Executive Summary

Our 2008 net sales reflect the impact of reduced discretionary consumer spending as a result of the slowdown in the U.S. economy. Partially offsetting the decrease in comparable store sales were the positive results of strong inventory and expense management.

Total net sales for 2008 were $16 billion, a 0.5% decrease from 2007. Comparable store sales decreased 6.9% as the result of a 5.9% decrease in the number of transactions per store and a 1.0% decrease in average transaction value. Accessories reported the strongest comparable store sales. The Northeast, Midwest and Mid-Atlantic regions had the strongest comparable store sales for 2008.

Gross margin as a percent of net sales was 36.9% for 2008, a 44 basis point improvement over 2007. Conservative inventory management, lower levels of clearance inventory, and increased penetration of private and exclusive brands contributed to the margin strength, despite the difficult economic environment. Inventory per store at year-end 2008 decreased 9.3% compared to year-end 2007.

Selling, general and administrative expenses increased 6.5% over 2007. As expected, these expenses increased more than sales, but less than new store growth of 8.1%.

Net income for 2008 was $885 million, or $2.89 per diluted share, compared with $1.1 billion or $3.39 per diluted share for 2007.

As of year-end 2008, we operated 1,004 stores, with 75 million square feet of selling space, in 48 states compared to 929 stores, with 70 million square feet of selling space, in 47 states as of year-end 2007. In 2009, we are planning to open approximately 55 new stores. We are also planning to remodel 51 stores, an increase from 36 remodels in 2008.

We believe our capital structure is well positioned to continue to support our expansion plans. We expect internally generated cash flows to continue to be our primary source of the funding required for future growth.

For 2009, we currently expect total sales to decrease in the range of 4% to 1% and comparable store sales to decrease in the range of 8% to 5% compared to 2008. We currently expect gross margin as a percentage of sales to be flat to up 10 basis points over 2008 and SG&A expense to increase 3% to 4% over 2008. Achieving these expectations would result in earnings per diluted share in the range of $2.00 to $2.30 for fiscal 2009.

Results of Operations

Our fiscal year ends on the Saturday closest to January 31. Unless otherwise noted, references to years in this report relate to fiscal years, rather than to calendar years. Fiscal year 2008 ("2008") ended on January 31, 2009 and was a 52-week year. Fiscal year 2007 ("2007") ended on February 2, 2008 and was a 52-week year. Fiscal year 2006 ("2006") ended on February 3, 2007 and was a 53-week year.

Net sales.

                                                 2008          2007          2006
       Net sales (in millions)                 $ 16,389      $ 16,474      $ 15,597
       Number of stores:
       Open at end of period                      1,004           929           817
       Comparable stores (a)                        817           732           637
       Sales growth:
       All stores                                  (0.5 %)        5.6 %        16.0 %
       Comparable stores (a)                       (6.9 %)       (0.8 %)        5.9 %
       Net sales per selling square foot (b)   $    222      $    249      $    256

(a) Comparable stores sales growth is based on sales for stores (including e-commerce sales and relocated or expanded stores) which were open throughout both the full current and prior year periods. Fiscal 2006 was a 53-week year. Comparable store sales growth for 2006 is presented for the 52-weeks ended January 27, 2007 and excludes approximately $200 million in sales which were earned in the 53rd week of that year.

(b) Net sales per selling square foot is based on stores open for the full current period, excluding e-commerce. Fiscal 2006 excludes the impact of the 53rd week.

Net sales for 2008 decreased $85 million, or 0.5%, from 2007. New stores contributed $1.0 billion to the increase in net sales over the prior year. Comparable store sales decreased $1.1 billion, or 6.9%, as the result of a 5.9% decrease in the number of transactions per store and a 1.0% decrease in average transaction value. We opened 75 new stores in 2008, 112 stores in 2007 and 85 stores in 2006. As we open new stores, especially in existing markets, sales may be transfered from existing stores. We estimate that opening new stores in existing markets negatively impacted comparable store sales by approximately 1% in 2008.

From a line of business perspective, Accessories reported the strongest comparable store sales with strength in sterling silver jewelry and accessories/handbags. Children's, Men's and Footwear outperformed the company's comparable store sales for the year, while Women's and Home trailed the company.

The Northeast, Midwest and Mid-Atlantic regions reported the strongest comparable store sales for 2008. E-commerce revenues increased 48% to $356 million for 2008 as we continue to expand the selections offered on-line.

Net sales per selling square foot decreased 11% to $222 in 2008. The decrease is primarily due to the decrease in comparable store sales. The remaining decrease is attributable to the percentage of stores opened in southern regions in 2007. The southern regions have been impacted more by the economic downturn than other regions.

Net sales for 2007 increased $877 million, or 5.6%, over 2006. New stores contributed $998 million to the increase in net sales over the prior year. Comparable store sales decreased $121 million, or 0.8%, as the result of a 1.4% decrease in the number of transactions per store, partially offset by a 0.6% increase in average transaction value. From a line of business perspective, Accessories reported the strongest comparable store sales in 2007 with strength in beauty and jewelry. Men's and Footwear outperformed the company for the year, while Women's and Home trailed the company. The Northeast region led our comparable store sales for 2007. E-commerce revenues increased 31% to $241 million for 2007 as we continued to expand the selections offered on-line.

As reflected in the table below, our merchandise mix has remained relatively constant over the last three years:

                                       2008     2007     2006
                         Women's         32 %     33 %     33 %
                         Men's           19       19       19
                         Home            18       18       18
                         Children's      13       13       13
                         Accessories     10        9        9
                         Footwear         8        8        8

Gross margin.

                                            2008        2007        2006
                                                (Dollars in millions)
               Gross margin                $ 6,055     $ 6,014     $ 5,675
               As a percent of net sales      36.9 %      36.5 %      36.4 %

Gross margin includes the total cost of products sold, including product development costs, net of vendor payments other than reimbursement of specific, incremental and identifiable costs; inventory shrink; markdowns; freight expenses associated with moving merchandise from our vendors to our distribution centers; shipping and handling expenses of e-commerce sales; and terms cash discount. Our gross margin may not be comparable with that of other retailers because we include distribution center costs in selling, general and administrative expenses while other retailers may include these expenses in cost of merchandise sold.

The net $41 million, or 0.7%, increase in gross margin dollars for 2008 compared to 2007 reflects incremental sales at newly-opened stores, substantially offset by decreases at comparable stores. The improvement in gross margin as a percent of net sales for 2008 compared to 2007 was driven by the continued impact of our merchandise and inventory management initiatives and increased penetration of private and exclusive brands. Sales of private and exclusive brands reached approximately 42% of net sales for 2008, an increase of over 260 basis points over 2007.

Gross margin for 2007 increased $339 million, or 6.0%, over 2006. The improvement in gross margin as a percent of net sales for 2007 compared to 2006 was driven by the continued impact of our merchandise and inventory management initiatives, improved markup and shortage results, the adoption of our markdown optimization systems, and increased penetration of private and exclusive brands. Sales of private and exclusive brands were approximately 39% of net sales for 2007, an increase of over 300 basis points over 2006.

Selling, general and administrative expenses.

                                                      2008        2007        2006
                                                          (Dollars in millions)
     Selling, general, and administrative expenses   $ 3,936     $ 3,697     $ 3,422
     As a percent of net sales                          24.0 %      22.4 %      21.9 %

Selling, general and administrative expenses ("SG&A") include compensation and benefit costs (including stores, headquarters, buying and merchandising and distribution centers); occupancy and operating costs of our retail, distribution and corporate facilities; freight expenses associated with moving merchandise from our distribution centers to our retail stores, and among distribution and retail facilities; advertising expenses, offset by vendor payments for reimbursement of specific, incremental and identifiable costs; net operations of servicing the Kohl's credit card; and other administrative costs. Depreciation and amortization and preopening expenses are not included in SG&A. The classification of these expenses varies across the retail industry.

SG&A for 2008 increased $239 million, or 6.5%, over 2007. The net increase in SG&A dollars reflects incremental costs at newly-opened stores, partially offset by decreases at comparable stores reflecting our ongoing efforts to control costs in the current economic environment. As expected, SG&A increased more than sales, but less than new store growth of 8.1%.

Distribution center costs, which are included in SG&A, totaled $166 million for 2008, $165 million for 2007 and $150 million for 2006. These costs reflect the benefits of investments in technology in our distribution centers that continue to generate operating efficiencies.

The revenue-sharing agreement related to our Kohl's credit card accounts generated higher revenues in 2008 than in 2007. Even though we continue to see an increase in the number of accounts which carry balances and are ultimately charged-off, these increases were more than offset by increases in finance charges and late charge fees.

Net advertising costs increased $51 million to $890 million for 2008. As a result of current market conditions, we made a conscious decision to increase advertising costs in 2008, including the most aggressive holiday marketing campaign in our history.

SG&A for 2007 increased $275 million, or 8.0%, over 2006. Even though the increase in SG&A was higher than the increase in sales, it was lower than new store growth of 13.8%. We achieved leverage in credit and corporate expenses for 2007, but stores, advertising and distribution centers did not leverage primarily due to lower comparable store sales, our desire to maintain a positive customer in-store experience and incremental marketing expenses associated with the launch of new brand initiatives and new store openings. These increases were partially offset by lower incentive compensation expenses.

Depreciation and amortization.

                                               2008          2007      2006
                                                  (Dollars in millions)
              Depreciation and amortization   $   541       $  452     $ 388
              As a percent of net sales           3.3 %        2.7 %     2.5 %

The increases in depreciation and amortization are primarily due to the addition of new stores and the mix of owned compared to leased stores.

Preopening expenses.

                                                      2008    2007    2006
              Preopening expenses (in millions)       $  42   $  61   $  50
              Number of stores opened                    75     112      85
              Average cost per store (in thousands)   $ 570   $ 500   $ 580

Preopening expenses include the costs incurred prior to new store openings, such as advertising, hiring and training costs for new employees, processing and transporting initial merchandise, and rent expense. The average cost per store fluctuates based on the mix of stores opened in new markets compared to existing markets (with new markets being more expensive) and the mix of leased and owned stores (with leased stores being more expensive).

The increase in the average cost per store for 2008 compared to 2007 is primarily due to an increase in the number of ground leased stores which were opened in 2008. Under GAAP, we are required to recognize rent expense when we take possession of the property, so must recognize rental expense for ground leased properties several months prior to the actual opening of the store and, in most cases, before rental payments are due. The decrease in the average cost per store for 2007 compared to 2006 is due to shifting more advertising to the post-grand opening period and to an increase in the percentage of stores which were opened in existing markets rather than new markets.

Operating income.

                                            2008        2007        2006
                                                (Dollars in millions)
               Operating income            $ 1,536     $ 1,804     $ 1,815
               As a percent of net sales       9.4 %      11.0 %      11.6 %

The changes in operating income and operating income as a percent of net sales are due to the factors discussed above.

Interest expense.

2008 2007 2006

Net interest expense for 2008 increased $49 million, or 79%, over 2007 primarily due to the $1 billion in new debt that was issued in September 2007. Reductions in capitalized interest due to lower capital expenditures also contributed to the increase.

Net interest expense for 2007 increased $21 million, or 51%, over 2006 primarily due to higher outstanding debt balances, including both advances on our short-term credit facilities and $1 billion in new debt that was issued in September 2007. Lower interest income on investments also contributed to the increase as we used proceeds from the 2007 debt issuance and the 2006 sale of our credit card portfolio to fund stock repurchases. These increases were partially offset by higher capitalized interest due to increased capital expenditures.

Income taxes.

                                              2008        2007       2006
                                                (Dollars in millions)
               Provision for income taxes   $    540     $  658     $  665
               Effective tax rate               37.9 %     37.8 %     37.5 %

The effective tax rate for 2008 was comparable to the 2007 rate. The increase in the effective tax rate for 2007 compared to 2006 was primarily due to a decrease in the amount of tax-exempt interest earned in 2007 compared to 2006 and a shift in the mix of new stores in certain jurisdictions. The tax rate for 2006 benefited from the tax-free interest earned on investments.

Inflation

Although we expect that our operating results will be influenced by general economic conditions, including fluctuations in food, fuel and energy prices, we do not believe that inflation has had a material effect on our results of operations during the periods presented. However, there can be no assurance that our business will not be affected by inflation in the future.

Liquidity and Capital Resources

Our primary ongoing cash requirements are for capital expenditures in connection with our expansion and remodeling programs and seasonal and new store inventory purchases. Our working capital and inventory levels typically build throughout the fall, peaking during the November and December holiday selling season.

Our primary sources of funds are cash flow provided by operations, short-term trade credit and our lines of credit. Short-term trade credit, in the form of extended payment terms for inventory purchases, represents a significant source of financing for merchandise inventories. Seasonal cash needs are met by the lines of credit available under our $900 million revolving credit facility.

We anticipate that we will be able to satisfy our working capital requirements, planned capital expenditures and debt service requirements with available cash and short-term investments, proceeds from cash flows from operations, short-term trade credit, seasonal borrowings under our revolving credit facility and other sources of financing. We expect to generate adequate cash flow from operating activities to sustain current levels of operations.

                                               2008         2007         2006
                                                   (Dollars in millions)
           Net cash provided by (used in):
           Operating activities              $  1,701     $  1,235     $  3,120
           Investing activities                (1,442 )     (1,568 )     (1,440 )
           Financing activities                  (273 )        325       (1,618 )

Operating activities.

Despite the decrease in net income, cash provided by operations increased 38% over 2007 to $1.7 billion in 2008. This increase in operating cash flow was primarily attributable to a $335 million reduction in cash used for inventory purchases.

At January 31, 2009, total merchandise inventories decreased $57 million, or 2%, from year-end 2007. On a per store basis, merchandise inventories at January 31, 2009 decreased 9.3% from year-end 2007. Clearance inventory units per store are down approximately four times as much as merchandise inventories per store. These reductions are the result of our conservative sales and receipt planning.

Accounts payable at January 31, 2009 increased $45 million from year-end 2007. Accounts payable as a percent of inventory was 31.5% at January 31, 2009, compared to 29.3% at year-end 2007, primarily due to strong inventory management, our cycle time reduction initiatives and improved vendor financing management.

The $1.9 billion decrease in net cash provided by operating activities for 2007 compared to 2006 was primarily due to the cash proceeds of $1.6 billion received in April 2006 in conjunction with the sale of our proprietary credit card portfolio. The primary use of operating cash flow for 2007 was an increase in merchandise inventories of $275 million. The primary source of operating cash flow for 2007 was a $149 million increase in accrued and other long-term liabilities. Accounts payable was a $98 million use of operating cash flow in 2007, compared to a $104 million source of operating cash flow in 2006.

Merchandise inventories used net cash of $275 million in 2007. The 11% increase in our ending inventory balance from year-end 2006 to 2007 was primarily due to the increase in the number of stores. On a per store basis, merchandise inventories at year-end 2007 decreased 2.6% from year-end 2006, due to conservative receipt plans for Spring 2008.

Accounts payable at year-end 2007 decreased $98 million from year-end 2006. Accounts payable as a percent of inventory was 29.3% at year-end 2007, compared to 36.2% at year-end 2006, reflecting reduced receipts of Spring 2008 merchandise as a result of conservative sales planning and increased vendor allowances.

Investing activities.

Net cash used in investing activities was $1.4 billion in 2008, compared to $1.6 billion in 2007 as decreases in capital expenditures were substantially offset by a comparable decrease in net investment activity.

Net purchases and sales of investments used cash of $439 million in 2008 and $52 million in 2007. As of January 31, 2009, we had investments in auction rate securities ("ARS") with a par value of $407 million and an estimated fair value of $332 million. ARS are long-term debt instruments with interest rates reset through periodic short term auctions, which are typically held every 35 days. Beginning in February 2008, liquidity issues in the global credit markets resulted in the failure of auctions for substantially all of our ARS. A "failed" auction occurs when the amount of securities submitted for sale in the auction exceeds the amount of purchase bids. As a result, holders are unable to liquidate their investment through the auction. A failed auction is not a default of the debt instrument, but does set a new interest rate in accordance with the terms of the debt instrument. A failed auction limits liquidity for holders until there is a successful auction, another market for ARS develops or the debt matures. ARS are generally callable by the issuer at any time. Scheduled auctions continue to be held until the ARS matures or is called. Proceeds from the sale of ARS were $93 million in 2008, including $17 million which were called at par subsequent to February 2008.

To date, we have collected all interest payable on outstanding ARS when due and expect to continue to do so in the future. At this time, we have no reason to believe that any of the underlying issuers of our ARS or their insurers are presently at risk. While the auction failures limit our ability to liquidate these investments, we believe that the ARS failures will have no significant impact on our ability to fund ongoing operations and growth initiatives.

Capital expenditures include costs for new store openings, store remodels, distribution center openings and other base capital needs. Capital expenditures totaled $1.0 billion for 2008, a $528 million decrease from 2007. This decrease is primarily due to a decrease in the number of new store openings in 2008 compared to 2007. We opened 75 stores in 2008 compared to 112 stores in 2007. Total capital expenditures for fiscal 2009 are expected to be approximately $800 million. The actual amount of our future capital expenditures will depend primarily on the number of new stores opened, the mix of owned, leased or acquired stores, the number of stores remodeled and the timing of distribution center openings. We do not anticipate that our expansion plans will be limited by any restrictive covenants in our financing agreements. We believe that our capital structure is well positioned to support our expansion plans. We anticipate that internally generated cash flows will be the primary source of funding for future growth.

Capital expenditures, including favorable lease rights, by major category were as follows:

                                                              2008        2007        2006
New stores                                                      68 %        77 %        76 %
Remodels / relocations                                          12           6           2
Distribution centers                                             4           3           6
Other                                                           16          14          16

Acquisition of property and equipment and favorable
lease rights                                                   100 %       100 %       100 %

Net cash used in investing activities increased $128 million for 2007 compared to 2006. The increase reflects higher capital expenditures, partially offset by the net impact of short-term investing activities. Net short-term investment activity resulted in a use of funds of $52 million in 2007 and $270 million in 2006. Net short-term investment activity reflects investment funds used to purchase treasury stock and the investment of proceeds from the $1 billion of new debt issued in September 2007 and the sale of our private label credit card portfolio in 2006. Capital expenditures totaled $1.5 billion for 2007, a $379 million increase over 2006 primarily due to an increase in the number of stores opened and an increase in the number of remodels.

Financing activities.

Our financing activities used cash of $273 million in 2008 and provided cash of $325 million in 2007. The change reflects the proceeds from issuance of debt in 2007 and lower treasury stock repurchases in 2008.

We have various facilities upon which we may draw funds, including a $900 million senior unsecured revolving facility and two demand notes with aggregate availability of $50 million. The $900 million revolving facility expires in October 2011. The co-leads of this facility, The Bank of New York Mellon and Bank of America, have each committed $100 million. The remaining 12 lenders have each committed between $30 and $130 million.

We had no amounts outstanding on our lines of credit at either year-end 2008 or year-end 2007. Average borrowings under these facilities were $40 million for 2008, $63 million for 2007 and $19 million for 2006. The decrease from 2007 to 2008 reflects decreased cash needs due to lower inventory levels, capital expenditures and stock repurchases.

Our credit ratings have been unchanged since September 2007 when we issued $1 billion in debt. Our ratings are currently as follows:

                                                Standard
                                      Moody's   & Poor's   Fitch
                     Long-term debt    Baa1       BBB+     BBB+

We may from time to time seek to retire or purchase our outstanding debt through open market cash purchases, privately negotiated transactions or otherwise. Such repurchases, if any, will depend on prevailing market conditions, our liquidity requirements, contractual restrictions and other factors. The amounts involved could be material.

In September 2007, our Board of Directors authorized a $2.5 billion share repurchase program which is intended to return excess capital to our . . .