of the indenture for its Senior Notes in its ability to make certain future discretionary payments, such as repurchasing stock, until it accumulates future earnings or modifies the agreements.

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

Interest Expense, Net. Interest Expense, Net was $5.3 million for the three months ended April 30, 2003 and 2002.

Income Taxes. The Income Tax provision for the nine months ended April 30, 2003 and 2002 was $54.5 million and $58.0 million, respectively, reflecting an effective tax rate of 37.0 percent (excluding the goodwill impairment charge of $136.3) and 36.9 percent, respectively. The Company may realize a cash benefit from utilization of tax net operating loss carryforward (“NOL”) (after limitations) against current and future tax liabilities. As of April 30, 2003, the Company had remaining NOL (after limitations) of approximately $111.0 million. The Company will not recognize a tax benefit associated with the writedown of Piercing Pagoda goodwill since the original acquisition was a nontaxable business combination for which the goodwill is not deductible for tax purposes.

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

Liquidity and Capital Resources

The Company’s cash requirements consist principally of funding inventory, capital expenditures primarily for new store growth, renovations, and upgrades to its management information systems and debt service. As of April 30, 2003, the Company had unrestricted cash and cash equivalents of $168.0 million and restricted cash of $4.7 million set aside as per the agreement with Citi Commerce Solutions. As of April 30, 2002, the Company had $148.6 million unrestricted cash and cash equivalents with no restricted cash.

The retail jewelry business is highly seasonal, with a significant proportion of sales and operating income being generated in November and December of each year. For fiscal years 2002 and 2001, approximately 41 percent and 42 percent of the Company’s annual revenues were made during the three months ended January 31, 2002 and 2001, respectively, which includes the holiday selling season. The Company’s working capital requirements fluctuate during the year, increasing substantially during the fall season as a result of higher planned seasonal inventory levels.

As previously discussed, the Company performed its annual review in the second quarter of fiscal year 2003 for impairment of goodwill related to its Piercing Pagoda, Inc. acquisition. This impairment review indicated that the market value of Piercing Pagoda was lower than its carrying value, reflective of the current market conditions and lower than expected performance. The Company performed an impairment calculation and recorded a non-cash charge of $136.3 million in the second quarter of fiscal year 2003, which is included as a component of operating earnings in the Consolidated Statement of Operations, to reduce the carrying value of the Piercing Pagoda goodwill to approximately $19 million. This impairment charge, being non-cash in nature, does not directly affect the Company’s liquidity, although the Company is currently limited under the terms of the indenture for its Senior Notes in its ability to make certain future discretionary payments, such as repurchasing stock, until it accumulates future earnings or modifies the agreements.

Finance Arrangements

• In order to support the Company’s seasonal borrowing needs, the Company maintains an unsecured Revolving Credit Agreement. The Revolving Credit Agreement provides for (i) a U.S. Revolving Credit facility in the aggregate principal amount of up to $215 million in commitments by certain U.S. lenders, including a $10 million sublimit for letters of credit, and (ii) a separate Canadian Revolving Credit facility, which provides for Canadian Dollar denominated loans in the aggregate principal amount of up to a U.S. Dollar equivalent of $10 million in commitments by a Canadian lender. The total commitment under the Revolving Credit Agreement to the Company and its subsidiaries is approximately $225 million. The facility expires in 2005. Under the Revolving Credit Agreement the Company may, subject to approval of the U.S. Agent or the Canadian Agent, as the case may be, increase the total U.S. commitment to $285 million and the Canadian commitment to a U.S. Dollar equivalent of $25 million provided that the commitments together do not exceed a U.S. Dollar equivalent of $300 million.

The revolving credit loans bear interest at floating rates as follows: (A) loans outstanding under the U.S. Revolving Credit facility bear interest, at the Company’s option, at either (i) the applicable Eurodollar Rate plus a margin equal to 1.00 percent (subject to adjustment), or (ii) the Base Rate (which is the higher of the annual rate of interest announced from time to time by the agent bank under the Revolving Credit Agreement as its base rate or 1.00 percent plus the Federal Funds Effective Rate); and (B) loans outstanding under the Canadian Revolving Credit facility bear interest, at the Company’s option, at either (i) a Bankers’ Acceptance Discount Rate (which varies depending upon whether the Canadian Lender is a bank named under Schedule I or II to the Bank Act (Canada) or neither) plus a margin equal to 1.00 percent (subject to adjustment), or (ii) the annual rate of interest announced from time to time by the Canadian agent bank under the Revolving Credit Agreement as its “prime rate” for commercial loans in Canadian Dollars to borrowers in Canada. At April 30, 2003, there were no outstanding amounts under the U.S. Revolving Credit facility or the Canadian Revolving Credit facility. The Revolving Credit Agreement contains certain restrictive covenants, which, among other restrictions, requires the Company to comply with certain financial covenants, including limitations on indebtedness, investments, capital expenditures and other distributions (including repurchases of the Company’s common stock). The Company is currently in compliance with all of its obligations under the Revolving Credit Agreement.

• In 1997, the Company issued $100 million of 8½ percent Senior Notes due in 2007. In fiscal year 2002, the Company repurchased $13 million of the Senior Notes. The Senior Notes are unsecured and are guaranteed by ZDel. The indenture relating to the Senior Notes contains restrictive covenants including but not limited to limitations on indebtedness, dividends and other restricted payments (including repurchases of the Company’s common stock), transactions with affiliates, liens and disposition of proceeds of asset sales, among others. The Company is currently in compliance with all of its obligations under the Senior Notes.

Capital Growth

As of April 30, 2003, the Company has opened 31 new locations including 12 new kiosks for which it has spent $6 million in capital expenditures. In addition, the Company has spent $15 million in capital expenditures to remodel, relocate or refurbish 82 additional locations. The Company has also spent $5 million for enhancements to its management information systems and infrastructure expansion. In total, the Company anticipates spending no more than $55 million on capital expenditures during fiscal year 2003. The Revolving Credit Agreement limits the Company’s capital expenditures to $85 million for fiscal year 2003. The Company is currently in compliance with all of its obligations under the Senior Notes.

Other Activities Affecting Liquidity

• Future liquidity will be enhanced to the extent that the Company is able to realize the cash benefit from utilization of its NOL against current and future tax liabilities. The cash benefit realized in fiscal year 2002 was approximately $9 million. As of April 30, 2003, the Company had a NOL (after limitations) of $111 million, which represents up to $43 million in future tax benefits. The utilization of this asset is subject to limitations. The most restrictive is the Internal Revenue Code Section 382 annual limitation of $19.5 million. The NOL can be utilized through fiscal year 2008.

• The Company has significant operating lease commitments related to leases on its store retail locations that are not reflected in the Consolidated Balance Sheet in accordance with accounting principles generally accepted in the United States. These leases generally range from five to ten years and may contain minimum rent escalations. Kiosk leases generally range from one to five years. Most of the store leases provide for the payment of base rentals plus real estate taxes, insurance, common area maintenance fees and merchants association dues, as well as percentage rents based on the stores’ gross sales. All leases are accounted for on a straight-line basis.

Future minimum rent commitments as of April 30, 2003, for all noncancelable leases of ongoing operations were as follows: Three months ended July 31, 2003 - $44.0 million; fiscal 2004 - $162.3 million; fiscal 2005 - $147.9 million; fiscal 2006 - $130.1 million; fiscal 2007 - $112.6 million; fiscal 2008 - $91.5 million; thereafter - $199.1 million; for a total of $887.5 million.

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

Based on account balances for the shared risk programs as of April 30, 2003, the Company’s maximum potential payment would be approximately $25 million if the entire portfolio defaulted. Based on historical performance, losses in these portfolios absorbed by the Company have been less than $800,000 since August 2000. Prior to fiscal year 2003, the Company was liable for all losses under these shared risk programs. Losses in fiscal year 2003 under new terms with Citi that limit the Company’s losses were less than $40,000 through April 30, 2003. The reserve for both portfolios is approximately $710,000 which the Company believes is adequate based on the historical trend of actual losses. In April 2003, the Company and Citi finalized an agreement that requires the Company to pledge an amount of $4.7 million as collateral to Citi in an interest bearing depository account that will fluctuate monthly based on the account balances of the shared risk programs.

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

Inflation

In management’s opinion, changes in net revenues, net earnings, and inventory valuation that have resulted from inflation and changing prices have not been material during the periods presented. The trends in inflation rates pertaining to merchandise inventories, especially as they relate to gold and diamond costs, are primary components in determining the Company’s LIFO inventory. Gold commodity prices have increased substantially over the last three months. Gold represents approximately 9.5 percent of the Company’s total inventory value. The Company currently hedges a portion of its gold purchases through forward contracts. The Company had $3.9 million of forward commodity agreements outstanding at April 30, 2003. There is no assurance that inflation will not materially affect the Company in the future.

Critical Accounting Policies and Estimates

The preparation of financial statements and related disclosures in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. For example, unexpected changes in market conditions or a downturn in the economy could adversely affect actual results. Estimates are used in accounting for, among other things, inventory obsolescence, goodwill valuation, LIFO inventory retail method, legal liability, credit insurance liability, product warranty, depreciation, employee benefits, taxes and contingencies. Estimates and assumptions are reviewed periodically and the effects of revisions are reflected in the Consolidated Financial Statements in the period they are determined to be necessary.

Management believes that its accounting policies regarding merchandise inventories, long lived assets and goodwill, revenue recognition and other reserves, among others, affect its more significant judgments and estimates used in the preparation of its Consolidated Financial Statements. For a description of these critical accounting policies and estimates, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations - Critical Accounting Policies” in the Company’s Annual Report on Form 10-K for the fiscal year ended July 31, 2002. Except with respect to matters described above relating to goodwill impairment of Piercing Pagoda under SFAS 142, management believes there have been no significant changes in the Company’s critical accounting policies or estimates since the Company’s fiscal year ended July 31, 2002.

Cautionary Notice Regarding Forward-Looking Statements

This Report on Form 10-Q contains forward-looking statements, including statements regarding the Company’s objectives and expectations regarding its, merchandising and marketing strategies, store renovation, remodeling and expansion, inventory management and performance, liquidity and cash flows, capital expenditures, development of its management information systems, reserves for future credit losses under the private label credit arrangement and the impact of recent accounting developments, which are based upon management’s beliefs as well as on assumptions made by and data currently available to management. In addition, the words “anticipate,” “estimate,” “project,” “intend,” “expect,” “believe,” “forecast,” and similar expressions may identify forward looking statements, but some of these statements may use other phrasing. These forward-looking statements are not guarantees of future performance and a variety of factors could cause the Company’s actual results to differ materially from the anticipated or expected results expressed in or suggested by these forward-looking statements. The following list, which is not intended to be an all encompassing list of risks and uncertainties affecting the Company, summarizes several factors that could cause the Company’s actual results to differ materially from those anticipated or expected in these forward-looking statements: that low or negative growth in the economy or in the financial markets will occur and reduce discretionary spending on goods that are, or are perceived to be “luxuries”; that levels of mall traffic may decline as a result of economic or other factors; that warehousing and distribution productivity and capacity can be maintained and further improved to support the Company’s distribution requirements; that strong competitive responses may impact the Company’s efforts to leverage its brand power with its marketing, merchandising and promotional efforts; that seasonality of the retail jewelry business or downturns in consumer spending during the fourth calendar quarter may adversely affect the Company’s results; that the Company may not be able to continue to manage its inventory and product supply effectively to respond to consumer demand; that fluctuations in gold and diamond prices may negatively affect the business; that the Company may not be able to integrate acquisitions into its existing operations or that new acquisition and alliance opportunities that enhance shareholder value may not be available on terms acceptable to the Company; that the efforts to define the strategic role of each brand may not be successful; that the Company may be unable to lease new and existing stores on suitable terms in desirable locations; that legal or governmental proceedings may have an adverse effect on the financial results or reputation of the Company; that alternate sources of merchandise supply may not be available on favorable terms to the Company during the three month period leading up to the Christmas season; that key personnel who have been hired or retained by the Company may depart; that any disruption in or changes to the Company’s private label credit card arrangement with Citi Commerce Solutions may adversely affect the Company’s ability to provide consumer credit and write credit insurance; or that changes in government or regulatory requirements may increase the cost of or adversely affect the Company’s operations. The Company disclaims any obligation to update or revise publicly or otherwise any forward-looking statements to reflect subsequent events, new information or future circumstances.

Item 3.
Quantitative and Qualitative Disclosures About Market Risk

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

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

Forward Commodity Agreements
(As of April 30, 2003)


	Contract		Fine Troy		Contract Gold		Contract Fair
Commodity	Settlement Date		Ounces of Gold		Price Per Ounce		Market Value

Gold		05-07-03		768	$	334.130	$	3,861
Gold		05-21-03		768		334.357		3,811
Gold		06-09-03		661		334.666		3,211
Gold		06-23-03		661		334.893		3,164
Gold		07-07-03		761		335.120		3,573
Gold		07-21-03		761		335.348		3,515
Gold		08-07-03		682		335.624		3,054
Gold		08-21-03		682		335.851		2,998
Gold		09-08-03		657		336.143		2,775
Gold		09-22-03		657		336.371		2,716
Gold		10-07-03		546		336.614		2,205
Gold		10-21-03		546		336.841		2,156
Gold		11-07-03		1,730		337.117		6,521
Gold		11-21-03		1,730		337.345		6,356

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

Otherwise, the Company believes that the market risk of the Company’s financial instruments as of April 30, 2003, has not materially changed since July 31, 2002. The market risk profile on July 31, 2002, is disclosed in the Company’s Annual Report on Form 10-K for the year ended July 31, 2002.

Item 4. Controls and Procedures

Evaluation of Disclosure Controls and Procedures

Within the 90 day period prior to the filing of this report, an evaluation was carried out under the supervision of the Company’s management, including the Chief Executive Officer and the Chief Financial Officer, of the effectiveness of the Company’s disclosure controls and procedures pursuant to Securities Exchange Act Rule 13a-14. Based on that evaluation, the Chief Executive Officer and Chief Financial Officer have concluded that the Company’s current disclosure controls and procedures are effective and timely, providing them with material information required to be disclosed in the reports filed or submitted under the Securities Exchange Act.

Changes in Internal Controls

Subsequent to the date of their evaluation, there were no significant changes in the Company’s internal controls or in other factors that could significantly affect the disclosure controls.

Part II. Other Information

Item 1. Legal Proceedings

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

During the first quarter of fiscal year 2003, the Company reached an agreement with counsel for the plaintiff to settle two purported class actions previously described in the second paragraph of Item 3 of the Company’s Annual Report on Form 10-K for the fiscal year ended July 31, 2002. The purported class actions were filed against the Company and certain of its subsidiaries in the Circuit Court for Colbert County, Alabama, and the United States District Court for the Eastern District of Texas, Texarkana Division, respectively, and concern allegations that the defendants marketed credit insurance to customers in violation of state statutory and common laws and federal anti-racketeering laws. The settlement agreement is subject to the approval of the respective courts.

The Company has reached an agreement with counsel for the plaintiff to settle the action previously described in the third paragraph of Item 3 of the Company’s Annual Report on Form 10-K for the fiscal year ended July 31, 2002. The purported class action was filed against the Company in the Superior Court of California, County of Los Angeles, Central District, and concerns allegations that current and former salaried store managers and assistant store managers of the Company were entitled to overtime pay and should not have been classified as exempt employees under California Law. The settlement agreement is subject to the approval of the court.

See “Commitments and Contingencies” on page 11 of this Report for a further discussion of these matters.

Otherwise, legal proceedings of the Company as of April 30, 2003, have not materially changed since July 31, 2002. Legal proceedings as of July 31, 2002, are disclosed in the Company’s Annual Report on Form 10-K for the year ended July 31, 2002.

Item 6. Exhibits and Reports on Form 8-K

(a) Exhibits

99.1 Amendment No. 1 To Amended and Restated Revolving Credit Agreement

99.2 Amendment to Citibank USA, N. A. Agreement

(b) Reports on Form 8-K

None.

SIGNATURE

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.


	Zale Corporation

	(Registrant)

Date June 12, 2003	/s/ Cynthia T. Gordon

	Cynthia T. Gordon
	Senior Vice President, Controller
	(principal accounting officer of the registrant)

CERTIFICATIONS

I, Mary L. Forté, certify that:

1. I have reviewed this quarterly report on Form 10-Q of Zale Corporation;

2. Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report;

3. Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report;

4. The registrant’s other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:

a) designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared;

b) evaluated the effectiveness of the registrant’s disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the “Evaluation Date”); and

c) presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;

5. The registrant’s other certifying officers and I have disclosed, based on the registrant’s most recent evaluation, to our auditors and the audit committee of registrant’s board of directors (or persons performing the equivalent function):

a) all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant’s ability to record, process, summarize and report financial data and have identified for the registrant’s auditors any material weaknesses in internal controls; and

b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal controls; and

6. The registrant’s other certifying officers and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.


Date: June12, 2003	By:	/s/ Mary L. Forté


		Mary L. Forté
		President and Chief Executive Officer,
		Director
		(principal executive officer of the registrant)

CERTIFICATIONS

I, Mark R. Lenz, certify that:


Date: June 12, 2003	By:	/s/ Mark R. Lenz


		Mark R. Lenz
		Group Senior Vice President and
		Chief Financial Officer
		(principal financial officer of the registrant)

EXHIBIT INDEX


99.1		Amendment No. 1 To Amended and Restated Revolving Credit Agreement

99.2		Amendment to Citibank USA, N. A. Agreement

Table of Contents

Table of Contents

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(a)		Exhibits

		99.1 Amendment No. 1 To Amended and Restated Revolving Credit Agreement

		99.2 Amendment to Citibank USA, N. A. Agreement

1.		I have reviewed this quarterly report on Form 10-Q of Zale Corporation;

2.		Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report;

3.		Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report;

4.		The registrant’s other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:

	a)		designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared;

	b)		evaluated the effectiveness of the registrant’s disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the “Evaluation Date”); and

	c)		presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;

	a)		all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant’s ability to record, process, summarize and report financial data and have identified for the registrant’s auditors any material weaknesses in internal controls; and

	b)		any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal controls; and