Gap's

(GPS) - Get Report

first-quarter earnings fell 7% from a year ago on essentially flat sales, beating bottom-line estimates.

The retailer earned $291 million, or 31 cents a share, in the quarter, compared with $312 million, or 33 cents a share, a year ago. Sales were $3.63 billion in the latest quarter compared with $3.67 billion a year ago. Analysts were expecting earnings of 30 cents a share on sales of $3.63 billion.

The stock added 51 cents, or 2.4%, to $22.25 in after-hours Instinet trading.

Gap finished the quarter with inventory that was 5% above a year earlier, saying the bulge was driven primarily by the timing associated with the early receipt of merchandise. At the end of the second quarter, the company expects inventory to be down from a year ago by a percentage in the low single digits.

"Overall, our first quarter results were disappointing as we were up against record high earnings from last year," the company said. "Our teams understand our challenges and they are taking the necessary steps to improve."

The company raised earnings guidance for 2005 and 2006 to reflect the reversal of a real-estate reserve. Gap now expects to earn $1.44 to $1.48 a share in 2005 and $1.58 to $1.62 a share in 2006. The consensus estimates for the years were $1.40 and $1.59 a share.

In the first quarter, Gap said, gross margins declined 2.3 points because of lower merchandise margins. Operating margin for the first quarter was 12.8%, and the company said it still sees operating margins above 13% for the year.