Gap Inc. (GPS) appears to be filling holes in its lingering slump, with its Old Navy stores leading the way.

The largest stand-alone clothing retailer by revenue Thursday issued second-quarter earnings guidance that was ahead of analysts' expectations as it posted a lower-than-expected drop in July same-store-sales.

Gap's sales at all stores open a year or more dropped 8% last month, when an 8.5% decline was expected, and better than an 11% fall in July 2008.

Same-store-sales at Old Navy, the retailer's largest sales division, fell 8% compared with a 16% plunge in July 2008. The figures suggest that Gap's efforts to provide better merchandise and value at Old Navy are having some success. Old Navy operated 1,066 stores in North America at the end of the first quarter.

Gap said Thursday that net sales for the second quarter, which closed at the end of July, were $3.24 billion, down 7% from the same period a year ago.

The retailer expects earnings per share for the second quarter to be 30 cents to 32 cents, ahead of the 28-cent average estimate of analyst polled by Thomson Reuters.

The better-than-expected July comparable-store showing at Old Navy came as customer traffic fell 6% from 4% in June. Gap investor relations chief Evan Price said on a conference call that the retailer "made a strategic decision to carry less markdown inventories into July versus last year, making it more difficult to drive comps," but producing better margins for Old Navy.

Gap's international division also showed improvement, with comparable-store-sales off 4% in July versus 9% a year ago. Banana Republic's comps dropped 7% versus 8% a year ago. Namesake Gap stores saw comps fall 9% compared with 6% a year ago.

The company is also operating more profitably, analysts said. "The benefits of tight inventories, reduced corporate costs and lower manufacturing and transportation costs are showing up in higher than anticipated gross and operating margins," said Jefferies retail analyst Randal Konik.

Konik raised his 2009 earnings per share estimates to $1.31 from $1.24 and 2010's to $1.42 from $1.35, calling Gap a "balance sheet/cash flow/turnaround" story.

Gap shares were strong performers on Thursday, rising more than 8% to close at $18.14.

-By Karen Talley; Dow Jones Newswires; karen.talley@dowjones.com; 212-416-2196