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UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Form 10-K

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

For the fiscal year ended July 31, 2003
OR

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

For the transition period from __________ to ________

Commission file no. 1-04129

Zale Corporation

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

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

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

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

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

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

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

     As of September 16, 2003, the registrant had outstanding 27,409,377 shares of its common stock, $.01 par value per share.

DOCUMENTS INCORPORATED BY REFERENCE.

     Part III of this report incorporates information from the registrant’s definitive Proxy Statement relating to the registrant’s annual meeting of stockholders to be held on November 6, 2003.

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PART I

ITEM 1. BUSINESS

General

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

     The Company believes it is well-positioned to compete in the approximately $40 billion, highly fragmented retail jewelry industry, leveraging its established brand names, economies of scale and geographic and demographic diversity. The Company enjoys significant brand name recognition as a result of its long-standing presence in the industry and its national and regional advertising campaigns. The Company believes that brand name recognition is an important advantage in jewelry retailing as products are generally unbranded and consumers must trust in a retailer’s reliability, credibility and commitment to customer service. The Company believes that consumers rely on known brand names to ensure quality. This assurance is especially important when consumers feel they lack the expertise to evaluate quality and value of jewelry purchases. As an industry leader, the Company continues to set the standard for delivering innovative and creative products to consumers. The Company believes its proven ability to capitalize on evolving merchandise trends is what differentiates it from its competition. In addition, as the largest specialty retailer of fine jewelry in North America, the Company believes it realizes economies of scale in purchasing, distribution, real estate, advertising and administrative costs. The Company also believes that the geographic diversity of its retail distribution network through all 50 states, Puerto Rico and Canada, and the demographic breadth of its target customer groups may serve to reduce earnings volatility typically associated with local or regional conditions.

     The Company was incorporated in Delaware in 1993, and through its predecessors has been in business since 1924. Its principal executive offices are located at 901 W. Walnut Hill Lane, Irving, Texas 75038-1003. Its telephone number at that address is (972) 580-4000, and its Internet address is www.zalecorp.com.

Business Initiatives and Strategy

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

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

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

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

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

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

     The Company furthered its commitment to training both store and corporate personnel through targeted training programs. The Company supported the development of the bridal categories by enhancing the product knowledge of its sales associates through targeted training programs focused on diamonds and solitaires. The Company has a buyer training program to develop and train new buyers on merchandise and Company standards. The Company also has a centralized purchasing process for each brand to ensure consistency of quality and cost. In addition, the Company leverages its size to achieve better prices, payment terms, return privileges and cooperative advertising arrangements with product suppliers.

     The Company’s marketing efforts are designed to enhance brand identity through distinctive brand communication to the customers. The Company has created highly visible marketing programs specifically targeted in television, newspaper inserts, radio and magazines. Most of these programs are product and event-focused, usually highlighting key items as well as capitalizing on jewelry trends, such as solitaires, three-stone jewelry and princess cut fashion jewelry. The Company maintains a balance in advertising between media and targeted direct mail. While the Company believes it dominates jewelry advertising on television during the Holiday season, marketing efforts extend beyond the Holiday season to tie in with other gift-giving holidays, such as Valentine’s Day and Mother’s Day. In addition, advertising and in-store promotions are synchronized with mall marketing efforts to take advantage of other periods of high mall traffic, such as Labor Day, which are typically not considered jewelry-oriented holidays.

     In fiscal year 2003, the Company also dedicated resources to improve the effectiveness in its marketing function. This increased focus included an investment in marketing development tools and establishing a database marketing team. The Company’s goal is to establish predictive customer data to maximize its marketing efforts to both its existing 18 million customer names and target new opportunities to individuals with a high propensity to spend. In addition, the Company believes ongoing research will enable it to better target the needs of each customer segment. These initiatives were also instrumental in identifying leveraging opportunities. By centralizing each of the brands marketing efforts, significant savings were realized which could be reinvested in the marketing budget.

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

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

     The Company plans to open approximately 66 new locations, principally under the brand names Zales, Zales Outlet, and Piercing Pagoda for which it expects to incur approximately $15 million in capital expenditures during fiscal year 2004. The Company is seeking strategic locations where it is underrepresented to solidify the Company’s core mall business and expand into new outlet centers. The Company targets premier regional mall locations throughout the country and selects sites based on a variety of well-defined demographic and store profitability characteristics. The Company also plans to refurbish, remodel or relocate approximately 176 stores and kiosks at a cost of approximately $29 million during fiscal year 2004.

Current Year

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

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

     On March 18, 2003, the Company announced that its Board of Directors had approved a stock repurchase program pursuant to which the Company, from time to time, and at management’s discretion may purchase up to an aggregate of $50 million of its Common Stock on the open market. Under this program, the Company purchased 209,000 shares at an aggregate cost of $7.5 million through July 31, 2003.

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

     On August 28, 2003, the Company announced that its Board of Directors had approved a stock repurchase program pursuant to which the Company, from time to time, and at management’s discretion may purchase up to an additional $100 million of its Common Stock on the open market. This action brings the Company’s remaining availability of the total authorization under its stock repurchase program to approximately $142 million.

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

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Industry

     The U.S. retail jewelry industry’s sales were approximately $40 billion in 2002. Specialty retail jewelry stores (such as the Company) account for approximately 60 percent of the industry, according to publicly available data. Historically, retail jewelry store sales have exhibited only limited effects of cyclicality. The United States Census Bureau has recorded only three years of negative growth in specialty retail jewelry store sales from 1984 to 2002. Other significant segments of the industry include national chain department stores (such as J.C. Penney Company, Inc. and Sears, Roebuck and Co.), mass merchant discount stores (such as Wal-Mart Stores, Inc.), other general merchandise stores and apparel and accessory stores. The remainder of the retail jewelry industry is composed primarily of catalog and mail order houses, direct-selling establishments, TV shopping networks (such as QVC, Inc.) and on-line jewelers.

     The U.S. retail jewelry industry is highly fragmented with the seven largest companies accounting for approximately 25 percent of the market. The largest jewelry retailer is believed to be Wal-Mart Stores, Inc., followed by the Company. The Company is the largest specialty retail jewelry chain in North America, with approximately nine percent of the specialty retail jewelry market share, based on estimates from the United States Census Bureau. Only two other specialty retail jewelers had greater than three percent market share.

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Operations

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

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

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Zales Jewelers

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

     Zales’ merchandise selection is generally standardized across the nation and targeted at customers representing a cross-section of mainstream America. In fiscal year 2003, bridal merchandise represented 39 percent of merchandise sales, while fashion jewelry and watches comprised the remaining 61 percent. The bridal merchandise category consists of engagement rings, bridal sets and diamond anniversary bands. Fashion jewelry consists generally of diamond fashion, jewelry, precious and semi-precious jewelry, gold jewelry, watches and various other items. The Company believes that the prominence of diamond jewelry in its product selection and its reputation for customer service for over 79 years fosters an image of quality and trust among consumers. While placing added emphasis on the bridal segment of the business, Zales maintains a balance with non-bridal merchandise such as fashion jewelry and watches to drive gift giving occasions throughout the year.

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

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

Zales the Diamond Store Outlet

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

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

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

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Gordon’s Jewelers

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

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

     Gordon’s distinguishes itself from Zales by providing a more upscale, contemporary product mix and tailoring a portion of the store inventory to regional tastes. Gordon’s has selections for both the entry price point customer as well as the more discerning, established jewelry customer. Gordon’s offers a broad range of merchandise, such as diamond solitaires, jewelry set in platinum and semi-precious gems. Gordon’s introduced the “Gordon’s Diamond,” which is exclusive to Gordon’s, in August 2002. The “Gordon’s Diamond” collection was expanded to also include a three-stone ring. In fiscal year 2004, this collection will further be enhanced by the addition of a princess cut solitaire.

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

Bailey Banks & Biddle Fine Jewelers

     For 171 years, Bailey Banks & Biddle has combined classic jewelry with contemporary designs, offering a prestigious shopping environment for the upscale customer. The stores are among the pre-eminent stores in their markets and carry both exclusive and recognized branded and designer merchandise selections to appeal to the more affluent customer, while maintaining a fine jewelry selection for the mall based customer. The Bailey Banks & Biddle merchandise assortments are carefully selected to provide treasures that will be appreciated for generations with a focus on diamonds, precious stones and gold jewelry, as well as watches and giftware.

     At July 31, 2003, Bailey Banks & Biddle operated 116 upscale jewelry stores in 31 states and Puerto Rico. The Company also utilizes the trade name Zell Bros.® for one of its stores. The stores have an average selling price per unit sold of $916, have an average store size of 3,593 square feet and accounted for 14 percent of the Company’s total revenues in fiscal year 2003.

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

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

Peoples Jewellers

     In May 1999, the Company acquired the Peoples Jewellers Corporation, a privately owned chain of jewelry retail outlets in Canada, operating under the banners of Peoples Jewellers and Mappins Jewellers. This operation now has 167 stores in nine provinces across Canada and enjoys the largest market share of any jewelry retailer in Canada. The stores have an average selling price per unit of $177, an average store size of 1,586 square feet and accounted for 7 percent of the Company’s total revenues in fiscal year 2003.

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

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

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

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

Piercing Pagoda

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

     Piercing Pagoda offers an extensive collection of popularly priced 14 karat and 10 karat gold chains, bracelets, earrings, charms and rings, as well as a selection of silver and diamond jewelry, all basic styles at everyday low prices. In addition, ear piercing services are performed by trained associates on site.

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

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

Insurance Affiliates

     The Company, through Zale Indemnity Company, Zale Life Insurance Company and Jewel Re-Insurance Ltd., provides insurance and reinsurance facilities for various types of insurance coverage, which typically are marketed to the Company’s private label credit card customers. The three companies are the insurers (either through direct written or reinsurance contracts) of the Company’s customer credit insurance coverages. In addition to providing replacement property coverage for certain perils, such as theft, credit insurance coverage provides protection to the creditor and cardholder for losses associated with the disability, involuntary unemployment, leave of absence or death of the cardholder. Zale Life Insurance Company also provides group life insurance coverage for eligible employees of the Company. Zale Indemnity Company, in addition to writing direct credit insurance contracts, also has certain discontinued business that it continues to run off. Credit insurance operations are dependent on the Company’s retail sales on its private label credit cards. In fiscal year 2003, over 38 percent of the Company’s private label credit card purchasers purchased some form of credit insurance. Under the current private label arrangement with Citi Commerce Solutions, (“Citi”) the Company’s insurance affiliates continue to provide insurance to holders of the Company’s private label credit cards and receive payments for such insurance products. Insurance premium revenues of $16.1 million, $18.3 million, and $19.0 million for fiscal years ended July 31, 2003, 2002 and 2001, respectively are included in total revenues.

Store Operations

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

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

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

     The Company has implemented inventory control systems, extensive security systems and loss prevention procedures to maintain low inventory losses. In fiscal year 2003, the Company experienced significant improvements in internal and external losses. The Company screens employment applicants and provides its store personnel with training in loss prevention. Despite such precautions, the Company experiences losses from theft from time to time and maintains insurance to cover such external losses.

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

Purchasing and Inventory

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

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

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

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

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

Proprietary Credit

     The Company’s private label credit card program helps facilitate the sale of merchandise to customers who wish to finance their purchases rather than use cash or other sources. The Company offers Revolving and Interest Free programs under its private label credit card program. Approximately 42 percent and 44 percent of the Company’s U.S. total sales excluding Piercing Pagoda, which does not offer proprietary credit, were generated by the proprietary credit cards in fiscal year 2003 and 2002, respectively. The Company’s Canadian propriety credit card sales represented approximately 27 percent and 25 percent of the Canadian total sales for the same respective time period.

     In fiscal year 2003, the proprietary credit offers expanded to include Same As Cash (“SAC”) options, as well as continued offerings of Revolving and Interest Free programs, all of which allowed the sales personnel to further enhance the customer’s buying experience. In July 2000, the Company entered into a ten-year agreement with Citi whereby Citi issues private label credit cards branded with appropriate Company trademarks, and provides financing for the Company’s customers to purchase merchandise in exchange for payment by the Company of a merchant fee based on a percentage of each credit card sale. The merchant fee varies according to the credit plan that is chosen by the customer (i.e., Revolving, Interest Free, SAC). In fiscal year 2001, the Company converted its Canadian private label credit agreement to Citi Commerce Solutions Canada.

Employees

     As of July 31, 2003, the Company had approximately 17,000 employees, less than 10 percent of whom were Canadian employees, and less than one percent of whom were represented by unions. The Company usually hires a limited number of temporary employees during each Holiday season.

Competition

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

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

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

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Seasonality

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

Management Information Systems

     The Company’s information systems provide information necessary for: (i) management operating decisions; (ii) sales and margin management; (iii) inventory control; (iv) profitability monitoring by many measures (merchandise category, buyer, store); and (v) expense control programs. Significant data processing systems include point-of-sale reporting, purchase order management, replenishment, warehouse management, merchandise planning and control, payroll, general ledger, sales audit, and accounts payable. Bar code ticketing and scanning are used at all point-of-sale terminals to ensure timely sales and margin data compilation and to provide for inventory control monitoring. Information is made available on-line to merchandising staff on a timely basis, thereby reducing the need for paper reports. In fiscal year 2003, a store-level forecasting system was implemented to enhance the current forecasting process used by the buyers. Future initiatives include improved connectivity between stores and the home office to enhance operating efficiencies.

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

     The Company has an operations services agreement with a third party for the management of the Company’s mainframe processing operations, client server systems, Local Area Network operations, Wide Area Network management and e-commerce hosting. The agreement, which was effective August 1, 2002, requires fixed payments totaling $11 million over a 36 month term plus a variable amount based on usage. The Company has an option to extend the current agreement for two consecutive one year periods. In fiscal year 2003, the payments under this contract reflected an annual cost savings of over $3 million as a result of investments in certain infrastructure over the past several years. The Company believes that by outsourcing this portion of its management information systems it achieves additional efficiencies and allows the Company to focus its internal information technology efforts on developing and enhancing enterprise systems for its core business.

     The Company has historically upgraded, and expects to continue to upgrade, its information systems to improve operations and support future growth. In fiscal year 2003, the Company developed a three year strategic plan for information technology to support the Company’s long term goals of gaining operating efficiencies and generating future growth. The Company estimates it will make capital expenditures of approximately $10 million in fiscal year 2004 for enhancements to its information systems and infrastructure.

Regulation

     The Company’s operations are affected by numerous federal and state laws that impose disclosure and other requirements upon the origination, servicing and enforcement of credit accounts and limitations on the maximum amount of finance charges that may be charged by a credit provider. In addition to the Company’s private label credit cards, credit to the Company’s customers is provided primarily through bank cards such as Visa®, MasterCard®, and Discover®. Any change in the regulation of credit which would materially limit the availability of credit to the Company’s traditional customer base could adversely affect the Company’s results of operations or financial condition.

     The Company is subject to the jurisdiction of various state and other taxing authorities. From time to time, these taxing authorities conduct reviews or audits of the Company.

     The sale of insurance products by the Company is also highly regulated. State laws currently impose disclosure obligations with respect to the Company’s sale of credit and other insurance. In addition, the Company’s sale of insurance

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products in connection with its private label credit cards appears to be subject to certain disclosure and other requirements under the Gramm-Leach-Bliley Act of 1999. The Company’s and its competitors’ practices are also subject to review in the ordinary course of business by the Federal Trade Commission and the Company’s and other retail companies’ credit cards are subject to regulation by state and federal banking regulators. The Company believes that it is currently in material compliance with all applicable state and federal regulations.

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

Available Information

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

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

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

Cautionary Notice Regarding Forward-Looking Statements

     This Annual Report on Form 10-K contains forward-looking statements, including statements regarding the Company’s objectives and expectations regarding its sales and earnings, merchandising and marketing strategies, store renovation, remodeling and expansion, inventory management and performance, liquidity and cash flows, capital expenditures, development of its management information systems, reserves for future credit losses under the private label credit arrangement and the impact of recent accounting developments, which are based upon management’s beliefs as well as on assumptions made by and data currently available to management. In addition, the words “anticipate,” “estimate,” “project,” “intend,” “expect,” “believe,” “forecast,” and similar expressions may identify forward looking statements, but some of these statements may use other phrasing. These forward-looking statements are not guarantees of future performance and a variety of factors could cause the Company’s actual results to differ materially from the anticipated or expected results expressed in or suggested by these forward-looking statements. The following list, which is not intended to be an all encompassing list of risks and uncertainties affecting the Company, summarizes several factors that could cause the Company’s actual results to differ materially from those anticipated or expected in these forward-looking statements: that low or negative growth in the economy or in the financial markets will occur and reduce discretionary spending on goods that are, or are perceived to be “luxuries;” that levels of mall traffic may decline as a result of economic or other factors; that warehousing and distribution productivity and capacity can be maintained and further improved to support the Company’s distribution requirements; that strong competitive responses may impact the Company’s efforts to leverage its brand power with its marketing, merchandising and promotional efforts; that seasonality of the retail jewelry business or downturns in consumer spending during the fourth calendar quarter may adversely affect the Company’s results; that the Company may not be able to continue to manage its inventory and product supply effectively to respond to consumer demand; that fluctuations in gold and diamond prices may negatively affect the business; that the Company may not be able to integrate acquisitions into its existing operations or that new acquisition and alliance opportunities that enhance shareholder value may not be available on terms acceptable to the Company; that the efforts to define the strategic role of each brand may not be successful; that the Company may be unable to lease new

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and existing stores on suitable terms in desirable locations; that legal or governmental proceedings may have an adverse effect on the financial results or reputation of the Company; that alternate sources of merchandise supply may not be available on favorable terms to the Company during the three month period leading up to the Holiday season; that key personnel who have been hired or retained by the Company may depart; that any disruption in or changes to the Company’s private label credit card arrangement with Citi may adversely affect the Company’s ability to provide consumer credit and write credit insurance; or that changes in government or regulatory requirements may increase the cost of or adversely affect the Company’s operations. The Company disclaims any obligation to update or revise publicly or otherwise any forward-looking statements to reflect subsequent events, new information or future circumstances.

ITEM 2. PRINCIPAL PROPERTIES

     The Company leases a 430,000 square foot corporate headquarters facility, which lease extends through 2008. The facility is located in Las Colinas, a planned business development in Irving, Texas, near the Dallas/Fort Worth International Airport. During fiscal year 1999, the Company sold a 120,000 square foot warehouse in Dallas, Texas, leasing back approximately 40,000 square feet of that warehouse. In June 2003, this property was subleased to a third party through the remainder of the lease term which extends through March 2009. The Company also owns a 73,000 square foot building in Bethlehem, Pennsylvania that formerly served as Piercing Pagoda’s distribution center. The Company plans to sell this building and is currently holding it available for sale. Another 71,000 square foot building owned by the Company is located adjacent to the Bethlehem property was used for additional distribution and warehousing functions. The Company leases a 7,400 square foot distribution and warehousing facility in Toronto, Ontario, Canada for Peoples. This lease extends to October 2005. The Company also leases a 20,000 square foot distribution and warehousing facility in Irving, Texas that serves as the Piercing Pagoda distribution center.

     The Company rents most of its store retail space under leases that generally range from five to ten years and may contain minimum rent escalations, while kiosk leases generally range from three to five years. Most of the store leases provide for the payment of base rentals plus real estate taxes, insurance, common area maintenance fees and merchants association dues, as well as percentage rents based on the stores’ gross sales.

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

     Management believes substantially all of the store leases expiring in fiscal year 2004 that it wishes to renew (including leases which expired earlier and are on month-to-month extensions) will be renewed on terms not materially less favorable to the Company than the terms of the expiring leases. Management believes its facilities are suitable and adequate for the Company’s business as presently conducted.

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ITEM 3. LEGAL PROCEEDINGS

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

     On November 3, 1999, a plaintiff amended a complaint filed in the Circuit Court for Colbert County, State of Alabama to commence a purported class action against the Company, Jewelers National Bank, Zale Indemnity Company, Zale Life Insurance Company, Jewelers Financial Services, Jewel Re-Insurance, Ltd. and certain employees of the Company. On July 21, 2000, the same plaintiff commenced a purported class action in the United States District Court for the Eastern District of Texas, Texarkana Division against the Company, Jewelers National Bank, Zale Indemnity Company, Zale Life Insurance Company, Jewel Re-Insurance, Ltd. and certain employees of the Company. Both purported class actions concern allegations that the defendants marketed credit insurance to customers in violation of state statutory and common laws and federal anti-racketeering laws. During the first quarter of fiscal year 2003, the Company reached an agreement with counsel for the plaintiff to settle the actions. Preliminary court approval of the settlement agreement has been granted, with final approval expected to occur in late November 2003.

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

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

     No matters were submitted to a vote of security holders of the Company during the quarter ended July 31, 2003.

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EXECUTIVE OFFICERS AND KEY EMPLOYEES OF THE REGISTRANT

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

Executive Officers

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

     Ms. Mary L. Forté was named President and Chief Executive Officer and appointed to the Company’s Board of Directors, effective August 1, 2002. Prior to that appointment, Ms. Forté served as Executive Vice President and Chief Merchandise Officer from February 2001 to July 2002. From January 1998 to February 2001, she served as Executive Vice President and Chief Administrative Officer. Ms. Forté joined the Company in July 1994 as the President of Gordon’s, and served in that position until January 1998. From January 1994 to July 1994, Ms. Forté served as Senior Vice President of QVC — Home Shopping Network. From July 1991 through January 1994, Ms. Forté served as Senior Vice President of the Bon Marché, Home Division of the Federated Department Store. From July 1989 to July 1991, Ms. Forté was Vice President of Rich’s Department Store, Housewares Division. In addition to the above, Ms. Forté has an additional 13 years of retailing and merchandising experience with Macy’s, The May Department Stores Company, Inc. and Federated Department Stores.

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     Ms. Sue E. Gove was appointed Chief Operating Officer effective August 1, 2002. She also remained in the position of Chief Financial Officer until February 2003. Prior to that appointment, Ms. Gove served as Executive Vice President, Chief Financial Officer from July 1998 to July 2002. From December 1997 to July 1998, she served as Group Vice President, Chief Financial Officer. From January 1996 to December 1997, she served as Senior Vice President, Corporate Planning and Analysis. From September 1996 through June 1997, Ms. Gove also served as Senior Vice President and Treasurer, overseeing Investor Relations and the Treasury, Tax and Control functions. Ms. Gove joined the Company in 1980 and served in numerous assignments until her appointment to Vice President in 1989.

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

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

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

Key Employees

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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PART II

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

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

     As of September 16, 2003, the outstanding shares of Common Stock were held by approximately 872 holders of record. The Company has not paid dividends on the Common Stock since its initial issuance on July 30, 1993, and does not anticipate paying dividends on the Common Stock in the foreseeable future. In addition, the Company’s long-term debt limits the Company’s ability to pay dividends. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Liquidity and Capital Resources” and “Notes to the Consolidated Financial Statements – Long Term Debt.”

     Equity Compensation Plan Information

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

Equity Compensation Plan Information

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

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ITEM 6. SELECTED FINANCIAL DATA

     The following selected financial data is qualified in its entirety by the Consolidated Financial Statements of the Company (and the related Notes thereto) contained elsewhere in this Form 10-K and should be read in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations.” The income statement and balance sheet data for each of the years ended July 31, 2003, 2002, 2001, 2000, and 1999 have been derived from the Company’s audited Consolidated Financial Statements.

(a)		Data includes insurance premium revenue from credit insurance operation.
(b)		In fiscal year 2002, the Company changed its method of determining price indices used in the valuation of last-in, first-out (“LIFO”) inventories. The effect of using internal indices instead of the Bureau of Labor Statistics price indices was to increase fiscal year 2002 net income by approximately $4.8 million. The impact on the individual prior years presented and the cumulative effect of this change on earnings at the beginning of fiscal year 2002 is not determinable.
(c)		Unusual items consist of Executive Transactions charge of $2.3 million and Retiree Medical Plan Curtailment gain of $3.5 million for the year ended July 31, 2002, and Executive Transactions charge of $4.7 million for the year ended July 31, 2001.
(d)		Change in accounting principle for the write off of the excess of revalued net assets over stockholders equity (negative goodwill).
		Note: Data from Peoples Jewellers in 1999 includes results from May 23, 1999, the date the Company acquired substantially all assets and certain operational liabilities of Peoples Jewellers Corp., through July 31, 1999. Data presented in fiscal year 2000 is inclusive of the sale of the Company’s private label credit card business. Data from Piercing Pagoda in 2001 includes results from September 20, 2000, the date the Company acquired Piercing Pagoda, Inc., through July 31, 2001.

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ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

     With respect to forward-looking statements made in this Management’s Discussion and Analysis of Financial Condition and Results of Operations see “Business – Cautionary Notice Regarding Forward-Looking Statements.”

Results of Operations

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

     In fiscal year 2001, Executive Transaction charges included the effect of the resignation of Beryl B. Raff, who resigned as Chairman of the Board and Chief Executive Officer in February 2001. In connection with her resignation, the Company agreed to pay certain benefits of approximately $2.5 million consisting principally of an amount equivalent to three years of salary and other severance related benefits, including accelerated vesting of certain options and restricted stock. Also in fiscal year 2001, Robert J. DiNicola retired as Chairman of the Board in September 2000. In connection with his severance arrangement, the Company paid certain benefits of approximately $1.9 million consisting principally of an amount equivalent to one year of salary and bonus and other severance related benefits, including the accelerated vesting of certain options held by Mr. DiNicola. Mr. DiNicola returned to the Company in February 2001 at the request of the Board of Directors.

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

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

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

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

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

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

Liquidity and Capital Resources

     The Company’s cash requirements consist principally of funding inventory growth, capital expenditures primarily for new store growth and renovations, upgrading its management information systems and debt service. As of July 31, 2003, the Company had cash and cash equivalents of $30.3 million, and restricted cash of $5.0 million set aside as per an agreement with Citi Commerce Solutions (“Citi”). This agreement requires the Company to pledge an amount as collateral to Citi in an interest bearing depository account that will fluctuate monthly based on the account balances of the shared risk programs. See “Notes to Consolidated Financial Statements- Guarantee Obligations.” The retail jewelry business is highly seasonal, with a significant proportion of sales and operating income being generated in November and December of each year. Approximately 41 percent of the Company’s annual revenues were made during both the three months ended January 31, 2003 and the three months ended January 31, 2002, which include the Holiday selling season. The Company’s working capital requirements fluctuate during the year, increasing substantially during the fall season as a result of higher planned seasonal inventory levels.

Operating Activities

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

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

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

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

Finance Arrangements

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

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

     The revolving credit loans bear interest at a floating rate at either (i) the applicable LIBOR Rate plus a margin equal to 1.75 percent (subject to adjustment as described below), or (ii) the Base Rate (which is the higher of the annual rate of interest announced from time to time by the agent bank under the Revolving Credit Agreement as its base rate or the Federal Funds Effective Rate plus 0.5 percent). The margin applicable to LIBOR Rates and letter of credit commission rates will be automatically reduced or increased from time to time based upon excess availability under the Revolving Credit Agreement. The Company pays a commitment fee of 0.375 percent on the preceding month’s unused commitment. The Company and its subsidiaries may repay the revolving credit loans under the Revolving Credit Agreement at any time without penalty prior to the maturity date. At July 31, 2003, there was $184 million outstanding under the Revolving Credit Agreement. The Revolving Credit Agreement requires the Company to comply with certain restrictive covenants including, among other things, limitations on indebtedness, investments, liens, acquisitions, and asset sales. In addition, if remaining borrowing availability under the facility is less than $75 million, the Company will be restricted in its ability to repurchase stock or pay dividends. If remaining borrowing availability is less than $50 million, the Company will be required to meet a minimum fixed charge coverage ratio. The Company is currently in compliance with all of its obligations under the Revolving Credit Agreement.

Capital Growth

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

Other Activities Affecting Liquidity

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

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

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

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

     •     On August 28, 2003, the Company announced that its Board of Directors had approved a stock repurchase program pursuant to which the Company, from time to time, and at management’s discretion may purchase up to an aggregate of $100 million of its Common Stock on the open market. This action brings the Company’s remaining availability of the total authorization under its stock repurchase program to approximately $142 million.

     •     Future liquidity will be enhanced to the extent that the Company is able to realize the cash benefit from utilization of its NOL against current and future tax liabilities. The cash benefit realized in fiscal year 2003 was approximately $9.6 million. As of July 31, 2003, the Company had a NOL (after limitations) of $106.2 million, which represents up to $40.8 million in future tax benefits. The utilization of this asset is subject to limitations. The most restrictive limitation is the Internal Revenue Code Section 382 annual limitation of $19.5 million. The NOL can be utilized through 2008.

     •     Contractual obligations – Aggregated information about the Company’s contractual obligations as of July 31, 2003 is presented in the following table.

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

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

New Accounting Pronouncements

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

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

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

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

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

Inflation

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

Critical Accounting Policies

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

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

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

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

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

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

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

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

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

     Revenue Recognition – The Company recognizes revenue in accordance with the Securities and Exchange Commission’s Staff Accounting Bulletin No. 101 “Revenue Recognition in Financial Statements” (“SAB 101”). Revenue related to merchandise sales, which is approximately ninety-five percent of total revenues is recognized at the time of the sale, reduced by a provision for returns. The provision for sales returns is based on historical evidence of the Company’s return rate. Repair revenues are recognized when the service is complete and the merchandise is delivered to the customers. Total Revenues include extended service agreements which are recognized over the period the services are performed. Revenues also include premiums from the Company’s insurance businesses, principally related to credit

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

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

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

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ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

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

     The Company is exposed to interest rate risk primarily through its borrowing activities, which are described under “Long-term Debt” in the Notes to the Consolidated Financial Statements. See “Long-term Debt” in the Notes to the Consolidated Financial Statements, which are incorporated herein by reference.

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

     Based on the Company’s market risk sensitive instruments (including variable rate debt) outstanding at July 31, 2003, the Company has determined that there was no material market risk exposure to the Company’s consolidated financial position, results of operations or cash flows as of such date.

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

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

Forward Commodity Agreements
(As of July 31, 2003)