May 31 (Bloomberg) -- Sears Holdings Corp. said sales declined and reported profit excluding one-time items that trailed analysts' estimates after the largest U.S. department- store chain lost customers to J.C. Penney Co. and Kohl's Corp.

First-quarter sales at Kmart and Sears stores open at least a year fell 3.9 percent, the eighth straight quarterly drop for Sears since Chairman Edward Lampert merged the two retailers in March 2005. The shares fell 1.8 percent.

The company is beginning new advertising campaigns for Sears and Kmart to win back sales lost to J.C. Penney and Kohl's, which have added designer clothes to appeal to more trend-conscious consumers. Lampert, 44, said earlier this month that fixing retail operations was ``a priority'' for Sears.

``They have to take a page out of J.C. Penney's playbook and revitalize the brands and improve sales,'' said Arun Daniel, who helps manage $40 billion, including Sears shares, at ING Investments LLC in New York. Sears is ceding market share to the rival department stores, he said.

Shoppers trimmed purchases of appliances and other home goods because of higher gasoline costs and a slumping U.S. housing market, the company said today. Gasoline prices rose 39 percent during the quarter, and house prices in the first quarter rose at the slowest pace in a decade, according to government data.

Net income climbed 20 percent to $216 million, or $1.40 a share, from $180 million, or $1.14, a year earlier. One-time items lifted profit by $44 million, or 30 cents a share, in the three months through May 5.

Sales

Revenue declined 2.5 percent to $11.7 billion, Sears said today in a statement.

Shares of Sears, which has 3,800 stores in the U.S. and Canada, fell $3.23 to $180.02 at 4 p.m. New York time in Nasdaq Stock Market composite trading. They have gained 7.2 percent this year.

Excluding the gains and charges, the Hoffman Estates, Illinois-based company said it earned $1.10 a share, trailing analysts' estimates of $1.21 a share, the average of seven projections compiled by Bloomberg.

Same-store sales fell 3.4 percent at the Sears division, 1 point more than the retailer had forecast on May 3. Kmart's same-store sales declined 4.4 percent on lower sales of home goods, health and beauty products and most other categories.

Canada, Lands' End

Sears reported higher operating profit at Sears Canada and lower costs at Sears Domestic. Sales at the Lands' End home services divisions improved. Kmart's total sales declined 5.6 percent, reducing operating income at the division.

Sears has opened Lands' End stores within its larger department stores in a bid to boost sales. The company bought Lands' End for $1.8 billion in June 2002.

Sears recorded an after-tax gain of $18 million from the settlement of a contractual dispute and $16 million from amendments to Sears Canada's post-retirement benefit plans. The company also received a $12 million dividend from an investment in Mexico, $9 million in insurance money from stores damaged by 2005 hurricanes and $2 million from asset sales.

Sears lost $13 million, or 8 cents, on investments in total-return swaps, agreements in which one investor makes payments based on any coupons and capital gains or losses of an asset and the other makes fixed or floating-rate payments.

J.C. Penney, Kohl's

J.C. Penney, the third-largest U.S. department-store chain, has boosted sales by adding exclusive lines of clothing by Liz Claiborne and a new lingerie line. First-quarter same-store sales rose 2.2 percent.

Kohl's has added clothing by Polo Ralph Lauren Corp. and sold its own brands to lure middle-income shoppers from higher- priced rivals. Comparable-store sales rose 3.9 percent in the first quarter.

Earlier this month, Sears began a new advertising campaign with the slogan, ``Sears, where it begins.'' At Kmart, it introduced Mr. Bluelight, an animated character who will highlight bargains and unique items for sale. Kmart was known for ``Blue Light Special'' sales in the 1970s and '80s.

Sears had $3.4 billion in cash and cash equivalents as of May 5. Lampert, a hedge fund manager, has said he'll use surplus cash for investments.

``The basic business is doing OK,'' said Scott Rothbort, president of Millburn, New Jersey-based Lakeview Asset Management, which has Sears among its top holdings. ``The real reason people invest in Sears is because of the strong balance sheet and the future potential which Eddie Lampert brings.''

To contact the reporters on this story: Heather Burke in New York at hburke2@bloomberg.net; Lauren Coleman-Lochner in New York at llochner@bloomberg.net.

Last Updated: May 31, 2007 16:08 EDT