Updated from 5:17 p.m. EDT

Gap

(GPS) - Get Report

will venture into plus sizes at its

Old Navy

division this summer in an effort to drive organic growth and continue its now more-than-two-year-old turnaround strategy.

Earlier, the apparel retailer posted an increase in first-quarter profit, and beat analysts' projections, helped by improved gross profit and a 9% rise in sales.

Nevertheless, shares of the San Francisco-based company were falling 11 cents, or 0.5%, at $22.40 in Thursday after-hours trading, after closing up 11 cents, or 0.5%, at $22.51 in the regular session.

Earnings rose to $312 million, or 32 cents a share, in the quarter ended May 1, from $202 million, or 22 cents a share, a year earlier. The latest quarter included expenses of about $30 million, or 2 cents a share, related to premiums paid on early retirement of $170 million of funded debt.

Analysts had been expecting the company to earn 32 cents a share.

Sales in the quarter were $3.7 billion, compared with $3.4 billion a year, while same-store sales increased 7%.

"During the quarter, we sold more at regular price vs. last year and realized better year-over-year margins on both markdown and regularly priced sales," Gap said on a post-earnings conference call.

By division, sales at domestic Gap stores were flat in the quarter at $1.2 billion, while

Banana Republic

sales increased to $503 million from $411 million a year ago. Sales at Old Navy rose to $1.5 billion from $1.4 billion last year.

Gross margin as a percent of sales was 43%, up 5 basis points, the company said.

The quarter's results help solidify the company's turnaround, which began in 2002. The company has moved from more than two years of negative same-store sales results to 18 straight months of positive results. Quarterly EPS results have matched or beaten the Wall Street consensus for the past two years.

Additionally, the company has gone from net debt of $1 billion in the first quarter of 2002 to net cash of $2 billion in the first quarter of 2004.

Gap said it is still progressing with its turnaround plan and plans to maintain focus on inventory management and improving traffic and operating margins. The company now expects margins to be at the low end of its 13.5% to 16.4% previously provided range.

Within its goal to rebalance its product assortment, the company will offer a new plus size fall line at Old Navy in July. The line will be released in 55 stores in separate sections but will be similar styles to regular product offerings, including some exclusives, the company said. Bathing suits and underwear will be offered exclusively for sale through the Internet.

"The line will target young adults with fashionable value," the company said.

The new initiative dovetails with Gap's goal to improve organic growth via product extensions similar to its Gap Body line, its maternity product offerings at Old Navy and jewelry and petites offered at Banana Republic. (The Old Navy maternity line will expand by 64 stores in 2004; it currently is in 160 stores).

The company added that it is "actively" exploring other new growth opportunities, which could be new brands or acquisitions. "We see not one, but multiple opportunities for our company," Gap said, including strong international expansion in countries like Japan, where it already has a presence.

Gap expects expenses in 2004 to increase 15% due in part to bonuses and payroll costs.

But the company did not provide second-quarter and full-year earnings targets. The Wall Street consensus is 27 cents a share in the second quarter and $1.37 a share in the year.

"I see improvements in all of the businesses," said Richard Hastings, retail sector analyst at Bernard Sands. "The merchandising is so different than what it was four years ago."