-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, PVNfkQwzAgfKHb7aBaiqCIAJec94/1zO1sZQvzVJ7j9D2UJhUb8i6DN2xGhmaGw4 gBxRRuj36a4bJdCqXHcuqw== 0000912057-02-032990.txt : 20020821 0000912057-02-032990.hdr.sgml : 20020821 20020821100409 ACCESSION NUMBER: 0000912057-02-032990 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 2 CONFORMED PERIOD OF REPORT: 20020707 FILED AS OF DATE: 20020821 FILER: COMPANY DATA: COMPANY CONFORMED NAME: MOVIE GALLERY INC CENTRAL INDEX KEY: 0000925178 STANDARD INDUSTRIAL CLASSIFICATION: SERVICES-VIDEO TAPE RENTAL [7841] IRS NUMBER: 631120122 STATE OF INCORPORATION: DE FISCAL YEAR END: 0103 FILING VALUES: FORM TYPE: 10-Q SEC ACT: 1934 Act SEC FILE NUMBER: 000-24548 FILM NUMBER: 02744340 BUSINESS ADDRESS: STREET 1: 900 WEST MAIN STREET CITY: DOTHAN STATE: AL ZIP: 36301 BUSINESS PHONE: 3346772108 MAIL ADDRESS: STREET 1: 900 WEST MAIN STREET CITY: DOTHAN STATE: AL ZIP: 36301 10-Q 1 a2087678z10-q.htm 10-Q
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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-Q

(Mark One)
ý	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended July 7, 2002
OR
o	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from to

Commission file number 0-24548

Movie Gallery, Inc.
(Exact name of registrant as specified in its charter)

Delaware (State or other jurisdiction of incorporation or organization)		63-1120122 (I.R.S. Employer Identification No.)
900 West Main Street, Dothan, Alabama (Address of principal executive offices)		36301 (Zip Code)
(334) 677-2108 (Registrant's telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to filing requirements for the past 90 days. YES o NO ý

The number of shares outstanding of the registrant's common stock as of August 14, 2002 was 31,931,052.

Movie Gallery, Inc.

Index

Part I. Financial Information
Item 1. Consolidated Financial Statements (Unaudited)
	Consolidated Balance Sheets—January 6, 2002 and July 7, 2002	1
	Consolidated Statements of Income—Thirteen weeks and twenty-six weeks ended July 1, 2001 and July 7, 2002	2
	Consolidated Statements of Cash Flows—Twenty-six weeks ended July 1, 2001 and July 7, 2002	3
	Notes to Consolidated Financial Statements—July 7, 2002	4
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations		8
Item 3. Quantitative and Qualitative Disclosures About Market Risk		15
Part II. Other Information
Item 1. Legal Proceedings		15
Item 4. Submission of Matters to a Vote of Security Holders		16
Item 6. Exhibits and Reports on Form 8-K		16

Movie Gallery, Inc.

Consolidated Balance Sheets

(in thousands)

		January 6, 2002			July 7, 2002
					(Unaudited)
Assets
Current assets:
	Cash and cash equivalents	$	16,349		$	45,900
	Merchandise inventory		6,739			9,263
	Prepaid expenses		2,085			2,423
	Store supplies and other		5,582			5,047
	Deferred income taxes		1,159			1,222

Total current assets			31,914			63,855
Rental inventory, net			88,424			98,960
Property, furnishings and equipment, net			71,739			78,067
Goodwill, net			71,682			93,095
Other intangibles, net			4,156			7,313
Deposits and other assets			2,217			3,086

Total assets		$	270,132		$	344,376

Liabilities and stockholders' equity
Current liabilities:
	Accounts payable	$	51,785		$	56,555
	Accrued liabilities		28,935			31,607

Total current liabilities			80,720			88,162
Long-term debt			26,000			—
Other accrued liabilities			606			331
Deferred income taxes			624			3,996
Stockholders' equity:
	Preferred stock, $.10 par value; 2,000,000 shares authorized, no shares issued or outstanding		—			—
	Common stock, $.001 par value; 65,000,000 shares authorized, 27,214,936 and 31,918,272 shares issued and outstanding, respectively		27			32
	Additional paid-in capital		140,475			214,494
	Retained earnings		21,713			37,187
	Accumulated other comprehensive income (loss)		(33	)		174

Total stockholders' equity			162,182			251,887

Total liabilities and stockholders' equity		$	270,132		$	344,376

See accompanying notes.

Movie Gallery, Inc.

Consolidated Statements of Income

(Unaudited)
(in thousands, except per share data)

		Thirteen Weeks Ended						Twenty-Six Weeks Ended
		July 1, 2001			July 7, 2002			July 1, 2001			July 7, 2002
Revenues:
	Rentals	$	78,381		$	115,634		$	164,036		$	232,052
	Product sales		4,606			6,944			10,522			13,656

Total revenues			82,987			122,578			174,558			245,708
Cost of sales:
	Cost of rental revenues		25,874			32,977			52,701			64,734
	Cost of product sales		3,496			5,382			8,384			9,922

Gross margin			53,617			84,219			113,473			171,052
Operating costs and expenses:
	Store operating expenses		40,477			60,835			81,871			120,675
	General and administrative		6,417			12,547			14,741			22,137
	Amortization of intangibles		1,590			360			3,504			697
	Stock option compensation		2,533			749			3,344			946

Operating income			2,600			9,728			10,013			26,597
Interest expense, net			(1,080	)		(394	)		(1,745	)		(840	)

Income before income taxes			1,520			9,334			8,268			25,757
Income taxes			593			3,734			3,322			10,283

Net income		$	927		$	5,600		$	4,946		$	15,474

Earnings per share:
	Basic	$	0.04		$	0.19		$	0.20		$	0.54

	Diluted	$	0.04		$	0.18		$	0.19		$	0.52

Weighted average shares outstanding:
	Basic		25,394			29,841			25,245			28,583
	Diluted		26,753			31,115			26,118			29,866

See accompanying notes.

Movie Gallery, Inc.

Consolidated Statements of Cash Flows

(Unaudited)
(in thousands)

		Twenty-Six Weeks Ended
		July 1, 2001			July 7, 2002
Operating activities:
Net income		$	4,946		$	15,474
Adjustments to reconcile net income to net cash provided by operating activities:
	Amortization of rental inventory		31,804			33,329
	Depreciation and intangibles amortization		11,262			9,567
	Stock option compensation		3,344			946
	Tax benefit of stock options exercised		468			3,875
	Deferred income taxes		874			3,309
Changes in operating assets and liabilities:
	Merchandise inventory		3,302			(2,341	)
	Notes receivable		(11,010	)		—
	Other current assets		(1,509	)		197
	Deposits and other assets		(188	)		(869	)
	Accounts payable		(2,814	)		4,970
	Accrued liabilities		1,049			2,347

Net cash provided by operating activities			41,528			70,804
Investing activities:
Business acquisitions			(120	)		(32,206	)
Purchases of rental inventory, net			(33,024	)		(39,550	)
Purchases of property, furnishings and equipment			(8,841	)		(12,907	)

Net cash used in investing activities			(41,985	)		(84,663	)
Financing activities:
Net proceeds from issuance of common stock			947			69,203
Net proceeds from (payments on) long-term debt			100			(26,000	)

Net cash provided by financing activities			1,047			43,203
Effect of exchange rate changes on cash and cash equivalents			—			207

Increase in cash and cash equivalents			590			29,551
Cash and cash equivalents at beginning of period			7,029			16,349

Cash and cash equivalents at end of period		$	7,619		$	45,900

See accompanying notes.

Movie Gallery, Inc.

Notes to Consolidated Financial Statements (Unaudited)

July 7, 2002

1. Basis of Presentation

The accompanying unaudited consolidated financial statements have been prepared in accordance with generally accepted accounting principles for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, the financial statements do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. Operating results for the twenty-six week period ended July 7, 2002 are not necessarily indicative of the results that may be expected for the fiscal year ending January 5, 2003. For further information, refer to the consolidated financial statements and footnotes thereto included in our annual report on Form 10-K for the fiscal year ended January 6, 2002.

In the first quarter of 2002, we began reporting the sale of previously viewed rental inventory as rental revenue and the related cost as cost of rental revenue. The sales and costs associated with previously viewed rental inventory were previously reported as product sales and cost of product sales, respectively. The sales and costs of previously viewed rental inventory in prior periods have been reclassified to conform to the current year presentation for comparative purposes. The reclassifications had no impact on total revenues, gross margins or net income as previously reported.

The extraordinary loss on early extinguishment of debt reported in the second quarter of 2001 ($177,000, net of taxes of $113,000) has been reclassified to interest expense and income taxes. The item is not material to our operating results and the reclassification had no impact on net income as previously reported.

2. Business Combinations, Goodwill and Other Intangible Assets

In June 2001, the FASB issued Statement No. 141, Business Combinations, and Statement No. 142, Goodwill and Other Intangible Assets. Statement 141 requires that all business combinations be accounted for by the purchase method, and requires all intangible assets acquired in a business combination to be recognized as assets apart from goodwill if they meet certain contractual-legal criterion or separability criterion. The provisions of Statement 141 apply to all business combinations with an acquisition date subsequent to June 30, 2001. The application of Statement 141 did not affect any of the previously reported amounts included in goodwill or other intangible assets. Under Statement 142, goodwill and indefinite lived intangible assets are no longer amortized but are reviewed for impairment annually, or more frequently if impairment indicators arise. Separable intangible assets that are not deemed to have an indefinite life will continue to be amortized over their useful lives. We adopted Statement 142 as of January 7, 2002. The adoption of Statement 142 did not have any impact on the classification of intangible assets. Application of the nonamortization provisions of Statement 142 as of January 1, 2001 would have increased net income by approximately $863,000, or $0.03 per diluted share, and $1,715,000, or $0.06 per diluted share, for the thirteen weeks and twenty-six weeks ended July 1, 2001, respectively. We completed the transitional impairment test and determined that none of the goodwill recorded was impaired as of January 7, 2002.

The components of amortized other intangible assets are as follows (in thousands):

	January 6, 2002					July 7, 2002
	Gross Carrying Amount		Accumulated Amortization			Gross Carrying Amount		Accumulated Amortization
Non-compete agreements	$	8,688	$	(5,662	)	$	8,990	$	(5,992	)
Customer lists		1,130		—			4,533		(218	)

Total	$	9,818	$	(5,662	)	$	13,523	$	(6,210	)

Estimated amortization expense for other intangible assets for the remainder of 2002 and the five succeeding fiscal years follows (in thousands):

2002 (remainder)	$	798
2003		1,575
2004		1,521
2005		1,048
2006		788
2007		712

The changes in the carrying amounts of goodwill for the twenty-six weeks ended July 7, 2002, are as follows (in thousands):

Balance as of January 6, 2002	$	71,682
Goodwill acquired		21,413

Balance as of July 7, 2002	$	93,095

3. Financing Obligations

On June 27, 2001, we entered into a credit agreement with a syndicate of banks, led by SouthTrust Bank, with respect to a new revolving credit facility. This credit facility replaced a similar revolving credit facility with First Union National Bank of North Carolina, which was due to expire on January 7, 2002. Our credit facility is unsecured and, as amended, provides for borrowings of up to $65 million through final maturity on July 4, 2004. The interest rate on our credit facility is based on LIBOR plus an applicable margin percentage, which depends on cash flow generation and borrowings outstanding. In December 2001, as required by the credit facility, we entered into an interest rate swap agreement in order to hedge exposure to interest rate fluctuations on $10 million of outstanding debt at a fixed rate of 3.5% plus an applicable margin percentage. In May 2002, we repaid all amounts outstanding under our credit facility with the proceeds from our stock offering (see note 5) and terminated the interest rate swap agreement.

4. Exit Costs

In connection with the purchase price allocation for Video Update, Inc. (acquired in December 2001), we recorded accrued expenses of approximately $1.3 million to terminate the operations of the Video Update corporate office and to transition those functions to our corporate offices. The accrual consists primarily of payroll costs, rent and utilities during the transition period. The accrual is subject to change if the transition period extends beyond that originally anticipated.

Adjustments to the accrual, if any, will be reported as an adjustment to the purchase price allocation. We paid approximately $387,000 and $1,036,000 against the accrual during the thirteen weeks and twenty-six weeks ended July 7, 2002, respectively.

5. Stockholders' Equity

Common Stock

Our Board of Directors approved two three-for-two stock splits, which were effected on August 31, 2001 and January 3, 2002 in the form of stock dividends. The stock splits increased the number of shares of common stock outstanding by a total of 14,894,399 shares. All prior periods have been restated to reflect the stock splits.

Earnings Per Share

Basic earnings per share is computed based on the weighted average number of shares of common stock outstanding during the periods presented. Diluted earnings per share is computed based on the weighted average number of shares of common stock outstanding during the periods presented, increased solely by the effects of shares to be issued from the exercise of dilutive common stock options (1,359,000 and 1,274,000 for the thirteen weeks ended July 1, 2001 and July 7, 2002, respectively; 873,000 and 1,283,000 for the twenty-six weeks ended July 1, 2001 and July 7, 2002, respectively). No adjustments were made to net income in the computation of basic or diluted earnings per share.

Stock Offering

On April 11, 2002, we filed a registration statement with the SEC for an offering of our common stock. The offering was priced at $18.25 and closed on May 21, 2002. We sold 3,900,000 shares and received the proceeds from 350,000 stock options exercised in conjunction with the offering for total proceeds, net of expenses of the offering, of approximately $67.5 million. A portion of the proceeds from the offering were used to repay outstanding borrowings under the credit facility. We plan to use the balance of the proceeds from the offering for new store openings, selective acquisitions, working capital and other general corporate purposes.

6. Comprehensive Income

Comprehensive income was as follows (in thousands):

	Thirteen Weeks Ended				Twenty-Six Weeks Ended
	July 1, 2001		July 7, 2002		July 1, 2001		July 7, 2002
Net income	$	927	$	5,600	$	4,946	$	15,474
Foreign currency translation adjustment		—		190		—		207

Comprehensive income	$	927	$	5,790	$	4,946	$	15,681

7. Legal Settlement

On April 19, 2002, we obtained preliminary court approval of a settlement agreement to resolve class action lawsuits regarding extended viewing fees charged to our customers. The terms of the settlement would provide coupons to eligible customers with values ranging from $9 to $16 to be used toward movie or game rentals or non-food purchases at Movie Gallery and affiliated stores nationwide. The agreement is subject to a fairness hearing currently scheduled for November 22, 2002. If final approval is received, the coupons will be issued and will be redeemable between January 30 and June 30, 2003. As a result of the agreement, we have recorded a one-time charge in the second quarter of 2002 of approximately $4 million, including attorneys' fees for the class of $850,000.

8. Supply Contract

We have a supply contract with Rentrak Corporation which requires us to order VHS rental inventory under lease sufficient to require an aggregate minimum payment of $4 million per year in revenue sharing, handling fees, sell through fees and end-of-term buyout fees. The agreement expires in 2006. In March 2001, the terms of our existing supply contract with Rentrak were amended. We paid Rentrak $1.6 million in connection with the amendment to the contract. Additionally, we prepaid approximately $0.9 million to be applied over a three-year period against future amounts due under the contract.

Movie Gallery, Inc.

Management's Discussion and Analysis of Financial Condition
and Results of Operations

Results of Operations

The following table sets forth, for the periods indicated, statements of income data and Adjusted EBITDA expressed as a percentage of total revenue and the number of stores open at the end of each period.

			Thirteen Weeks Ended						Twenty-Six Weeks Ended
			July 1, 2001		July 7, 2002		Increase (Decrease)		July 1, 2001		July 7, 2002		Increase (Decrease)
Revenues:
	Rentals		94.4	%	94.3	%	(0.1	)%	94.0	%	94.4	%	0.4	%
	Product sales		5.6		5.7		0.1		6.0		5.6		(0.4	)

Total revenues			100.0		100.0		—		100.0		100.0		—
Cost of sales:
	Cost of rental revenues		31.2		26.9		(4.3	)	30.2		26.4		(3.8	)
	Cost of product sales		4.2		4.4		0.2		4.8		4.0		(0.8	)

Gross margin			64.6		68.7		4.1		65.0		69.6		4.6
Operating costs and expenses:
	Store operating expenses		48.8		49.6		0.8		46.9		49.1		2.2
	General and administrative
		Recurring expenses	7.7		7.0		(0.7	)	7.6		7.4		(0.2	)
		Non-recurring items	—		3.3		3.3		0.9		1.6		0.7
	Amortization of intangibles		1.9		0.3		(1.6	)	2.0		0.3		(1.7	)
	Stock option compensation		3.1		0.6		(2.5	)	1.9		0.4		(1.5	)

Operating income			3.1		7.9		4.8		5.7		10.8		5.1
Interest expense, net			(1.3	)	(0.3	)	1.0		(1.0	)	(0.3	)	0.7

Income before income taxes			1.8		7.6		5.8		4.7		10.5		5.8
Income taxes			0.7		3.0		2.3		1.9		4.2		2.3

Net income			1.1	%	4.6	%	3.5	%	2.8	%	6.3	%	3.5	%

Adjusted EBITDA			15.5	%	14.8	%	(0.7	)%	16.5	%	15.5	%	(1.0	)%
Number of stores open at end of period			1,050		1,560		510		1,050		1,560		510

Revenue. For the thirteen weeks and twenty-six weeks ended July 7, 2002, total revenues were $122.6 million and $245.7 million, respectively, increases of 47.7% and 40.8% over the comparable periods in 2001. The increase for the year was due primarily to the expansion of our store base to 1,560 stores at the end of the second quarter of 2002 from 1,050 at the end of the second quarter last year, representing a 42.6% increase in the average number of stores open during the second quarter of 2002. The incremental stores in 2002 are primarily attributable to our acquisition of 324 Video Update stores in December 2001 and the internal development of new stores over the last year. Increases in same store revenues of 1.3% and 0.8% for the second quarter and year-to-date period of 2002, respectively, also contributed to the overall increase in total revenues. The increase in same store revenues was the result of: (i) continued growth of DVD rental revenue; (ii) increases in the sales of previously viewed movies and previously played games; (iii) higher video game rental revenues driven by growth in the video game industry and consumer acceptance of new platforms released late in 2001; and, (iv) a

favorable slate of new release titles in the second quarter of 2002 versus the second quarter of 2001. The revenue increases were partially offset by: (i) a significant decline in rental revenue from VHS product due to the continued consumer transition to DVD; (ii) unfavorable weather during the first half of 2002 as compared to the first half of 2001; (iii) the broadcast of the Winter Olympics during the first quarter of 2002; and, (iv) a less than optimal home movie release schedule in the first quarter of 2002 as compared to the first quarter of 2001.

Cost of Sales. The gross margin on rental revenue for the second quarter and year-to-date period of 2002 was 71.5% and 72.1%, respectively, versus 67.0% and 67.9% for the comparable quarter and year-to-date period of 2001. The cost of rental revenues includes the amortization of rental inventory, revenue sharing expenses incurred and the unamortized value of previously viewed rental inventory sold during the period. The improvement in the gross margin on rental revenue is a result of (i) the increasing shift of movie rentals from videocassettes to DVD, which currently has a lower cost structure than videocassettes and (ii) the purchase price allocation of Video Update that produced lower than normal rental inventory amortization in the first half of 2002. The improvement in rental margins was partially offset by the initial investment in our game expansion program that is taking place in order to provide significant copy depth of all game platforms in our stores.

Cost of product sales includes the costs of new VHS and DVD, concessions and other goods. The gross margin on product sales decreased to 22.5% for the second quarter of 2002 from 24.1% in the second quarter of 2001, and increased to 27.3% for the year-to-date period of 2002 versus 20.3% in the comparable period of 2001. The increase in the year-to-date gross margin was due to the decreased level of lower margin, new movies available for sale in 2002 versus 2001, coupled with deep discounts of certain new sales merchandise in the first quarter of 2001 to diminish levels of slow moving inventory.

Operating Costs and Expenses. Store operating expenses, which include store-level expenses such as lease payments and in-store payroll, increased to 49.6% and 49.1% of total revenue for the second quarter and year-to-date period of 2002, respectively. This reflects an increase from 48.8% and 46.9% in the comparable periods of 2001, respectively. The increase in store operating expenses as a percentage of total revenue was primarily due to a higher cost structure associated with the recently acquired 324 Video Update stores. The increase was offset partially by: (i) continued initiatives to reduce operating costs; (ii) strong performance of new stores; (iii) continued closure of under-performing units; and, (iv) the same store revenues increase of 1.3% and 0.8% in the second quarter and year-to-date period of 2002, respectively.

General and administrative expenses include a legal settlement charge of $4.0 million in the second quarter of 2002 regarding our extended viewing fee policy and a non-recurring charge of $1.6 million related to an amendment of our supply agreement with Rentrak Corporation in the first quarter of 2001. Excluding these two items, general and administrative expenses as a percentage of revenue decreased to 7.0% and 7.4%, respectively, for the second quarter and year-to-date period of 2002 from 7.7% and 7.6% for the comparable periods in 2001, respectively. The decrease was attributable to increased revenues while leveraging general and administrative expenses associated with an increased store base.

Amortization of intangibles as a percentage of total revenue for the thirteen weeks and twenty-six weeks ended July 7, 2002 was 0.3%, decreases from 1.9% and 2.0% for the comparable periods of

2001, respectively. This decrease is due to the adoption of Financial Accounting Standards Board Statement No. 142. (See "Business Combinations, Goodwill and Other Intangible Assets").

Stock option compensation expense represents the non-cash charge associated with certain stock options that were repriced during the first quarter of 2001 and are subsequently accounted for as variable stock options under FASB Interpretation No. 44, Accounting for Certain Transactions involving Stock Compensation, an interpretation of APB Opinion No. 25. We expect to record adjustments to income from stock option compensation in future periods.

Interest expense as a percentage of total revenue decreased to 0.3% for the thirteen weeks and twenty-six weeks ended July 7, 2002, from 1.3% and 1.0% in the comparable periods of 2001, respectively. The decrease is primarily due to the repayment of all outstanding debt in May 2002.

As a result of the impact of the above factors on revenues and expenses, operating income increased by 274.2% and 165.6%, respectively, for the second quarter and year-to-date period of 2002 to $9.7 million and $26.6 million, respectively. Excluding the legal settlement charge, the non-recurring charge to amend a supply contract and non-cash stock option compensation expense, operating income increased by 182.0% and 110.9% for the second quarter and year-to-date period of 2002 to $14.5 million and $31.5 million, respectively.

Business Combinations, Goodwill and Other Intangible Assets

In June 2001, the FASB issued Statement No. 141, Business Combinations, and Statement No. 142, Goodwill and Other Intangible Assets. Statement 141 requires that all business combinations be accounted for by the purchase method, and requires all intangible assets acquired in a business combination to be recognized as assets apart from goodwill if they meet certain contractual-legal criterion or separability criterion. The provisions of Statement 141 apply to all business combinations with an acquisition date subsequent to June 30, 2001. The application of Statement 141 did not affect any of the previously reported amounts included in goodwill or other intangible assets. Under Statement 142, goodwill and indefinite lived intangible assets are no longer amortized but are reviewed for impairment annually, or more frequently if impairment indicators arise. Separable intangible assets that are not deemed to have an indefinite life will continue to be amortized over their useful lives. We adopted Statement 142 as of January 7, 2002. Our adoption of Statement 142 did not have any impact on the classification of intangible assets. Application of the nonamortization provisions of Statement 142 as of January 1, 2001 would have increased net income by approximately $863,000, or $0.03 per diluted share, for the second quarter of 2001 and by approximately $1,715,000, or $0.06 per diluted share, for the first half of 2001. We completed the transitional impairment test and determined that none of the goodwill recorded was impaired as of January 7, 2002.

General Economic Trends, Quarterly Results of Operations and Seasonality

Our business is subject to fluctuations in operating results due to a number of factors, many of which are outside of our control. These fluctuations may be caused by, among other things:

•: the number, timing and performance of new or acquired stores;
•: public acceptance of, interest in, and availability of, newly released movies;
•: our mix of products rented and sold;
•: marketing programs and new release acquisition costs;
•: seasonality—compared to other months during the year, we experience peak revenues during the months of November, December and January due to the holidays in these months as well as inclement weather conditions. Additionally, revenues generally rise in the months of June, July

and August when most schools are out of session, providing people with additional discretionary time to spend on entertainment; and

•: special events, such as the Olympics or ongoing major news events of significant public interest.

Liquidity and Capital Resources

Our primary capital needs are for opening and acquiring new stores and for purchasing inventory. Other capital needs include refurbishing, remodeling and relocating existing stores and refreshing, rebranding, and supplying new computer hardware for acquired stores. We fund inventory purchases, remodeling, rebranding and relocation programs, new store opening costs and acquisitions primarily from cash flow from operations, proceeds from our common stock offering and, if necessary, loans under revolving credit facilities.

During the twenty-six weeks ended July 7, 2002 we generated approximately $38.0 million in Adjusted EBITDA, a 31.7% increase over $28.8 million for the comparable period in the prior year. This increase was primarily driven by the revenue growth and gross margin increases as discussed above. Adjusted EBITDA is defined as earnings before interest, taxes, depreciation and amortization, non-cash stock option compensation and non-recurring items, less our purchases of rental inventory which excludes rental inventory purchases specifically for new store openings. Adjusted EBITDA is presented not as an alternative measure of operating results or cash flow from operations (as determined in accordance with accounting principles generally accepted in the United States), but because, in the home video specialty retail industry, it is a widely accepted financial indicator of a company's ability to incur and service debt. Our calculation of Adjusted EBITDA is not necessarily comparable to reported EBITDA and/or Adjusted EBITDA of other companies due to the lack of uniform definitions of EBITDA and Adjusted EBITDA. Our calculation of Adjusted EBITDA is as follows:

	Thirteen Weeks Ended						Twenty-Six Weeks Ended
	July 1, 2001			July 7, 2002			July 1, 2001			July 7, 2002
Operating income	$	2,600		$	9,728		$	10,013		$	26,597
Amortization of rental inventory		16,076			16,474			31,804			33,329
Depreciation and intangibles amortization		5,533			4,847			11,262			9,567
Stock option compensation(a)		2,533			749			3,344			946
Non-recurring items(b)		—			4,000			1,600			4,000
New release replenishment, net(c)		(13,919	)		(17,638	)		(29,175	)		(36,451	)

Adjusted EBITDA	$	12,823		$	18,160		$	28,848		$	37,988

(a): Non-cash compensation expense associated with certain stock options that were repriced during the first quarter of 2001 and are subsequently accounted for as variable stock options.
(b): Reflects a legal settlement of $4 million for the second quarter and year-to-date period of 2002 and a supply contract amendment of $1.6 million for the year-to-date period of 2001.
(c): Represents the cost of replenishing new release rental videocassettes, DVDs and video games for existing stores (net of the write-off of the net book value of previously viewed rental inventory sold) that are included in investing activities on our statements of cash flows. This cost is in addition to the cost of rental inventory represented by revenue sharing expense included in our statements of income.

We fund short-term working capital needs, including the purchase of rental inventory, primarily through cash flow from operations. Net cash provided by operating activities was $70.8 million for the

twenty-six weeks ended July 7, 2002 compared to $41.5 million for the twenty-six weeks ended July 1, 2001. Net cash provided by operating activities continues to be sufficient to cover our rental inventory and capital asset replenishment needs.

Net cash used in investing activities was $84.7 million for the first half of 2002, versus $42.0 million for the comparable period in 2001. The increase is primarily due to more significant acquisition activity in 2002 versus 2001 and increased rental inventory purchases in 2002 to support a larger store base.

Net cash provided by financing activities was $43.2 million for the first half of 2002, versus $1.0 million for the comparable period in 2001. The increase is primarily due to the net result of the proceeds from our stock offering and the subsequent repayment of amounts outstanding under our credit facility.

On April 11, 2002, we filed a registration statement with the SEC for an offering of our common stock. The offering was priced at $18.25 and closed on May 21, 2002. We sold 3,900,000 shares and received the proceeds from 350,000 stock options exercised in conjunction with the offering for total proceeds, net of expenses of the offering, of approximately $67.5 million. We used a portion of the proceeds to repay outstanding borrowings under our credit facility. We plan to use the balance of the proceeds from the offering for new store openings, selective acquisitions, working capital and other general corporate purposes.

On June 27, 2001, we entered into a credit agreement with a syndicate of banks, led by SouthTrust Bank, with respect to a new revolving credit facility. This credit facility replaced a similar revolving credit facility with First Union National Bank of North Carolina, which was due to expire on January 7, 2002. Our credit facility is unsecured and, as amended, provides for borrowings of up to $65 million through July 4, 2004. The interest rate on our credit facility is based on LIBOR plus an applicable margin percentage, which depends on cash flow generation and borrowings outstanding. In December 2001, as required by the credit facility, we entered into an interest rate swap agreement in order to hedge exposure to interest rate fluctuations on $10 million of outstanding debt at a fixed rate of 3.5% plus an applicable margin percentage. In May 2002, we repaid all amounts outstanding under our credit facility with the proceeds from our stock offering and terminated the interest rate swap agreement.

We grow our store base through internally developed and acquired stores. We opened 45 internally developed stores, acquired 119 stores and closed 19 stores during the first half of 2002. We expect to open 140 new stores in 2002. To the extent available, new stores and future acquisitions may be completed using proceeds from our recent stock offering, funds available under our credit facility, financing provided by sellers, alternative financing arrangements such as funds raised in public or private debt or equity offerings or shares of our stock issued to sellers. However, we cannot assure you that financing will be available to us on terms which will be acceptable, if at all.

At July 7, 2002, we had a working capital deficit of $24.3 million, due to the accounting treatment of rental inventory. Rental inventory is treated as a noncurrent asset under accounting principles generally accepted in the United States because it is a depreciable asset and a portion of this asset is not reasonably expected to be completely realized in cash or sold in the normal business cycle. Although the rental of this inventory generates the major portion of our revenue, the classification of this asset as noncurrent results in its exclusion from working capital. The aggregate amount payable for this inventory, however, is reported as a current liability until paid and, accordingly, is included in working capital. Consequently, we believe that working capital is not an appropriate measure of our liquidity and we anticipate that we will continue to operate with a working capital deficit.

The following table discloses our contractual obligations and commercial commitments as of July 7, 2002:

	Payments Due by Period (in thousands)
Contractual Obligations	Total		Less than 1 year		1-3 Years		4-5 Years		After 5 Years
Credit facility—outstanding(1)	$	—	$	—	$	—	$	—	$	—
Operating leases		191,522		6,084		137,996		33,548		13,894
Unconditional purchase obligations		16,838		4,000		12,000		838		—

Total contractual cash obligations	$	208,360	$	10,084	$	149,996	$	34,386	$	13,894

(1): The total commercial commitment under our credit facility is $65 million, which expires on July 4, 2004. As of July 7, 2002, there were standby letters of credit outstanding under our credit facility of $537,000, of which $325,000 expires on December 31, 2002 and $212,000 expires on June 27, 2003.

We believe our projected cash flow from operations, cash on hand, borrowing capacity under our credit facility and trade credit will provide the necessary capital to fund our current plan of operations, including our anticipated new store openings and acquisition program, through fiscal 2002. However, to fund a major acquisition, or to provide funds in the event that our need for funds is greater than expected, or if the financing sources identified above are not available to the extent anticipated or if we increase our growth plan, we may need to seek additional or alternative sources of financing. This financing may not be available on satisfactory terms. Failure to obtain financing to fund our expansion plans or for other purposes could have a material adverse effect on our operating results.

Our ability to fund our current plan of operations and our growth plans will depend upon our future performance, which is subject to general economic, financial, competitive and other factors that are beyond our control. We cannot assure you that our business will continue to generate sufficient cash flow from operations in the future to fund capital resource needs, cover the ongoing costs of operating our business and service any debt incurred in the future. If we are unable to satisfy these requirements with cash flow from operations and cash on hand, we may be required to sell assets or to obtain additional financing. We cannot assure you that any such sales of assets or additional financing could be obtained.

Critical Accounting Policies

Our significant accounting policies are described in note 1 to our consolidated financial statements as filed in our annual report on Form 10-K for the fiscal year ended January 6, 2002. Our discussion and analysis of financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of the financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues, expenses, and related disclosure of contingent assets and liabilities. On an on-going basis, we evaluate the estimates that we have made. These estimates have been based upon historical experience and on various other assumptions that we believe to be reasonable under the circumstances. Actual results may differ from these estimates under different conditions or using different assumptions. We believe our most critical accounting policies include our policies with respect to rental inventory amortization, the recognition of extended viewing fee revenue, impairment of long-lived assets, purchase price allocation of acquired businesses and deferred income taxes. These policies are discussed in Item 7 of our annual report on Form 10-K for the fiscal year ended January 6, 2002.

With respect to rental inventory, a major component of our cost structure is based upon the method by which we amortize our rental inventory. This method (described in note 1 to our consolidated financial statements as filed in our annual report on Form 10-K for the fiscal year ended January 6, 2002) is dependent upon the net realizable value of our inventory and the demand patterns of the rental products we provide. The largest two chains in our industry tend to operate in more urban areas with higher levels of DVD penetration. As a result of the transition of consumer preferences from renting videocassettes to DVDs, these two companies have changed their estimates used to amortize rental inventory by reducing the residual values of the videocassette product and by accelerating the write-off period. We periodically evaluate the necessity of accelerating our amortization method based on consumer demand for our products and at some time in the future may make a change in our methods or estimates. Such a change could result in a significant one-time non-cash charge to our earnings, which could have a negative effect on our results of operations.

Forward Looking Statements

To take advantage of the "safe harbor" provisions of the Private Securities Litigation Reform Act of 1995, you are hereby cautioned that this report contains forward-looking statements that are based upon current expectations and involve a number of risks and uncertainties. These risks and uncertainties include, but are not limited to, the risk factors that are discussed from time to time in our SEC reports, including, but not limited to, the report on Form 10-K for the fiscal year ended January 6, 2002, and the Prospectus filed pursuant to rule 424(b)(1), filed with the SEC on May 17, 2002. We undertake no obligation to update any forward-looking statements, whether as a result of new information, future events, or otherwise.

Item 3. Quantitative and Qualitative Disclosures About Market Risks

In May 2002, we repaid all outstanding debt and terminated our interest rate swap agreement. There have been no other material changes in our inherent market risks since the disclosures made as of January 6, 2002 in our annual report on Form 10-K.

Part II—Other Information

Item 1. Legal Proceedings

As discussed in our report on Form 10-Q for the quarter ended April 7, 2002 and filed with the Securities and Exchange Commission on May 22, 2002, we are a defendant in one putative class action lawsuit in Alabama, Sable Denise Mack, et. al. v. M.G.A., Inc., filed on December 8, 2000 in the Circuit Court of Tuscaloosa County, Alabama; one putative class action lawsuit filed on August 17, 2001 in the 71^stJudicial District Court, Harrison County, Texas, Shannon Thompson, et. al. v. M.G.A., Inc.; and one putative class action lawsuit filed on December 3, 2001, in the Chancery Court of Fayette County, Tennessee, Michael McCullar, et al. v. Movie Gallery, Inc., et al. Each of these lawsuits alleges, on behalf of a nationwide class of all customers, that the extended viewing fees we charge our customers for keeping our rental products beyond the initial rental period are penalties in violation of common law and equitable theories. The dollar amounts that plaintiffs seek in each of the foregoing three putative class action lawsuits is not set forth in the complaints. Similar class action lawsuits have been filed against the two largest chains in our industry. Without admitting any fault, one of our competitors settled all of these class action lawsuits pending against it. According to the announced terms of the settlement, this company agreed to make certificates available to class members for rentals and cash discounts and to pay approximately $9.0 million of the plaintiffs' attorneys' fees. Although the settlement of this case was approved by the trial court, an appeal of the approval filed by some of the class members is currently pending.

In April 2002, we obtained a court order preliminarily approving a settlement agreement between us and the plaintiffs in the Tennessee case, by which we agreed to settle claims of all of the members of the nationwide class of customers. Under the terms of the settlement agreement, we are required to give class members certificates with values ranging from $9 to $16, redeemable between January 30, 2003 and June 30, 2003, for movie rentals, game rentals, and non-food purchases in our stores. We would also pay the plaintiffs' attorneys up to $850,000 in fees. A fairness hearing regarding this settlement has been scheduled for November 22, 2002. At this hearing, the court will consider any objections to the settlement agreement brought by class members, their attorneys or other interested parties, and will determine whether to approve, reject or modify the terms of the settlement. If approved on the proposed terms, the settlement would likely release all claims made by all class members in all the pending class actions, other than members who choose not to participate in the settlement. We believe that our extended viewing fees do not violate any laws. As a result, in the event the settlement described above is not approved by the court we intend to continue to vigorously defend the lawsuits filed against us.

In connection with the settlement, the class action lawsuits in Alabama and Texas have been stayed, requiring the plaintiffs to stop their actions in those lawsuits pending final approval of the settlement.

Although we believe that the foregoing claims against us are unwarranted and without merit, we cannot assure you as to the outcome of these proceedings, or that any settlement will receive final court approval. We did, however, incur a one-time charge to our earnings of approximately $4 million in the second quarter of 2002, as a result of the settlement agreement described above, which amount includes $850,000 of plaintiffs' attorneys' fees.

In addition, we are involved in litigation in the ordinary course of our business, none of which, if decided adversely to us, individually or in the aggregate, would be material to our business or results of operations.

Item 4. Submission of Matters to a Vote of Security Holders

Our Annual Meeting of Stockholders was held on June 13, 2002. The following action was taken at the Annual Meeting, for which proxies were solicited pursuant to Regulation 14 under the Securities Exchange Act of 1934, as amended:

1.: The five nominees proposed by the Board of Directors were elected as directors by the following votes:

Name	For	Withheld
J. T. Malugen	16,107,184	5,047,627
H. Harrison Parrish	16,207,584	4,947,227
William B. Snow	20,259,422	895,389
Sanford C. Sigoloff	20,259,422	895,389
Philip B. Smith	20,259,422	895,389

2.: A proposal to approve an amendment to our Certificate of Incorporation to increase the authorized shares of common stock from 35,000,000 to 65,000,000 was approved by a vote of 20,006,143 for versus 1,110,053 against. There were 38,615 abstentions.

Item 6. Exhibits and Reports on Form 8-K

a): Exhibits

10.1

Amendment to Credit Agreement between Movie Gallery, Inc. and SouthTrust Bank dated August 15, 2002.

b): Reports on Form 8-K

We filed a Form 8-K/A reporting on Item 7 on April 10, 2002, including audited historical financial statements of Video Update, Inc. for the fiscal year ended April 30, 2001 and unaudited pro forma financial information for Movie Gallery, Inc. for the fiscal year ended January 6, 2002.

Signatures

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

		MOVIE GALLERY, INC. (Registrant)

Date: August 21, 2002		/s/ J. STEVEN ROY J. Steven Roy, Executive Vice President and Chief Financial Officer

QuickLinks

Movie Gallery, Inc. Index
Movie Gallery, Inc. Consolidated Balance Sheets (in thousands)
Movie Gallery, Inc. Consolidated Statements of Income (Unaudited) (in thousands, except per share data)
Movie Gallery, Inc. Consolidated Statements of Cash Flows (Unaudited) (in thousands)
Movie Gallery, Inc. Notes to Consolidated Financial Statements (Unaudited) July 7, 2002
Movie Gallery, Inc. Management's Discussion and Analysis of Financial Condition and Results of Operations

Item 3. Quantitative and Qualitative Disclosures About Market Risks

Part II—Other Information

Item 1. Legal Proceedings

Item 4. Submission of Matters to a Vote of Security Holders

Item 6. Exhibits and Reports on Form 8-K

Signatures
EX-10.1 3 a2087678zex-10_1.htm EXHIBIT 10.1
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EXHIBIT 10.1

THIRD AMENDMENT TO CREDIT AGREEMENT

THIS THIRD AMENDMENT TO CREDIT AGREEMENT (the "Third Amendment") is made effective as of the 15^th day of August, 2002, between MOVIE GALLERY, INC., a Delaware corporation (the "Borrower"), and SOUTHTRUST BANK, an Alabama banking corporation, as Agent (the "Agent"). Capitalized terms used herein but not defined shall have the meanings as set forth in the Credit Agreement, as amended (as hereinafter defined).

WHEREAS, pursuant to that certain Credit Agreement dated as of June 27, 2001, among Borrower, Agent, and the other Lender Parties a party thereto (the "Credit Agreement"), Lenders made available to Borrower, subject to the terms and conditions thereof, (i) the Revolving Loan in the initial principal amount of up to Sixty-Five Million and 00/100 Dollars ($65,000,000.00), and (ii) the Swing Line Loan of up to Five Million and 00/100 Dollars ($5,000,000.00); and

WHEREAS, pursuant to that certain First Amendment to Credit Agreement dated as of September 25, 2001 (the "First Amendment"), the Credit Agreement was amended in order to amend Section 8.8 of the Credit Agreement, pertaining to Hedge Agreements; and

WHEREAS, pursuant to that certain Second Amendment to Credit Agreement dated as of January 14, 2002 (the "Second Amendment"), the Credit Agreement was amended in order to amend the definition of "Permitted Acquisition" (the Credit Agreement, as amended by the First Amendment and the Second Amendment, hereinafter referred to as the "Credit Agreement, as amended"); and

WHEREAS, Agent and Borrower have agreed to amend the Credit Agreement, as amended, in order to, among other things, (i) allow for certain additional Permitted Acquisitions, (ii) amend the definition of "Equity Issuance" to not require a mandatory prepayment in connection with the issuance of 3,900,000 shares of common stock on May 17, 2002, for public offering at a price of $18.25 per share, and (iii) remove the step-down provision from the definition of "Revolving Loan Amount" all as hereinafter provided.

NOW, THEREFORE, in consideration of One Dollar ($1.00) and other good and valuable consideration, the receipt and adequacy of which are hereby acknowledged, the parties agree that the Credit Agreement, as amended, is hereby amended as follows:

1. The Credit Agreement, as amended, is hereby amended by adding the following capitalized terms as a defined terms in Article I:

"M.G. Midwest" means M.G. Midwest, Inc., a Delaware corporation (formerly known as Video Update, Inc.) and a Wholly Owned Subsidiary of Borrower.

"Movie Gallery Canada" means Movie Gallery Canada, Inc., a New Brunswick (Canada) corporation (formerly known as Video Update Canada Inc.) and a Wholly Owned Subsidiary of M.G. Midwest.

"Tangible Net Worth" means Net Worth, reduced by goodwill and other assets which should be classified as intangible assets in accordance with Generally Accepted Accounting Principles.

2. The Credit Agreement, as amended, is hereby amended by deleting the definitions of "Equity Issuance", "Permitted Acquisition", and "Revolving Loan Amount" in their entirety, and by substituting the following new definitions, respectively, in lieu thereof:

"Equity Issuance" means (i) the issuance, sale or other disposition by Borrower or any of its Subsidiaries of its Equity Interests, any rights, warrants or options to purchase or acquire any Equity Interests, or any other security or instrument representing, convertible into or exchangeable for any Equity Interest in Borrower or any of its Subsidiaries, and (ii) the receipt by Borrower or any of its Subsidiaries of any capital contribution (whether or not evidenced by any security or instrument); provided, however, that the term "Equity Issuance"

shall not include (w) that certain issuance of 3,900,000 shares of common stock on May 17, 2002, for public offering at a price of $18.25 per share, (x) any rights, warrants or options issued to directors, officers or employees of Borrower or any of its Subsidiaries pursuant to bona fide employee benefit plans established in the Ordinary Course of Business and any capital stock issued upon the exercise thereof, (y) any capital contribution to any Subsidiary, to the extent made directly or indirectly by Borrower, or (z) any Equity Interest issued or sold in connection with any Permitted Acquisition and constituting all or a portion of the applicable purchase price.

"Permitted Acquisition" means any Acquisition if (i) the business acquired is a Permitted Line of Business; (ii) any securities given as consideration therewith are securities of Borrower; (iii) immediately after the Acquisition, the business so acquired (and the assets constituting such business) shall be owned and operated by Borrower or a wholly-owned Subsidiary of Borrower; (iv) no Default shall have occurred and be continuing at the time of the consummation of such Acquisition or would exist immediately after such Acquisition; and (v) after the consummation of such Acquisition, the Leverage Ratio shall be less than 1.0 to 1.0 and the ratio of Funded Debt to Tangible Net Worth must be less than 1.0 to 1.0 (the compliance with such ratios to be evidenced by the certificate to be delivered under Section 8.9(D)).

"Revolving Loan Amount" means Sixty-Five Million and No/100 Dollars ($65,000,000.00); provided, however, that upon five (5) Business Days' prior written notice to Agent, Borrower may reduce the amount of the Revolving Loan Amount at any time in an aggregate amount of not less than $5,000,000 (or if greater in integral multiples of $1,000,000 in excess thereof) and the Revolving Loan Amount shall be automatically and permanently reduced by prepayments required under Sections 5.3(B), (C) and (D).

3. The Credit Agreement, as amended, is hereby amended by deleting Exhibit "B" to the Credit Agreement, as amended, in its entirety, and by substituting in lieu thereof the Exhibit "B" attached to this Third Amendment.

4. As a condition to the effectiveness of this Third Amendment (a) Borrower shall have executed and delivered to Agent, or caused to be executed and delivered to Agent, a First Amendment to Pledge Agreement and a Joinder Agreement (Guaranty), together with all stock certificates and other items required by Agent in connection therewith (notwithstanding any provision to the contrary in the Credit Agreement, as amended, it is hereby acknowledged and agreed by the parties that M.G. Midwest is not required to execute and deliver a Pledge Agreement, or pledge the stock of Movie Gallery Canada as collateral security for payment of the Obligations); (b) Borrower shall reimburse the Lender Parties for all of the Lender Parties' fees and expenses, including, but not limited to, any and all filing fees, recording fees, and reasonable expenses and fees of the Lender Parties' legal counsel, incurred in connection with the preparation, amendment, modification or enforcement of this Third Amendment, the Credit Agreement, as amended, and any and all documents executed and delivered in connection herewith or therewith; (c) Borrower shall execute and deliver to Agent all further documents and perform all other acts which Agent reasonably deems necessary or appropriate to perfect or protect its security for the Loans; and (d) Borrower shall have delivered to Agent such other documentation, if any, as may be requested by Agent to satisfy Agent that this Third Amendment, and all other documents and instruments executed by Borrower in connection with this Third Amendment or in furtherance hereof have each been duly authorized, executed and delivered on behalf of Borrower, and constitute valid and binding obligations of Borrower.

5. Borrower represents and warrants to Agent that all representations and warranties given by Borrower in Article VII of the Credit Agreement, as amended, are true and correct as of the

date hereof, except to the extent affected by this Third Amendment. Borrower represents and warrants to Agent that Borrower is in full compliance with all of the covenants of Borrower contained in Articles VIII, IX and X of the Credit Agreement, as amended, except to the extent affected by this Third Amendment.

6. Except as heretofore or herein expressly modified, or as may otherwise be inconsistent with the terms of this Third Amendment (in which case the terms and conditions of this Third Amendment shall govern), all terms of the Credit Agreement, as amended, and all documents and instruments executed and delivered in furtherance thereof shall be and remain in full force and effect, and the same are hereby ratified and confirmed in all respects.

7. The undersigned Guarantors execute this Third Amendment to expressly evidence their assent to all the terms of the Credit Agreement, as amended, and this Third Amendment, and to further acknowledge and agree that the Guaranty remains in full force and effect and that the "Guaranteed Obligations" under the Guaranty shall include, without limitation, all obligations of Borrower under the Credit Agreement, as amended, and as amended by this Third Amendment.

[THE REMAINDER OF THIS PAGE INTENTIONALLY LEFT BLANK]

IN WITNESS WHEREOF, this Third Amendment has been duly executed as of the day and year first above written.

		BORROWER:
		MOVIE GALLERY, INC.

		By:	/s/ S. PAGE TODD
		Its:	Sr. Vice President

		GUARANTORS:
		M.G.A., INC.

		By:	/s/ S. PAGE TODD
		Its:	Sr. Vice President

		MOVIEGALLERY.COM, INC.

		By:	/s/ S. PAGE TODD
		Its:	Sr. Vice President

		MOVIE GALLERY FINANCE, INC.

		By:	/s/ S. PAGE TODD
		Its:	Sr. Vice President

		M.G. MIDWEST, INC.

		By:	/s/ S. PAGE TODD
		Its:	Sr. Vice President

		MOVIE GALLERY CANADA, INC.

		By:	/s/ S. PAGE TODD
		Its:	Sr. Vice President


		AGENT:
		SOUTHTRUST BANK, as Agent

		By:	CHRIS S. ABELE
		Its:	Commercial Loan Officer

STATE OF ALABAMA
COUNTY OF HOUSTON

I, the undersigned, a Notary Public in and for said County in said State, hereby certify that S. Page Todd, whose name as Sr. Vice President of Movie Gallery, Inc., a Delaware corporation, is signed to the foregoing instrument, and who is known to me, acknowledged before me that, being informed of the contents of such instrument, he, as such officer and with full authority, executed the same voluntarily for and as the act of said corporation.