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Following bad reports from JCPenney, Macy’s and Kohl’s, Sears and Kmart (under the Sears Holding umbrella) lost $400 million in sales in its third quarter ending Nov. 3. Earnings dropped from $196 million last year to $2 million for the quarter.

Inventories for the quarter increased from $11.5 billion last year to $12.03 billion in 2007. The company had $4 billion in cash and equivalents on Feb. 3, 2007 and that was down to $1.5 billion. Eddie Lampert, Sears’ CEO, spent a great amount of the cash reserve to buy 6.7 million shares at an average of $131.72. The stock was trading about $100 Thursday morning after the news release.

Perhaps things are improving. In the Nov. 4 to Nov. 27 period, Sears’ sales were up 1.9 percent while Kmart was down 3.3 percent. (For the 3-month qtr, Sears’ comparable sales declined 4.2 percent and Kmart declined by 5 percent.) This means Sears’ 3rd qtr sales increases outpaced Macy’s and JCPenney. But Kmart took it on the chin as super discounter Wal-Mart took prices down and hurt comparable discounters’ sales and margins.

But what appears to be puzzling is how much Sears Holdings’ sales dropped in the August, September and October time period. And why did its inventories balloon? A drop in apparel, lawn and garden sales were mentioned. When Americans aren’t spending for their lawns and gardens, it usually means we’re in or heading for a recession.

Or, those who own houses in foreclosure don’t bother landscaping. But there is more here than meets the eye or the bottom line. Why didn’t the company mark-down more merchandise to clean out old inventory? Why was Lampert, who operates a hedge fund, buying stock when margins and sales were dropping? How do you have a $400 million shortfall in sales and an increase of $500 million in inventories? Who’s minding the store?

Lampert’s hedge fund was also investing in Citi Bank, whose stock and financial prospects fell off a cliff due to sub-prime woes. And Sears wants to buy Restoration Hardware, another basket case that needs turning around.

If Sears decides to have “fire” sales to clean out stale inventories, would Target and Wal-Mart counter these moves? And if they do, can Sears survive?

And Lampert’s whole premise for combining Kmart and Sears is that the underlying real estate assets of the stores are far more valuable than what is shown on the books. If regional malls, particularly older ones where Sears is an anchor, cannot generate traffic, their real estate values will drop. If the stores don’t make money, the real estate in malls will dramatically fall.

So many questions, so little time, but in Mottus & Associates’ annual prestige study, these questions will be answered.