(FORTUNE Magazine) – Buzzing around the dressing room, clutching lacy tops and flirty skirts from her latest collection, French fashion designer Michele Bohbot is feeling a little nervous. She always gets that way before a fashion show, although this show isn't on a catwalk in Paris or in New York City's Bryant Park, but at a J.C. Penney store in the Bronx. Outside, a limo pulls up to discharge its cargo of leggy models onto the pavement in front of a bus stop. No red carpet.

Bohbot, the talent behind Bisou Bisou, a trendy line of sexy clothes (Sharon Stone and Britney Spears are fans), never expected to be here. Until recently the clothes she designs--and her husband, Marc, markets--were sold in chic boutiques and upscale department stores. Then J.C. Penney rocked the fashion world in February by signing an exclusive deal with the Bohbots. Now the retail chain whose name evokes visions of polyester pantsuits will be the nation's only distributor of the Bisou Bisou line. Michele's cargo pants, which used to sell for $118, go for $29.99 off the rack at Penney's. And you can buy them in Cleveland. When the line debuted at the 500 largest Penney stores this spring, some items sold out in a few days.

Before the deal, neither of the Bohbots had ever been inside a J.C. Penney store. Two years ago, when Vanessa Castagna, CEO of Penney's department-store division, slipped the Bohbots her card at an apparel summit in Florida, Marc thought she was crazy. "Zhay-See Pen-ney?" (It sounds so much better in a French accent.) "No, no, no, no, no!"

But Castagna and her colleagues didn't give up. A call here, a card there. No pressure, just a casual correspondence. Meanwhile, the wall between high fashion and mass retail began to crack. Target snagged partnerships with designers Mossimo and Todd Oldham, and even Kmart got into the game with Joe Boxer. The Bohbots were getting calls from other big-name mall retailers. Soon Castagna's idea didn't sound so crazy. "It started to feel right," says Michele, with the giddiness of a new crush.

Squeezed between Wal-Mart's everyday low prices and Target's trendiness, Penney is trying to carve out its own niche in the crowded fashion-to-the-masses field. If it was hard to sell the Bohbots on this idea, it'll be even harder to convince hipster-wannabe shoppers. J.C. Penney CEO Allen Questrom, who assumed the post at the end of 2000, recognizes that the chain has a huge image problem to overcome. "Customers see us as that store from their childhood that their grandma dragged them to when the family had no money," he says. But with his new focus on fashion, Questrom insists, "we're not your granny's store anymore."

Questrom had better hope that Granny really disapproves of Bisou Bisou print bustiers and V-neck tanks, because he has a lot riding on this fashion bet. Just three years ago J.C. Penney was on the verge of bankruptcy. Same-store sales at the $32-billion-a-year company were declining, and the stock had nose-dived almost 80%, to a low of $8.75. The slump was so bad that its market share among department stores fell from 3.5% in 1990 to 2.4% in 1999, even though it had more stores than any other chain. In stepped Questrom. A retail turnaround master, he had led successful makeovers at Federated, Neiman Marcus, and Barneys. He got to work right away shoring up the company by centralizing buying, closing failing stores, and installing new management. The results looked good: Same-store sales rose, the stock perked up, net income rose 300% last year, to $405 million, and Penney was one of only a few retailers to have a good Christmas.

Questrom cautions that "we still have a long way to go." The numbers for the most recent quarter make that plain. After two years of rising quarterly earnings, Questrom got slapped when same-store sales fell nearly 5% and net income dropped by 29%, more than analysts had expected. Blaming the war, the economy, and unusually cold weather, Questrom called the past quarter "one of the most difficult" in retail history. Indeed, other retailers also suffered during the period, but Penney's loss of momentum--and one analyst's downgrade--was a big setback for its turnaround story. Moreover, Questrom still hasn't dealt with troubled pharmacy chain Eckerd, which has been a drag on the stock. Shares are hovering at around $17, down from a high of $21 earlier this year.

To get the momentum back, Questrom will have to recreate Penney's image. And with all of its problems, the company does have one thing going for it: Questrom's eye. Questrom likes fashion, unapologetically. The stylish CEO (he once modeled for a Neiman Marcus catalogue) is just as comfortable in the front row of fashion shows as he is laying out the numbers to Wall Street. Since apparel accounts for 85% of J.C. Penney store sales, Questrom's interests are, shall we say, a good fit. Penney is currently in discussions with several runway designers (though the company won't reveal whom), and Questrom hopes to announce another deal by the end of the year. The company is also recruiting new designers to its headquarters in Plano, Texas, to improve its own private-label brands. The hope is that with chic designer clothes and revived house brands, Penney will be able to attract the Holy Grail of retail: women between the ages of 25 and 35, who spend almost $15 billion a year on clothes. The average Penney customer today? A very uncool 46.

Questrom isn't trying to transform Penney into Saks; after all, its average shopper, whose household income is between $30,000 and $80,000, is looking for a bargain. But he knows his customers would shop at Saks if they could. "They are finally realizing--finally--that even a blue-collar person still may want to sport a multicolor collar," says Kurt Barnard, head of Barnard's Retail Consulting Group. "This kind of transformation in retail just doesn't usually happen."

In that fashion-saves-the-day mode, the chain has hired trend expert David Hacker, who jet-sets to St.-Tropez, Miami, and New York City, scouts out European runways for tips, and is always thumbing through Vogue to make sure that the stores are ready to, say, stock the next hot color for spring (pink--which Hacker forecast a year ago). The results are getting noticed by fashion bibles like Cosmopolitan and In Style, where Penney's affordable merchandise has been featured alongside the likes of DKNY and Armani.

Hiring a trendspotter like Hacker may not be unusual in retail, but it is radical for J.C. Penney. The infamously insular company culture--Questrom is the first outside CEO in the company's 101-year history--used to be the butt of jokes among industry insiders. They said the retailer never even bothered to look around the mall at what the competition was doing. Much less at Gucci.

No more. Questrom's first task was to centralize the chain's backward buying operation, which allowed each of its 1,049 store managers to buy merchandise for his individual store. "Before, anyone with a Winnebago could pull up to a J.C. Penney and sell us merchandise," says Liz Sweney, executive vice president for women's apparel and accessories.

Executives were not only hopelessly out of touch with style but also deluded about their own products. They thought Arizona, the flagship private-label brand, appealed to a trendy young customer. Two years ago Questrom asked Jeff Bergus, who had held design posts at Geoffrey Beene and Izod, to take over the brand. Bergus did some research and discovered that the average Arizona customer was actually between 44 and 46 years old, not the 17-to 24-year-old J.C. Penney envisioned.

Bergus demanded only one thing for his office when he arrived at J.C. Penney: MTV. (He watches it constantly to check out what people are wearing.) It was a first at the Plano headquarters. Bergus has transformed the Arizona line and is now sending designers to Avril Lavigne concerts to scan the audience for inspiration. This spring the company launched a new Arizona TV ad campaign featuring young models wearing strategically placed denim and barely buttoned blouses.

Bergus is one of many new hires whom Questrom has plucked from competitors, including Wal-Mart, Federated, Target, the Limited, and Neiman Marcus. Under the old regime, top executives proudly wore the company anniversary ring. Today it's a badge of honor to have a tenure under 18 months. "I would never have seriously considered J.C. Penney before Questrom," says 18-monther Michael Cape, director of visual merchandise and store design, whose resume includes Mervyn's, Williams-Sonoma, and Pottery Barn. "There is a cultural shift going on not only in the stores but in the [headquarters] building here."

Cape is a perfect example of the new face of JCP. With his platinum-blond goatee and silver hoop earrings, Cape refers to himself as the "orchestrator" and the store as the "stage." His job is to spiff up the stores and give the chain a uniform, updated look. Retail analysts see that as crucial to crafting a new image, though Questrom says the company has barely begun the effort. He says only about 5% to 8% of the stores look the way he wants them to. "They're doing a lot of things right but still have to get a customer in the store," says analyst Robert Buchanan of A.G. Edwards.

Still, Zhay-See Pen-ney has at least managed to get fashionistas to say, Yes, yes, yes, yes. Back at the Bronx store, the Bisou Bisou fashion show is a hit. The crowd swells to almost 100 mostly young, stylish women. "I'm a big Bisou Bisou fan," gushes Alexa Tirado, 27, decked out in one of the designer's tight T-shirts emblazoned with a pair of lips (bisou is French slang for "little kiss") and trendy flare-leg pants. Clutching two Penney shopping bags of new clothes, she whispers, "I guess I'm going to have to start coming to J.C. Penney now. Wow! Who'da thought?"

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