updated 8/30/2007 12:45:48 PM ET 2007-08-30T16:45:48

Sears Holdings Corp. said Thursday that its second-quarter profit tumbled 40 percent because of lower overall sales and weaker operating results from Kmart and its domestic Sears operations.

Meanwhile, the nation’s No. 2 retailer, led by hedge fund guru Ed Lampert, said its war chest of cash that once swelled to $4.4 billion less than two years ago has been cut to $2.6 billion.

Sears shares dropped nearly 3 percent in midday trading.

“We are disappointed with our second quarter results,” said Aylwin Lewis, Sears Holdings’ chief executive and president. “Our gross margins came under pressure from sales declines and increased promotional activity, and as a result, our net income was significantly below last year and our expectations.”

Net income for the period ending Aug. 4 fell to $176 million, or $1.17 per share, compared with $294 million, or $1.88 per share, in the previous year.

This quarter’s earnings were compared with year-ago results that included a gain on a large legal settlement.

Quarterly revenue dipped 4 percent to $12.24 billion versus $12.79 billion a year ago.

Analysts polled by Thomson Financial expected earnings of $1.13 per share and revenue of $12.32 billion after the company narrowed its earnings projections earlier this month. The analysts’ estimates typically exclude one-time items.

Many investors have regarded Sears as a hedge fund masquerading as a retailer since Lampert, who acquired Kmart in 2003 and Sears, Roebuck and Co. in 2005, took the helm.

Wall Street has been anxiously awaiting word from Lampert about a possible expansion that could turn around the company’s fortunes. But while Sears’ profits and stock price have fared well in the past two years, revenues have continued to slump.

On Thursday, speculation mounted that Lampert could run into more headwinds as a stagnant Sears fights with competitors that are continuing to invest in stores and expand their operations.

“The worst is yet to come,” said Howard Davidowitz, chairman of the retail consulting and investment banking firm Davidowitz & Associates Inc. “If Eddie Lampert’s strategy is right, then Wal-mart’s wrong, Target’s wrong, Limited is wrong, every great retailer in the history of America is wrong.”

Morgan Stanley analyst Gregory Melich said he was concerned that the company’s inventory climbed 13 percent in the past two years while sales slid seven percent during the same period.

“We were hoping to see (Sears) work through its inventory this quarter,” he wrote in a research note. “While markdown may have helped move some apparel, it was not enough in our view as inventory continues to rise faster than sales.”

The Hoffman Estates-based company blamed its latest lackluster performance on lower operating results at Sears Domestic and Kmart that were partially offset by improved results at Sears Canada.

Still, same-store sales at Sears’ U.S. stores sank 4.3 percent while Kmart’s comparable store sales fell 3.8 percent. Same-store sales figures are an important retail industry metric of stores open at least one year.

Sales in Kmart and Sears stores were sluggish in nearly all categories. However, some increases were recorded in both stores’ women’s apparel lines and Sears’ footwear and consumer electronics.

The prior year’s results included a gain of $22 million, or 14 cents per share, related to the settlement of Visa/MasterCard antitrust litigation.

Sears said it had $2.6 billion in cash and equivalents on hand at the end of the quarter, down from $3.7 billion last year. The company said much of the money was used to repurchase about $1.5 billion in shares during the second-quarter.

Sears stock fell midday trading Thursday.

© 2012 The Associated Press. All rights reserved. This material may not be published, broadcast, rewritten or redistributed.

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