Item 2 - Management's Discussion and Analysis of Financial Condition and Results of Operations

In the first quarter of 2004, the Company recorded income from continuing operations of $118 million, or $0.38 per share compared to $20 million, or $0.05 per share for the comparable 2003 period, as a result of strong sales and operating profit. Operating profit and its components are discussed beginning on page 16. All references to earnings per share (EPS) are on a diluted basis. The Company ended the first quarter of 2004 with $3 billion of cash and short-term investments, or 57% of the $5.4 billion outstanding long-term debt. In addition, the Company improved free cash flow compared to 2003 as discussed on page 19.

With the Company's major centralization initiatives implemented, JCPenney has entered into a new phase, the growth of its core three-channel retailing business. The Company's strategies for growing its business include a focus on consistent execution, new growth opportunities and attracting new customers. The Company's financial goal is to generate operating profit of 6% to 8% of sales in 2005. The successful execution of the turnaround, growth of the business and progress toward improving profitability is impacted by customers' response to the Company's merchandise offerings, competitive conditions, the effects of current economic conditions, continued improvement in gross margin and the reduction of the expense structure. The Company's Strategic Plan, Financing Strategy and Risk Management are detailed in the 2003 10-K.

Effective January 27, 2002, J. C. Penney Company, Inc. changed its corporate structure to a holding company format. As part of this structure, J. C. Penney Company, Inc. changed its name to J. C. Penney Corporation, Inc. (JCP) and became a wholly owned subsidiary of a newly formed affiliated holding company (Holding Company). The holding company assumed the name J. C. Penney Company, Inc. The Holding Company has no direct subsidiaries other than JCP, nor does it have any independent assets or operations. All outstanding shares of common and preferred stock were automatically converted into the identical number and type of shares in the Holding Company. Stockholders' ownership interests in the business did not change as a result of the new structure. Shares of the Company remain publicly traded under the same symbol (JCP) on the New York Stock Exchange. The Holding Company is a co-obligor (or guarantor, as appropriate) regarding the payment of principal and interest on JCP's outstanding debt securities. The guarantee by the Holding Company of certain of JCP's outstanding debt is full and unconditional. The Holding Company and its consolidated subsidiaries, including JCP, are collectively referred to in this report as "Company" or "JCPenney," unless indicated otherwise.

Management's discussion and analysis of its financial condition and results of operations is based upon the Company's consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these financial statements requires the Company to make estimates and judgments that affect reported amounts of assets, liabilities, revenues and expenses, and related disclosures of contingent assets and liabilities. Management bases its estimates on historical experience and on other assumptions that are believed to be reasonable under the circumstances. On an ongoing basis, management evaluates estimates used, including those related to inventory valuation under the retail method; valuation of long-lived and intangible assets, including goodwill; estimation of reserves and valuation allowances specifically related to closed stores, insurance, income taxes, litigation and environmental contingencies; and pension accounting. Actual results may differ from these estimates under different assumptions or conditions. Item 7, Management's Discussion and Analysis of Financial Condition and Results of Operations, in the 2003 10-K includes detailed descriptions of certain judgments that management makes in applying its accounting policies in these areas.

Eckerd Drugstores

On April 4, 2004, the Company and certain of its subsidiaries signed definitive agreements with The Jean Coutu Group (PJC) Inc. (Coutu), and CVS Corporation and CVS Pharmacy, Inc. (collectively, CVS) for the sale of the Company's Eckerd drugstore operations for a total of $ 4.525 billion in cash. In the Coutu transaction, the Company and its indirect wholly owned subsidiary, TDI Consolidated Corporation, will sell the stock of Eckerd Corporation (Eckerd), Genovese Drug Stores, Inc. (Genovese), and Thrift Drug, Inc. (Thrift) for $2.375 billion. Coutu will acquire Eckerd drugstores and support facilities located in 13 Northeast and Mid-Atlantic states, as well as the Eckerd Home Office located in Florida. In the CVS transaction the Company, Eckerd, Genovese, Thrift, and Eckerd Fleet, Inc. will sell Eckerd drugstores and support facilities located in the remaining southern states, principally Florida and Texas, and Eckerd's pharmacy benefits management, mail order and specialty pharmacy businesses, to CVS for $2.150 billion. After closing adjustments, taxes, fees and other expenses relating to the transactions, the Company expects to generate approximately $3.5 billion in cash proceeds. Closing of the transactions, which are subject to normal and customary regulatory approvals, is anticipated to occur by the end of the second quarter of 2004.

In the first quarter of 2004, the Company recorded a $77 million charge, net of taxes, to adjust the fair value that was estimated at year-end 2003, based on the results of the final negotiations and signed agreements. See Note 2 for a more detailed discussion, including the adjustment that was recorded at year-end 2003.

Mexico Department Stores

Effective November 30, 2003, the Company closed on the sale of its six Mexico department stores to Grupo Sanborns S.A. de C.V. of Mexico City. The stock sale transaction, which included the Mexico holding company and operating companies comprising JCPenney's Mexico department store operation, resulted in a loss of $14 million, net of a $27 million tax benefit. The loss was principally related to currency translation losses of $25 million accumulated since operations began in 1995 that were previously reflected as reductions to stockholders' equity. Additional components of the loss include potential liability on certain real estate leases and merchandise and transaction costs.

($ in millions, except EPS)                                          13 weeks ended
                                                             -------------------------------
                                                                   May 1,         Apr. 26,
                                                                    2004             2003
                                                             -------------- ----------------
Retail sales, net                                                $ 4,033          $ 3,711
                                                             -------------- ----------------
Gross margin                                                       1,615          $ 1,456
SG&A expenses                                                      1,386            1,372
                                                             -------------- ----------------
Operating profit                                                     229               84
Net interest expense                                                  57               65
Real estate and other (income)                                        (8)              (9)
                                                             -------------- ----------------
Income from continuing operations before
   income taxes                                                      180               28
Income tax expense                                                    62                8
                                                             -------------- ----------------
Income from continuing operations                                 $  118            $  20
                                                             ============== ================
Diluted EPS from continuing operations                           $  0.38           $ 0.05

Ratios as a percent of sales:
    Gross margin                                                    40.1%            39.2%
    SG&A expenses                                                   34.4%            37.0%
    Operating profit                                                 5.7%             2.2%

Depreciation and amortization in operating profit                  $  87           $   89

The Company continued its trend of improved profitability during the first quarter of 2004 as reflected in income from continuing operations of $118 million, or $0.38 per share compared to $20 million, or $0.05 per share for the comparable 2003 period. The significant increase over the soft first quarter of 2003 reflects improved operating profit, resulting from strong sales growth, continued gross margin improvement and leveraging of selling, general and administrative (SG&A) expenses.

Operating profit for the first quarter of 2004 more than doubled to $229 million or 5.7% of sales as compared to $84 million or 2.2% of sales for the comparable period last year.

Operating profit and its components (sales, gross margin and SG&A) are the key measurements on which management evaluates the financial performance of the retail operations. Real estate activities, gains and losses on the sale of real estate properties, asset impairments and other charges associated with closing store and catalog facilities are evaluated separately from operations, and recorded in real estate and other in the consolidated statement of operations.

Retail Sales, Net

($ in millions)
                                                        13 weeks ended
                                                 ------------------------------
                                                        May 1,        Apr. 26,
                                                         2004            2003
                                                 --------------  --------------
Retail sales, net                                 $     4,033     $     3,711
                                                 --------------  --------------
Sales percent increase/(decrease):
  Comparable stores (1)                                   9.5%          (4.9)%
  Total department stores                                 9.2%          (6.3)%
  Catalog/Internet                                        6.5%         (11.1)%

(1) Comparable store sales include sales from stores which have been open for 12 consecutive months. A store's sales become comparable on the first day of the 13th fiscal month.

Department store sales were strong for the first quarter of 2004, with particular strength in February and March. Comparable department store sales increased 9.5% for the quarter, while total department store sales increased 9.2%. Sales, which reflect good customer response to both fashion and basic merchandise, planned marketing events, improved store environment, particularly visual presentation, and added convenience, continued to be strong across the country and in most merchandise divisions. The fashionable merchandise program and fresh receipts of new seasonal assortments contributed to the improvement in apparel sales.

Catalog/Internet sales increased 6.5% for the first quarter of 2004 compared to last year, and similar to Department Stores, Catalog/Internet sales were particularly strong in February and March. Sales reflect less reliance on Big Books, a focus on targeted specialty media and the expanded assortments and convenience of the Internet. Total Internet sales, which are an integral part of the Company's three-channel retailing strategy, increased more than 45% in the first quarter.

The Company is launching two programs in the second and third quarters of 2004. In May, the Company launched the Chris Madden home furnishings collection, which demonstrates the Company's continuing commitment to delivering affordable, trend-right fashion with remarkable quality to its customers. Chris Madden's "Turning Home Into Haven" collection is JCPenney's largest home furnishings launch ever and was introduced with a comprehensive national advertising campaign. In addition, the Company is partnering with Colin Cowie, a nationally recognized wedding planner, to launch in the third quarter of 2004, a new innovative technology-based wedding registry and a new line of tableware and giftware.

Gross Margin

Gross margin improved 90 basis points as a percent of sales in this year's first quarter to $1,615 million compared to $1,456 million in the comparable 2003 period. The improvement reflects better inventory management, good sell-through of seasonal merchandise, better execution and continuing benefits from the centralized merchandising model. Benefits of the centralized model have included enhanced merchandise offerings, a more integrated marketing plan, more leverage in the buying and merchandising process and more efficient selection and allocation of merchandise to individual department stores.

SG&A Expenses

SG&A expenses in this year's first quarter were $1,386 million compared to $1,372 million in last year's first quarter. Expenses were well leveraged, improving by 260 basis points as a percent of sales. The improvement reflects savings in labor costs, centralized store expense management, a decline in non-cash pension costs and early savings from the Company's previously announced cost savings initiatives, offset by additional implementation costs related to the initiative.

For the first quarter of 2004, net interest expense allocated to Eckerd discontinued operations was $44 million compared to $38 million for the same period last year. The higher interest expense is the result of increases in both the Company's weighted average interest rate and the intercompany loan balance between Eckerd and JCPenney. Upon closing of the Eckerd sale transactions, JCP interest expense will increase as debt and related interest that had been attributed to Eckerd will remain an obligation of the Company. See page 20 for a discussion of the use of estimated proceeds from the Eckerd sale transaction.

Real estate and other consists of real estate activities, gains and losses on the sale of real estate properties, and asset impairments, and other charges associated with closing store and catalog facilities. Real estate and other for the first quarter of 2004 was a net credit of $8 million, which consisted of a $7 million credit for real estate operations, $2 million of gains on the sale of closed units and $1 million of costs related to PVOL for closed stores.

For the first quarter of 2003, real estate and other was a net credit of $9 million, which consisted of a $4 million credit for real estate operations, $21 million of gains on the sale of closed units, $12 million of accelerated depreciation of catalog facilities scheduled to close, $3 million of expenses related to future rent for closed units and $1 million of other expenses.

The Company's effective income tax rate for continuing operations was 34.5% for the first quarter of 2004 compared with 28.2% for the same period last year. The rate increase is primarily due to improved earnings, which decreased the favorable impact of permanent adjustments, principally the deduction for dividends paid to the employee stock ownership plan.

Merchandise inventory was $3,338 million at May 1, 2004 compared to $3,326 million at April 26, 2003 and $3,156 million at January 31, 2004. While basically flat compared to last year, inventory at the end of the first quarter of 2004 was well managed and reflected a good balance of seasonal and basic merchandise, with less clearance. The Company has enhanced its ability to allocate and flow merchandise to stores in season by recognizing sales trends earlier and accelerating receipts, replenishing individual stores based on rates of sale, and consistently providing high in-stock levels in basics and advertised items.

The Company's financial condition remains strong with approximately $3.0 billion in cash and short-term investments as of May 1, 2004, which represents 57% of the $5.4 billion of outstanding consolidated long-term debt, including current maturities. Included in the total cash and short-term investment balance were restricted short-term investment balances of $88 million and $87 million as of May 1, 2004 and April 26, 2003, respectively, which are pledged as collateral for import letters of credit not included in the bank credit facility and for a portion of casualty program liabilities. Cash flow used in operating activities for the first quarter of 2004 was $20 million compared to $362 million used in operating activities in the comparable period of 2003. The improvement was due primarily to better earnings and inventory leverage.

Free cash flow from continuing operations was a deficit of $99 million in the first quarter of 2004, a significant improvement compared to a deficit of $440 million for the comparable 2003 period. Better earnings and inventory leverage contributed to the improvement. While free cash flow is a non-GAAP financial measure, management believes it is important in evaluating the Company's financial performance and measuring the ability to generate cash without incurring additional external financing. Free cash flow should be considered in addition to, rather than as a substitute for, cash flows from operating activities. The following table reconciles net cash used in operating activities (GAAP) to free cash flows from continuing operations (non-GAAP measure):

($ in millions)                                                  13 weeks ended
                                                     ----------------------------------------
                                                        May 1, 2004          Apr. 26, 2003
                                                     ------------------    ------------------
Net cash (used in) operating activities  (GAAP)                $ (20)               $ (362)
Less:
   Capital expenditures                                          (64)                  (67)
   Dividends paid                                                (34)                  (34)
Plus:
   Proceeds from sale of assets                                   19                    23
                                                     ------------------    ------------------
Free cash flow from continuing operations                      $ (99)               $ (440)
                                                     ==================    ==================

Capital expenditures were $64 million the first quarter of 2004 compared with $67 million for the comparable 2003 period. Capital spending was in the strategic areas of new stores, store renewals and modernizations, and technology, including gift registry. Management continues to expect total capital expenditures for the full year to be in the area of $500 million.

Net proceeds from the exercise of stock options were approximately $130 million for the first quarter of 2004 and immaterial for 2003.

The Company's next scheduled debt maturity is the $208 million of 7.375% Notes Due on June 15, 2004.

As discussed in Note 2 and on page 15, the Company continues to expect the Eckerd sale transactions to close by the end of the second quarter of 2004. After closing adjustments, taxes, fees and other expenses related to the transactions, the Company expects to generate approximately $3.5 billion in cash proceeds. Subject to approval by the Company's Board of Directors, management anticipates that the proceeds will be used for an appropriate mix of both common stock repurchases and debt retirements. Effective May 20, 2004, Eckerd's managed care receivables securitization program was paid off in the amount of $221 million and terminated. On May 17, 2004, the waiting period under the Hart-Scott-Rodino Antitrust Improvements Act of 1976 (HSR) expired in connection with the Company's sale of that portion of its Eckerd drugstore operations to Coutu. On June 1, 2004, the Company announced that the Federal Trade Commission had completed its review of the Company's sale of that portion of its Eckerd drugstore operations to CVS, and granted early termination of the waiting period under the HSR.

For the remainder of 2004, management believes that cash flow generated from operations, combined with the short-term investment position, will be adequate to fund cash requirements for capital expenditures, working capital and dividend payments and, therefore, no external funding will be required. The payment of dividends is subject to approval by the Company's Board of Directors on a quarterly basis. At the present time, management does not expect to access the capital markets for any external financing for the remainder of 2004. However, the Company may access the capital markets on an opportunistic basis. Management believes that the Company's financial position will continue to provide the financial flexibility to support its turnaround initiatives.

Additional liquidity strengths include the available $1.5 billion credit facility discussed in the 2003 10-K and in Note 12, which was amended effective June 2, 2004 to permit the sale of the Eckerd Corporation, and its affiliates and assets, allow a broader range of cash investments, and permit issuing banks to extend maturities of certain letters of credit past the expiration of the Credit Agreement as long as they are collateralized with cash at that time. No borrowings, other than the issuance of trade and standby letters of credit, which totaled $235 million as of the end of the first quarter of 2004, have been, or are expected to be, made under this facility. On a consolidated basis, the Company was in compliance with all financial covenants of the credit facility as of May 1, 2004.

Operating cash flows may be impacted by many factors, including the competitive conditions in the retail industry, and the effects of the current economic conditions and consumer confidence. Based on the nature of the Company's businesses, management considers the above factors to be normal business risks.

Quarterly dividends of $0.125 per share on the Company's outstanding common stock were paid on February 1, 2004 to stockholders of record on January 10, 2004 and on May 1, 2004 to stockholders of record on April 10, 2004.

As discussed in the 2003 10-K, the Company follows Accounting Principles Board Opinion (APB) No. 25, "Accounting for Stock Issued to Employees," which does not require expense recognition for stock options when the exercise price of an option equals, or exceeds, the fair market value of the common stock on the date of grant. The Financial Accounting Standards Board (FASB) proposed a new rule that would require expense recognition of stock options in the statement of operations beginning in 2005. The Company will adopt any new rules required by the FASB when they are effective. As required by Statement of Finanical Accounting Standards (SFAS) No. 123 for companies retaining APB 25 accounting, the Company discloses the estimated impact of fair value accounting for stock options granted. See Note 1 for the pro forma impact on the first quarters of 2004 and 2003.

Recently issued accounting pronouncements are discussed in Note 1 to the unaudited Interim Consolidated Financial Statements.

During the first quarter of 2004, the Audit Committee of the Company's Board of Directors approved estimated fees for the remainder of 2004 related to the performance of both audit and allowable non-audit services by the Company's external auditors, KPMG LLP.

The results of operations and cash flows for the 13 weeks ended May 1, 2004 are not necessarily indicative of the results for the entire year. The Company's business depends to a great extent on the last quarter of the year. Historically for that period, Department Stores and Catalog/Internet sales have averaged approximately one-third of annual sales and income from continuing operations has averaged about 60% of the full year total.