UNITED STATES SECURITIES AND EXCHANGE COMMISSION

ZALE CORPORATION

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

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

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

Indicated by check mark whether the registrant is an accelerated filer (As defined in rule 12b-2 of the exchange act). Yes þ. No o.

APPLICABLE ONLY TO CORPORATE ISSUERS:

As of March 1, 2004, 26,521,226 shares of the registrant’s common stock were outstanding.

ZALE CORPORATION AND SUBSIDIARIES

Index

Part I. Financial Information

Item 1. Financial Statements

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

See Notes to Consolidated Financial Statements.

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

See Notes to Consolidated Financial Statements.

4

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

See Notes to Consolidated Financial Statements.

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

BASIS OF PRESENTATION

     Zale Corporation, along with its wholly owned subsidiaries (collectively, the “Company”), is the largest and most diversified specialty retailer of fine jewelry in North America. At January 31, 2004, the Company operated 2,228 specialty retail jewelry stores and kiosks located primarily in shopping malls throughout the United States of America, Canada and Puerto Rico. The Company primarily operates under seven 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.com. It has also leveraged its brand strength through Zales the Diamond Store Outlet® which focuses on the brand conscious, value oriented shopper in outlet malls and value oriented neighborhood power centers. Peoples Jewellers®, the Company’s national brand in Canada, offers traditional moderately priced jewelry to customers throughout Canada. Gordon’s Jewelers® in the United States of America, and Mappins Jewellers® in Canada, target the moderate and more discerning customer with merchandise assortments designed to promote slightly higher priced purchases. Bailey Banks & Biddle Fine Jewelers® operates 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.

     The accompanying Consolidated Financial Statements are those of the Company as of and for the three month and six-month periods ended January 31, 2004 and January 31, 2003. The Company consolidates substantially all of its U.S. operations into Zale Delaware, Inc. (“ZDel”), a wholly owned subsidiary of Zale Corporation. ZDel is the parent company for several subsidiaries, including three that are engaged primarily in providing credit insurance to credit customers of the Company. The Company consolidates its Canadian retail operations into Zale International, Inc., which is a wholly owned subsidiary of Zale Corporation. All significant intercompany transactions have been eliminated. The Consolidated Financial Statements are unaudited and have been prepared by the Company in accordance with accounting principles generally accepted in the United States of America for interim financial information. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. In management’s opinion, all material adjustments and disclosures necessary for a fair presentation have been made. The accompanying Consolidated Financial Statements should be read in conjunction with the audited Consolidated Financial Statements and related notes thereto included in the Company’s Form 10-K for the fiscal year ended July 31, 2003. The classifications in use January 31, 2004 have been applied to the financial statements for July 31, 2003 and January 31, 2003.

     The results of operations for the three month and six month periods ended January 31, 2004 and January 31, 2003, are not indicative of the operating results for the full fiscal year due to the seasonal nature of the Company’s business. Seasonal fluctuations in retail sales historically have resulted in higher earnings in the quarter of the fiscal year that includes the holiday selling season.

EARNINGS (LOSS) PER COMMON SHARE

     Basic earnings (loss) per share is computed by dividing earnings (loss) available to common shareholders by the weighted average number of common shares outstanding for the reporting period. Diluted earnings per share reflects the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock. Outstanding stock options issued by the Company represent the only dilutive effect reflected in diluted weighted average shares. Securities that were not included in the computation of diluted earnings per share due to their antidilutive impact were 14,500 and 44,500 of outstanding common stock options for the three and six month periods ended January 31, 2004 and 2,702,612 of outstanding common stock options for the three and six month periods ended January 31, 2003.

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

EARNINGS (LOSS) PER COMMON SHARE (continued)

STOCK REPURCHASE PLAN

     On August 28, 2003, the Company announced that its Board of Directors had approved a stock repurchase program pursuant to which the Company, from time to time and at management’s discretion, may purchase up to an additional $100 million of its common stock. This most recent approval, combined with existing repurchase authorizations, made possible the Company’s repurchase of a total of approximately $142 million worth of its common stock. As of January 31, 2004, the Company has purchased approximately 2.2 million shares of its common stock at an aggregate cost of $104 million, leaving approximately $38 million available for future repurchases under its stock repurchase program.

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

STOCK-BASED COMPENSATION

     The Company accounts for its Stock Option and Employee Stock Purchase Plans under the recognition and measurement principles of Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees”, and related interpretations.

     The following table illustrates the effect on the Company’s net earnings (loss) and earnings (loss) per share if the Company had applied the fair value recognition provisions of SFAS 123, “Accounting for Stock-Based Compensation”, and as allowed by SFAS 148, “Accounting for Stock-Based Compensation - Transition and Disclosure — An Amendment of SFAS No. 123” to stock-based employee compensation.

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

COMPREHENSIVE INCOME (LOSS)

     Comprehensive income (loss) represents the change in equity during a period from transactions and other events, except those resulting from investments by and distributions to stockholders. The components of comprehensive income (loss) for the three and six month periods ended January 31, 2004 and January 31, 2003 are as follows:

     Income taxes are generally not provided for foreign currency translation adjustments or such adjustments that relate to permanent investments in international subsidiaries.

LONG-TERM DEBT

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

     The loans made under the Revolving Credit Agreement bear interest at a floating rate at either (i) the applicable 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 January 31, 2004, there was $138.7 million outstanding under the Revolving Credit Agreement. The effective interest rate at January 31, 2004 was 3.30 percent. Based on the terms of the Revolving Credit Agreement, the Company had approximately $361.3 million in available borrowings at January 31, 2004.

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

     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 Revolving Credit Agreement requires the Company to comply with certain restrictive covenants including, among other things, limitations on indebtedness, investments, liens, acquisitions, and asset sales. The Company is currently in compliance with all of its obligations under the Revolving Credit Agreement.

COMMITMENTS AND CONTINGENCIES

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

GOODWILL

     In accordance with Statement of Financial Accounting Standards (“SFAS”) No. 142, “Goodwill and Other Intangible Assets”, the Company tests goodwill for impairment annually, at the end of its second quarter, or more frequently if events occur which indicate a potential reduction in the fair value of a reporting unit’s net assets below its carrying value. An impairment is deemed to exist if the net book value of a reporting unit exceeds its estimated fair value. In the second quarter of fiscal year 2004, the Company performed its annual review for impairment of goodwill related to its Piercing Pagoda, Inc., People’s Jewellers and other smaller acquisitions. The Company concluded that there was no evidence of impairment related to the goodwill of approximately $19.4 million for Piercing Pagoda, $61.3 million recorded for the People’s acquisition and $5.0 million for other smaller acquisitions. In the second quarter of fiscal year 2003, the Company did conclude that the fair value of Piercing Pagoda was lower than its carrying value, reflective of the current market conditions and lower than expected performance. The Company recorded a non-cash charge of $136.3 million in the second quarter of fiscal year 2003, which is included as a component of operating earnings in the Consolidated Statement of Operations, to reduce the carrying value of the Piercing Pagoda goodwill to approximately $19.4 million.

NEW ACCOUNTING PRONOUNCEMENTS

     In December 2003, SFAS 132, “Employers’ Disclosures about Pensions and other Post Retirement Benefits” was revised (“SFAS 132R”). This statement amends APB Opinion No. 28, “Interim Financial Reporting” to require interim-period disclosure of the components of net periodic benefit cost and the amounts of contributions and projected contributions to fund post retirement benefit plans, if significantly different from prior period disclosures. The interim-period disclosures requirements are effective for interim periods beginning December 15, 2003. The Company does not expect SFAS 132R to require any additional disclosure.

     In December 2003, the Securities and Exchange Commission issued Staff Accounting Bulletin No. 104 (“SAB 104”) “Revenue Recognition”. SAB 104 revises, clarifies or rescinds portions of Staff Accounting Bulletin No. 101 “Revenue Recognition in Financial Statements”. The adoption of SAB 104 had no impact on the Company’s financial position, results of operations or cash flows.

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

VENDOR ALLOWANCES

     The Company receives cash or allowances from merchandise vendors primarily in connection with cooperative advertising programs and reimbursements for markdowns taken to sell the vendor’s products. The Company has agreements in place with each vendor setting forth the specific conditions for each allowance or payment. The majority of these agreements are entered into or renewed annually at the beginning of each fiscal year. The Company adopted EITF 02-16, “Accounting by a Reseller (including a Retailer) for Cash Consideration Received from a Vendor” in fiscal year 2003, which is required to be applied to new vendor arrangements entered into after January 1, 2003. Accordingly, for fiscal year 2003, qualifying vendor reimbursements of costs incurred to advertise vendor’s products were recorded as a reduction of selling, general, and administrative expenses (“SG& A”).

     Beginning in fiscal year 2004, upon the annual renewal of existing agreements or the creation of any new agreements, certain of these vendor reimbursements have been included as a reduction of cost of sales when the inventory is sold. The table below shows the accounting impact of cash consideration received for cooperative advertising agreements resulting in decreases to cost of sales and SG&A.

     Had the prior methodology been consistently applied, the reduction to SG&A expense for vendor reimbursements for the three and six months ended January 31, 2004 would have been approximately $14.1 million and $23.9 million, respectively, and there would have been no reductions to cost of sales.

GUARANTEE OBLIGATIONS

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

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

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

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

     Based on account balances for the shared risk programs as of January 31, 2004, the Company’s maximum potential payment would be approximately $32 million if the entire portfolio defaulted. Under the shared risk programs, the Company incurred approximately $240,000 of losses for the six months ended January 31, 2004.

     As of January 31, 2004, the reserve for both portfolios is approximately $600,000, which the Company believes is adequate based on the historical trend of actual losses. As part of the shared risk programs, the Company is required to pledge collateral to Citi in the form of an interest bearing depository account that will fluctuate monthly based on the account balances of the shared risk programs. The current collateral balance as of January 31, 2004 is approximately $5.2 million.

     Product Warranty Programs. The Company sells extended service agreements (“ESA’s”) to customers to cover sizing and breakage for a two-year period on certain products purchased from the Company. The revenue on these agreements is recognized over the two-year period in proportion to the costs expected to be incurred in performing services under the agreements. In addition to ESA’s, the Company provides warranty services that cover diamond replacement costs on certain diamond merchandise sold as long as the customer follows certain inspection practices over the time of ownership of the merchandise. The Company has established a reserve for potential non-ESA warranty issues based primarily on historical experience of actual expenses.

     The changes in the Company’s product warranty programs for the reporting periods are as follows:

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Item 2.

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

This discussion and analysis should be read in conjunction with the unaudited Consolidated Financial Statements of the Company (and the related notes thereto) included elsewhere in this report.

Results of Operations

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

Three Months Ended January 31, 2004 Compared to Three Months Ended January 31, 2003

     Total Revenues. Total revenues for the three months ended January 31, 2004, were $949.0 million, an increase of 4.5 percent over total revenues of $908.4 million for the prior year.

     Comparable store sales increased 4.3 percent in the three months ended January 31, 2004 as compared to the prior year. Comparable store sales excludes amortization of extended service agreements and includes sales for those stores in their thirteenth full month of operation. The Company attributes the increase in comparable store sales to the customer’s response to its merchandising and marketing initiatives. Merchandising was driven by expanded offerings of charms and body jewelry at Piercing Pagoda, the strength of the diamond and watch categories at Bailey Banks & Biddle Fine Jewelers, and diamond fashion assortments in the moderate brands. The marketing strategy included increased media impressions and the introduction of new branding campaigns.

     Total revenues include insurance premium revenue for credit insurance operations of $3.2 million and $3.6 million for the quarters ended January 31, 2004 and 2003, respectively.

     During the three months ended January 31, 2004, the Company opened 14 new stores and closed 8 stores. In addition, the Company opened 7 kiosks and closed 23 kiosks during the current period.

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Cost of Sales. Cost of sales as a percentage of revenues was 49.5 for the three months ended January 31, 2004, a decrease of 1.3 percentage points compared to the prior year. The decrease in cost of sales as a percentage of revenues was driven primarily by initiatives implemented at Piercing Pagoda which represented approximately 0.6 percentage points of the reduction. These initiatives included direct sourcing from countries such as China and Italy, resulting in lower product costs. In addition, 0.5 percentage points of the decrease in cost of sales relates to cash consideration received from vendors previously recorded as a reduction to Selling, General and Administrative expenses.

     The Company’s LIFO provision was $0.5 million and $2.7 million for the three months ended January 31, 2004 and 2003, respectively.

     Selling, General and Administrative Expenses. Selling, General and Administrative expenses (“SG&A”) increased 0.9 percentage points to 32.4 percent of revenues for the three months ended January 31, 2004, from 31.5 percent for the three months ended January 31, 2003. The increase was due to the results of the reclassification of certain cash consideration received from vendors previously recorded as a reduction to SG&A to a reduction of inventory costs in accordance with EITF 02-16 “Accounting by a Reseller (including a Retailer) for Cash Consideration Received from a Vendor”. This was offset partially by an improvement in store productivity.

     Cost of Insurance Operations. The Cost of Insurance Operations decreased $0.8 million to $1.3 million due to prior year legal fees and lower paid insurance claims than in the prior period.

Six Months Ended January 31, 2004 Compared to Six Months Ended January 31, 2003

     Total Revenues. Total revenues for the six months ended January 31, 2004, were $1.4 billion, an increase of 3.4 percent over total revenues of $1.3 billion for the prior year.

     Comparable store sales increased 3.4 percent in the six months ended January 31, 2004 as compared to the prior year. Comparable store sales excludes amortization of extended service agreements and includes sales for those stores in their thirteenth full month of operation. The Company attributes the increase in comparable store sales to the customer’s response to its merchandising and marketing initiatives. Merchandising was driven by expanded offerings of charms and body jewelry at Piercing Pagoda, the strength of the diamond and watch categories at Bailey Banks & Biddle Fine Jewelers, and diamond fashion assortments in the moderate brands. The marketing strategy revolved around increased media impressions and the introduction of new branding campaigns.

     Total revenues include insurance premium revenue for credit insurance operations of $6.4 million and $8.5 million for the six months ended January 31, 2004 and 2003, respectively.

     For the six months ended January 31, 2004, the Company opened 21 new stores and closed 12 stores. In addition, the Company opened 12 kiosks and closed 27 kiosks during the current period.

     Cost of Sales. Cost of sales, as a percentage of revenues was 49.5 for the six months ended January 31, 2004, a decrease of 0.9 percentage points compared to the prior year. The decrease in cost of sales as a percentage of revenues was driven primarily by initiatives implemented at Piercing Pagoda which represented approximately 0.6 percentage points of the reduction. These initiatives include direct sourcing from countries such as China and Italy, resulting in lower product costs. In addition, 0.4 percentage points of the decrease in cost of sales relates to cash consideration received from vendors previously recorded as a reduction to Selling, General and Administrative expenses.

     The Company’s LIFO provision was $0.5 million and $2.7 million for six months ended January 31, 2004 and 2003, respectively.

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     Selling, General and Administrative Expenses. Selling, General and Administrative expenses (“SG&A”) increased 0.9 percentage points to 37.7 percent of revenues for the six months ended January 31, 2004 from January 31, 2003. The increase was due to the result of the reclassification of certain cash consideration received from vendors previously recorded as a reduction to SG&A to a reduction of inventory costs in accordance with EITF 02-16 “Accounting by a Reseller (including a Retailer) for Cash Consideration Received from a Vendor”.

     Cost of Insurance Operations. The Cost of Insurance Operations decreased $1.5 million to $3.0 million due to prior year legal fees and lower paid insurance claims than in the prior period.

Liquidity and Capital Resources

     The Company’s cash requirements consist primarily of funding inventory growth, capital expenditures primarily for new store growth, renovations of the existing portfolio, upgrades to its management information systems and debt service. As of January 31, 2004, the Company had cash and cash equivalents of $55.6 million, of which approximately $5.2 million is restricted due to an agreement with Citi Commerce Solutions (“Citi”). This agreement requires the Company to pledge an amount as collateral to Citi in the form of an interest bearing depository account that will fluctuate monthly based on the account balances of the shared risk programs.

     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 2002, which includes the Holiday selling season. The Company’s working capital requirements fluctuate during the year, increasing substantially during the fall season as a result of higher planned seasonal inventory levels.

Finance Arrangements

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

     The loans made under the Revolving Credit Agreement bear interest at a floating rate at either (i) the applicable 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 January 31, 2004, there was $138.7 million outstanding under the Revolving Credit Agreement. The effective interest rate at January 31, 2004 was 3.30 percent. Based on the terms of the Revolving Credit Agreement, the Company had approximately $361.3 million in available borrowings at January 31, 2004.

     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 charged coverage ratio. The Revolving Credit Agreement requires the Company to comply with certain restrictive covenants including, among other things, limitations on indebtedness, investments, liens, acquisitions, and asset sales. The Company is currently in compliance with all of its obligations under the Revolving Credit Agreement.

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Capital Expenditures

     The Company plans to open 83 new locations, including 23 new kiosks, for which it expects to make $20 million in capital expenditures during fiscal year 2004. During fiscal year 2004, the Company anticipates spending $31 million to remodel, relocate or refurbish approximately 174 additional locations. This along with approximately $7 million to support continued enhancements to maintain the existing store locations will allow the Company to focus on productivity of core store locations. The Company also estimates that it will make 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 $70 million of capital expenditures during fiscal year 2004.

Other Activities Affecting Liquidity

•

On August 28, 2003, the Company announced that its Board of Directors had approved a stock repurchase program pursuant to which the Company, from time to time and at management’s discretion, may purchase up to an additional $100 million of its common stock. This most recent approval combined with existing repurchase authorizations, made possible the Company’s repurchase of a total of approximately $142 million worth of its common stock. As of January 31, 2004, the Company has purchased approximately 2.2 million shares of its common stock at an aggregate cost of $104 million, leaving approximately $38 million available for future repurchases under its stock repurchase program.

	•		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 January 31, 2004, 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 is the Internal Revenue Code Section 382 annual limitation of $19.5 million. The NOL can be utilized through 2008.
	•		Citi Commerce Solutions (“Citi”), a subsidiary of Citi Group provides financing to the Company’s customers through the Company’s private label credit card program, in exchange for payment by the Company of a merchant fee (subject to periodic adjustment) based on a percentage of each credit card sale. The receivables established through the issuance of credit by Citi are originated and owned by Citi. As defined in the contract with Citi, losses related to a “standard credit account” (an account within the credit limit approved under the original merchant agreement between the Company and Citi) are assumed entirely by Citi without recourse to the Company, except where a Company employee violates the credit procedures agreed to in the merchant agreement.
			However, in an effort to better service customers, the Company and Citi developed two programs that extend credit to qualifying customers beyond the standard credit account. The incremental credit extension is at the Company’s discretion and is based upon either additional down payments made at the time of sale or the total amount of the sale transaction. The Company bears a portion of customer default losses as defined in the agreement with Citi arising from these accounts.
			Based on account balances for the shared risk programs as of January 31, 2004, the Company’s maximum potential payment would be approximately $32 million if the entire portfolio defaulted. Under the shared risk programs, the Company incurred approximately $240,000 of losses for the six months ended January 31, 2004. As of January 31, 2004, the reserve for both portfolios is approximately $600,000, which the Company believes is adequate based on the historical trend of actual losses. As part of the shared risk programs, the Company is required to pledge collateral to Citi in the form of an interest bearing depository account that will fluctuate monthly based on the account balances of the shared risk programs. The current collateral balance as of January 31, 2004 is approximately $5.2 million.

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

New Accounting Pronouncements

     In December 2003, SFAS 132, “Employers’ Disclosures about Pensions and other Post Retirement Benefits” was revised (“SFAS 132R”). This statement amends APB Opinion No. 28, “Interim Financial Reporting” to require interim-period disclosure of the components of net periodic benefit cost and the amounts of contributions and projected contributions to fund post retirement benefit plans, if significantly different from prior period. The interim-period disclosures requirements are effective for interim periods beginning December 15, 2003. The Company does not expect SFAS 132R to require any additional disclosure.

     In December 2003, the Securities and Exchange Commission issued Staff Accounting Bulletin No. 104 (“SAB 104”) “Revenue Recognition”. SAB 104 revises, clarifies or rescinds portions of Staff Accounting Bulletin No. 101 “Revenue Recognition in Financial Statements”. The adoption of SAB 104 had no impact on the Company’s financial position, results of operations or cash flows.

Inflation

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

Critical Accounting Policies

     The preparation of financial statements and related disclosures in conformity with accounting principles generally accepted in the United States of America 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 and Mappins Jewellers of Canada is valued using the first-in, first-out (“FIFO”) retail inventory method. Under the retail method, inventory is segregated into categories of merchandise with similar characteristics at its current retail selling value. The determination of inventory at cost and the resulting gross margins are calculated by applying an average cost to retail ratio to the retail value of inventory.

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

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

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

     Long-lived Assets and Goodwill – Long-lived assets are periodically reviewed for impairment by comparing the carrying value of the assets with their estimated fair values. If the evaluation indicates that the carrying amount of the asset may not be recoverable, the potential impairment is measured based on a projected discounted 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.

     In accordance with Statement of Financial Accounting Standards (“SFAS”) No. 142, “Goodwill and Other Intangible Assets”, the Company tests goodwill for impairment annually, at the end of its second quarter, or more frequently if events occur which indicate a potential reduction in the fair value of a reporting unit’s net assets below its carrying value. An impairment is deemed to exist if the net book value of a reporting unit exceeds its estimated fair value. In the second quarter of fiscal year 2004, the Company performed its annual review for impairment of goodwill related to its Piercing Pagoda, Inc., People’s Jewellers and other smaller acquisitions. The Company concluded that there was no evidence of impairment related to the goodwill of approximately $19.4 million for Piercing Pagoda, $61.3 million recorded for the People’s acquisition and $5.0 million for other smaller acquisitions. In the second quarter of fiscal year 2003, the Company did conclude that the fair value of Piercing Pagoda was lower than its carrying value, reflective of the current market conditions and lower than expected performance. The Company recorded a non-cash charge of $136.3 million in the second quarter of fiscal year 2003, which is included as a component of operating earnings in the Consolidated Statement of Operations, to reduce the carrying value of the Piercing Pagoda goodwill to approximately $19.4 million.

     Revenue Recognition – The Company recognizes revenue in accordance with the Securities and Exchange Commission’s Staff Accounting Bulletin No. 104 “Revenue Recognition.” Revenue related to merchandise sales, which is approximately 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 that are recognized over the two-year period in proportion to the costs expected to be incurred in performing services under the agreements. Revenues also include premiums from the Company’s insurance businesses, principally related to credit insurance policies sold to customers who purchase the Company’s merchandise under the proprietary credit program. Insurance premiums are recognized over the coverage period.

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     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 January 31, 2004 the realization of the deferred income tax asset is more likely than not and thus there was no valuation reserve recorded.

Cautionary Notice Regarding Forward-Looking Statements

     This Quarterly Report on Form 10-Q 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 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.

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Item 3. Quantitative and Qualitative Disclosures About Market Risk

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

     In fiscal years 2003 and 2004, the Company entered into forward contracts for the purchase of some of its gold in order to hedge the risk of gold price fluctuations. The table below provides information about the Company’s derivative financial instruments that are sensitive to gold prices.

Forward Commodity Agreements
(As of January 31, 2004)

     In fiscal year 2004, the Company entered into foreign currency forward exchange contracts to reduce the effects of fluctuating Canadian currency exchange rates. The table below provides information about the Company’s derivative financial instruments that are sensitive to Canadian currency exchange rates.

Foreign Exchange Contracts
(As of January 31, 2004)

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

     Otherwise, the Company believes that the market risk of the Company’s financial instruments as of January 31, 2004 has not materially changed since July 31, 2003. The market risk profile as of July 31, 2003 is disclosed in the Company’s Annual Report on Form 10-K for the year ended July 31, 2003.

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Item 4. Controls and Procedures

     Under the supervision and with the participation of the Company’s management, including its Chief Executive Officer and Chief Financial Officer, the Company has evaluated the effectiveness of its disclosure controls and procedures, as of the end of the period covered by this report. Based on that evaluation, the Chief Executive Officer and Chief Financial Officer have concluded that these disclosure controls and procedures are effective in enabling the Company to record, process, summarize and report information required to be included in its periodic SEC filings within the required time period. There has been no change in the Company’s internal control over financial reporting that occurred during the Company’s most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.

Part II. Other Information

Item 1. Legal Proceedings

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

Item 6. Exhibits and Reports on form 8-K

(a) Exhibits

     31.1 Certification of Principal Executive Officer

     31.2 Certification of Principal Financial Officer

     32.1 Certification of Principal Executive Officer

     32.2 Certification of Principal Financial Officer

(b) Reports on Form 8-K

     On November 6, 2003, the Company furnished under item 12 of Form 8-K, a press release reporting its sales results for the first quarter      ended October 31, 2003.

     On November 18, 2003, the Company furnished under item 12 of Form 8-K, a press release reporting its financial results for its fiscal      quarter ended October 31, 2003.

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SIGNATURE

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

	Zale Corporation
	(Registrant)
Date March 9, 2004	/s/ Cynthia T. Gordon
	Cynthia T. Gordon
	Senior Vice President, Controller (principal accounting officer of the registrant)

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