The following discussion, which presents our results, should be read in conjunction with the accompanying consolidated financial statements and notes thereto beginning on page F-3, along with the unaudited Five-Year Financial and Operations Summaries on pages 11 and 12, the risk factors beginning on page 4 and the cautionary statement regarding forward-looking information on page 39. Unless otherwise indicated, this Management's Discussion and Analysis (MD&A) relates only to results from continuing operations, all references to earnings per share (EPS) are on a diluted basis and all references to years relate to fiscal years rather than to calendar years. Fiscal 2008 and 2007 each contained 52 weeks, while 2006 contained 53 weeks.

Corporate Governance and Financial Reporting

We remain committed to maintaining the highest standards of corporate governance and continuously improving the transparency of our financial reporting by providing stockholders with informative financial disclosures and presenting a clear and balanced view of our financial position and operating results. We continue to employ a reporting matrix that requires written certifications on a quarterly basis from a cross-disciplined team of approximately 20 senior members of our management team who have responsibility for preparing, verifying and reporting corporate results.

For this Annual Report on Form 10-K, we made further enhancements to our financial reporting with expanded disclosures in several areas, such as:

• reordered the sequence of MD&A to present a better flow of information;

• included in the discussion of gross margin and selling, general and administrative (SG&A) expenses a description of the key components;

• added a liquidity table to facilitate the discussion of financial condition and liquidity;

• added pension expense as a separate line item on the Consolidated Statements of Operations to enhance and clarify disclosures regarding pension expense;

• added clarity to the balance sheet by reclassifying income taxes receivable to a separate line item and credit card transactions awaiting settlements to cash and cash equivalents, which were formerly included in the "receivables" line item; and

• changed the balance sheet line item "cash and short-term investments" to "cash and cash equivalents," which is more representative of its components.

Consistent with the requirements of Section 404 of the Sarbanes-Oxley Act of 2002, we are required to report on the effectiveness of our internal control over financial reporting each fiscal year. In relation to these requirements, our external auditors expressed an unqualified opinion regarding the effective operation of our internal control over financial reporting.

Executive Overview

The fourth quarter of 2008 marked the sixth consecutive quarter in which our results of operations were negatively impacted by the weakened economic environment. For the full year of 2008, we experienced a decline in comparable store sales of 8.5%. While comparable store sales were down 5.8% during the first half of the year, they decreased sharply by 10.5% during the second half of the year, indicating a further decline in consumer confidence that reached new lows when the economic downturn became a global economic crisis. Income from continuing operations for 2008 decreased

48.7% to $567 million. Diluted EPS from continuing operations was $2.54 for 2008 compared to $4.90 for 2007. Operating income was $1,135 million, or 6.1% of sales, versus $1,888 million, or 9.5% of sales, in 2007. To enhance our liquidity position and ensure we maintain a strong financial position, we addressed these difficult operating conditions by focusing on those areas within our control, specifically by reducing inventory and tightly controlling operating expenses. As a result of our efforts, we finished the year with approximately $2.4 billion of cash and cash equivalents on our balance sheet. Our strong liquidity and solid financial position allow us to focus our efforts on appropriately managing inventory levels, operating expenses and capital expenditures under our Bridge Plan without the need for substantial changes to our business model. A significant accomplishment and indication of our solid financial position is shown by our free cash flow (a non-GAAP financial measure defined and discussed on page 28), which provided a positive $21 million despite the harsh economic conditions.

2008 Key Items

• The difficult economic environment impacting consumers continued to deteriorate in 2008 and included a further pronounced slowdown in consumer spending levels during the second half of the year. Tightening credit availability, the downturn of the housing and real estate market, rising unemployment and turmoil in the global capital markets weighed heavily on the consumer. Lower consumer spending and declining mall traffic impacted our sales. However, despite the challenging environment, we continued to focus on managing inventory and controlling operating expenses. At the same time, we continued to execute initiatives to deliver on the value proposition that our customers have come to expect from JCPenney - through newness in merchandise, competitive pricing, enhanced customer service and convenience of shopping in stores, catalog and jcp.com.

• Despite the economic conditions, during 2008 we generated $21 million of positive free cash flow (a non-GAAP financial measure defined and discussed on page 28). This represents a $163 million improvement over 2007.

• Comparable store inventory as of the end of 2008 decreased 13.5% from the prior year as a result of significant actions to lower merchandise receipts and increased clearance activity. Merchandise inventory at the end of 2008 was in alignment with sales trends expected for the near term.

• SG&A expenses decreased $7 million, or 0.1%, in 2008 as compared to 2007, despite the incremental expenses associated with 35 new stores (26 net of closings and relocations). SG&A expenses for 2008 were well managed across the organization without compromising the customer shopping experience.

• In 2008, we opened 35 new and relocated stores, including 31 in the off-mall format. Net of relocations and store closings, gross selling space increased 3.0%. We also opened 44 new Sephora inside JCPenney locations during the year, which brought the total to 91 locations. Sephora inside JCPenney brings an industry-leading beauty concept to JCPenney customers and continues to be one of the strongest areas of our business.

Current Developments

• In March 2009, our Board declared a quarterly dividend of $0.20 per share to be paid to stockholders on May 1, 2009. The dividend rate remains unchanged from our previous quarterly dividend payment.

• In March 2009, we opened nine new stores, including one relocation. We also opened 14 additional Sephora inside JCPenney locations, including nine in the new stores and five in

• In February 2009, we launched our spring marketing campaign showcasing our compelling selection of affordable, exclusive designer brands. The campaign kicked off with commercials at the 2009 Academy Awards featuring several authentic designers from our portfolio, including nicole® by Nicole Miller, Bisou Bisou® by Michele Bohbot, ALLEN B.® by Allen B. Schwartz, Fabulosity™ by Kimora Lee Simmons and I "Heart" Ronson™ by Charlotte Ronson. Our spring campaign reflects our success as we are stepping up our style in delivering brands that inspire and enable customers to have exceptional style and quality at affordable prices.

• In February 2009, we launched an interactive, fully-integrated, virtual runway show on jcp.com featuring spring styles from our compelling selection of affordable exclusive designer brands, including nicole® by Nicole Miller, Bisou Bisou® by Michele Bohbot, ALLEN B.® by Allen B. Schwartz and I "Heart" Ronson™ by Charlotte Ronson. The online experience gives our customers the opportunity to experience a dynamic runway show, complete with high energy music and 360 degree views of models in styles from each designer's collection. The experience also includes video vignettes of our design partners sharing the inspiration behind their new collections along with their views on upcoming styles for spring.

• Also in February 2009, we announced our official sponsorship of the "Rascal Flatts American Living Unstoppable Tour" presented by JCPenney. The tour will promote American Living, an affordable, all-American lifestyle brand developed exclusively for our customers by Polo Ralph Lauren's Global Brand Concepts with offerings across 40 merchandise categories. Representing true Americana, Rascal Flatts' music transcends genres and resonates strongly with many of our customers. The fully integrated two-year sponsorship will kick off in early June 2009, with the tour hitting about 60 cities across the nation each year. In conjunction with the tour, Rascal Flatts has written a new song inspired by the spirit of the brand titled "American Living," which will serve as the soundtrack for our new American Living commercial and will be available in our stores.

• In March 2009, we were recognized for our continued commitment to strategic energy management by the U.S. Department of Energy with the ENERGY STAR Award for Sustained Excellence in Energy Management. We are the first retailer to be honored with this award for our efforts in using energy efficiently in facility operations and integrating superior energy management into our overall organization strategy. We were selected from more than 12,000 organizations that participate in the ENERGY STAR program.

Results of Operations

The following discussion and analysis, consistent with all other financial data throughout this Annual Report on Form 10-K, focuses on the results of operations and financial condition from our continuing operations.

Three-Year Comparison of Operating Performance



($ in millions, except EPS)               2008                  2007                     2006
Total net sales                         $  18,486             $  19,860                $  19,903
Percent (decrease)/increase
from prior year                              (6.9 )%               (0.2 )%(1)                6.0 %(1)
Comparable store sales
(decrease)/increase(2)                       (8.5 )%                0.0 %                    4.9 %

Gross margin                                6,915                 7,671                    7,825
Operating expenses:
Selling, general and
administrative (SG&A)                       5,395                 5,402                    5,470
Pension (income)/expense                      (90 )                 (45 )                     51
Depreciation and amortization                 469                   426                      389
Pre-opening                                    31                    46                       27
Real estate and other
(income), net                                 (25 )                 (46 )                    (34 )

Total operating expenses                    5,780                 5,783                    5,903

Operating income                            1,135                 1,888                    1,922
As a percent of sales                         6.1 %                 9.5 %                    9.7 %
Net interest expense                          225                   153                      130
Bond premiums and unamortized
costs                                           -                    12                        -

Income from continuing
operations before income taxes                910                 1,723                    1,792
Income tax expense                            343                   618                      658

Income from continuing
operations                              $     567             $   1,105                $   1,134

Diluted EPS from continuing
operations                              $    2.54             $    4.90                $    4.88

(1) 2006 contained 53 weeks. Total net sales percent includes the effect of the 53rd week in 2006. Excluding sales of $254 million for the 53rd week in 2006, total net sales increased 1.1% and 4.6% for 2007 and 2006, respectively.

(2) Comparable store sales are presented on a 52-week basis and include sales from new and relocated stores that have been opened for 12 consecutive full fiscal months and online sales through jcp.com. Stores closed for an extended period are not included in comparable store sales calculations, while stores remodeled and minor expansions not requiring store closures remain in the calculations.

Income from continuing operations was $567 million in 2008, compared to $1,105 million in 2007 and $1,134 million in 2006. Our 2008 results were impacted by pressure on gross margins in a highly promotional selling environment, particularly during the holiday season. Gross margin declined both in dollars and as a percentage of sales from the pressure of declining sales levels that resulted from the slowdown in consumer spending. The impact on operating income from lower gross margin was somewhat mitigated by effective control over operating expenses, despite incremental expenses related to new store openings.

EPS from continuing operations in 2008 was $2.54, compared to $4.90 in 2007 and $4.88 in 2006. EPS in 2007 benefited from the reduction in average shares outstanding compared to the prior year due to the 2007 and 2006 common stock repurchase programs. Additionally, the 2007 results reflected tax credits of $38 million, or $0.17 per share, while 2006 results reflected a tax credit of $32 million, or

$0.14 per share, both of which were due to the release of income tax reserves resulting from the favorable resolution of prior year tax matters.

Our 2007 results were impacted by gross margin pressure from the onset of the economic downturn that began in the second half of the year. Our 2006 earnings increased as a result of strong sales and gross margin improvement, combined with lower interest expense and bond premiums.

2008 Compared to 2007

Total Net Sales

Our year-to-year change in total net sales is comprised of (a) sales from new stores net of closings and relocations including catalog print media and outlet store sales, referred to as non-comparable store sales and (b) sales of stores opened in both years as well as online sales from jcp.com, referred to as comparable store sales. We consider comparable store sales to be a key indicator of our current performance measuring the growth in sales and sales productivity of existing stores. Positive comparable store sales contribute to greater leveraging of operating costs, particularly payroll and occupancy costs, while negative comparable store sales contribute to de-leveraging of costs. Comparable store sales also have a direct impact on our total net sales and the level of cash flow.

           ($ in millions)                        2008            2007
           Total net sales                     $   18,486      $   19,860

           Sales percent (decrease)/increase
           Total net sales                           (6.9 )%         (0.2 )%
           Comparable store sales                    (8.5 )%          0.0 %
           Sales per gross square foot(1)      $      160      $      177

(1) Calculation includes the sales of stores that were open for the full fiscal year as of each year end, as well as online sales from jcp.com.

Total net sales in 2008 decreased $1,374 million as a result of a sharp slow down in consumer spending. The decline was mainly attributed to a comparable store sales decline of 8.5% and a decrease, as expected, in catalog print media and outlet store sales in our Direct channel. While comparable store sales decreased, sales from non-comparable stores opened in 2008 and 2007, net of closings, added $434 million. In 2008, we opened 26 net new stores (35 stores, net of 9 closings and relocations) and in 2007 we opened 34 net new stores (50 stores, net of 16 closings and relocations.) Over the course of 2008, the worsening consumer spending environment resulted in reduced sales from lower traffic in our mall stores, which decreased 5.4% from prior year traffic levels. Our off-mall traffic was also down compared to last year but had stronger traffic trends than our mall stores. Consistent with the difficult retail environment and the pronounced decrease in consumer spending, the number of transactions and the number of units sold declined for the year. Geographically, the best performing regions for the year were the central and northwest regions, while the southeast and southwest regions, which were more heavily impacted by declining home values, delivered the weakest performance. Sales of jcp.com, which are included in comparable stores sales, were essentially flat with last year at about $1.5 billion.

Although consumer spending steadily decreased over the year, we continued our leadership position in apparel, bringing style and newness through the launch of several private and exclusive brands. For the year, family shoes, along with women's apparel and accessories were the best performing divisions. By contrast, and consistent with industry results, fine jewelry and home were the weakest businesses.

Private and exclusive brands found only at JCPenney totaled approximately 52% and 49% of total merchandise sales for 2008 and 2007, respectively.

Total Net Sales Mix

The following percentages represent the mix of total net sales:



                                                   2008     2007
                   Women's apparel                   24 %     23 %
                   Home                              20 %     21 %
                   Men's apparel and accessories     19 %     20 %
                   Children's apparel                11 %     11 %
                   Women's accessories               10 %      9 %
                   Family footwear                    6 %      6 %
                   Fine jewelry                       5 %      5 %
                   Services and other                 5 %      5 %

                                                    100 %    100 %

Merchandise Initiatives

We remain committed to offering our customers compelling merchandise with the combination of style, quality and smart prices that they desire. In February 2008, we launched American Living™, a new updated traditional lifestyle brand created exclusively for JCPenney by Polo Ralph Lauren's Global Brand Concepts. American Living™ is in the higher quality and pricing segment of our offerings across 40 merchandise categories for women, men and children, as well as shoes, accessories and home goods.

In April 2008, we launched Linden Street™, which was the most comprehensive home brand launch in our history. It is a blend of traditional and contemporary styles offering a classic, timeless design.

For the Back-to-School season, in junior's, we launched private brand Decree®, a denim-inspired line of apparel for girls and young women, and two new exclusive brands: LeTigre™ from Kenneth Cole Productions and Fabulosity™, a complete line of sportswear designed by Kimora Lee Simmons. For young men's, we extended the exclusive American Living™ brand with new denim, graphic t-shirts and jackets, and launched White Tag™, a new "urban rock" inspired national brand of premium denim and art-driven t-shirts. In addition to the new fashion brands for Back-to-School, we introduced Dorm Life™, a new private modern lifestyle brand in the home division featuring merchandise to furnish a college dorm or off-campus housing.

In October 2008, we announced the significant enhancement of the longstanding and highly successful career brands Worthington® for women and Stafford ® for men, to retain longtime customers and to attract new shoppers. We updated the private brands with new categories, fits and fabrics that overlap seasons.

Also in October 2008, we announced the spring 2009 launches of two new exclusive designer brands, I "Heart" Ronson™, a complete women's fashion sportswear line designed by Charlotte Ronson, an innovator in the fashion industry; and ALLEN
B.®, a complete women's fashion sportswear and dress collection by Allen B. Schwartz, a designer with talent in bringing the latest trends to market in record time. I "Heart" Ronson™ and ALLEN B.®are exciting additions to our growing portfolio of exclusive designer brands, which continue to offer our customers coveted designer brands at smart prices.

Marketing Initiatives

In July and November 2008, we supported the apparel launches with integrated marketing campaigns featuring the new brands. The campaigns targeted teens and included both traditional ads and non-traditional media components, such as in-cinema ads and mobile phone marketing, emails, web search and targeted direct mail and catalog. The messages were coordinated across all lines of the business, stores and Direct that represent an alignment of our offerings and provide a seamless shopping experience for customers.

Customer Service Initiatives

During 2008, store associates participated in CustomerFIRST, a training program focused on delivering extraordinary customer service that empowers associates to exceed customers' expectations when they shop at our stores. Results of the CustomerFIRST program have been positive. Based on consumer research, customers rank us number one when asked about customer service, sales associate availability and whether they are treated with respect by sales associates. In January 2009, the National Retail Federation (NRF) Foundation/American Express 2008 Customer Service Survey, which placed us first in customer service among department store retailers, confirmed our leading customer service ranking and improved our overall ranking by five spots to seventh place.

Gross Margin

Gross margin is a measure of profitability of a retail company at the most fundamental level of buying and selling merchandise and measures a company's ability to effectively manage the total costs of sourcing and allocating merchandise against the corresponding retail pricing designed to offer quality merchandise at smart prices. Gross margins not only cover marketing, selling and other operating expenses, but also must include a profit element to reinvest back into the business. Gross margin is the difference between total net sales and cost of the merchandise sold and is typically expressed as a percentage of total net sales. The cost of merchandise sold includes all direct costs of bringing merchandise to its final selling destination. These costs include:

• cost of the merchandise (net of • merchandise examination discounts or allowances earned) • inspection and testing
• freight • store merchandise distribution
• warehousing center expenses
• sourcing and procurement • shipping and handling costs
• buying and brand development costs incurred related to direct sales to including buyers' salaries and related customers expenses

            ($ in millions)                             2008        2007
            First-in first-out (FIFO) gross margin     $ 6,916     $ 7,664
            Last-in first-out (LIFO) (charge)/credit        (1 )         7

            Gross margin                               $ 6,915     $ 7,671

            As a percent of sales                         37.4 %      38.6 %

Gross margin declined by $756 million, or 120 basis points as a percentage of sales in 2008. The decline was a result of a decrease in unit sales, as well as a decrease in average unit retail. The lower average unit retail reflected higher markdowns from increased clearance activity in response to softer sales and to achieve desired levels of inventory.

Selling, General and Administrative (SG&A) Expenses

The following costs are included in SG&A expenses except if related to merchandise buying, sourcing, warehousing or distribution activities:

• salaries • administrative costs related to our
• marketing home office, district and regional
• occupancy and rent operations
• utilities and maintenance • credit card fees
• information technology • real, personal property and other taxes (excluding income taxes)

                     ($ in millions)          2008        2007
                     SG&A                    $ 5,395     $ 5,402

                     As a percent of sales      29.2 %      27.2 %

SG&A expenses were well managed across the entire organization in 2008, decreasing $7 million despite the addition of 26 net new stores since last year. In 2008, we realized the first full year of benefit from our workforce management tool that facilitates efficient staffing levels. The rollout of this tool provided a positive impact on associate productivity, as well as stores payroll expense. Store salaries declined on a dollar basis, but were not leveraged against sales and increased about 40 basis points as a percent of sales. Total marketing costs were slightly under the prior year, but as a percent of sales increased 50 basis points. Likewise, store occupancy and utility expenses were also well managed, but were up about 50 basis points. Total SG&A expenses as a percent of sales experienced approximately 200 basis points of de-leveraging as a result of the sales decline.

During 2008 and 2007, advertising allowances that offset gross advertising expense were $167 million and $210 million, respectively. The year-over-year decrease was primarily due to lower merchandise receipts.

Pension (Income)/Expense

Pension income doubled to $90 million in 2008 from $45 million in the prior year primarily from the pension credit from our qualified pension plan (primary plan), which is a defined benefit funded plan. The net pension income of $90 million is comprised of the qualified pension plan income of $133 million and pension expense of $43 million from the defined benefit supplemental pension plans, which are unfunded. Our 2008 pension income was measured on February 3, . . .