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Movie Gallery (NASD:MOVI), the movie rental store chain, announced Q1 06 numbers for the period ending April 2. This year's results included the figures from Hollywood Entertainment, which was acquired April 27, 2005.

This deal increased the number of stores in the chain from 2,543 to 4,773. With the new stores in place, revenue increased to $694.4 million from $233.8 million. However, gross margin dropped to 61% from 66% in the period a year ago. Operating income rose to $67.5 million from $30.6 million. That means that operating margin dropped from over 13% to under 10%. Cash and cash equivalents are low for a company this size at $34.5 million.

The company did say that it was continuing to work on getting rid of real estate that it does not need so that its lease obligations will drop. The company also said it is going to stop expanding its store base. In the end, this will buy the company time to rebuild its business.

But can it be rebuilt? Same store sales dropped 6.5% and same store rental revenues fell 7.7%.

Wall Street went nearly crazy over the results, sending the stock up to $5 in early trading, an increase of almost 60% over the previous day. The company's high for the year is $34.13, so the share price is still miles below where it was.

Movie Gallery shares the Blockbuster (NYSE:BBI) problem, which is that fewer and fewer people rent movies from stores, turning instead to companies like NetFlix (NASD:NFLX) which offer DVDs for rental online. The internet download model is gaining share both for watching movies and television shows. The launch of the new ABC Network Internet site cannot be positive news for the store rental model.

It is good for shareholders of Movie Gallery to see a rebound in the fortunes of the share price, but with sales-per-store dropping, seemingly inexorably, investors have to wonder how long the company has.

MOVI 1-yr chart:

Douglas A. McIntyre is the former Editor-in-Chief and Publisher of Financial World Magazine. He is also the former president of Switchboard.com, which was the 10th most visited site in the world at the time, according to MediaMetrix. He has been chief executive of FutureSource LLC and On2 Technologies, Inc. and has served on the boards of TheStreet.com and Edgar Online. He does not own securities in companies he writes about. He can be reached at douglasamcintyre@gmail.com.

Source: Can Movie Gallery Escape In The Final Scene? (MOVI)