Attached files

file	filename
EX-14 - EX-14 - ZALE CORP	a2195130zex-14.htm
EX-31.2 - EXHIBIT 31.2 - ZALE CORP	a2195130zex-31_2.htm
EX-23.1 - EXHIBIT 23.1 - ZALE CORP	a2195130zex-23_1.htm
EX-32.1 - EXHIBIT 32.1 - ZALE CORP	a2195130zex-32_1.htm
EX-32.2 - EXHIBIT 32.2 - ZALE CORP	a2195130zex-32_2.htm
EX-10.2 - EXHIBIT 10.2 - ZALE CORP	a2195130zex-10_2.htm
EX-31.1 - EXHIBIT 31.1 - ZALE CORP	a2195130zex-31_1.htm
EX-10.13 - EXHIBIT 10.13 - ZALE CORP	a2195130zex-10_13.htm

Business Segment Data

        Information concerning sales and segment income attributable to each of our business segments is set forth below in Item 6, "Selected Financial Data," Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations," and in the "Notes to Consolidated Financial Statements," all of which are incorporated herein by reference.

Store Operations

        Our stores are designed to differentiate our brands, create an attractive environment, make shopping convenient and enjoyable, and maximize operating efficiencies, all of which enhance the customer experience. We focus on store layout, with particular focus on arrangement of display cases, lighting, and choice of materials to optimize merchandise presentation. Promotional displays are changed periodically to provide variety or to reflect seasonal events.

        Each of our stores is led by a store manager who is responsible for store-level operations, including overall store sales and personnel matters. Administrative matters, including purchasing, distribution and payroll, are consolidated at the corporate level to maintain efficiency and lower operating costs. In addition to selling jewelry, watches and gift items, each store also offers standard warranties and return policies, and provides extended warranty coverage that may be purchased at the customer's option. In order to facilitate sales, stores will hold merchandise in layaway, generally requiring a deposit of not less than 20 percent of the purchase price at the inception of the layaway transaction.

        We have implemented inventory control systems, extensive security systems and loss prevention procedures to maintain low inventory losses. We screen employment applicants and provide our store personnel with training in loss prevention. Despite such precautions, we experience theft losses from time to time, and maintain insurance to cover such external losses.

        We believe it is important to provide knowledgeable and responsive customer service and we maintain a strong focus on connecting with the customer, both through advertising and in-store communications and service. Our goal is to form and sustain an effective relationship with the customer from the first sale by

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maintaining a customer connection. We have a centralized customer service call center to effectively address customer service issues at lower aggregate cost.

        We continue to focus on the level and frequency of our employee training programs, particularly with store managers and key jewelry consultants. We provide sales and merchandise product training for all store personnel. In addition, we provide management training for store managers. Under the banner of Zale Corporation University, we offer training to employees at every level of the organization.

Purchasing and Inventory

        We purchase the majority of our merchandise in finished form from a network of established suppliers and manufacturers located primarily in the United States, India, Southeast Asia and Italy. We procure approximately 56 percent of our merchandise from wholesalers, 28 percent directly from manufacturers and 16 percent from our internal assembly organization. All purchasing is done through buying offices at our Store Support Center. Consignment inventory has historically consisted of test programs, merchandise at higher price points or merchandise that otherwise does not warrant the risk of ownership. Consignment merchandise can be returned to the vendor at any time or converted to owned inventory if it meets certain sales thresholds. We had $71.5 million and $114.3 million of consignment inventory on hand at July 31, 2009 and 2008, respectively. During fiscal years 2009 and 2008, we purchased approximately 12 percent and 14 percent, respectively, of our finished merchandise from our top five vendors with no single vendor exceeding three percent in 2009. If our supply with these top vendors were disrupted, particularly at certain critical times during the year, our sales could be adversely affected in the short term until alternative supply arrangements could be established.

        As a specialty retail jeweler, we could be affected by industry-wide fluctuations in the prices of diamonds, gold and other metals and stones. The supply and prices of diamonds in the principal world markets are significantly influenced by a single entity, Diamond Trading Company, which has traditionally controlled the sale 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 Diamond Trading Company and our suppliers is to some extent dependent on the political environment in diamond-producing countries and on continuation of prevailing supply and marketing arrangements for raw diamonds. Until alternate sources are developed, any sustained interruption in the supply of diamonds could adversely affect us and the retail jewelry industry as a whole. The inverse is true with respect to any oversupply from diamond-producing countries, which could cause diamond prices to fall.

Proprietary Credit

        Our 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 payment sources. We offer revolving and interest free credit plans under our private label credit card program. Approximately 40 percent of our U.S. sales, excluding Piercing Pagoda which does not offer proprietary credit, were financed by proprietary credit in fiscal years 2009 and 2008. Our Canadian propriety credit card sales represented approximately 30 percent and 25 percent of Canadian total sales for fiscal years 2009 and 2008, respectively.

        In fiscal year 2009, our proprietary credit offerings included same-as-cash, revolving and interest free programs, all of which allowed our sales personnel to provide the customer a variety of financing options.

        In March 2001, we entered into a 10-year agreement with Citibank under which Citibank issues private label credit cards branded with appropriate trademarks, and provides financing for our customers to purchase merchandise in exchange for payment by us of a merchant fee based on a percentage of each credit card sale. The merchant fee varies according to the credit plan that is chosen by the customer (i.e., revolving, interest free, same-as-cash).

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Employees

        As of July 31, 2009, we had approximately 14,500 employees, of whom approximately 13 percent were Canadian employees and less than one percent of whom were represented by unions. Additionally, we usually hire temporary employees during November and December of each year, the Holiday season.

Seasonality

        As a specialty retailer of fine jewelry, our business is seasonal in nature, with our second quarter, which includes the months of November through January, accounting for a proportionally greater percentage of annual sales, earnings from operations and cash flow than the other three quarters. Other important periods include Valentine's Day and Mother's Day. We expect such seasonality to continue.

Information Technology

        Our technology systems provide information necessary for (i) store operations; (ii) inventory control; (iii) profitability monitoring by many measures (merchandise category, buyer, store); (iv) customer care; (v) expense control programs; and (vi) overall management decision support. Significant data processing systems include point-of-sale reporting, purchase order management, replenishment, warehouse management, merchandise planning and control, payroll, general ledger, sales audit, and accounts payable. Bar code ticketing and scanning are used at all point-of-sale terminals to ensure accurate sales and margin data compilation and to provide for inventory control monitoring. Information is made available online to merchandising staff on a timely basis, thereby increasing the merchants' ability to be responsive to changes in customer behavior. We are also improving the connectivity between stores and our Store Support Center to enhance operating effectiveness.

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

        We have a data center operations services agreement with a third party for the management of our client server systems, Local Area Network operations, Wide Area Network management and e-commerce hosting. The agreement began in 2005 and requires fixed payments totaling $30.0 million over an 84-month period plus a variable amount based on usage, and extends through 2012. We believe that by outsourcing our data center operations, we are better able to focus our resources on developing and executing the strategic initiatives discussed in the Business section.

        We have historically upgraded, and expect to continue to upgrade, our information systems to improve operations and support future growth. We estimate we will make capital expenditures of approximately $6 million in fiscal year 2010 for enhancements to our information systems and infrastructure.

Regulation

        Our 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 our private label credit cards, credit to our 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 our traditional customer base could adversely affect our results of operations or financial condition.

        We are 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.

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        The sale of insurance products also is regulated. Our three wholly owned insurance companies are required to file reports with various insurance commissions, and are also subject to regulations relating to capital adequacy, the payment of dividends and the operation of their businesses generally. State laws also impose registration and disclosure obligations with respect to the credit and other insurance products that we sell to our customers. In addition, the providers of our private label credit programs are subject to disclosure and other requirements under state and federal law and are subject to review by the Federal Trade Commission and the state and federal banking regulators.

        Merchandise in the retail jewelry industry is frequently sold at a discount off the "regular" or "original" price. We are subject to federal and state regulations requiring retailers offering merchandise at promotional prices to offer the merchandise at regular or original prices for stated periods of time. Additionally, we are subject to certain truth-in-advertising and various other laws, including consumer protection regulations that regulate retailers generally and/or the promotion and sale of jewelry in particular.

Available Information

        We provide links to our filings with the Securities and Exchange Commission ("SEC") and to the SEC filings (Forms 3, 4 and 5) of our directors and executive officers under Section 16 of the Securities Exchange Act of 1934, as amended (the "Exchange Act"), free of charge, on our website at www.zalecorp.com, under the heading "SEC Filings" in the "Shareholder Information" section. These links are automatically updated, so the filings are available immediately after they are made publicly available by the SEC. These filings also are available through the SEC's EDGAR system at www.sec.gov.

        Our certificate of incorporation and bylaws as well as the charters for the compensation, audit, nominating and corporate governance committees of our Board of Directors and the corporate governance guidelines are available on our website at www.zalecorp.com, under the heading "Corporate and Social Responsibility."

        We have a Code of Business Conduct and Ethics (the "Code"). All of our directors, executive officers and employees are subject to the Code. The Code is available on our web site at www.zalecorp.com, under the heading "Corporate and Social Responsibility-Code of Business Conduct and Ethics." Waivers of the Code, if any, for directors and executive officers would be disclosed in a SEC filing on Form 8-K or, to the extent permitted by law, on our website.

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ITEM 1A.    RISK FACTORS

        We make forward-looking statements in this Annual Report on Form 10-K, in other reports we file with the SEC and in presentations to investors and others. In addition, members of our senior management make forward-looking statements orally in presentations to analysts, investors, the media and others. Forward-looking statements include statements regarding our objectives and expectations with respect to our financial plan, sales and earnings, merchandising and marketing strategies, acquisitions and dispositions, share repurchases, store opening, renovation, remodeling and expansion, inventory management and performance, liquidity and cash flows, capital structure, capital expenditures, development of our information technology and telecommunications plans and related management information systems, e-commerce initiatives, human resource initiatives and other statements regarding our plans and objectives. In addition, the words "plans to," "anticipate," "estimate," "project," "intend," "expect," "believe," "forecast," "can," "could," "should," "will," "may," or similar expressions may identify forward-looking statements, but some of these statements may use other phrasing. These forward-looking statements are intended to relay our expectations about the future, and speak only as of the date they are made. We disclaim any obligation to update or revise publicly or otherwise any forward-looking statements to reflect subsequent events, new information or future circumstances, except as required by law.

        Forward-looking statements are not guarantees of future performance and a variety of factors could cause our actual results to differ materially from the anticipated or expected results expressed in or suggested by these forward-looking statements.

         If the general economy performs poorly, discretionary spending on goods that are, or are perceived to be, "luxuries" may not grow and may decrease.

        Jewelry purchases are discretionary and may be affected by adverse trends in the general economy (and consumer perceptions of those trends). In addition, a number of other factors affecting consumers such as employment, wages and salaries, business conditions, energy costs, credit availability and taxation policies, for the economy as a whole and in regional and local markets where we operate, can impact sales and earnings. The economic downturn in 2008 and 2009 has significantly impacted our sales and the continuation of this downturn, and particularly its worsening, would have a material adverse impact on our business and financial condition.

         The concentration of a substantial portion of our sales in three relatively brief selling periods means that our performance is more susceptible to disruptions.

        A substantial portion of our sales are derived from three selling periods—Holiday (Christmas), Valentine's Day and Mother's Day. Because of the briefness of these three selling periods, the opportunity for sales to recover in the event of a disruption or other difficulty is limited, and the impact of disruptions and difficulties can be significant. For instance, adverse weather (such as a blizzard or hurricane), a significant interruption in the receipt of products (whether because of vendor or other product problems), or a sharp decline in mall traffic occurring during one of these selling periods could materially impact sales for the affected period and, because of the importance of each of these selling periods, commensurately impact overall sales and earnings.

        Most of our sales are of products that include diamonds, precious metals and other commodities. A substantial portion of our purchases and sales occur outside the United States. Fluctuations in the availability and pricing of commodities or exchange rates could impact our ability to obtain, produce and sell products at favorable prices.

        The supply and price of diamonds in the principal world market are significantly influenced by a single entity, which has traditionally controlled the marketing of a substantial majority of the world's supply of diamonds and sells rough diamonds to worldwide diamond cutters at prices determined in its sole discretion. The availability of diamonds also is somewhat dependent on the political conditions in

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diamond-producing countries and on the continuing supply of raw diamonds. Any sustained interruption in this supply could have an adverse affect on our business.

        We also are affected by fluctuations in the price of diamonds, gold and other commodities. A significant change in prices of key commodities could adversely affect our business by reducing operating margins or decreasing consumer demand if retail prices are increased significantly. In addition, foreign currency exchange rates and fluctuations impact costs and cash flows associated with our Canadian operations and the acquisition of inventory from international vendors.

        In addition, a substantial portion of our raw materials and finished goods are sourced in countries generally described as having developing economies. Any instability in these economies could result in an interruption of our supplies, increases in costs, legal challenges and other difficulties.

         Our sales are dependent upon mall traffic.

        Our stores and kiosks are located primarily in shopping malls throughout the U.S., Canada and Puerto Rico. Our success is in part dependent upon the continued popularity of malls as a shopping destination and the ability of malls, their tenants and other mall attractions to generate customer traffic. Accordingly, a significant decline in this popularity, especially if it is sustained, would substantially harm our sales and earnings. In addition, even assuming this popularity continues, mall traffic can be negatively impacted by weather, gas prices and similar factors.

         We operate in a highly competitive and fragmented industry.

        The retail jewelry business is highly competitive and fragmented, and we compete with nationally recognized jewelry chains as well as a large number of independent regional and local jewelry retailers and other types of retailers who sell jewelry and gift items, such as department stores and mass merchandisers. We also compete with internet sellers of jewelry. Because of the breadth and depth of this competition, we are constantly under competitive pressure that both constrains pricing and requires extensive merchandising efforts in order for us to remain competitive.

         Any failure by us to manage our inventory effectively will negatively impact sales and earnings.

        We purchase much of our inventory well in advance of each selling period. In the event we misjudge consumer preferences or demand, we will experience lower sales than expected and will have excessive inventory that may need to be written down in value or sold at prices that are less than expected, which could have a material adverse impact on our business and financial condition.

         Any failure of our pricing and promotional strategies to be as effective as desired will negatively impact our sales and earnings.

        We set the prices for our products and establish product specific and store-wide promotions in order to generate store traffic and sales. While these decisions are intended to maximize our sales and earnings, in some instances they do not. For instance, promotions, which can require substantial lead time, may not be as effective as desired or may prove unnecessary in certain economic circumstances. Where we have implemented a pricing or promotional strategy that does not work as expected, our sales and earnings will be adversely impacted.

         Because of our dependence upon a small concentrated number of landlords for a substantial number of our locations, any significant erosion of our relationships with those landlords or their financial condition would negatively impact our ability to obtain and retain store locations.

        We are significantly dependent on our ability to operate stores in desirable locations with capital investment and lease costs that allow us to earn a reasonable return on our locations. We depend on the leasing market and our landlords to determine supply, demand, lease cost and operating costs and conditions. We cannot be certain as to when or whether desirable store locations will become or remain available to us at reasonable lease and operating costs. Several large landlords dominate the ownership of

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prime malls, and we are dependent upon maintaining good relations with those landlords in order to obtain and retain store locations on optimal terms. From time to time, we do have disagreements with our landlords and a significant disagreement, if not resolved, could have an adverse impact on our business. In addition, any financial weakness on the part of our landlords could adversely impact us in a number of ways, including decreased marketing by the landlords and the loss of other tenants that generate mall traffic.

         Changes in regulatory requirements relating to the extension of credit may increase the cost of or adversely affect our operations.

        Our operations are affected by numerous U.S. and Canadian federal and state or provincial laws that impose disclosure and other requirements upon the origination, servicing and enforcement of credit accounts and limitations on the maximum aggregate amount of finance charges that may be charged by a credit provider. Any change in the regulation of credit (including changes in the application of current laws) which would materially limit the availability of credit to our customer base could adversely affect our sales and earnings.

         Any disruption in, or changes to, our private label credit card arrangement with Citibank, N.A. may adversely affect our ability to provide consumer credit and write credit insurance.

        Under arrangements with Citibank, N.A. and one of its subsidiaries (collectively, "Citibank"), Citibank provides financing for our customers to purchase merchandise through private label credit cards. The arrangement also enables us to write credit insurance. Customers use our Citibank arrangements to pay for approximately 40 percent of purchases in the U.S. and approximately 30 percent of purchases in Canada. Under the agreements governing our arrangement, our Canadian and U.S. subsidiaries must satisfy various financial and other covenants. We recently amended these arrangements in order to obtain relief from certain covenants that we did not meet. Any disruption in our arrangement with Citibank, particularly in the current credit market in which replacing Citibank might be difficult, would have an adverse effect on our business, especially to the extent that it materially limits credit availability to our customer base. See Part II, Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations" for more detailed information related to the Citibank agreement.

         We are dependent upon our revolving credit agreement for our liquidity needs.

        We have a revolving credit facility with a syndicate of banks led by Bank of America that contains various financial and other covenants. See Part II, Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations." Should we be unable to fulfill the covenants contained in the facility, or should the facility not be renewed or replaced when it matures in August 2011, we would be unable to fund our operations without a significant restructuring of our business.

         If the credit markets continue to deteriorate, our ability to obtain the financing needed to operate our business could be adversely impacted.

        We utilize a revolving credit facility to finance our working capital requirements, including the purchase of inventory, among other things. If our ability to obtain the financing needed to meet these requirements was adversely impacted as a result of continued deterioration in the credit markets, our business could be significantly impacted. In addition, the amount of available borrowings under our credit facility is based, in part, on the appraised liquidation value of our inventory. Any declines in the appraised value of our inventory could impact our ability to obtain the financing necessary to operate our business.

         Acquisitions and dispositions involve special risk, including the risk that we may not be able to complete proposed acquisitions or dispositions or that such transactions may not be beneficial to us.

        We have made significant acquisitions and dispositions in the past and may in the future make additional acquisitions and dispositions. Difficulty integrating an acquisition into our existing infrastructure and operations may cause us to fail to realize expected return on investment through revenue increases,

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cost savings, increases in geographic or product presence and customer reach, and/or other projected benefits from the acquisition. In addition, we may not achieve anticipated cost savings or may be unable to find attractive investment opportunities for funds received in connection with a disposition. Additionally, attractive acquisition or disposition opportunities may not be available at the time or pursuant to terms acceptable to us and we may be unable to complete acquisitions or dispositions.

         Ineffective accounting controls can have adverse impacts on the Company.

        We recently identified two material weaknesses in our internal control over financial reporting. See "Management's Report on Internal Control Over Financial Reporting." While we are in the process of remediating these weaknesses, and while we concluded that the financial statements contained in this report fairly presented in all material respects our financial condition, results of operations and cash flows under generally accepted accounting principles, material weaknesses can result in a range of adverse impacts to us, including increased audit and compliance costs and the loss of investor confidence in our financial reports.

         Changes in estimates, assumptions and judgments made by management related to our evaluation of goodwill and store impairments could significantly affect our financial results.

        Evaluating the need for goodwill and store impairments is highly complex and involves many subjective estimates, assumptions and judgments by our management. For instance, management makes estimates and assumptions with respect to future cash flow projections, terminal growth rates, discount rates and long-term business plans. If our actual results are not consistent with our estimates, assumptions and judgments by our management, we may be required to recognize additional impairments.

         Additional factors that may adversely affect our financial performance.

        Increases in expenses that are beyond our control including items such as increases in interest rates, inflation, fluctuations in foreign currency rates, higher tax rates and changes in laws and regulations, may negatively impact our operating results.

ITEM 1B.    UNRESOLVED STAFF COMMENTS

        Not applicable.

ITEM 2.    PROPERTIES

        We lease a 430,000 square foot facility, which serves as our corporate headquarters ("Store Support Center") and primary distribution facility. The lease for this facility extends through March 2018. The facility is located in Las Colinas, a planned business development in Irving, Texas, near the Dallas/Fort Worth International Airport. Our Canadian distribution and production operations are conducted in a leased 26,280 square foot facility in Toronto, Ontario with a lease term through November 2014. We also lease a 20,000 square foot distribution and warehousing facility in Irving, Texas, with a lease term through June 2010, that serves as the Piercing Pagoda distribution center.

        We rent our store retail space under leases that generally range in terms from 5 to 10 years and may contain minimum rent escalation clauses, 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 store's gross sales.

        We lease 18 percent of our store and kiosk locations from Simon Property Group and 14 percent of our store and kiosk locations from General Growth Management, Inc. Otherwise, we have no relationship with any lessor amounting to 10 percent or more of our store and kiosk locations.

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        The following table indicates the expiration dates of the current terms of our leases as of July 31, 2009:

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(a)

Other includes the Store Support Center, warehouses, distribution centers and storage facilities.

        During fiscal 2009 we closed a substantial number of stores. For additional discussion regarding these closures, see Part II, Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations."

        Management believes substantially all of the store leases expiring in fiscal year 2010 that it wishes to renew (including leases which expired earlier and are currently being operated under month-to-month extensions) will be renewed. Generally, although rents continue to increase, we otherwise expect leases will be renewed on terms not materially less favorable to us than the terms of the expiring or expired leases. Management believes our facilities are suitable and adequate for our business as presently conducted.

ITEM 3.    LEGAL PROCEEDINGS AND OTHER MATTERS

        As a result of the discovery of the matters disclosed in the Company's Form 8-K filed on September 18, 2009, the Audit Committee of the Board of Directors retained outside counsel to review those matters. The review has been concluded and resulted in the restatement of the Company's financial statements, as reported herein. The Audit Committee is monitoring the remediation of the material weaknesses in internal control over financial reporting, as discussed in Exhibit F-1 to this report.

        Subsequent to the Company's disclosure in its Form 8-K filed on September 18, 2009 that it would restate certain financial statements, the Staff of the Fort Worth, Texas office of the Securities and Exchange Commission notified the Company that it had begun an investigation and requested certain information relating to the matters disclosed in the Company's Form 8-K. The Company is cooperating with the Staff's investigation. The Company cannot predict the outcome or duration of the SEC investigation, but at this time, the Company does not believe that the investigation will have a material effect on the Company's financial condition or results of operations.

        Additional information regarding legal proceedings is incorporated by reference from Note 18 to our consolidated financial statements set forth, under the heading, "Contingencies," in Part IV of this report.

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

        Not applicable.

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PART II

ITEM 5.    MARKET FOR THE REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

        Our common stock is listed on the New York Stock Exchange under the symbol "ZLC." The following table sets forth the high and low sale prices as reported on the NYSE for our common stock for each fiscal quarter during the two most recent fiscal years.

        As of October 19, 2009, the Company's outstanding shares of common stock were held by approximately 504 holders of record. We have not paid dividends on the common stock since its initial issuance on July 30, 1993, and do not anticipate paying dividends on the common stock in the foreseeable future. In addition, our long-term debt limits our ability to pay dividends or repurchase our common stock if borrowing availability under our $500 million revolving credit facility is less than $75 million. At July 31, 2009, we had borrowing availability under the revolving credit agreement of approximately $136 million. See "Management's Discussion and Analysis of Financial Condition and Results of Operations—Liquidity and Capital Resources" and "Notes to the Consolidated Financial Statements—Debt."

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Corporate Performance Graph

        The following graph shows a comparison of cumulative total returns for the Company, the S&P 500 Index, the S&P 600 Specialty Store Index and the S&P 600 Smallcap Index for the period from August 1, 2004 to July 31, 2009. The comparison assumes $100 was invested on August 1, 2004 in the Company's common stock and in each of the three indices and, for the S&P 500 Index, the S&P 600 Specialty Store Index and the S&P 600 Smallcap Index, assumes reinvestment of dividends. The Company has not paid any dividends during this period.

        The stock price performance depicted in the above graph is not necessarily indicative of future price performance. The Corporate Performance Graph shall not be deemed "soliciting material" or to be "filed" with the SEC, nor shall such information be incorporated by reference into any future filing by the Company under the Securities Act or the Exchange Act, except to the extent that the Company specifically incorporates the graph by reference in such filing.

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ITEM 6.    SELECTED FINANCIAL DATA

        The following selected financial data is qualified in its entirety by our consolidated financial statements (and the related notes thereto) contained elsewhere in this Annual Report on Form 10-K and should be read in conjunction with "Management's Discussion and Analysis of Financial Condition and Results of Operations." The statement of operations and balance sheet data for each of the fiscal years ended July 31, 2009 and 2008 has been derived from our audited consolidated financial statements. The statement of operations and balance sheet data for each of the fiscal years ended July 31, 2007, 2006 and 2005 has been derived from our unaudited consolidated financial statements (see Note 2 to our consolidated financial statements for more detailed information related to the restatement). During fiscal year 2008, we sold Bailey Banks & Biddle. As a result, their operations are reflected as discontinued operations in the following consolidated statements of operations. All amounts in the following table are in thousands, except per share amounts.

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Segment Data

        We report our business under three segments: Fine Jewelry, Kiosk Jewelry and All Other. The All Other segment includes insurance and reinsurance operations. Operating earnings by segment are calculated before unallocated corporate overhead, interest and taxes but include an internal charge for inventory carrying cost to evaluate segment profitability. Unallocated costs are before income taxes and include corporate employee related costs, administrative costs, information technology costs, corporate facilities costs and depreciation and amortization. All amounts in the following table are in thousands.

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

        For important information regarding forward-looking statements made in this Management's Discussion and Analysis of Financial Condition and Results of Operations see "Item 1A—Risk Factors."

        On September 17, 2009, management of Zale Corporation (the "Company") and the Audit Committee of the Company's Board of Directors concluded that the Company's previously issued consolidated financial statements for fiscal years 2008 and prior periods required restatement as a result of adjustments associated with advertising costs, intercompany accounts receivable, depository bank accounts, federal income taxes and personal property tax reserves. The cumulative impact of the adjustments totaled $35.4 million, $32.2 million after taxes, as of July 31, 2008 and consisted of the following items:

•

A $23.7 million charge, $20.4 million after taxes, related primarily to prepaid advertising costs. Previously, certain advertising costs were recorded as prepaid advertising subsequent to the period in which the advertisement ran. The charge includes $21.7 million related to fiscal year 2007 and prior periods.



•

A $5.9 million charge, $5.1 million after taxes, related to an intercompany accounts receivable associated with our wholly owned insurance subsidiaries. The Company pays certain expenses on behalf of its insurance subsidiaries and is subsequently reimbursed by those subsidiaries. The charge was the result of the Company recording accounts receivable in excess of the actual expenses incurred and included $5.9 million related to fiscal year 2007 and prior periods.



•

A $4.2 million charge, $4.6 million after taxes, to correct amounts previously recorded with respect to the reconciliation of certain depository bank accounts. The charge corrected the recording of cash receipts from Bailey Banks & Biddle subsequent to disposition of the brand in fiscal year 2008 and certain other errors associated with our cash reconciliation system. The charge includes $1.5 million related to fiscal year 2007 and prior periods.



•

A $3.9 million charge for federal income taxes resulting primarily from an incorrect determination made during fiscal year 2008 related to whether earnings from our Puerto Rican based operations could be utilized to offset U.S. operating losses that were expiring.

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•

A $2.3 million benefit, $1.8 million after taxes, related to personal property tax reserves. The benefit was the result of excess reserves that were not adjusted on a timely basis following final payments and includes $2.1 million related to fiscal year 2007 and prior periods.

        The table below provides a summary of certain line items from our consolidated statements of operations and balance sheets for fiscal years 2005 through 2008 that were affected by this restatement. The consolidated statements of operations summary and consolidated balance sheet data for the fiscal year ended July 31, 2008 have been derived from our audited consolidated financial statements. The consolidated statements of operations summary and consolidated balance sheet data for each of the fiscal years ended July 31, 2007, 2006 and 2005 have been derived from our unaudited consolidated financial statements (see Note 2 to our consolidated financial statements for more detailed information related to the restatement of certain previously issued consolidated financial statements).

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Overview

        We are a leading specialty retailer of fine jewelry in North America. At July 31, 2009, we operated 1,247 fine jewelry stores and 684 kiosks located primarily in shopping malls throughout the United States of America, Canada and Puerto Rico. Our operations are divided into three business segments: Fine Jewelry, Kiosk Jewelry and All Other.

        The Fine Jewelry segment focuses on diamond product, but differentiates its brands through merchandise assortments and marketing. The Kiosk Jewelry segment reaches the opening price point of fine jewelry customers primarily through mall-based kiosks in the United States of America operating primarily under the name Piercing Pagoda®. The All Other segment consists of our insurance operations, which provide insurance and reinsurance facilities for various types of insurance coverage offered primarily to our private label credit card customers.

        Our results for fiscal year 2009 were significantly below expectations. Comparable store sales decreased by approximately 17 percent reflecting the extremely challenging economic environment and gross margins decreased by 150 basis points to approximately 48 percent due primarily to an increase in store-wide discounts during the 2008 Holiday season. The 150 basis point decline in gross margins excludes the 80 basis point impact of the inventory impairment charge recorded in fiscal year 2009. After the 2008 Holiday season, we returned to a more disciplined promotional strategy resulting in gross margins of approximately 50 percent during the third and fourth quarters of fiscal year 2009 excluding the inventory impairment charge, as compared with approximately 45 percent during the Holiday season. In addition, during fiscal year 2009 we made significant progress in achieving the initiatives we began in the second half of fiscal year 2008 to reduce inventory and costs. As a result, we generated approximately $32 million of cash flows from operating activities and reduced debt by $22 million during the fourth quarter of fiscal year 2009. We expect to continue to realize the benefits from these initiatives during fiscal year 2010.

        We believe that the three initiatives we introduced in fiscal year 2008 remain critical to our long-term success. The initiatives include (1) focusing on our core customer by providing clarity and value through compelling merchandise assortments, cleaner in-store presentation and an improved marketing message, (2) enhancing our operational effectiveness to ensure that our people and processes are aligned and focused on providing outstanding products and customer service and (3) maintaining financial discipline with a continued focus on free cash flow generation and prudent use of capital. We believe that the most important of these initiatives under the current economic environment is maintaining financial discipline. Accordingly, over the last two fiscal years we have accomplished the following under this initiative:

•

In February 2009, we announced inventory and cost reduction programs expected to be realized through fiscal 2010 totaling approximately $75 million and $65 million, respectively.



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The inventory reductions are to be achieved by selling and not replenishing inventory in closed stores and improved productivity through more efficient store level allocation at existing stores. The reductions achieved as of July 31, 2009 totaled approximately $54 million.



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As of July 31, 2009, the cost savings realized since inception of the initiative totaled approximately $26 million and consist primarily of selling, general and administrative expenses.



•

In February 2008, we announced plans to permanently reduce inventory by $100 million and to achieve cost savings totaling in excess of $65 million.



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The permanent inventory reductions of approximately $100 million were achieved as of July 2008.



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As of July 31, 2009, the cost savings realized since inception of the initiative totaled approximately $62 million and consist primarily of selling, general and administrative expenses. The remaining cost savings will be realized during fiscal 2010.

        During the third quarter of fiscal 2009, we began a review of our lease portfolio to accelerate the closure of underperforming locations and to identify opportunities to renegotiate rents under existing leases. The evaluation of our lease portfolio resulted in the closure of 109 fine jewelry stores and 10 kiosks in the fourth quarter of fiscal 2009. We recorded a charge during the fourth quarter associated with the

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closures totaling $27.0 million consisting, primarily of lease termination costs of $16.1 million, impairments related to long-lived assets of $8.9 million and severance costs of $1.1 million. We closed a total of 191 underperforming locations during calendar year 2009, of which 160 were fine jewelry stores and 31 were kiosks. The 191 closed locations had a negative contribution of approximately $14 million for the twelve months preceding closure and carried approximately $53 million of inventory. We have also finalized agreements or entered into agreements in principle on certain existing stores that will result in a reduction in aggregate rental obligations commencing in fiscal year 2010.

        In connection with the sale of the Bailey Banks & Biddle brand in November 2007, the buyer, Finlay Fine Jewelry Corporation ("Finlay"), assumed the obligations for the store operating leases. As a condition of this assignment, we remained contingently liable for the leases for the remainder of the respective current lease terms, which generally ranged from fiscal 2009 through fiscal 2017. The maximum potential liability for base rent payments under the leases totaled approximately $62 million as of July 31, 2009. As of October 29, 2009, we finalized agreements or reached agreements in principle with the landlords to settle the contingent lease obligations for 38 of 45 leases. Settlement discussion with respect to the contingent obligations for the remaining 7 locations are still under negotiation. Base rents for the remaining 7 stores totaled approximately $28 million as of July 31, 2009. On August 5, 2009, Finlay filed for Chapter 11 bankruptcy protection and subsequently decided to liquidate. We recorded a $23.2 million charge during the fourth quarter of fiscal 2009 associated with all 45 Bailey Banks & Biddle locations. The charge was based on the preliminary agreements reached with the landlords and expectations of future payments required to settle the contingent obligations for the remaining 7 leases.

        During the fiscal year ended July 31, 2009, the average Canadian currency rate depreciated by approximately 10 percent relative to the U.S. dollar. Due to our Canadian operations being reported at the average U.S. dollar equivalent, the depreciation in the Canadian dollar resulted in a $35.0 million decrease in reported revenues, substantially offset by a decrease in reported cost of sales and selling, general and administrative expenses of $17.2 million and $12.9 million, respectively. In addition, as a result of the depreciation in the Canadian dollar we recorded losses associated with the settlement of Canadian accounts payable totaling $8.6 million during the fiscal year ended July 31, 2009 compared to gains of $1.0 million during the same period in the prior year.

        Comparable store sales include internet sales and exclude revenue recognized from warranties and insurance premiums related to credit insurance policies sold to customers who purchase merchandise under our proprietary credit programs. The sales results of new stores are included beginning with their thirteenth full month of operation. The results of stores that have been relocated, renovated or refurbished are included in the calculation of comparable store sales on the same basis as other stores. However, stores closed for more than 90 days due to unforeseen events (e.g., hurricanes, etc.) are excluded from the calculation of comparable store sales.

        From time to time, we include non-GAAP measurements of financial information in Management's Discussion and Analysis of Financial Condition and Results of Operations. We use these measurements as part of our evaluation of the performance of the Company. In addition, we believe these measures provide useful information to investors, particularly in evaluating the performance of the Company in the current fiscal year as compared to prior periods.

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Results of Operations

        The following table sets forth certain financial information from our audited consolidated statements of operations expressed as a percentage of revenues and should be read in conjunction with our consolidated financial statements and notes thereto included elsewhere in this Form 10-K. Certain fiscal year 2008 amounts have been restated as a result of the adjustments previously described in Management's Discussion and Analysis of Financial Condition and Results of Operations.

Year Ended July 31, 2009 Compared to Year Ended July 31, 2008

        Revenues.    Revenues for fiscal year 2009 were $1,779.7 million, a decrease of 16.8 percent compared to revenues of $2,138.0 million for the same period in the prior fiscal year. Comparable store sales decreased 16.6 percent as compared to the same period in the prior year. The decrease in comparable store sales was driven by a 20.8 percent decrease in the number of customer transactions in our fine jewelry stores, partially offset by an increase in the average transaction price. We attribute the decline in the number of customer transactions primarily to the general decline in the overall retail environment. The decline was also due to a $35.0 million impact associated with the depreciation of the Canadian dollar and a decrease in the number of open stores, partially offset by a $10.6 million increase in revenues recognized related to lifetime warranties.

        The Fine Jewelry segment contributed $1,535.6 million of revenues in the fiscal year ended July 31, 2009, a decrease of 18.2 percent as compared to $1,876.2 million for the same period in the prior year.

        Revenues include $232.8 million for the Kiosk Jewelry segment compared to $249.5 million in the prior year, representing a decrease of 6.7 percent. The decrease relates primarily to a decline in the number of kiosks to 684 from 739 as of July 31, 2009 and 2008, respectively.

        The All Other segment contributed $11.3 million in revenues for the fiscal year ended July 31, 2009 as compared to $12.4 million for the same period in the prior year, representing a decrease of 8.7 percent.

        During the fiscal year ended July 31, 2009, we opened 14 stores in the Fine Jewelry segment. In addition, we closed 163 stores in the Fine Jewelry segment and 55 kiosks in the Kiosk Jewelry segment.

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        Cost of Sales.    Cost of sales includes cost of merchandise and services sold, as well as receiving and distribution costs. Cost of sales as a percentage of revenues was 53.3 percent for the year ended July 31, 2009, compared to 51.0 percent for the same period in the prior year. The increase is primarily due to an increase in store-wide discounts during the Holiday season and an inventory impairment charge recorded during the fourth quarter of fiscal 2009 totaling approximately 80 basis points associated with our decision to accelerate the sale of certain clearance merchandise. The increase was partially offset by an increase in revenues recognized associated with lifetime warranties.

        Our last-in, first-out ("LIFO") inventory charges were $1.0 million and $2.4 million for the fiscal years ended July 31, 2009 and 2008, respectively.

        Selling, General and Administrative.    Included in selling, general and administrative ("SG&A") are store operating, advertising, buying and general corporate overhead expenses. SG&A was 52.1 percent of revenues for the year ended July 31, 2009, compared to 46.1 percent for the same period in the prior year. On a dollar basis, SG&A decreased by $57.8 million to $927.2 million for the year ended July 31, 2009. The percentage increase is due to lower total revenues during the current year compared to the prior year. The dollar decrease is the result of expense reductions totaling $64.1 million and a $15.1 million decrease in incentive based compensation due to lower sales. The decrease was partially offset by a $6.7 million increase in legal settlement and severance costs and a $9.6 million increase in foreign currency losses.

        Depreciation and Amortization.    Depreciation and amortization as a percent of revenues for the year ended July 31, 2009 and 2008 was 3.3 percent and 2.8 percent, respectively. The increase is due to lower total revenues during the current year compared to the prior year, partially offset by store closures.

        Other Charges and Gains.    Other charges and gains for the year ended July 31, 2009 includes a $27.0 million charge associated with store closures, a $23.2 million charge related to the Bailey Banks & Biddle contingent lease obligation, a $14.9 million charge related to the impairment of long-lived assets associated with underperforming stores and a $5.0 million goodwill impairment charge related to a reporting unit in the Fine Jewelry segment. Other charges and gains for the year ended July 31, 2008 includes a $12.6 million benefit related to a change in our vacation policy and a $1.9 million charge related to the impairment of long-lived assets associated with underperforming stores.

        Interest Expense.    Interest expense as a percent of revenues for the year ended July 31, 2009 and 2008 was flat at 0.6 percent. Interest expense decreased by $2.0 million to $10.4 million for the year ended July 31, 2009. The weighted average effective interest rate decreased from 5.1 percent last year to 2.6 percent this year. The decrease in the weighted average effective interest rate was offset by an increase in average borrowings compared to the same period in the prior year and a decrease in total revenues.

        Other Income.    During the year ended July 31, 2008, we sold our interest in a diamond known as the "Incomparable Diamond" and recognized a gain of $3.5 million.

        Income Tax (Benefit) Expense.    The income tax benefit totaled $53.0 million for the year ended July 31, 2009, compared to a $4.8 million income tax expense for the year ended July 31, 2008. The income tax benefit for the year ended July 31, 2009 includes a net charge totaling $13.9 million related to our decision to revoke our election under Accounting Principles Board No. 23, "Accounting for Income Taxes-Special Areas" ("APB 23") and a $21.5 million charge related to uncertainties surrounding the utilization of net operating loss carryforwards. Income tax expense for the year ended July 31, 2008 includes a $4.3 million charge related to the expiration of certain net operating loss carryforwards.

Liquidity and Capital Resources

        Our cash requirements consist primarily of funding ongoing operations, including inventory requirements, capital expenditures for new stores, renovations of existing stores, upgrades to our

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information technology systems and distribution facilities and debt service. In addition, from time to time we have repurchased shares of our common stock.

        Net cash provided by operating activities decreased from $134.5 million for the year ended July 31, 2008 to $2.7 million for the year ended July 31, 2009. The decrease in cash provided by operating activities is primarily the result of operating losses generated during fiscal year 2009 compared to operating earnings for the same period in the prior year. The operating losses in the current year are primarily due to the general decline in the overall retail environment and an increase in store-wide discounts during the Holiday season. The decrease is also the result of a decrease in net cash received related to lifetime warranties of approximately $38 million. The decrease was partially offset by an approximately $38 million decrease in amounts due from vendors for returned merchandise and vendor deposits and an approximately $7 million increase in federal and state income tax refunds net of taxes paid.

        Our business is highly seasonal, with a disproportionate amount of sales (approximately 35 percent) occurring in November and December of each year, the Holiday season. Other important periods include Valentine's Day and Mother's Day. We purchase inventory in anticipation of these periods and, as a result, have higher inventory and inventory financing needs immediately prior to these periods. Owned inventory at July 31, 2009 was $740.3 million, a decrease of $58.9 million compared to July 31, 2008.

        Our cash requirements are funded through cash flows from operations, funds available under our U.S. revolving credit facility with a syndicate of lenders led by Bank of America, and vendor payment terms. As of July 31, 2009, our U.S. revolving credit facility provided for borrowings up to $500 million. Borrowings under the U.S. facility are capped at the lesser of (1) 73 percent of the cost of eligible inventory during October through December and 69 percent for the remainder of the year (minus certain reserves that may be established under the credit facility), plus 85 percent of credit card receivables or (2) 90 percent of the appraised liquidation value of eligible inventory (minus certain reserves that may be established under the credit facility), plus 85 percent of credit card receivables. The U.S. facility also provides for increased seasonal borrowing capabilities of up to $100 million and contains an accordion feature that allows us to permanently increase the facility size in $25 million increments up to an additional $100 million. Under the terms of the U.S. credit facility, we are required to maintain $50 million of borrowing availability or satisfy a minimum fixed charge coverage ratio of 1.1:1.0 for an applicable 12 month reference period. We do not currently meet the minimum fixed charge coverage ratio. Due to the seasonal nature of our business, borrowings under our credit facility during the Holiday season increase significantly and our borrowing availability must be closely managed. Based on our cash flow projections for the remainder of fiscal 2010, we believe our borrowing availability will remain above $50 million, which will not trigger the fixed charge coverage ratio. However, if we do not meet our cash flow projections, our borrowing availability threshold may not remain above $50 million. These cash flow projections are based on revenue and expenditure estimates for the remainder of fiscal 2010. We also manage availability under the credit facility by monitoring the timing of merchandise receipts and vendor payments. Our vendor terms are generally 30 to 60 days, but have decreased slightly during the year due to conditions in the credit markets.

        Based on an inventory appraisal performed as of June 30, 2009, the available borrowings under the U.S. credit facility are currently determined under item (2) described above. For the period of September 2009 through August 2010 monthly borrowing rates calculated from the cost of eligible inventory are as follows: 66 percent for September 2009, 73 percent for October 2009 through December 2009, and are projected to range from 60 percent to 63 percent for January 2010 through August 2010. These rates are subject to periodic adjustment under the provisions of the U.S. Agreement. In February 2009, we terminated our Canadian credit facility and entered into certain Joinder Agreements under which we utilize our Canadian and Puerto Rican subsidiaries' inventory, credit card receivables and certain other assets as collateral under the U.S. facility. The increase in collateral under the U.S. facility offset the decline in available borrowings that would have occurred as a result of the decrease in the appraised liquidation value. There were no borrowings outstanding under the Canadian facility at the time of termination.

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        Our credit facility expires in August 2011. Conditions in the credit markets are volatile and it is unclear under what terms we will be able to extend or replace the facility.

        As of July 31, 2009, we had cash and cash equivalents of $25.0 million and had approximately $136.1 million available under our revolving credit facilities. We believe that we have sufficient capacity under our revolving credit facilities to meet our financing needs during fiscal 2010.

        In February 2009, we announced inventory and cost savings initiatives expected to be realized through fiscal 2010 totaling approximately $75 million and $65 million, respectively. The inventory reductions are to be achieved by selling and not replenishing inventory in closed stores and improved productivity through more efficient store level allocation at existing stores. The inventory reductions achieved as of July 31, 2009 totaled approximately $54 million. As of July 31, 2009, the cost savings realized since inception of the initiative totaled approximately $26 million and consist primarily of selling, general and administrative expenses.

        In February 2008, we announced plans to permanently reduce inventory by $100 million and to achieve cost savings totaling in excess of $65 million. The inventory reductions were achieved as of July 2008. As of July 31, 2009, the cost savings realized since inception of the initiative totaled approximately $62 million and consist primarily of selling, general and administrative expenses. The remaining cost savings will be realized during fiscal 2010.

        During the third quarter of fiscal 2009, we began a review of our lease portfolio to accelerate the closure of underperforming locations and to identify opportunities to renegotiate rents under existing leases. The evaluation of our lease portfolio resulted in the closure of 109 fine jewelry stores and 10 kiosks in the fourth quarter of fiscal 2009. We recorded a charge during the fourth quarter associated with the closures totaling $27.0 million consisting primarily of lease termination costs of $16.1 million, impairments related to long-lived assets of $8.9 million and severance costs of $1.1 million. We have closed a total of 191 underperforming locations during calendar year 2009, of which 160 were fine jewelry stores and 31 were kiosks. The 191 closed locations had a negative contribution of approximately $14 million for the twelve months preceding closure and carried approximately $53 million of inventory. We have also finalized agreements or entered into agreements in principle on certain existing stores which will result in a reduction in aggregate rental obligations commencing in fiscal year 2010.

        In connection with the sale of the Bailey Banks & Biddle brand in November 2007, the buyer, Finlay Fine Jewelry Corporation, assumed the obligations for the store operating leases. As a condition of this assignment, we remained contingently liable for the leases for the remainder of the respective current lease terms, which generally ranged from fiscal 2009 through fiscal 2017. The maximum potential liability for base rent payments under the leases totaled approximately $62 million as of July 31, 2009. As of October 29, 2009, we finalized agreements or reached agreements in principle with the landlords to settle the contingent lease obligations for 38 of 45 lease guarantees. Settlement discussions with respect to the contingent obligations for the remaining 7 locations are still under negotiation. Base rents for the remaining 7 stores totaled approximately $28 million as of July 31, 2009. On August 5, 2009, Finlay filed for Chapter 11 bankruptcy protection and subsequently decided to liquidated. We recorded a $23.2 million charge during the fourth quarter of fiscal 2009 associated with all 45 Bailey Banks & Biddle locations. The charge was based on the preliminary agreements reached with the landlords and expectations of future payments required to settle the remaining 7 lease guarantees.

        Under arrangements with Citibank, N.A. and one of its subsidiaries (collectively, "Citibank"), Citibank provides financing for our customers to purchase merchandise through private label credit cards. The arrangements also enable us to write credit insurance. Customers use our Citibank arrangements to pay for approximately 40 percent of purchases in the U.S. and approximately 30 percent of purchases in Canada. Under the agreements governing our arrangements, our Canadian and U.S. subsidiaries must satisfy various financial and other covenants. As of May 2009, our Canadian subsidiary did not satisfy a fixed charge coverage covenant, which could allow Citibank to terminate the Canadian agreement upon

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30 days written notice, and our U.S. subsidiary did not satisfy a minimum sales threshold, which could allow Citibank to terminate the U.S. agreement upon 180 days written notice if certain cure provisions were not met by us. In June 2009, we amended the agreements with Citibank as follows: (1) Citibank waived its right to terminate both agreements for the covenant violations described above prior to March 2010, (2) we will provide Citibank a $5 million letter of credit and, for the period November 15 through February 14 of each year, an additional $10 million seasonal letter of credit in connection with our U.S. agreement, (3) the minimum sales threshold was lowered related to our U.S. subsidiary and (4) Citibank released its right to require us to purchase the U.S. receivable portfolio upon termination of the agreement as a result of our failure to meet the minimum sales threshold.

        During fiscal 2008, the Board of Directors authorized share repurchases of $350 million. As part of the stock repurchase program, we repurchased a total of 17.6 million shares of our common stock, or $326.7 million, in fiscal 2008. As of July 31, 2009, we have approximately $23.3 million in remaining authorization under our repurchase program.

Capital Growth

        During fiscal 2009, we invested approximately $7.0 million in capital expenditures to open 14 new stores in the Fine Jewelry segment. We invested approximately $17.4 million to remodel, relocate and refurbish 34 stores in our Fine Jewelry segment, and seven stores in our Kiosk Jewelry segment. We also invested $4.0 million in infrastructure, primarily related to our information technology and our distribution centers. We anticipate investing approximately $20 million in capital expenditures in fiscal year 2010, including eight new stores, primarily in the Peoples brand, and approximately $6 million in capital investments related to information technology infrastructure and support operations.

Contractual Obligations

        Aggregate information about our contractual obligations as of July 31, 2009 is presented in the following table (in millions):

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(a)

Long-term debt relates to principal payments due under our revolving credit agreement. This amount does not reflect any interest, which would be based on the current effective rate, which was 2.6 percent for fiscal 2009, and assumes no prepayments.

(b)

Operating lease obligations relate to minimum payments due under store lease agreements. Most of the store operating leases provide for the payment of base rentals plus real estate taxes, insurance, common area maintenance fees and merchant association dues. Real estate taxes, insurance, common area maintenance fees and merchant association dues were approximately 25 percent of base rentals for the year ended July 31, 2009.

(c)

We have an operations services agreement with a third party for the management of our client server systems, Local Area Network operations, Wide Area Network management and e-commerce hosting.

(d)

Other long-term liabilities reflect loss reserves related to credit insurance. We have reflected these payments under "Other," as the timing of these future payments is dependent on the actual processing of the claims.

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        Not included in the table above as contractual obligations are our obligations under employment agreements and ordinary course purchase orders for merchandise, including certain merchandise on consignment.

Recent Accounting Pronouncement

        In September 2006, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards ("SFAS") No. 157, "Fair Value Measurements," ("SFAS 157"). SFAS 157 clarifies the definition of fair value, describes methods used to appropriately measure fair value, and expands fair value disclosure requirements, but does not change existing guidance as to whether or not an instrument is carried at fair value. For financial assets and liabilities, SFAS 157 is effective for fiscal years beginning after November 15, 2007 and for non-financial assets and liabilities, SFAS 157 is effective for fiscal years beginning after November 15, 2008. The Company adopted SFAS 157 for financial assets and liabilities on August 1, 2008, as required. The adoption of SFAS 157 did not have a material impact on our consolidated financial statements.

        In May 2009, the FASB issued SFAS No. 165, "Subsequent Events," ("SFAS 165"). SFAS 165 establishes general standards of accounting for and disclosure of events that occur after the balance sheet date but before financial statements are issued or available to be issued. SFAS 165 is effective for interim or annual reporting periods ending after June 15, 2009. The Company adopted SFAS 165 for the fiscal year ended July 31, 2009, as required. The adoption of SFAS 165 did not have a material impact on our consolidated financial statements.

        In June 2009, the FASB issued SFAS No. 168, "The FASB Accounting Standards Codification and the Hierarchy of Generally Accepted Accounting Principles, a replacement of FASB Statement No. 162." ("SFAS 168"). SFAS 168 identifies the sources of accounting principles and the framework for selecting the principles to be used in the preparation of financial statements of nongovernmental entities that are presented in conformity with generally accepted accounting principles in the United States ("GAAP"). Rules and interpretive releases of the Securities and Exchange Commission ("SEC") are also sources of authoritative GAAP for SEC registrants. SFAS 168 is effective for financial statements issued for interim and annual periods ending after September 15, 2009. We do not expect the adoption of SFAS 168 to have a material effect on the consolidated financial statements.

Off-Balance Sheet Arrangements

        In connection with the sale of the Bailey Banks & Biddle brand in November 2007, the buyer, Finlay Fine Jewelry Corporation, assumed the obligations for the store operating leases. As a condition of this assignment, we remained contingently liable for the leases for the remainder of the respective current lease terms, which generally ranged from fiscal 2009 through fiscal 2017. The maximum potential liability for base rent payments under the leases totaled approximately $62 million as of July 31, 2009. As of October 29, 2009, we finalized agreements or reached agreements in principle with the landlords to settle the contingent lease obligations for 38 of 45 leases. Settlement discussions with respect to the contingent obligations for the remaining 7 locations are still under negotiation. Base rents for the remaining 7 stores totaled approximately $28 million as of July 31, 2009. On August 5, 2009, Finlay filed for Chapter 11 bankruptcy protection and subsequently decided to liquidate. We recorded a $23.2 million charge during the fourth quarter of fiscal 2009 associated with all 45 Bailey Banks & Biddle locations. The charge was based on the preliminary agreements reached with the landlords and expectations of future payments required to settle the contingent lease obligations for the remaining 7 leases.

Inflation

        In management's opinion, changes in revenues, net earnings, and inventory valuation that have resulted from inflation and changing prices have not been material during the periods presented. Although currently not material, recent increases in gold prices have negatively affected the cost of merchandise

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inventory. The inflation rates pertaining to merchandise inventories, especially as they relate to gold and diamond costs, are primary components in determining our last-in, first-out inventory and was approximately eight percent during fiscal year 2009. There is no assurance that inflation will not materially affect us in the future.

Critical Accounting Policies and Estimates

        Our significant accounting policies are disclosed in Note 1 of our consolidated financial statements. The following discussion addresses our most critical accounting policies, which are those that are both important to the portrayal of our financial condition and results of operations and that require significant judgment or use of complex estimates.

        Merchandise Inventories.    Merchandise inventories are stated at the lower of cost or market. Substantially all U.S. inventories represent finished goods which are valued using the LIFO retail inventory method. Merchandise inventory of Peoples Jewellers and Mappins Jewellers of Canada is valued using the first-in, first-out ("FIFO") retail inventory method. Under the retail method, inventory is segregated into categories of merchandise with similar characteristics at its current average 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. At the end of fiscal year 2009, approximately four percent of our total inventory represented raw materials and other inventory associated with internally sourced product. This inventory is valued at the weighted average cost of the items.

        We are 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. We apply internally developed indices that we believe accurately and consistently measure inflation or deflation in the components of our merchandise (i.e., diamonds, gold and other metals and precious stones) and our overall merchandise mix. We believe our internally developed indices more accurately reflect inflation or deflation in our own prices than the U.S. Bureau of Labor Statistics ("BLS") producer price indices or other published indices.

        We also reduce our inventory valuation for discontinued, slow-moving and damaged inventory. This write-down of inventory 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 and significant changes in physical inventory results could impact our shrinkage reserve.

        Impairment of Long-Lived Assets.    Long-lived assets are periodically reviewed for impairment by comparing the carrying value of the assets with their estimated undiscounted future cash flows. If the evaluation indicates that the carrying amount of the asset may not be recoverable, the potential impairment is measured based on a projected discounted cash flow method using a discount rate that is considered to be commensurate with the risk inherent in our 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, particularly store performance or market conditions, could result in an unanticipated impairment charge. For instance, in the event of a major market downturn or adverse developments within a particular market or portion of our business, 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.

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        Goodwill.    In accordance with Statement of Financial Accounting Standards No. 142, "Goodwill and Other Intangible Assets," we test goodwill for impairment annually, at the end of our 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. We calculate estimated fair value using the present value of future cash flows expected to be generated using weighted average cost of capital, terminal values and updated financial projections. If our actual results are not consistent with estimates and assumptions used to calculate fair value, we may be required to recognize additional goodwill impairments.

        Revenue Recognition.    We recognize revenue in accordance with the Securities and Exchange Commission's Staff Accounting Bulletin No. 104 "Revenue Recognition." Revenue related to merchandise sales, which is approximately 95 percent of total revenues, is recognized at the time of the sale, reduced by a provision for sales returns. The provision for sales returns is based on historical evidence of our return rate. Repair revenues are recognized when the service is complete and the merchandise is delivered to the customers. We offer our customers lifetime warranties on certain products that cover sizing and breakage, with an option to purchase theft protection for a two-year period. The revenue from the lifetime warranty is recognized on a straight-line basis over a five-year period. Revenues also include premiums from our insurance businesses, principally related to credit insurance policies sold to customers who purchase our merchandise under the proprietary credit program. Insurance premiums are recognized over the coverage period.

        Self-Insurance.    We are self-insured for certain losses related to general liability, workers' compensation and medical claims. Our liability represents an estimate of the ultimate cost of claims incurred as of the balance sheet dates. The estimated liability is not discounted and is established based upon analysis of historical data and actuarial estimates. While we believe these estimates are reasonable based on the information currently available, if actual trends, including the severity or frequency of claims, medical cost inflation, or fluctuations in premiums differ from our estimates, our results of operations could be impacted.

        Other Reserves.    We are 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 our 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. In addition, from time to time we close stores prior to the expiration of the lease term which requires us to record reserves associated with the leases. Certain assumptions are used in estimating lease reserves including the period of time that is required to finalize agreements with the landlords and the amounts that are required to terminate the leases. If our estimates and assumptions used to record these charges change, we may be required to record additional charges.

        Income taxes are estimated for each jurisdiction in which we operate. 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.

ITEM 7A.    QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

        We are exposed to market risk from changes in interest rates, which may adversely affect our financial position, results of operations and cash flows. We do not use derivative financial instruments for trading or other speculative purposes and are not party to any leveraged financial instruments.

        The investments of our insurance subsidiaries, primarily stocks and bonds, had an approximate market value at July 31, 2009 of $25 million.

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        Based on our market risk-sensitive instruments (including variable rate debt) outstanding at July 31, 2009, we have determined that there was no material market risk exposure to our consolidated financial position, results of operations or cash flows as of such date.

        Commodity Risk.    We principally address commodity risk through retail price point adjustments and have, from time to time, purchased forward contracts for gold and silver.

        Foreign Currency Risk.    We are not subject to substantial currency fluctuations because most of our purchases are U.S. dollar-denominated. However, as a result of our Canadian operations, we are exposed to market risk from currency rate exposures which may adversely affect our financial position, results of operations and cash flows. During the fiscal year ended July 31, 2009, the average Canadian currency rate depreciated by approximately 10 percent relative to the U.S. dollar. Due to our Canadian operations being reported at the average U.S. dollar equivalent, the depreciation in the Canadian dollar resulted in a $35.0 million decrease in reported revenues, substantially offset by a decrease in reported cost of sales and selling, general and administrative expenses of $17.2 million and $12.9 million, respectively. In addition, as a result of the depreciation of the Canadian dollar we recorded losses associated with the settlement of Canadian accounts payable totaling $8.6 million during the fiscal year ended July 31, 2009 compared to gains of $1.0 million during the same period in the prior year.

ITEM 8.    FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

        We refer you to the Index to Consolidated Financial Statements attached hereto on page 37 for a listing of all financial statements. The consolidated financial statements are included on pages F-1 through F-33. We incorporate these consolidated financial statements in this document by reference.

ITEM 9.    CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS AND FINANCIAL DISCLOSURE

        Not applicable.

ITEM 9A.    CONTROLS AND PROCEDURES

Disclosure Controls and Procedures

        At the end of the period covered by this Annual Report on Form 10-K, the Company conducted an evaluation, under the supervision and with the participation of our Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures. Based on that evaluation, the Chief Executive Officer and Chief Financial Officer have concluded that the Company's disclosure controls and procedures were not effective for the purpose of recording, processing, summarizing and timely reporting of material information required to be included in its periodic reports. Notwithstanding the material weaknesses discussed in Management's Report on Internal Control Over Financial Reporting referenced below, we concluded that the consolidated financial statements included in this Annual Report on Form 10-K fairly present, in all material respects, the Company's financial condition, results of operations and cash flows in conformity with generally accepted accounting principles.

Management's Report on Internal Control Over Financial Reporting

        Our Management's Report on Internal Control Over Financial Reporting is included on page F-1 of this Annual Report on Form 10-K. The report of Ernst & Young LLP, our independent registered public accounting firm, regarding the effectiveness of our internal control over financial reporting is included on page F-3 of this Annual Report on Form 10-K.

        There has been no change in our internal control over financial reporting that occurred during our most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, our

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internal control over financial reporting, although subsequent to the end of the quarter we have made various changes as a result of the ineffectiveness of controls.

ITEM 9B.    OTHER INFORMATION

        Not applicable.

PART III

ITEM 10.    DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE

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

Executive Officers

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

        Mr. Neal Goldberg has served as a director of the Company and as Chief Executive Officer of the Company since December 20, 2007. Mr. Goldberg also served as President of the Company from December 20, 2007 until August 5, 2008. From January 2004 until December 2007, Mr. Goldberg was the President of The Children's Place Retail Stores, Inc., a leading specialty retailer of children's merchandise marketed under "The Children's Place" and "Disney Store" brands. From April 10, 2005 until December 8, 2006, Mr. Goldberg also was an Executive Vice President of Hoop Holdings, LLC, a subsidiary of the Children's Place Retail Stores, Inc., which in March 2008, subsequent to Mr. Goldberg ending his affiliation, filed a bankruptcy petition. From September 2001 to October 2003 he was the President of The Gap Inc.'s Outlet Division, a distributor of clothing.

        Mr. Theo Killion has served as President of the Company since August 5, 2008. From January 23, 2008 to August 5, 2008, Mr. Killion served as Executive Vice President of Human Resources, Legal and Corporate Strategy. From May 2006 to January 2008, Mr. Killion was employed with the executive recruiting firm Berglass+Associates, focusing on companies in the retail, consumer goods and fashion industries. From April 2004 through April 2006, Mr. Killion served as Executive Vice President of Human Resources at Tommy Hilfiger. From 1996 to 2004, Mr. Killion served in various management positions with Limited Brands.

        Mr. Matthew W. Appel was named Executive Vice President of the Company effective May 2009 and appointed Chief Financial Officer of the Company on June 15, 2009. From March 2007 to May 2009, Mr. Appel served as Vice President and Chief Financial Officer of ExlService Holdings, Inc. Prior to ExlService Holdings, Inc, Mr. Appel was Vice President, BPO Product Management from 2006 to 2007 and Vice President, Finance and Administration BPO from 2003 through 2005 at Electronic Data Systems

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Corporation. From 2001 to 2003, Mr. Appel was the Senior Vice President, Finance and Accounting BPO at Affiliated Computer Services, Inc. Mr. Appel began his career with Arthur Andersen, where he spent seven years in their audit practice. Mr. Appel is a certified public accountant and certified management accountant.

        Mr. William Acevedo was appointed Executive Vice President, Chief Stores Officer of the Company effective April 11, 2008. Prior to joining the Company, Mr. Acevedo served as a Vice President of Banana Republic from 2002 to 2008. From April 1996 to May 2002, Mr. Acevedo served in various management positions with Macy's East.

        Mr. Gilbert P. Hollander was appointed Executive Vice President and Chief Sourcing and Supply Chain Officer in September 2007. Prior to that appointment, Mr. Hollander served as President, Corporate Sourcing/Piercing Pagoda beginning in May 2006, and was given the additional title of Group Senior Vice President in August 2006. From January 2005 to August 2006, he served as President, Piercing Pagoda. Prior to and up until that appointment, Mr. Hollander served as Vice President of Divisional Merchandise for Piercing Pagoda, to which he was appointed in August 2003. Mr. Hollander served as Senior Vice President of Merchandising for Piercing Pagoda from February 2000 to August 2003. Prior to February 2000, Mr. Hollander held various management positions within Piercing Pagoda beginning in May of 1997.

        Ms. Mary P. Kwan was appointed Executive Vice President, Chief Merchandising Officer of the Company on August 5, 2008. From 2006 to August 2008, Ms. Kwan served as President and Chief Merchandising Officer of Goody's Family Clothing. Ms. Kwan served as Senior Vice President, Merchandising and Design, Roxy Brand of Quicksilver Incorporated from 2004 to 2006. From 2002 to 2004, Ms. Kwan served as Vice President Merchandising, Marketing and Licensing, Value Channel of Levis Strauss & Company.

        Mr. Richard A. Lennox was named Executive Vice President, Chief Marketing Officer of the Company effective August 2009. Prior to joining the Company, Mr. Lennox served as Executive Vice President, Marketing Director at J. Walter Thompson—New York. Mr. Lennox started at J. Walter Thompson in 1989 and held various senior level marketing positions. He began his career in 1987 with AGB—London.

        Mr. James E. Sullivan was appointed Vice President, Controller and Chief Accounting Officer in July 2009. Mr. Sullivan served as Vice President, Financial Reporting and Compliance since joining the Company in January 2007. Prior to joining the Company, Mr. Sullivan served as Assistant Controller of Affiliated Computer Services, Inc. from October 2006 to January 2007. Mr. Sullivan was Senior Director, Financial Reporting for Brinker International, Inc. from July 2001 to September 2006 and previously served as a Senior Audit Manager for PricewaterhouseCoopers, LLP. Mr. Sullivan is a certified public accountant.

        The information set forth under the headings "Proposal No. 1: Election of Directors," "Corporate Governance," Executive Compensation and "Section 16(a) Beneficial Ownership Reporting Compliance" in our definitive Proxy Statement for the 2009 Annual Meeting of Stockholders is incorporated herein by reference.

ITEM 11.    EXECUTIVE COMPENSATION

        The information set forth under the headings "Compensation Discussion and Analysis," "Compensation Committee Report," "Compensation Committee Interlocks and Insider Participation" and "Director Compensation" in our definitive Proxy Statement for the 2009 Annual Meeting of Stockholders is incorporated herein by reference.

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ITEM 12.    SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS

        The information set forth under the headings "Outstanding Voting Securities of the Company and Principal Holders Thereof" and "Equity Compensation Plan Information" in our definitive Proxy Statement for the 2009 Annual Meeting of Stockholders is incorporated herein by reference.

ITEM 13.    CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE

        The information set forth under the headings "Independence of Board of Directors" and "Related Party Transactions" in our definitive Proxy Statement for the 2009 Annual Meeting of Stockholders is incorporated herein by reference.

ITEM 14.    PRINCIPAL ACCOUNTANT FEES AND SERVICES

        The information set forth under the heading "Independent Auditor Fee Information" in our definitive Proxy Statement for the 2009 Annual Meeting of Stockholders is incorporated herein by reference.

PART IV

ITEM 15.    EXHIBITS AND FINANCIAL STATEMENTS SCHEDULES

        The following documents are filed as part of this report.

1.

Financial Statements

        We make reference to the Index to Consolidated Financial Statements attached to this document on page 37 for a listing of all financial statement documents included on pages F-1 through F-33.

2.

Financial Statement Schedules

        All other financial statements and financial statement schedules for which provision is made in the applicable accounting regulation of the SEC are not required under the related instructions, are not material or are not applicable and, therefore, have been omitted or are included in the consolidated financial statements or notes thereto.

3.

Exhibits

        Each management contract or compensation plan required to be filed as an exhibit is identified by an asterisk (*).

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34

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35

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36

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INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

37

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MANAGEMENT'S REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING

        Management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Rule 13a-15(f) promulgated under Securities Exchange Act of 1934, as amended. The Company conducted an evaluation, under the supervision and with the participation of our Chief Executive Officer and Chief Financial Officer, of the effectiveness of our internal control over financial reporting as of July 31, 2009 using the criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. A material weakness is a deficiency, or combination of deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of the Company's annual or interim financial statements will not be prevented or detected on a timely basis. In its assessment of the effectiveness of internal control over financial reporting as of July 31, 2009, the Company determined that there were control deficiencies that constituted material weaknesses in the following areas:

•

The Company did not maintain effective controls over certain account reconciliations. Specifically, account reconciliations associated with advertising, depository bank accounts and intercompany accounts receivable lacked appropriate supporting documentation and were not reviewed in a satisfactory manner. This material weakness contributed to the restatement of the financial statements as of and for the year ended July 31, 2008 included in this Annual Report on Form 10-K.



•

The Company did not maintain effective segregation of duties and oversight with respect to its advertising programs. The responsibility to initiate and approve transactions was maintained by the same individual who determined the timing of when advertising transactions were recorded and expensed. In addition, the appropriate level of oversight did not exist to ensure that advertising transactions were recorded in the appropriate period. This material weakness contributed to the restatement of the financial statements as of and for the year ended July 31, 2008 included in this Annual Report on Form 10-K.

        As a result of these material weaknesses, management concluded that the Company did not maintain effective internal control over financial reporting as of July 31, 2009.

        The Company's management has taken, or is in the process of taking, various actions that are intended to remediate these material weaknesses. The Company's new Chief Financial Officer, appointed in June 2009, and its new Controller, appointed in July 2009, are overseeing the implementation of these remediation efforts, including:

•

The hiring of an Internal Audit leader and the addition of third party internal audit resources.



•

A review of the Company's internal controls, policies and procedures and organization structure relating to the areas where material weaknesses were identified.



•

The hiring of additional personnel and the retraining of existing personnel within its finance organization.

        The effectiveness of our internal control over financial reporting was audited by Ernst & Young LLP, an independent registered public accounting firm, as stated in their report on page F-3.

F-1

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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

The Board of Directors and Stockholders of
Zale Corporation:

        We have audited the accompanying consolidated balance sheet of Zale Corporation and subsidiaries as of July 31, 2009 and 2008, and the related consolidated statements of operations, stockholders' investment, and cash flows for the two years in the period ended July 31, 2009. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.

        We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

        In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Zale Corporation and subsidiaries at July 31, 2009 and 2008, and the consolidated results of their operations and their cash flows for each of the two years in the period ended July 31, 2009, in conformity with U.S. generally accepted accounting principles.

        As discussed in Note 2 to the financial statements, the accompanying fiscal 2008 financial statements have been restated.

        We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), Zale Corporation's internal control over financial reporting as of July 31, 2009, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated October 29, 2009 expressed an adverse opinion thereon.

/s/ ERNST & YOUNG LLP  

Dallas, Texas
October 29, 2009

F-2

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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

The Board of Directors and Stockholders of
Zale Corporation:

        We have audited Zale Corporation's internal control over financial reporting as of July 31, 2009, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (the COSO criteria). Zale Corporation's management is responsible for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting included in the accompanying Management's Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the company's internal control over financial reporting based on our audit.

        We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.

        A company's internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company's internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company's assets that could have a material effect on the financial statements.

        Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

        A material weakness is a deficiency, or combination of deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of the company's annual or interim financial statements will not be prevented or detected on a timely basis. The following material weaknesses have been identified and included in management's assessment:

•

The Company did not maintain effective controls over certain account reconciliations. Specifically, account reconciliations associated with advertising, depository bank accounts and intercompany accounts receivable lacked appropriate supporting documentation and were not reviewed in a satisfactory manner. This material weakness contributed to the restatement of the financial statements as of and for the year ended July 31, 2008.



•

The Company did not maintain effective segregation of duties and oversight with respect to its advertising programs. The responsibility to initiate and approve transactions was maintained by the same individual that determined the timing of when advertising transactions were recorded and expensed. In addition, the appropriate level of oversight did not exist to ensure that advertising

F-3

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transactions were recorded in the appropriate period. This material weakness contributed to the restatement of the financial statements as of and for the year ended July 31, 2008.

        These material weaknesses were considered in determining the nature, timing, and extent of audit tests applied in our audit of the 2009 financial statements, and this report does not affect our report dated October 29, 2009 on those financial statements.

        In our opinion, because of the effect of the material weaknesses described above on the achievement of the objectives of the control criteria, Zale Corporation has not maintained effective internal control over financial reporting as of July 31, 2009, based on the COSO criteria.

/s/ ERNST & YOUNG LLP  

Dallas, Texas
October 29, 2009

F-4

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ZALE CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS

(in thousands, except per share amounts)

See notes to the consolidated financial statements.

F-5

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ZALE CORPORATION AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

(in thousands, except per share amounts)

See notes to the consolidated financial statements.

F-6

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ZALE CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)

See notes to the consolidated financial statements.

F-7

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ZALE CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF STOCKHOLDERS' INVESTMENT

(in thousands)

See notes to the consolidated financial statements.

F-8

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ZALE CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

        Basis of Presentation.    We are, through our wholly owned subsidiaries, a leading specialty retailer of fine jewelry in North America. At July 31, 2009, we operated 1,247 specialty retail jewelry stores and 684 kiosks located mainly in shopping malls throughout the United States of America, Canada and Puerto Rico. We report our operations under three segments: Fine Jewelry, Kiosk Jewelry and All Other.

        Our Fine Jewelry segment is comprised of five brands, predominantly focused on the value-oriented consumer as our core customer target. Each brand specializes in fine jewelry and watches, with merchandise and marketing emphasis focused on diamond products. Additionally, each brand differentiates itself through a customer experience with different points of emphasis. Our brands have a centralized merchandising function that creates significant synergies and allows for teaming across brands. Zales Jewelers® is our national brand in the U.S. providing moderately priced jewelry to a broad range of customers. Zales Outlet® focuses on a slightly higher-income female self purchaser in outlet malls and neighborhood power centers. Gordon's Jewelers® is a value-oriented regional jeweler that caters to local fashions and emphasizes customer relationships. Peoples Jewellers®, our national brand in Canada, provides customers with an affordable assortment and an accessible shopping experience. Mappins Jewellers® offers Canadian customers a broad selection of merchandise from engagement rings to fashionable and contemporary fine jewelry. The brands in the Fine Jewelry segment have expanded their presence in the retail market through their e-commerce sites, zales.com and gordonsjewelers.com. During fiscal year 2009, our Fine Jewelry segment generated $1.5 billion of revenues.

        The Kiosk Jewelry segment operates under the brand names Piercing Pagoda®, Plumb Gold™, and Silver and Gold Connection® through mall-based kiosks and reaches the opening price point select jewelry customer. The Kiosk Jewelry segment specializes in gold and silver products that capitalize on the latest fashion trends. During fiscal year 2009, our Kiosk Jewelry segment generated $232.8 million of revenues.

        The accompanying consolidated financial statements and related notes are for the twelve month fiscal periods ended July 31, 2009 and 2008. Certain information included in the notes to the consolidated financial statements as of and for the year ended July 31, 2008 has been restated. We consolidate substantially all of our 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 our credit customers. We consolidate our Canadian retail operations into Zale International, Inc., which is a wholly owned subsidiary of Zale Corporation. All significant intercompany transactions have been eliminated.

        See Note 2 for information related to the restatement of our previously issued financial statements.

        Cash and Cash Equivalents.    Cash and cash equivalents include cash on hand, deposits in banks and short-term marketable securities at varying interest rates with original maturities of three months or less. Also included in cash equivalents are proceeds due from credit card transactions with settlement terms of less than five days. The carrying amount approximates fair value due to the short-term maturity of those instruments.

        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 average 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. At the end of fiscal year 2009,

F-9

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approximately four percent of our total inventory represented raw materials and other inventory associated with internally sourced product. This inventory is valued at the weighted average cost of the items. The LIFO charge was $1.0 million and $2.4 million for the years ended July 31, 2009 and 2008, respectively. The cumulative LIFO provision reflected in the accompanying consolidated balance sheets was $13.2 million and $12.2 million at July 31, 2009 and 2008, respectively. Domestic inventories on a FIFO basis were $652.9 million and $702.1 million at July 31, 2009 and 2008, respectively. Our Canadian inventory accounted for on the FIFO retail method was approximately $100.6 million and $109.3 million at July 31, 2009 and 2008, respectively.

        Consignment inventory and related contingent obligations are not reflected in our consolidated financial statements. Consignment inventory has historically consisted of test programs, merchandise at higher price points, or merchandise that otherwise does not warrant the risk of outright ownership. Consignment inventory can be returned to the vendor at any time. At the time consigned inventory is sold, we record the purchase liability in accounts payable and the related cost of merchandise in cost of sales. We had $71.5 million and $114.3 million of consignment inventory on hand at July 31, 2009 and 2008, respectively.

        We are 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. We apply internally developed indices that we believe accurately and consistently measure inflation or deflation in the components of our merchandise (i.e., the proper weighting of diamonds, gold and other metals and precious stones) and our overall merchandise mix. We believe our internally developed indices more accurately reflect inflation or deflation in our own prices than the U.S. Bureau of Labor Statistics producer price indices or other published indices.

        We also write-down our 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 and significant changes in physical inventory results, could impact our shrinkage reserve.

        Impairment of Long-Lived Assets.    Long-lived assets are reviewed for impairment by comparing the carrying value of the assets with their estimated future cash flows. If the evaluation indicates that the carrying amount of the asset may not be recoverable, the potential impairment is measured based on a projected discounted cash flow method, using a discount rate that is commensurate with the risk inherent in our current business model. Assumptions are made with respect to cash flows expected to be generated by the related assets based upon the most recent projections. Any changes in key assumptions, particularly store performance or market conditions, could result in an unanticipated impairment charge. For instance, in the event of a major market downturn or adverse developments within a particular market or portion of our business, individual stores may become unprofitable, which could result in a write-down of the carrying value of the assets located in those stores.

        Goodwill.    In accordance with Statement of Financial Accounting Standards ("SFAS") No. 142, "Goodwill and Other Intangible Assets," ("SFAS 142") we test goodwill for impairment annually, at the end of our second quarter, or more frequently if events occur which indicate a potential reduction in the

F-10

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fair value of a reporting unit's net assets below its carrying value. We calculate estimated fair value using the present value of future cash flows expected to be generated using weighted average cost of capital, terminal values and updated financial projections. If our actual results are not consistent with estimates and assumptions used to calculate fair value, we may be required to recognize additional goodwill impairments. See Note 6 for additional disclosures related to goodwill.

        Revenue Recognition.    We recognize revenue in accordance with the Securities and Exchange Commission's Staff Accounting Bulletin No. 104 "Revenue Recognition." Revenue related to merchandise sales, which is approximately 95 percent of total revenues, is recognized at the time of the sale, reduced by a provision for sales returns. The provision for sales returns is based on historical evidence of our return rate. Repair revenues are recognized when the service is complete and the merchandise is delivered to the customers. We offer our customers lifetime warranties on certain products that cover sizing and breakage, with an option to purchase theft protection for a two-year period. The revenue from the lifetime warranty is recognized on a straight-line basis over a five-year period. Revenues also include premiums from our insurance businesses, principally related to credit insurance policies sold to customers who purchase our merchandise under the proprietary credit program. Insurance premiums are recognized over the coverage period.

        In connection with the sale of our customer receivables in fiscal year 2000, we entered into a 10-year merchant services agreement whereby Citibank, N.A. issues private label credit cards branded with appropriate Company trademarks. We received a $41.8 million incentive for entering into the agreement that is being recognized ratably over 10 years. The deferred revenue related to this incentive as of July 31, 2009 and 2008 totaled $4.2 million and $8.4 million, respectively.

        Cost of Sales.    Cost of sales includes cost of merchandise sold, as well as receiving and distribution costs.

        Selling, General and Administrative.    Included in selling, general and administrative ("SG&A") are store operating, advertising, buying and general corporate overhead expenses.

        Operating Leases.    Rent expense is recognized on a straight-line basis, including consideration of rent holidays, tenant improvement allowances received from the landlords and applicable rent escalations over the term of the lease. The commencement date of the rent expense is the earlier of the date when we become legally obligated for the rent payments or the date when we take possession of the building for construction purposes.

        Depreciation and Amortization.    Buildings and leasehold improvements are stated at cost and are amortized using the straight-line method over the estimated useful lives of the assets or remaining lease life, whichever is shorter, which generally range from 5 to 10 years. Fixtures and equipment are amortized using the straight-line method over the estimated useful lives of the assets, which range from 3 to 15 years. Original cost and related accumulated depreciation or amortization is removed from the accounts in the year assets are retired. Gains or losses on dispositions of property and equipment are recorded in the year of disposal and are included in SG&A in the accompanying consolidated statements of operations. Repairs and maintenance costs are expensed as incurred.

        Stock-Based Compensation.    Stock-based compensation is accounted for under SFAS No. 123 (Revised 2004), "Share-Based Payment" ("SFAS 123(R)"), which requires the use of the fair value method of accounting for all stock-based compensation, including stock options. Stock-based compensation expense for fiscal 2009 and 2008 includes compensation expense for new share-based awards and for share-based awards granted prior to, but not yet vested, as of July 31, 2005.

        Preferred Stock.    At July 31, 2009 and 2008, 5.0 million shares of preferred stock, par value of $0.01, were authorized. None were issued or outstanding.

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        Credit Insurance Operations.    Insurance premium revenue from credit insurance subsidiaries was $11.3 million and $12.4 million for the fiscal years ended July 31, 2009 and 2008, respectively. These insurance premiums are included in revenues in the accompanying consolidated statements of operations.

        Self-Insurance.    We are self-insured for certain losses related to general liability, workers' compensation and medical claims. Our liability represents an estimate of the ultimate cost of claims incurred as of the balance sheet dates. The estimated liability is not discounted and is established based upon analysis of historical data and actuarial estimates. While we believe these estimates are reasonable based on the information currently available, if actual trends, including the severity or frequency of claims, medical cost inflation, or fluctuations in premiums differ from our estimates, our results of operations could be impacted.

        Advertising Expenses.    Advertising is generally expensed when the advertisement is utilized and is a component of SG&A. All related production costs are expensed upon the first occurrence of the advertisement. Advertising expenses were $87.9 million and $96.3 million for the fiscal years ended July 31, 2009 and 2008, respectively, net of amounts contributed by vendors. The amounts of prepaid advertising at July 31, 2009 and 2008 were $0.9 million and $2.2 million, respectively, and are classified as components of other current assets in the accompanying consolidated balance sheets.

        Vendor Allowances.    We receive cash or allowances from merchandise vendors primarily in connection with cooperative advertising programs and reimbursements for markdowns taken to sell the vendor's products. We have 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. Qualifying vendor reimbursements of costs incurred to specifically advertise vendors' products are recorded as a reduction of advertising expense. All other allowances or cash payments received are recorded as a reduction to the cost of merchandise. Vendor allowances included in advertising expense totaled $5.9 million and $4.3 million for the fiscal years ended July 31, 2009 and 2008, respectively. Vendor allowances included in cost of sales totaled $1.3 million for the year ended July 31, 2009. There were no vendor allowances included in cost of sales for the year ended July 31, 2008.

        Income Taxes.    Income taxes are accounted for under the asset and liability method prescribed by SFAS No. 109, "Accounting for Income Taxes." Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and operating loss and tax credit carryforwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. A valuation allowance is recorded to reduce the carrying amounts of deferred tax assets unless it is more likely than not such assets will be realized.

        Effective August 1, 2007, we adopted the provisions of the Financial Accounting Standards Board's Interpretation No. 48, "Accounting for Uncertainty in Income Taxes" ("FIN 48"). As a result of the adoption of FIN 48 in the first quarter of fiscal 2008, we recognized a decrease of $0.6 million in the liability for unrecognized tax benefits, net of the federal deferred tax benefit, with a corresponding increase to accumulated earnings.

        We file income tax returns in the U.S. federal jurisdiction, in various states and in certain foreign jurisdictions. We are no longer subject to U.S. federal examinations by tax authorities for fiscal years before July 31, 2005. We are subject to audit by taxing authorities of most states and certain foreign jurisdictions and are subject to examination by these taxing jurisdictions for fiscal years generally after July 31, 2004.

        Sales Tax.    We present revenues net of taxes collected and record the taxes as a liability in the consolidated balance sheets until the taxes are remitted to the appropriate taxing authority.

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        Foreign Currency.    Translation adjustments result from translating foreign subsidiaries' financial statements into U.S. dollars. Balance sheet accounts are translated at exchange rates in effect at the balance sheet date. Income statement accounts are translated at average exchange rates during the period. Resulting translation adjustments are included as a component of comprehensive income in the accompanying consolidated statements of stockholders' investment.

        Earnings Per Common Share.    Basic earnings per common share is computed by dividing income available to common stockholders by the weighted average number of common shares outstanding for the reporting period. Diluted earnings per share reflect the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock. For the calculation of diluted earnings per share, the basic weighted average number of shares is increased by the dilutive effect of stock options and restricted share awards determined using the treasury stock method. There were antidilutive stock options of 2.6 million as of July 31, 2009 and 2008.

        We incurred a net loss of $189.5 million for the year ended July 31, 2009. A net loss causes all outstanding stock options and restricted share awards to be antidilutive (that is, the potential dilution would decrease the loss per share). As a result, the basic and dilutive losses per common share are the same.

        Financial Instruments.    In September 2006, the Financial Accounting Standards Board issued SFAS No. 157, "Fair Value Measurements," ("SFAS 157"). SFAS 157 clarifies the definition of fair value, describes methods used to appropriately measure fair value, and expands fair value disclosure requirements, but does not change existing guidance as to whether or not an instrument is carried at fair value. For financial assets and liabilities, SFAS 157 was effective for fiscal years beginning after November 15, 2007 and for non-financial assets and liabilities, SFAS 157 was effective for fiscal years beginning after November 15, 2008. The Company adopted SFAS 157 on August 1, 2008, as required. The adoption of SFAS 157 did not have a material impact on our consolidated financial statements.

        SFAS 157 establishes a three-tier fair value hierarchy, which prioritizes the inputs used in measuring fair values. These tiers include:

        As cash and short-term cash investments, trade payables and certain other short-term financial instruments are all short-term in nature, their carrying amount approximates fair value.

        The fair value of the $310.5 million of borrowings under our revolving credit facility totaled approximately $304 million as of July 31, 2009. The fair value was based on estimates of current interest rates for similar debt.

        The investments of our insurance subsidiaries, primarily stocks and bonds, are accounted for as available-for-sale securities and are reflected in other assets in the accompanying consolidated balance sheets. The fair values of these instruments as of July 31, 2009 and 2008 were approximately $25 million and $28 million, respectively, and are based on quoted market prices in an active market, a Level 1 measurement in the fair value hierarchy.

        Concentrations of Business and Credit Risk.    During fiscal year 2009, we purchased approximately 12 percent of our finished merchandise from five vendors with no single vendor exceeding three percent, compared to approximately 14 percent in the same period of the prior year. In fiscal years 2009 and 2008, approximately 16 percent and 13 percent, respectively, of our merchandise requirements were provided by

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our internal sourcing organization. If purchases from these top vendors were disrupted, particularly at certain critical times during the year, our sales could be adversely affected in the short term until alternative supply arrangements could be established. As of July 31, 2009 and 2008, we had no significant concentrations of credit risk.

        Use of Estimates.    Our accounting and financial reporting policies are in conformity with U.S. generally accepted accounting principles. The preparation of financial statements in conformity with U.S. generally accepted accounting principles 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 valuation, goodwill and long-lived asset valuation, LIFO inventory retail method, legal liability, credit insurance liability, product warranty, depreciation, workers' compensation, tax and contingencies. Estimates and assumptions are reviewed periodically and the effects of revisions are reflected in the consolidated financial statements in the period they are determined to be necessary.

        Reclassifications.    The classifications in use at July 31, 2009 have been applied to the restated financial statements for July 31, 2008.

        Subsequent Events.    We have evaluated subsequent events through the issuance of the financial statements, which occurred on October 29, 2009.

2. RESTATEMENT OF PREVIOUSLY ISSUED FINANCIAL STATEMENTS

        On September 17, 2009, management of Zale Corporation (the "Company") and the Audit Committee of the Company's Board of Directors, concluded that the Company's previously issued consolidated financial statements for fiscal years 2008 and prior periods required restatement as a result of adjustments associated with advertising costs, intercompany accounts receivable, depository bank accounts, federal income taxes and personal property taxes.

        The tables below provide a reconciliation of our consolidated statement of operations and balance sheet for fiscal year 2008 from amounts previously reported to the restated amounts. We also have included a reconciliation of certain line items affected within our consolidated statement of cash flows for fiscal year 2008 from amounts previously reported to the restated amounts. Our consolidated statement of stockholders' investment as of July 31, 2008 reflects the cumulative effect of the restatement as of July 31, 2007 for those items that impacted fiscal year 2007 and prior. Following the tables are additional disclosures surrounding each item affecting the restatements.

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CONSOLIDATED STATEMENT OF OPERATIONS
YEAR ENDED JULY 31, 2008
(in thousands, except per share amounts)

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