10-K

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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-K

(Mark One)
ý	ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended January 5, 2003
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 (IRS 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)
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act: Common Stock, $.001 par value (Title of class)

        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 such filing requirements for the past 90 days. Yes ý    No o

        Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy statement or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  o

        Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act). Yes ý    No o

        The aggregate market value of the common stock held by non-affiliates of the registrant as of July 7, 2002, was approximately $481,242,686, assuming solely for purposes of this calculation that all directors and executive officers of the registrant and all stockholders beneficially owning more than 10% of the registrant's common stock are "affiliates." This determination of affiliate status is not necessarily a conclusive determination for other purposes.

        The number of shares of common stock outstanding on March 17, 2003, was 32,129,238 shares.

Documents incorporated by reference:

1.

Notice of 2003 Annual Meeting and Proxy Statement (Part III of Form 10-K).

The exhibit index to this report appears on page 37.

ITEM 1.    BUSINESS

Our Company

        We are the leading home video specialty retailer primarily focused on rural and secondary markets. We own and operate 1,809 retail stores, located in 43 states and seven Canadian provinces, that rent and sell videocassettes, DVDs and video games. Our target markets are small towns and suburban areas of cities with populations generally between 3,000 and 20,000 where our primary competitors are typically independently owned stores and small regional chains. Since our initial public offering in August 1994, we have grown from 97 stores to our present size through acquisitions and new store openings.

        We believe we are the lowest cost operator among the leading national home video specialty retail chains. We have developed and implemented a flexible and disciplined business strategy that centers on driving revenue growth, maximizing store level productivity and profitability and minimizing operating costs. By focusing primarily on rural and secondary markets we are able to reduce our operating costs through lower rents, flexible leases, reduced labor costs and economies of scale while simultaneously offering a large product assortment. We compete directly with the two largest chains in our industry in approximately one-third of our store locations.

        As a result of our competitive strengths, our operating and growth strategies and our management team, we have achieved substantial growth over the past seven fiscal years. From fiscal 1995, the first full year of operations following our initial public offering, to fiscal 2002, we have grown total revenues from $149.2 million to $529.0 million, a compound annual growth rate of 19.8%, and have grown Adjusted EBITDA (earnings before interest, taxes, depreciation and amortization, non-cash compensation and nonrecurring items, less purchases of rental inventory, exclusive of new store opening inventory) from $8.8 million to $82.3 million, a compound annual growth rate of 37.7%. For a reconciliation of Adjusted EBITDA to operating income, see Part II, Item 6 of this Form 10-K.

        Movie Gallery, Inc. was incorporated in Delaware in June 1994. Substantially all of our operations are conducted through our wholly-owned subsidiaries, M.G.A., Inc., and M. G. Midwest, Inc. Our executive offices are located at 900 West Main Street, Dothan, Alabama 36301, and our telephone number is (334) 677-2108.

Industry Overview

Home Video Industry

        Size and Growth.    According to Adams Media Research, the domestic home video industry grew from an estimated $15.3 billion in revenue in 1996 to $22.2 billion in 2002, representing a 6.4% compound annual growth rate, exceeding the 2.3% growth rate of the Consumer Price Index during the same period. Adams Media expects this industry to reach $30.1 billion in revenue by 2007, fueled primarily by DVD penetration. At the end of 2002, approximately 90% of all television households owned a VCR and approximately 36% owned a DVD player. According to Adams Media, the number of households owning DVD players is expected to increase from approximately 38.8 million at the end of 2002 to over 75 million by 2007. Based on our experience, we believe that for a period of time after a household purchases a DVD player, there is an increase in both rentals and purchases.

        Trends.    The home video specialty retail industry is highly fragmented and continues to experience consolidation, particularly in the rural and secondary markets in which we operate. According to the Video Software Dealers Association, there are over 27,000 domestic stores in our industry. Further, the three largest video store chains account for approximately 9,000 stores, or 33% of total domestic stores, with an estimated 56% of the total rental market share. The remaining 67% of total stores are comprised of independent operators, small chains and other rental outlets. We believe that the home video specialty retail industry will continue to consolidate into regional and national chains. Over the

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past several years, the combination of increased product offerings, economies of scale, access to capital and improved marketing efforts have solidified the positions of the largest retail chains versus independent operators and undercapitalized second-tier regional chains.

        Interdependence of Movie Studios and Home Video.    Historically, new technologies, including the development of the VCR and, more recently, DVD, have led to the creation of additional distribution channels for movie studios beyond the traditional movie theater arena. Movie studios seek to maximize their revenue from distribution channels by releasing movies in sequential release date "windows" to the various movie distribution channels. The order of distribution of movies is currently: (1) movie theaters; (2) home video, which includes home video specialty retailers such as Movie Gallery and other distribution channels for packaged media such as mass merchant retailers; (3) pay-per-view, which includes newer video-on-demand ("VOD") technologies; and (4) all other sources, including cable and syndicated television. Most movie studios release hit movie titles to the home video market from 30 days to 60 days prior to the pay-per-view release date. We believe that this window of release from the movie studios is indicative of the importance of the home video retail channel to the overall profitability of movie studios and other independent movie suppliers. We also believe that because the sequential release method has allowed movie studios to increase their overall revenues, movie studios will continue the practice of sequential release even as VOD becomes more readily available to consumers.

        According to industry sources, home video is currently the largest single source of domestic revenue for the movie studios, accounting for over half of the domestic studio revenue in 2002. Only a small percentage of the movies produced are profitable from the studios' portion of the theatrical box office receipts. As a result, the movie studios depend on the revenues earned from the home video industry to produce substantial revenues from not only the hit movies, but the lower grossing non-hit and made-for-video movies.

        Product Pricing.    The home video retail channel is comprised of both rentals and sales of videocassettes and DVDs. Movie studios attempt to maximize revenues primarily through three standard pricing strategies designed to influence the relative levels of movie rentals versus sales:

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Sell-Through Movies.    Under this pricing strategy, movie studios sell DVDs and videocassettes at relatively low prices, typically less than $20 per copy. These movies are generally promoted both for rental and sale.



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Revenue Sharing.    Revenue sharing between retailers and movie studios was embraced by the industry in 1998. Under revenue sharing, retailers and movie studios share the risks associated with the rental performance of individual titles. The movie studios receive a fee, based on a predetermined percentage, typically not more than 50% of the revenue generated from the rental of these titles. After a specified period of time, generally six months to a year, these titles are no longer subject to revenue sharing and are either purchased by the retailer from the movie studio for a nominal amount, returned to the studio or destroyed. Revenue sharing is now being used by the studios on a broad base of titles in both VHS and DVD formats. We believe that revenue sharing agreements provide significant advantages to retailers, including:



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substantial increases in both quantity and selection of newly-released video titles;



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potential increases in revenues as a result of higher transaction volume; and



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further interdependence of movie studios and video retailers.

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Rental Priced Movies.    Before the prominence of revenue sharing in 1998, the majority of movie titles were released under this pricing strategy. Movies released under rental pricing typically cost between $35 and $65 per copy, and are promoted primarily as rental titles as the pricing structure is too high to motivate the consumer to purchase versus rent. With the industry's acceptance of revenue sharing and the recent penetration of DVD into the customer base, very few titles are released under a rental pricing structure today. Of the titles that are not available at sell-through pricing or under revenue sharing agreements, many can be obtained directly from the studios at reduced prices made available through volume discount offers.

Video Game Industry

        According to industry reports, domestic sales of video game software increased to approximately $6.0 billion in 2002 from approximately $4.6 billion in 2001. Domestic sales of video game hardware were estimated at $4.2 billion in 2002 versus $3.7 billion in 2001. These increases were primarily attributable to sales of Microsoft Xbox and Nintendo GAMECUBE hardware and software which were released in the fourth quarter of 2001, as well as continued sales of Sony PlayStation 2 hardware and software which was released in the fourth quarter of 2000.

        The video game industry is characterized by the short lifecycles of hardware and software due to the rapid changes that tend to occur in technology. Growth in this industry is driven by increases in the installed base of video game hardware systems and is dependent upon the introduction of new hardware platforms and continued improvement in systems technology leading to the development of new game titles. At the end of 2002, the installed base of video game hardware systems in the United States was estimated at approximately 28.3 million Sony PlayStation units, 18.1 million Nintendo 64 units, 15.9 million Sony PlayStation 2 units, 4.6 million Microsoft Xbox units and 3.6 million Nintendo GAMECUBE units, representing a cumulative increase in the installed base from the end of 2001 of approximately 24%. We expect the video game industry to continue to grow as a result of significant technological advancements made in the last few years. These advancements allow for more flexibility and creativity in software development, as well as the introduction of hardware with the potential to offer capabilities beyond gaming, such as DVD and compact disc play and backward compatibility of game software.

Competitive Strengths

        Primary Focus on Rural and Secondary Markets.    We aim to locate newly built stores in small towns or suburban areas of cities with populations typically between 3,000 and 20,000 where we can be the market leader. We believe our focus on smaller markets allows us to achieve a higher return on invested capital than we would obtain in larger urban markets because of the reduced level of competition, lower operating costs and our expertise in operating in rural and secondary markets. Our principal competitors are single store and small chain operators with smaller advertising budgets than ours, limited inventory breadth and depth and less access to capital than we have. As a result, we believe we are the leader in the majority of our markets.

        We believe our market focus also delays competition arising from new technologies such as VOD. We expect that the rural and secondary markets in which we operate are likely to be among the last markets to build the infrastructure necessary to support VOD. The typical plant upgrades required to deliver VOD are costly, and as a result, cable and digital subscriber line operators have pursued development in higher density areas where they can achieve better returns on invested capital.

        Low Cost Operator.    We believe that we are a low cost operator in each of our markets. In 2002, our average initial investment to build new stores was approximately $135,000 per store. This

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investment included leasehold improvements, fixtures, signage and inventory (net of payables). We have developed a strategy to minimize operating expenses that includes:

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negotiating favorable lease terms;



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centralized purchasing;



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reduced labor costs;



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stringent expense controls; and



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sophisticated information systems.

        Flexible and Disciplined Business Model.    We have a flexible and disciplined business model designed to maximize our revenues and reduce our costs. The components of our business model include:

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flexible store formats, which allow us to tailor the size, inventory and look of each store to fit its locale; our stores generally range in size from approximately 2,000 to 9,000 square feet, average approximately 4,600 square feet, and have inventories generally ranging from approximately 4,000 to 20,000 movies and 200 to 1,000 video games for rental;



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short lease terms that allow us to respond quickly to changing demographics, competition and other market conditions and to close non-performing stores promptly; our remaining lease terms currently average 3 years with over 400 leases considered for renewal each year;



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inventory management; and



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pricing management, including store specific pricing of promotional programs that are managed and modified based upon competitive factors, demographic issues and various operating considerations.

        Proven Acquisition Strategy.    From 1994 to 1996, we grew from 97 stores to over 860 stores, primarily as a result of an aggressive acquisition strategy. Beginning in 1999, we reinitiated our opportunistic acquisition strategy. From the beginning of fiscal 1999 through March 17, 2003, we acquired 780 stores in 54 separate transactions. Acquired stores are rapidly integrated into our operations with minimal disruption. Typically, we are able to increase revenue and cash flow in our acquired stores due to our product purchasing practices and economies of scale. The average cost of converting an acquired store to the Movie Gallery format is minimal and consists primarily of expenditures related to new signage, implementing our point of sale system and minor remodeling. We believe there are opportunities to continue to improve results in some of our recently acquired locations.

        Proprietary Information Systems to Drive Revenue and Enhance Profitability.    We compete with other home video specialty retailers to provide our customers with a broad selection of movies and video games for rental at the lowest price. To help us manage our inventory in the most profitable manner, we have developed proprietary management information systems and a point of sale system for our stores designed to enable us to optimize inventory levels, monitor customer purchase patterns and selection preferences, as well as provide comparative revenue and profitability data on a daily basis. We believe these capabilities enable us to efficiently aggregate and manage our existing and new rental inventory as well as reallocate rental inventory and adjust our merchandising selection to meet the specific product selection requirements of individual stores or markets.

        Focus on Customer Service.    We view the personal interaction of our employees with our customers as an integral part of our organizational culture and point of differentiation from our competitors. We believe that our culture, together with our established training programs for our hourly employees, store managers and field management, results in a superior customer experience and higher

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visit frequency. As part of our customer service initiatives, we maintain a database of over 5 million active customers that captures pertinent customer preferences and purchase history, and enables our store associates to provide our customers with useful product rental guidance and offer suggestive selling reminders. We believe providing prompt, friendly and knowledgeable service helps us ensure higher levels of customer satisfaction and customer loyalty.

        Experienced Management Team.    Our executive management team has demonstrated an ability to grow our business profitably through both new store openings and acquisitions. We have a highly experienced executive management team with an average of 13 years in home video specialty retailing and an average of 10 years with us in an industry that is only approximately 20 years old. We believe this continuity has allowed us to deliver a consistent offering for our customers and in turn generate high levels of customer loyalty.

Growth Strategy

        The key objective of our growth strategy is to increase market share in our existing and new markets. The key elements of our growth strategy are:

        Driving Same Store Revenues and Enhancing Operating Margins.    We focus on continuous improvement of same store revenues and profit growth through:

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capitalizing on the continued strong industry growth driven by strong DVD and video game trends;



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adopting merchandising and pricing initiatives; and



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achieving targeted cost savings.

        Developing New Stores in Attractive Markets.    We believe that the transferability of our standardized retailing format, which can be adapted easily for a variety of locations, and our record of successfully opening stores provide us with a strong foundation for expansion through new store development. Although developed stores generally require approximately one year for revenues to reach the level of mature stores, they typically become profitable within the first six months of operation and produce a positive return on investment within 24 to 30 months. We believe there are more than 4,000 markets available for further potential development that fit our typical market profile. We currently expect to open between 175 and 200 new stores in 2003 and, subject to market and industry conditions, to continue to open new stores on a similar pace over the next several years.

        Pursuing Opportunistic Acquisitions.    We believe that growth through acquisitions is attractive because:

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acquired stores provide an installed base of revenue and cash flow;



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we are able to grow more rapidly, thus providing increased benefits of scale;



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conversion to our formats and systems provides us with operating efficiencies; and



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entry into new markets is facilitated.

        In evaluating potential acquisition candidates, we consider a number of factors, including:

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strategic fit and desirability of location;



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price;



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ability to improve productivity and profitability; and



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assurances that the anticipated returns on investment approximate those generated by newly developed stores.

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        We believe that there is continued opportunity for growth through acquisitions given the existing industry fragmentation and because we believe that we are currently the most active acquirer in a majority of our target markets.

        The following table is a historical summary showing store openings, acquisitions and store closings since the beginning of fiscal 1999:

	Fiscal Year Ended
	January 2, 2000	December 31, 2000	January 6, 2002	January 5, 2003	January 6 to March 17, 2003
New store openings	53	110	77	145	28
Stores acquired	131	16	355	265	13
Stores closed	58	69	37	41	16
Total stores at end of period	963	1,020	1,415	1,784	1,809

        Acquisition of Video Update.    Effective December 21, 2001, we acquired 100% of the newly issued common stock of the reorganized Video Update under its plan of reorganization which was confirmed by the United States Bankruptcy Court on December 20, 2001. Video Update had been operating under Chapter 11 of the United States Bankruptcy Code since its voluntary bankruptcy filing on September 18, 2000. The acquisition of the newly issued common stock of Video Update was in satisfaction of all amounts owed to us by Video Update under a $6.5 million debtor-in-possession financing agreement. In addition, we purchased senior secured debt of Video Update in May 2001 for $8.5 million, funded amounts due to secured and unsecured creditors in accordance with confirmation of the plan of reorganization totaling approximately $6.3 million, and assumed other post-bankruptcy filing liabilities of Video Update totaling approximately $20.4 million. During 2002 we converted all Video Update stores to our point-of-sale system, implemented Movie Gallery operating procedures and began external sign conversions, which will be substantially completed as of the end of the first quarter of fiscal 2003.

Products

        We offer a wide selection of movies and video games for rent and sale. Our goal is to stock each store with a product assortment tailored to that store. In fiscal 2002, our revenues by product category were as follows:

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Movie rentals: 73% (VHS 48%; DVD 25%);



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Video game rentals: 10%;



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Previously viewed product sales (VHS, DVD and video games): 10%;



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Concessions, accessories and other: 4%; and



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New movie sales (VHS and DVD): 3%.

        In each of fiscal 2000 and fiscal 2001, revenues from movie rentals represented 75% of our total revenue.

        Depending upon location, our stores offer from 4,000 to 20,000 movies and from 200 to 1,000 video games for use with most video game platforms. New release movies are displayed alphabetically and older titles are displayed alphabetically by category, such as "Action," "Comedy," "Drama" and "Children." Video games are displayed alphabetically by platform.

        From 2000 to 2002, we significantly increased our DVD inventory. Additionally, during the first quarter of 2003 we purchased approximately $7 million in DVD catalog titles to supplement our existing VHS catalog inventory. Because of the ease of use and durability of DVDs, it is anticipated that eventually DVDs will replace videocassettes. The acquisition costs of DVD hardware have reached

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levels competitive with the VCR and it is estimated that as of the end of 2002, approximately 36% of domestic television households had DVD hardware. In the near term, we believe we will be able to continue to expand our DVD offerings at attractive pricing levels comparable to sell-through movies. For the fourth quarter of fiscal 2002, DVD rental revenue represented approximately 40% of our total movie rental revenue, versus approximately 18% in the fourth quarter of fiscal 2001.

        In 2001, we significantly increased our video game inventory by expanding our selection of available titles for the 32-bit and 64-bit platforms. In 2002 we have continued to support these platforms while also purchasing video game inventory for the newer 128-bit platforms, Sony's PlayStation 2, Microsoft's Xbox and Nintendo's GAMECUBE. The Sony PlayStation 2 was the leading platform within our stores and generated over 40% of our game revenue in 2002. We will continue to monitor the performance of the 128-bit platforms and intend to make future inventory investments accordingly. In addition to video games, we offer basic video game hardware accessories in many of our stores and we rent and sell video game hardware in a select base of stores.

        We review our store inventory on an ongoing basis for movies and games that have not rented for a period of time and offer these previously viewed products for sale.

Store Operations

        As of March 17, 2003, we operated a total of 1,809 retail stores located in 43 states and seven Canadian provinces.

        We maintain a flexible store format, tailoring the size, inventory and look of each of our stores to local demographics. Our stores generally range from approximately 2,000 to 9,000 square feet, averaging approximately 4,600 square feet, with inventories generally ranging from approximately 4,000 to 20,000 movies and 200 to 1,000 video games.

        Store interiors are designed to create a visually appealing, up-beat ambiance using bright lighting, vibrant graphics and carpet and coordinating signage. The inviting atmosphere is augmented by a background of television monitors displaying MGTV, a customized video program which plays movie previews and promotions of coming attractions, and by posters and stand-up displays promoting specific movie titles. Movies are arranged in attractive display boxes organized into categories by topic, except for new releases, which are assembled alphabetically in their own section for ease of selection by customers. Our stores are generally open seven days a week, from 10:00 a.m. to 11:00 p.m. on weekends and from 10:00 a.m. to 10:00 p.m. on weekdays.

        Each of our stores typically employs five to 14 hourly, part-time associates and one full-time store manager. Store Managers report to District Managers, who supervise the operations of 10 to 15 stores. The District Managers report to one of 16 Regional Managers, who report directly to one of two Zone Vice Presidents. The Zone Vice Presidents report directly to our Executive Vice President of Operations. We have increased the number of District Managers and Regional Managers over time as necessary to support our growth. The support center staff has regular meetings with the Regional Managers and District Managers to review operations. Compliance with our policies, procedures and regulations is monitored on a store-by-store basis through exception-based reporting systems and quarterly quality assurance audits performed by District Managers and members of our training department. The performance and accuracy of the quarterly District Manager audits is monitored by our support operations team.

Site Selection

        We continuously search for appropriate markets in which to develop new stores. In selecting sites for new stores, we use an evaluation process designed to enhance our return on investment by focusing on lease terms, demographics, population density, traffic volume, store-front visibility and presence,

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ease of access and economic development in the market area. We also review the location of competitive stores and customer activity at those stores.

        We develop both freestanding stores and stores located in strip centers anchored by major grocery or discount drug store chains. Lease terms are a critical element in our site selection process. In negotiating lease agreements and lease renewals, we attempt to obtain short lease terms and favorable options to extend terms. As a result, we have the flexibility necessary to react to changing demographics, competition and other market conditions. To date, we have not experienced difficulty in obtaining favorable leases or renewals at market rates in suitable locations. The current average remaining life of our leases is approximately 3 years with over 400 leases considered for renewal each year.

        We actively pursue relocation opportunities to adapt to changes in customer shopping patterns and retail market shifts. We regularly review the profitability and prospects of each of our stores and evaluate whether any underperforming stores should be closed or relocated to more desirable locations. The cost of closing a unit is minimal and usable inventory, signage, fixtures and equipment is transferred to existing or new locations.

Marketing and Advertising

        We use market development funds, cooperative allowances from our suppliers and movie studios, and internal funds to purchase radio, direct mail and newspaper advertising, in-store visual merchandising and in-store media. Through the use of market development funds, our trade name is promoted along with a video or game title. Creative copy is prepared by us in conjunction with the movie studios and is placed by our in-house media buyers in the appropriate medium. We also prepare a monthly consumer magazine, Video Buzz, and a customized video program, MGTV, both of which feature Movie Gallery programs, promotions and new releases. Along with these traditional forms of advertising, we have developed and implemented a customer loyalty program, Reel Players. The program is based on a point system that provides customers the opportunity to earn free rentals and other incentives.

        From time to time we conduct trivia games designed to drive customer visits. For example, in 2002 we entered into a promotional partnership with The Coca-Cola Company®, the National Association for Stock Car Auto Racing, Inc. (NASCAR®) and the Richard Petty Driving Experience™ relating to a scratch-and-win/collect-and-win movie trivia game.

        To date, our expenditures for advertising in excess of the allowances from our suppliers and movie studios have been less than 1% of annual revenues.

E-Commerce

        In 1999, we developed a consumer-oriented web site, www.moviegallery.com, to sell new and used movies and used video games. We designed our web site to serve our customers and complement our store operations by providing movie news and reviews and information on upcoming new rental releases, as well as general information about our company, press releases and SEC filings of interest to stockholders and potential investors. Since inception, we have not invested significant amounts of capital in our e-commerce business. In 2002, we decided to re-focus the retail sales functions of the web site back into our stores and continue to maintain the web site for customer service and investor information use. We did not incur any costs associated with the modifications to this business.

Studio and Distribution Relationships

        We negotiate the majority of our movie purchases directly with movie studios through revenue sharing and other direct purchase arrangements. The movies are delivered directly to our stores by third-party distributors. These distributors function largely as fulfillment agents. We pay distributors a

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flat fulfillment fee for packing and shipping product directly to our stores. Because of our direct relationships with the studios, we believe that if one of our distributors were unable or unwilling to satisfy their commitment to us, a viable alternative, such as self-distribution, could be implemented without materially adversely impacting our business.

        Several companies acquired by us prior to 1997 had pre-existing long-term contracts with Rentrak Corporation under which product would be provided under pay-per-transaction revenue sharing arrangements. During late 1996, we consolidated existing contracts with Rentrak into one national agreement. Under this agreement, which expires in September 2006, we have a minimum gross annual purchase commitment in revenue sharing, handling fees, sell-through fees and end-of-term buyouts equal to less than 3% of our annual product requirements. We utilize Rentrak on a selective title-by-title basis and have exceeded the minimum purchase requirements in each year since 1996.

        We currently source our video game inventory from third-party distributors.

Inventory Management and Distribution Facility

        Inventory Management.    We are committed to offering as many copies and the widest variety of new releases as is necessary to be competitive within a market, while at the same time keeping our costs as low as possible. New videocassettes and DVDs offered for sale are primarily hit titles promoted by the studios for sell-through, as well as special interest and children's titles and seasonal titles related to particular holidays. Videocassettes, DVDs and video games utilized as initial inventory in our newly developed stores consist of excess copies of older titles and new release titles from existing stores, supplemented as necessary by purchases directly from suppliers.

        New release movie and game products are allocated to individual stores through a system that considers the revenue levels and customer demographic profiles of each store. Rental history on movie titles is captured for each store and used as a comparison point for future titles of a similar genre.

        Distribution Facility.    Inventory for newly developed stores is assimilated at our processing and distribution facility located in Dothan, Alabama. Excess inventory in existing stores is gathered and supplemented as needed with purchases, and the inventory is then shipped to our new store ready for use. Our distribution facility is also used to ship store supplies, computer supplies and marketing materials to our stores, process returns to our suppliers and to stock balance inventory within our chain of stores.

Management Information Systems

        Our stores utilize a proprietary point of sale system. Our point of sale system provides detailed information on store operations, including the rental history of titles and daily operations for each store, which is telecommunicated to our support center on a daily basis. Our point of sale system is installed in all developed stores prior to opening and in acquired stores shortly after the closing of an acquisition.

        Our point of sale system records all rental and sale information upon customer checkout using scanned bar code information and updates the information when the movies and video games are returned. Our point of sale system is linked to a management information system at our support center. Our point of sale system transmits store data nightly into the management information system where all data is processed. The management information system then generates reports that allow management to effectively monitor store operations and inventory, to review rental history by title and location and to assist in making purchasing decisions with respect to new releases. Our point of sale system enables us to perform our monthly physical inventory using bar code recognition, to process human resource information and to provide system-based training modules.

        We also maintain a financial reporting system, relating to the general ledger, human resources/payroll, revenue and accounts payable functions, capable of handling our current needs and anticipated growth. Additional proprietary systems which have been internally developed and implemented include a collections system, a processing/distribution center system and various other database systems and auditing systems.

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Competition

        The home video specialty retail industry is highly competitive. We compete with other home video specialty stores, including stores operated by regional chains and by the other two largest national chains, Blockbuster and Hollywood Entertainment. From time to time, the two larger national chains have discussed the implementation of a rural strategy that is focused more on the rural and secondary markets we predominately serve. Retail pricing strategies for videocassettes, DVDs and video games are a major competitive factor in the home video specialty industry and we have fewer financial and marketing resources, lower market share and less name recognition than the two larger national chains. We also compete with other businesses offering videocassettes, DVDs and video games such as mass merchants, supermarkets, pharmacies, convenience stores, bookstores, online stores, mail order operations (such as Netflix) and other retailers, as well as noncommercial sources, such as libraries. We believe the principal competitive factors in the home video specialty retail industry are store location and visibility, title quality, availability and selection, rental period, customer service and pricing.

        In addition to competing with other home video specialty retailers, we compete with all forms of entertainment, such as movie theaters, network and cable television, direct broadcast satellite television, personal video recorders, Internet related activities, live theater, sporting events and family entertainment centers. We believe our most significant competition outside of the home video specialty retail industry is cable and satellite television. The expanded number of channels and programming offered by these providers could result in the rental of fewer videocassettes and DVDs by consumers.

        We also compete with pay-per-view in which cable or satellite subscribers pay a fee to view a movie. New and recently introduced technologies, such as VOD, enable cable companies and other telecommunication companies to broadcast a large assortment of movies to homes at scheduled intervals throughout the day. Although VOD services previously offered a limited number of channels and movies at scheduled intervals, developing technologies are enabling providers to transmit substantially more movies directly to homes at more frequently scheduled and convenient intervals throughout the day. Pay-per-view purchases could significantly increase if VOD services were to become more convenient, widely available and accepted. Further improvements in VOD and other technologies, including personal video recorders, could lead to the availability of a broad selection of movies on demand at a price that is competitive with the price of movie rentals and with the functionality of VHS and DVD.

        Studios are also experimenting with limited play DVDs that would enable users to view a movie from a DVD any number of times within a certain time frame, such as one week, before automatically erasing its contents. These DVDs have not yet been fully developed or embraced by any movie studios. We believe movie studios have a significant interest in maintaining a viable movie rental business because the sale of movies to video retail stores and other home video outlets currently represents the studios' largest source of domestic revenue. In addition, we believe VOD does not represent a near-term threat to our business because:

•

the technology and infrastructure to compress and deliver VOD in a scalable, cost-effective manner has not yet been developed;



•

piracy and other electronic security issues have not yet been adequately addressed;



•

studios have not yet determined how VOD can enhance revenues instead of merely cannibalizing highly lucrative VHS and DVD rental and sale revenues; and



•

VOD does not allow for the impulse rental opportunities from browsing through lesser-known titles that video specialty stores offer.

11

Seasonality

        There is a distinct seasonal pattern to the home video business. 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.

Intellectual Property

        We own a number of U.S. and Canadian service mark registrations, including the marks MOVIE GALLERY and VIDEO UPDATE.

Foreign Operations

        For disclosure of financial information by geographic area, refer to Note 10 to our consolidated financial statements included in Part II, Item 8 of this Form 10-K.

Employees

        As of March 17, 2003, we employed approximately 14,500 persons, referred to by us as "associates," including approximately 14,000 in retail stores and the remainder in our support center, field management staff and distribution facility. Of our retail associates, approximately 2,000 were full-time and 12,000 were part-time. None of our associates are represented by a labor union and we believe that our relations with our associates are good.

        Throughout the last year, we have developed internal hiring, training and retention programs designed to enhance consistent and thorough communication of our operating policies and procedures as well as increase the rate of internal promotions.

        We have an incentive and discretionary bonus program under which retail management associates receive quarterly bonuses when stores meet or exceed criteria established under the program. Additionally, we have periodic sales and marketing programs which provide our associates opportunities to earn incremental bonus compensation based on relative performance to pre-established goals and to actual performance of some of our associates. We believe our bonus programs reward excellence in management, give associates an incentive to improve operations, and result in an overall reduction in the cost of operations. In addition, certain associates are eligible to receive bonuses, based on individual and overall company performance, and options to purchase shares of our common stock, generally exercisable at the fair market value on the date of grant, subject to service requirements.

Available Information

        The address of our internet website is www.moviegallery.com. Through links on the Investor Relations portion of our website, we make available free of charge our annual report on Form 10-K, quarterly reports on Form 10-Q and current reports on Form 8-K, and any amendments to those reports, filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934. Such material is made available through our website as soon as reasonably practicable after we electronically file or furnish the material with the SEC.

Cautionary Statements

        This annual report on Form 10-K contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended, which represent our expectations or beliefs about future events and financial performance. Forward-looking statements are identifiable by the fact that they do not relate strictly to

12

historical information and may include words such as "believe," "anticipate," "expect," "intend," "plan," "will," "may," "estimate" or other similar expressions and variations thereof. In addition, any statements that refer to expectations, projections or other characterizations of future events or circumstances are forward-looking statements. Our forward-looking statements are based on management's current intent, belief, expectations, estimates and projections regarding our company and our industry. Forward-looking statements are subject to known and unknown risks and uncertainties, including those described below. In light of these risks, uncertainties and assumptions, the forward-looking events discussed in this Form 10-K might not occur. In addition, actual results could differ materially from those suggested by the forward-looking statements, and therefore you should not place undue reliance on the forward-looking statements. We undertake no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise. We desire to take advantage of the "safe harbor" provisions of the Private Securities Litigation Reform Act of 1995 and in that regard we caution the readers of this Form 10-K that the following important factors, among others, could affect our actual results of operations and may cause changes in our strategy with the result that our operations and results may differ materially from those expressed in any forward-looking statements made by us, or on our behalf.

We may be unable to successfully implement our growth strategy

        Our long-term strategy is to grow through new store openings and acquisitions of existing stores. Successful implementation of this strategy is contingent upon numerous conditions, and we cannot assure you that our business plan can be successfully executed. We require significant capital to acquire existing stores and to open new stores. To date, our growth strategy has been funded primarily through proceeds from public offerings of common stock, bank borrowings, internally generated cash flow, use of our common stock as acquisition consideration and seller financing. These and other sources of capital, including public or private sales of debt or equity securities, may not be available to us in the future on terms satisfactory to us or at all.

        New Store Openings.    Our ability to open new stores as planned, and the profitability of these new stores, may be adversely affected by a number of factors, including:

•

our ability to identify and secure new sites;



•

our ability to negotiate acceptable leases and timely implement cost-effective development plans for new stores;



•

the availability of capital; and



•

our ability to hire, train and assimilate skilled store managers and other personnel.

        If we do not grow as planned, our earnings could be negatively impacted.

        Our planned growth may result in increased pressure on our management and operations. We continuously review and modify our financial controls and management information systems. There are no assurances that we will be able to anticipate and respond to, in a timely and sufficient manner, the potential changing demands this expansion could have on our operations and business.

        In addition, our growth strategy contemplates the opening of new stores in markets in which we do not currently operate. Accordingly, there are no assurances that these new stores will realize revenue or profitability levels comparable to those of our current stores, or that such levels will be achieved within our estimated time frames.

        Acquisitions.    Our ability to acquire stores and operate them at the desired levels of sales and profitability may be adversely affected by:

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•

our ability to identify acquisition candidates that fit our criteria, including, among others, size, location and profitability and that are willing to sell at prices we consider reasonable;



•

our ability to consummate identified acquisitions due to, among other things, a lack of available capital;



•

a reduction in the number of stores available for purchase by us;



•

increased competition for acquisitions;



•

misrepresentations and breaches of contracts by sellers;



•

our limited knowledge of the operating history of the acquired stores;



•

the integration of the acquired stores' operating and information systems into our systems and procedures; and



•

our ability to retain and motivate employees of the acquired stores.

Our business could be adversely affected by increased competition

        From time to time, the two larger chains in our industry have discussed the implementation of a rural strategy that is focused more on the rural and secondary markets we predominately serve. Therefore, we cannot assure you that the two larger chains in our industry will not become a more significant competitive force in our markets. Pricing strategies for movies and video games are a major competitive factor in the video retail industry and we have fewer financial and marketing resources, lower market share and less name recognition than the two larger chains.

        In addition, there is no guarantee that smaller regional chains, supermarkets, pharmacies, convenience stores, bookstores, online stores, mail order operations (such as Netflix), mass merchants, franchisees, specialty retailers and other retailers, as well as noncommercial sources, such as libraries, will not develop an increased market share of the home video retail industry in the markets we serve. Other types of entertainment, such as theaters, television, personal video recorders, Internet related activities, sporting events and family entertainment centers, also compete with our video and video game businesses. If any of our competitors were to substantially increase their presence in the markets we serve, our revenues and/or profitability could decline, our financial condition, liquidity and results of operations could be harmed and the continued success of our business would be challenged.

Our business could be adversely affected if we lost key members of our executive management team

        We are highly dependent on the efforts and performance of our executive management team. If we were to lose any key members of this team, our business could be adversely affected. You should read the information under "Directors and Executive Officers" for a detailed description of our executive management team.

Our business could be adversely affected by the failure of our management information systems to perform as expected

        We depend on our management information systems for the efficient operation of our business. Our merchandise operations use our inventory utilization system to track rental activity by individual VHS, DVD and video game to determine appropriate buying, distribution and disposition of our inventory. We also rely on a scalable client-server system to maintain and update information relating to revenue, rental and sales activity, VHS, DVD and video game rental patterns, store membership demographics and individual customer history. These systems, together with our point-of-sale and in-store systems, allow us to control our cash flow, keep our in-store inventories at optimum levels, move our inventory more efficiently and track and record our performance. If our management

14

information systems failed to perform as expected, our ability to manage our inventory and monitor our performance could be adversely affected, which, in turn, could harm our business and financial condition.

Our financial results could be adversely affected if we are unable to manage our merchandise inventory effectively

        The increase in our merchandise inventory has increased our risks associated with inventory management, obsolescence and theft. Our operating results could suffer if we are unable to:

•

maintain the appropriate levels of inventory to support customer demand without building excess inventories;



•

obtain or maintain favorable terms from our vendors with respect to product returns; and



•

control shrinkage resulting from theft, loss or obsolescence.

Our business could be negatively impacted if movie studios significantly alter the movie distribution windows

        Studios distribute movies in a specific sequence in order to maximize studio revenues on each title they release. The order of distribution of movies is currently: (1) movie theaters; (2) home video retailers; (3) pay-per-view; and (4) all other sources, including cable and syndicated television. Our industry has an early "window" that is exclusive of most other forms of non-theatrical movie distribution as noted above. The length of the movie rental window varies, but typically ranges between 30 and 60 days. We cannot be certain that movie studios will maintain this exclusive window in the future. We could be adversely affected if the movie studios shorten or eliminate these exclusive windows, or if the movie rental windows were no longer among the first windows following the theatrical release, because newly released movies would be made available earlier through other forms of non-theatrical movie distribution. As a result, consumers would no longer need to wait until after the home video distribution window to view these movies through other distribution channels.

Our business may be negatively impacted by new and existing technologies

        New Technologies.    New technologies, including VOD, streaming movies over the internet and single-play DVDs, represent a material risk to our company and the home video specialty retail industry. VOD is intended to afford subscribers the luxury of watching, at any time of the day, any movie included in a list of titles maintained by the VOD provider. Consumers may prefer alternative movie delivery systems such as VOD over traditional video rentals or purchases if such alternative systems were to allow the consumers to conveniently choose, watch and control movies at any time of the day, if the alternative systems were able to be provided at a reasonable price and if new releases were made available simultaneously with, or prior to, their availability for rental at the video stores. Single-play DVDs are programmed to stop working after a limited time of use, such as one week, during which time the movie can be viewed an unlimited number of times. Although this technology is still being developed, it has not been adopted by any studios and is as yet unproven. However, certain studios have announced that they are exploring the use of this technology. We could see a significant negative impact to our financial position and survival if these technologies are widely accepted by consumers.

        Existing Technologies.    Cable, satellite and pay-per-view television systems are expected to continue to increase and expand offerings to consumers. The cable and satellite television systems offer movie channels, which require a subscription fee for access to movies selected by the provider at times selected by the provider, and VOD services, which require a discrete fee to view a movie selected by the subscriber. VOD, cable and satellite services allow consumers to avoid trips to the video store for movie rentals and returns, and remove the possibility of their incurring extended viewing fees. Although

15

VOD services previously offered a limited number of channels and movies at scheduled intervals, developing technologies are enabling cable, satellite, internet service providers and others to transmit substantially more movies directly to homes at more frequently scheduled and convenient intervals throughout the day. Pay-per-view purchases could significantly increase if VOD services were to become more convenient, widely available and accepted, which could adversely affect our business. If consumers more widely accept satellite and digital cable and/or VOD services, they may rent fewer movies from us in favor of the expanded number of channels and expanded programming offered through these existing technologies.

Our business could be adversely affected if studios initially price a significant number of new movie releases as sell-through products and consumers decide to purchase rather than rent movies

        Historically, studios have priced a number of movies they distribute at "rental" pricing, which is typically too high a price to generate significant consumer demand to purchase these movies. At times, the studios determine that consumers are more likely to purchase certain titles, and therefore price these titles at a lower price. This pricing method is known as sell-through pricing. While relatively few VHS titles have been historically released at sell-through prices, substantially all titles currently released on DVD are priced at sell-through prices. As DVD continues to penetrate the market, the mix of rental versus sell-through priced movie product is shifting more to sell-through pricing. Sell-through priced movies are purchased to rent by home video specialty retailers and to sell by both home video specialty retailers and mass merchants, among others. Sell-through retail margins are generally lower than rental margins. Some of our competitors, such as online stores, mass merchants and warehouse clubs, may operate at margins lower than ours and are able to distribute and sell movies at lower price points than us. These competitors may even be willing to sell movies below cost due to their broad inventory mix. Further decreases in studio sell-through pricing and/or sustained or further depressed pricing by competitors could result in increased consumer desire to purchase rather than rent movies and could result in increased competition. If we are not able to derive most of our revenues from our higher margin rental business, our profit levels would be adversely impacted and we may not be able to compete with our competitors for the consumer's sell-through dollar.

Our business could be adversely impacted if movie studios negatively altered revenue sharing programs

        Prior to studio revenue sharing programs and the advent of DVD, we would typically pay between $35 and $65 per videocassette for major theatrical releases not priced as sell-through titles. Under studio revenue sharing programs we are able to pay a minimal up-front cost per videocassette and thereafter pay a percentage of each revenue dollar earned for a specified period of time to the studios. We currently utilize these types of programs on a significant number of VHS and DVD movie releases. These programs have enabled us to significantly increase the number of copies carried for each title, thereby enabling us to better meet consumer demand. After a specified period of time, we offer them for sale to our customers as "previously viewed movies" at lower prices than new copies of the movie. We could be adversely affected if these programs are changed to give the movie studios a greater percentage of each revenue dollar or if they are discontinued. Further, some of our agreements may be terminated on short notice.

Our expected gross margins may be adversely affected if the average sales price for our previously viewed product is not at or above an expected price

        We earn rental revenues from video rentals and from the sale of previously viewed movies to the public. We need to sell previously viewed movies at an expected price in order to reach our estimated gross margins. Our estimated gross margins may be adversely affected if the number of rents we expect to generate does not materialize or if the average sales price for previously viewed movies is not at or above the expected price.

16

        A consumer's desire to own a particular movie and the number of previously viewed movies available for sale to the public by our competitors are factors that affect our ability to sell previously viewed movies at the expected price. Additionally, sales of previously viewed movies also compete with newly released videos that are priced for sell-through. As a result, there are no assurances that we will be able to sell an appropriate quantity of previously viewed movies at or above the expected price.

The video store industry could be adversely affected by conditions impacting the motion picture industry

        The availability of new movies produced by the movie studios is vital to our industry. The quality and quantity of new movies available in our stores could be negatively impacted by factors that adversely affect the motion picture industry, such as financial difficulties, regulatory requirements and work disruptions involving key personnel such as writers or actors. A decrease in the quality and quantity of new movies available in our stores could result in reduced consumer demand, which could negatively impact our revenues and harm our business and financial position.

Our business could be adversely affected if video game software and hardware manufacturers do not introduce new products in a timely manner

        The video game industry is characterized by the significant impact on consumer spending that accompanies the introduction of new game software and hardware platforms. Retail spending in the video game industry typically grows rapidly with the introduction of new platforms but declines considerably prior to the release of new platforms. Consumer demand for video games available in our stores could be adversely affected if manufacturers fail to introduce new games and systems in a timely manner. A decline in consumer demand for video games available in our stores could negatively affect our revenues and harm our business and financial position.

Piracy of the products we offer may adversely affect our results of operations

        The development of the Internet and related technologies increases the threat of piracy by making it easier to duplicate and widely distribute pirated content. We cannot assure you that movie studios and others with rights in the product will take steps to enforce their rights against Internet piracy or that they will be successful in preventing the distribution of pirated content. Technological developments and advances of products such as at-home DVD burners also may increase piracy of movies and games. Increased piracy could negatively affect our revenues and results of operations.

The value of our securities may be affected by variances in our quarterly operating results that are unrelated to our long-term performance

        Historically, our quarterly operating results have varied and we anticipate that they will vary in the future. Factors that may cause our quarterly operating results to vary, many of which are not in our control, include:

•

consumer demand for our products;



•

prices at which we can rent or sell our products;



•

timing, cost and availability of newly-released movies, new video games and new video game systems;



•

competition from providers of similar products and other forms of entertainment;



•

seasonality;



•

acquisitions by us of existing stores;



•

variations in the timing and number of store openings;

17

•

profitability of new stores;



•

weather patterns that can significantly increase business (inclement conditions that prohibit outdoor activities) or decrease business (mild temperatures and dry conditions that reduce the consumer's desire to relax indoors); and



•

acts of God or public authorities, war, civil unrest, fire, floods, earthquakes, acts of terrorism and other matters beyond our control.

The market price for our common stock may fluctuate substantially

        Future developments concerning our business, our competitors or the home video specialty retail industry, including fluctuations in our operating results, the introduction of new products, the performance of other similar companies, changes in financial estimates by financial analysts or our failure to meet these estimates and other factors, could have a significant impact on the market price of our common stock. In addition, in recent years the stock market has experienced a high level of price and volume volatility, and market prices for the stock of many companies have experienced wide fluctuations that have not necessarily been related to the operating performance of these companies. Since our initial public offering our stock price has experienced significant volatility. These broad market fluctuations could have a material adverse effect on the market price of our common stock, business, results of operations or financial condition.

        In addition, historically, companies that have experienced market price volatility have been the target of securities class action litigation. We could incur significant costs and our management's time and resources could be diverted from the operation of our business if we were the target of a securities class action litigation.

Terrorism, war or other acts of violence could have a negative impact on our stock price or our business

        Terrorist attacks, such as the attacks that occurred in New York and Washington, D.C. on September 11, 2001, as well as the on-going war in Iraq or other acts of violence and civil unrest in the nation and throughout the world could influence the financial markets and the economy. Consumers' television viewing habits may be altered as a result of these events such that the demand for home video entertainment is reduced. These factors could have a negative impact on our results of operations or our stock price.

Directors and Executive Officers

        The following table sets forth the name, age and position held by each of our executive officers and directors, as of March 17, 2003:

Name	Age	Position(s) Held
J. T. Malugen(1)	51	Chairman of the Board, President and Chief Executive Officer
H. Harrison Parrish(1)	55	Vice Chairman of the Board and Senior Vice President
J. Steven Roy	42	Executive Vice President and Chief Financial Officer
Jeffrey S. Stubbs	40	Executive Vice President—Operations
S. Page Todd	41	Senior Vice President, Secretary and General Counsel
Sanford C. Sigoloff(2)(3)	72	Director
Philip B. Smith(2)(3)	67	Director
William B. Snow(1)(2)(3)	71	Director

(1)

Member of our Executive Committee.

(2)

Member of our Compensation Committee.

(3)

Member of our Audit Committee.

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        Mr. Malugen co-founded Movie Gallery in 1985 and has been our Chairman of the Board and Chief Executive Officer since that time. Mr. Malugen was appointed President effective January 4, 2002. Prior to our initial public offering in August 1994, Mr. Malugen had been a practicing attorney in the states of Alabama and Missouri since 1978, but spent a majority of his time managing the operations of Movie Gallery beginning in early 1992. Mr. Malugen received a B.S. degree in Business Administration from the University of Missouri-Columbia, his J.D. from Cumberland School of Law, Samford University and his LL.M. (in Taxation) from New York University School of Law.

        Mr. Parrish co-founded Movie Gallery in 1985 and has served as a Director since that time. He was elected Vice Chairman of the Board in June 2002. Mr. Parrish served as President of Movie Gallery from 1985 until his resignation on January 4, 2002, at which time Mr. Parrish assumed the position of Senior Vice President. From December 1988 until January 1992, Mr. Parrish was Vice President of Deltacom, Inc., a regional long distance telephone provider. Mr. Parrish received a B.A. degree in Business Administration from the University of Alabama.

        Mr. Roy was elected Senior Vice President—Finance and Principal Accounting Officer in June 1995, was elected Chief Financial Officer in May 1996 and was elected Executive Vice President in March 1998. Mr. Roy was an accountant with the firm of Ernst & Young LLP for the 11 years prior to joining Movie Gallery. Mr. Roy was recently elected to serve as director and audit committee chairman of SunSouth Bank, a community bank based in southeast Alabama. Mr. Roy is a Certified Public Accountant and received a B.S. degree in Business Administration from the University of Alabama.

        Mr. Stubbs was elected Executive Vice President—Operations in April 2001 after serving as Senior Vice President—Operations since November 1997. He joined Movie Gallery in November 1995 and served as Regional Manager over Texas, Louisiana and Mississippi. Prior to joining Movie Gallery, Mr. Stubbs served as Vice President and General Manager of A.W.C. Corporation, a video specialty and restaurant retailer in east Texas, from 1987 to 1995. He has an additional eight years experience in grocery and convenience store management. Mr. Stubbs attended Texas A & M University and graduated from Southwest Texas State University, where he received a B.B.A. degree in Business Administration and Marketing.

        Mr. Todd was elected Senior Vice President, Secretary and General Counsel in December 1994. Prior to joining Movie Gallery, he had been an attorney practicing tax and corporate law in Dothan, Alabama. Mr. Todd received a B.S. degree in Business Administration from the University of Alabama, his J.D. from the University of Alabama School of Law and his LL.M. (in Taxation) from New York University School of Law.

        Mr. Sigoloff became a director of Movie Gallery in September 1994. Since 1989, Mr. Sigoloff has been Chairman of the Board, President and Chief Executive Officer of Sigoloff & Associates, Inc., a management consulting company. In August 1989, LJ Hooker Corporation, a client of Sigoloff & Associates, Inc., appointed Mr. Sigoloff to act as its Chief Executive Officer during its reorganization under Chapter 11 of the United States Bankruptcy Code. From March 1982 until 1988, Mr. Sigoloff was Chairman of the Board, President and Chief Executive Officer of Wickes Companies, Inc., one of the largest retailers in the United States. In addition, Mr. Sigoloff is an adjunct full professor at the John E. Anderson Graduate School of Management at the University of California at Los Angeles.

        Mr. Smith became a director of Movie Gallery in September 1994. Mr. Smith is serving as Vice Chairman of the Board of Laird & Co., LLC and IQ Ventures, Inc., merchant banks. In addition, from 1991 until August 1998, Mr. Smith served as Vice Chairman of the Board of Spencer Trask Securities Incorporated, an investment banking firm. Mr. Smith is a founding General Partner of Lawrence Venture Associates, a venture capital limited partnership headquartered in New York City. From 1981 to 1984, he served as Executive Vice President and Group Executive of the worldwide corporations group at Irving Trust Company. Prior to joining Irving Trust Company, he was at Citibank for 15 years,

19

where he founded Citicorp Venture Capital as President and Chief Executive Officer. Since 1988 he has also been the managing general partner of Private Equity Partnership, L.P. Mr. Smith is a director of several private companies.

        Mr. Snow served as Vice Chairman of the Board from July 1994 until June 2002, and he served as Chief Financial Officer from July 1994 until May 1996. Mr. Snow was the Executive Vice President and Chief Financial Officer and a Director of Consolidated Stores Corporation, a publicly held specialty retailer, from 1985 until he retired in June 1994. Mr. Snow is a Certified Public Accountant, and he received his Masters in Business Administration from the Kellogg Graduate School of Management at Northwestern University and his Masters in Taxation from DePaul University.

        Directors are elected to serve until our next annual meeting of stockholders or until their successors are elected and qualified. Officers serve at the discretion of our Board of Directors, subject to any contracts of employment. Non-employee directors receive an annual fee of $20,000, a fee of $1,000 for each Board meeting attended and a fee of $500 for each committee meeting attended. We have granted vested options to purchase shares of our common stock to each of the non-employee directors, in each case at or above the fair market value of the common stock on the date of grant.

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ITEM 2.    PROPERTIES

        Stores.    Substantially all of our retail stores are leased. Our new store leases typically provide for an initial lease term of three to seven years, with at least one renewal option for an additional one to three years. The following table provides information regarding the number of stores we operated in each state or province as of March 17, 2003:

United States:
Alabama		165
Florida		124
Texas		108
Georgia		106
Ohio		103
Virginia		100
Missouri		70
S. Carolina		67
Arkansas		66
Indiana		64
N. Carolina		64
Tennessee		63
Pennsylvania		59
Kentucky		48
Maine		48
Mississippi		46
Minnesota		44
Oklahoma		39
Wisconsin		32
Illinois		25
Iowa		21
New York		19
Washington		19
Massachusetts		18
Kansas		17
Michigan		17
New Hampshire		17
Connecticut		15
Louisiana		15
Nebraska		12
New Mexico		12
W. Virginia		9
Arizona		7
Colorado		7
Idaho		6
South Dakota		6
Alaska		5
Nevada		4
Vermont		3
New Jersey		1
Oregon		1
Rhode Island		1
Utah		1
	Total United States	1,674
Canada:
British Columbia		57
Alberta		52
Ontario		10
Manitoba		8
Saskatchewan		6
Nova Scotia		1
Yukon		1
	Total Canada	135
TOTAL		1,809

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        Headquarters and Distribution Facility.    Our corporate headquarters and inventory distribution facility are located in an approximately 90,000 square foot building in Dothan, Alabama which we own. We are also leasing approximately 30,000 square feet of off-site warehouse space for supply distribution and record storage in Dothan.

ITEM 3.    LEGAL PROCEEDINGS

        We were 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^st Judicial 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 alleged, on behalf of a nationwide class of all customers, that the extended viewing fees we charged our customers for keeping our rental products beyond the initial rental period were penalties in violation of common law and equitable theories. The dollar amounts that plaintiffs sought in each of the foregoing three putative class action lawsuits was not set forth in the complaints.

        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 were 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 also agreed to pay the plaintiffs' attorneys up to $850,000 in fees. A fairness hearing regarding this settlement was held on November 22, 2002. At this hearing, the court determined that the settlement was fair, and the court approved the terms of the settlement. The settlement released all claims made by all class members in all the pending class actions, other than a de minimis number of members who chose not to participate in the settlement. The court's order approving the settlement has become final and non-appealable. We are currently implementing the terms of the settlement.

        We incurred 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

        None.

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PART II

ITEM 5.    MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS

        Our common stock is listed on the Nasdaq National Market under the symbol "MOVI." The prices shown below are the high and low closing prices for our common stock as reported on the Nasdaq National Market for the fiscal periods indicated.

	High		Low
2002:
Fourth Quarter	$	18.56	$	12.26
Third Quarter		18.95		12.81
Second Quarter		21.20		15.49
First Quarter		17.17		10.07
2001:
Fourth Quarter		18.93		14.07
Third Quarter		14.82		7.65
Second Quarter		8.04		3.02
First Quarter		3.26		1.36

        On March 17, 2003, the last sale price of our common stock as reported on the Nasdaq National Market was $17.12 per share. As of March 17, 2003, we had approximately 9,100 stockholders, including 56 stockholders of record.

        We currently do not expect to pay any cash dividends on our common stock and plan to retain our earnings to finance operations, future growth and acquisitions. The payment of dividends on our common stock will be at the discretion of our board of directors and must comply with applicable law. In addition, the terms of our senior credit facility prohibit us from paying dividends without the prior written consent of our bank lender. Any decisions to pay dividends in the future will depend on a number of factors, including potential changes in tax laws related to dividends, our financial condition, capital requirements, future business prospects, the terms of any documents governing our indebtedness and other factors that our board of directors deems relevant.

ITEM 6.    SELECTED FINANCIAL DATA

        The following table sets forth our historical consolidated financial data. We prepared this information using our audited consolidated financial statements for each of the five fiscal years ended January 5, 2003. In addition to the information provided below, you should read our consolidated financial statements and notes thereto and "Management's Discussion and Analysis of Financial Condition and Results of Operations" included in Part II, Item 7 of this Form 10-K. The selected historical consolidated financial data do not necessarily indicate the results to be expected in the future.

23

		Fiscal Year Ended(1)
		January 3, 1999			January 2, 2000			December 31, 2000			January 6, 2002			January 5, 2003
		(in thousands, except per share and store data)
Statements of Operations Data:
Revenues:
	Rentals	$	236,697		$	253,000		$	294,298		$	347,464		$	490,836
	Product sales		30,936			23,945			24,638			21,667			38,152
Total revenues			267,633			276,945			318,936			369,131			528,988
Cost of sales:
	Cost of rental revenues		120,529	(2)		79,305			94,105			108,732			164,818	(3)
	Cost of product sales		22,407			16,295			19,066			17,715			29,852
Gross margin			124,697			181,345			205,765			242,684			334,318
Operating costs and expenses:
	Store operating expenses		130,473			137,128			153,665			171,409			253,865
	General and administrative		17,996			21,403			24,945			29,288	(4)		40,995	(5)
	Amortization of intangibles		7,068			8,452			7,465			6,656			1,298
	Stock option compensation(6)		—			—			—			8,161			2,279
Operating income (loss)			(30,840	)		14,362			19,690			27,170			35,881
Interest expense, net			(5,325	)		(3,349	)		(3,779	)		(3,026	)		(1,024	)
Income (loss) before income taxes, extraordinary item and cumulative effect of accounting change			(36,165	)		11,013			15,911			24,144			34,857
Income taxes			(13,089	)		4,615			6,425			9,788			13,923
Income (loss) before extraordinary item and cumulative effect of accounting change			(23,076	)		6,398			9,486			14,356			20,934
Extraordinary loss on early extinguishment of debt			—			(682	)		—			—			—
Cumulative effect of accounting change			—			(699	)		—			—			—
Net income (loss)		$	(23,076	)	$	5,017		$	9,486		$	14,356		$	20,934
Basic earnings (loss) per share:
	Income (loss) before extraordinary item and cumulative effect of accounting change	$	(0.77	)	$	0.21		$	0.37		$	0.56		$	0.69
	Extraordinary loss on early extinguishment of debt		—			(0.02	)		—			—			—
	Cumulative effect of accounting change		—			(0.02	)		—			—			—
Net income (loss) per share—basic		$	(0.77	)	$	0.17		$	0.37		$	0.56		$	0.69
Diluted earnings (loss) per share:
	Income (loss) before extraordinary item and cumulative effect of accounting change	$	(0.77	)	$	0.21		$	0.37		$	0.53		$	0.67
	Extraordinary loss on early extinguishment of debt		—			(0.02	)		—			—			—
	Cumulative effect of accounting change		—			(0.02	)		—			—			—
Net income (loss) per share—diluted		$	(0.77	)	$	0.17		$	0.37		$	0.53		$	0.67
Weighted average shares outstanding:
	Basic		30,123			29,509			25,801			25,837			30,273
	Diluted		30,123			30,083			25,868			27,220			31,436
Balance Sheet Data (at end of period):
Cash and cash equivalents		$	6,983		$	6,970		$	7,029		$	16,349		$	39,526
Rental inventory, net			44,998			52,357			61,773			88,424			82,880
Total assets			202,369			209,527			217,536			270,132			363,574
Long-term debt, less current maturities			46,212			44,377			40,600			26,000			—
Stockholders' equity			124,115			125,421			129,209			162,182			259,051
Other Data:
Number of stores at end of period			837			963			1,020			1,415			1,784
Average revenues per store(7)		$	317		$	313		$	328		$	342		$	337
Adjusted EBITDA(8)		$	37,378		$	35,494		$	39,744		$	61,581		$	82,260
Increase in same store revenues(9)			3.9	%		0.4	%		3.8	%		2.7	%		3.2	%

(1)

Results for fiscal 2001 reflect a 53-week year and include 17 days of operations for Video Update, Inc., which we acquired out of bankruptcy on December 21, 2001. All other fiscal years presented reflect 52-week years.

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(2)

Effective July 6, 1998, we changed our method of amortizing rental inventory resulting in a non-cash, pre-tax charge of approximately $43.6 million.

(3)

Effective October 7, 2002, we changed the estimates used to amortize rental inventory resulting in a non-cash charge of approximately $27.9 million in the fourth quarter of fiscal 2002.

(4)

Includes a $1.6 million charge related to the amendment of our supply agreement with Rentrak Corporation.

(5)

Includes a $4.0 million charge related to a legal settlement in the second quarter of fiscal 2002.

(6)

Represents non-cash compensation expense associated with stock options that were repriced in March 2001 and are subsequently required to be accounted for as variable stock options (see Note 7 to our consolidated financial statements).

(7)

Calculated as total revenues divided by the weighted average number of stores open in each period. Results for the fiscal year ended January 6, 2002 include approximately $9,000 per store related to the extra fifty-third week.

(8)

Adjusted EBITDA is defined as earnings before interest, taxes, depreciation and amortization, non-cash compensation and nonrecurring items, less purchases of rental inventory exclusive of 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 it is a widely accepted financial indicator in the home video specialty retail industry of a company's ability to incur and service debt assuming rental inventory is expensed upon purchase instead of being capitalized and amortized. Our calculation of Adjusted EBITDA is not necessarily comparable to reported EBITDA and/or Adjusted EBITDA of other companies due to lack of uniform definitions of EBITDA and Adjusted EBITDA. Our calculation of Adjusted EBITDA for the periods indicated is set forth below:

	Fiscal Year Ended
	January 3, 1999			January 2, 2000			December 31, 2000			January 6, 2002			January 5, 2003
Operating income (loss)	$	(30,840	)	$	14,362		$	19,690		$	27,170		$	35,881
Rental inventory amortization and non-cash cost of rental inventory sold		113,314			59,097			66,078			80,703			128,300
Depreciation and intangibles amortization		19,750			21,691			22,327			22,332			19,346
Stock option compensation		—			—			—			8,161			2,279
Legal settlement		—			—			—			—			4,000
Supply contract amendment		—			—			—			1,600			—
Purchases of rental inventory		(66,073	)		(62,842	)		(74,829	)		(83,840	)		(117,753	)
New store rental inventory purchases	$	1,227		$	3,186		$	6,478		$	5,455		$	10,207
Adjusted EBITDA	$	37,378		$	35,494		$	39,744		$	61,581		$	82,260

(9)

Same store revenues are calculated based on the aggregate revenues from stores we have operated for at least 13 months.

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ITEM 7.    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. Results for fiscal 2001 reflect a 53-week year.

Statements of Income Data:

		Fiscal Year Ended
		December 31, 2000		January 6, 2002		January 5, 2003
Revenues:
	Rentals	92.3	%	94.1	%	92.8	%
	Product sales	7.7		5.9		7.2
Total revenues		100.0		100.0		100.0
Cost of sales:
	Cost of rental revenues	29.5		29.5		31.2
	Cost of product sales	6.0		4.8		5.6
Gross margin		64.5		65.7		63.2
Operating costs and expenses:
	Store operating expenses	48.2		46.4		48.0
	General and administrative	7.8		7.9		7.8
	Amortization of intangibles	2.3		1.8		0.2
	Stock option compensation	—		2.2		0.4
Operating income		6.2		7.4		6.8
Interest expense, net		(1.2	)	(0.8	)	(0.2	)
Income before income taxes		5.0		6.6		6.6
Income taxes		2.0		2.7		2.6
Net income		3.0	%	3.9	%	4.0	%
Adjusted EBITDA		12.5	%	16.7	%	15.6	%

Fiscal year ended January 5, 2003 (a 52-week year) compared to the fiscal year ended January 6, 2002 (a 53-week year)

Revenue.    For fiscal 2002, total revenues increased 43.3% to $529.0 million from $369.1 million in fiscal 2001. The increase for the year was due primarily to a 3.2% increase in same store revenues and a 45.5% increase in the average number of stores operated during fiscal 2002 versus fiscal 2001. The increase in same store revenues was the result of: (i) continued growth of DVD rental and sales 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 new movie release schedule in fiscal 2002 versus fiscal 2001. The revenue increase was 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) an extra week of revenues (totaling approximately $10.0 million) in fiscal 2001.

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        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. Additionally, the non-cash cost (unamortized book value) of previously viewed rental inventory sold has been reclassified on the statement of cash flows to be reported with rental inventory amortization. These costs were previously netted against purchases of rental inventory as investing activities in the statement of cash flows. The current presentation is more consistent with the classification of these costs in the income statement and discloses the gross rental inventory purchases, before the write-off of previously viewed inventory sold, on the face of the statement of cash flows. The amounts reclassified on the statements of cash flows for fiscal 2000 and 2001 are as follows (in thousands):

	2000		2001
First Quarter	$	2,605	$	4,165
Second Quarter		2,392		3,813
Third Quarter		2,428		3,739
Four Quarter		4,193		5,348
	$	11,618	$	17,065

        Cost of Sales.    The gross margin on rental revenue for fiscal 2002 was 66.4%, versus 68.7% in fiscal 2001. The cost of rental revenues includes the amortization of rental inventory, revenue sharing expenses incurred and the cost of previously viewed rental inventory sold. The decrease in the gross margin on rental revenue was primarily due to a change in our amortization policy for rental inventory during the fourth quarter of fiscal 2002 (see Note 1 to our consolidated financial statements) and the initial investment in our game expansion program that took place in order to provide significant copy depth of all game platforms in our stores. The decrease was partially offset by (i) the increasing shift of movie rentals from VHS to DVD, which currently has a lower cost structure than VHS and (ii) the purchase price allocation of Video Update that produced lower than normal rental inventory amortization in the first half of 2002.

        Cost of product sales includes the costs of new videocassettes and DVDs, concessions and other goods sold. The gross margin on product sales increased to 21.8% for fiscal 2002 from 18.2% in fiscal 2001. The increase in profitability of product sales was due to the decreased level of lower margin, new movies available for sale in the first half of 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. However, the gross margin on product sales for the fourth quarter of fiscal 2002 reflects an expected trend of reduced margins due to our increased commitment to offer more new movies for sale.

        Operating Costs and Expenses.    Store operating expenses, which include store-level expenses such as lease payments and in-store payroll, increased to 48.0% of total revenue for fiscal 2002 from 46.4% in fiscal 2001. The increase in store operating expenses as a percentage of total revenue was primarily due to a higher cost structure associated with the 324 Video Update stores acquired in December 2001 and the benefits in fiscal 2001 of an extra week of revenues. 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 3.2% in fiscal 2002.

        General and administrative expenses as a percentage of revenue decreased to 7.8% in fiscal 2002 from 7.9% in fiscal 2001. 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 charge of $1.6 million related to an amendment of our supply agreement with Rentrak Corporation in the first

27

quarter of 2001. These two items substantially offset the decrease in general and administrative expenses as a percentage of revenue which was achieved by leveraging general and administrative expenses against the increased revenues associated with the growth in our store base.

        Amortization of intangibles as a percentage of total revenue for fiscal 2002 was 0.2%, a decrease from 1.8% in fiscal 2001. This decrease was due to goodwill no longer being amortized pursuant to the adoption of FASB Statement No. 142, Goodwill and Other Intangible Assets, as of the beginning of fiscal 2002.

        Stock option compensation expense represents the non-cash charge associated with certain stock options that were repriced during the first quarter of fiscal 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 (see Note 7 to our consolidated financial statements). We expect to continue to record adjustments to income from stock option compensation in future periods.

        Interest expense includes fees for the unused borrowings available under our credit facility and amortization of the associated debt issue costs, as well as the costs of any outstanding borrowings under our credit facility, net of interest income. Interest expense as a percentage of total revenue decreased to 0.2% in fiscal 2002 from 0.8% in fiscal 2001. The decrease was 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 32.1% in fiscal 2002 to $35.9 million from $27.2 million in fiscal 2001. The increase includes the benefit of lower stock option compensation expense in fiscal 2002 and was partially offset by the legal settlement charge and the charge to amend a supply contract.

        Pending the completion of final closing tax returns for Video Update, we had net operating loss carryforwards for income taxes at January 6, 2002 resulting from the Video Update acquisition (see Note 2 to our consolidated financial statements) of approximately $67.0 million, with an $18.4 million related valuation allowance. Based on the final 2001 tax returns for Video Update, at January 5, 2003 the net operating loss carryforward for income taxes was adjusted to approximately $84.1 million in U.S. loss carryforwards and $6.5 million in foreign loss carryforwards that expire in years 2007 through 2021. We have recorded a valuation allowance of $24.9 million related to our net deferred tax assets as we are uncertain as to whether sufficient taxable income will be generated to allow the net deferred tax assets to be fully realized.

Fiscal year ended January 6, 2002 (a 53-week year) compared to the fiscal year ended December 31, 2000 (a 52-week year)

        Revenue.    For fiscal 2001, total revenues increased 15.7% to $369.1 million from $318.9 million in fiscal 2000. The increase for the year was due primarily to a 2.7% increase in same store revenues and an 11.5% increase in the average number of stores open during fiscal 2001 versus fiscal 2000. The increase in revenues was the result of: (i) significant increases in DVD rental revenue; (ii) an increase in the sales of previously viewed movies and previously played games; (iii) successful, chain-wide internal marketing programs designed to generate more consumer excitement and traffic in our base of stores; (iv) a favorable new release schedule in the last half of the year; (v) an extra week of revenues (totaling approximately $10.0 million) in fiscal 2001; and (vi) additional revenues from the Video Update acquisition (totaling approximately $4.9 million) in fiscal 2001. The revenue increase was partially offset by (i) soft game rentals through the third quarter of fiscal 2001 due to consumer anticipation of new game platforms being introduced late in the fourth quarter of fiscal 2001; and (ii) a decline in new movie sales as a result of the liquidation of older sell-through titles in certain stores during fiscal 2000 and into the first quarter of fiscal 2001.

28

        Cost of Sales.    The gross margin on rental revenue for fiscal 2001 was 68.7%, versus 68.0% in fiscal 2000. The cost of rental revenues includes the amortization of rental inventory, revenue sharing expenses incurred and the cost of previously viewed rental inventory sold during the period. The improvement in the gross margin on rental revenue is a result of the 2.7% increase in same store revenues and the benefit of stronger margins on DVD rentals versus VHS rentals due to the difference in purchasing models for these two formats. The increase was achieved inclusive of a $2.1 million reserve against previously viewed VHS inventory in the fourth quarter of fiscal 2001 (see Note 1 to our consolidated financial statements).

        Cost of product sales includes the costs of new videocassettes and DVDs, concessions and other goods sold. The gross margin on product sales decreased to 18.2% for fiscal 2001 from 22.6% in fiscal 2000. The decrease in profitability of product sales was primarily a result of significant discounting associated with the continued liquidation of older sell-through titles and other slow moving inventory in certain stores early in fiscal 2001.

        Operating Costs and Expenses.    Store operating expenses, which include store-level expenses such as lease payments and in-store payroll, decreased to 46.4% of total revenue for fiscal 2001 from 48.2% in fiscal 2000. The decrease in store operating expenses as a percentage of total revenue was primarily due to: (i) the same store revenues increase of 2.7% in fiscal 2001; (ii) continued initiatives to reduce operating costs; (iii) strong performance of new stores; (iv) continued closure of under-performing units; and (v) the benefits of an extra week of revenues in fiscal 2001.

        General and administrative expenses represented 7.9% of total revenue in fiscal 2001 versus 7.8% in fiscal 2000. The increase was the result of a $1.6 million charge related to an amendment of our supply agreement with Rentrak Corporation in fiscal 2001. The increase was substantially offset by the revenue growth (benefiting from an extra week of revenues in fiscal 2001) achieved with only minimal increases to administrative staffing levels.

        Amortization of intangibles as a percentage of total revenue for fiscal 2001 was 1.8%, a decrease from 2.3% in fiscal 2000. This decrease was primarily due to the increase in revenue and the expiration of significant levels of five-year non-compete agreements throughout fiscal 2000 as well as lower impairment charges in fiscal 2001 versus fiscal 2000.

        Stock option compensation expense represents the non-cash charge associated with certain stock options that were repriced during the first quarter of fiscal 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 (see Note 7 to our consolidated financial statements). We expect to record adjustments to income from stock option compensation in future periods.

        As a result of the impact of the above factors on revenues and expenses, operating income increased by 38.0% in fiscal 2001 to $27.2 million from $19.7 million in fiscal 2000. The increase was partially offset by the charge to amend a supply contract and stock option compensation expense.

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 versus sold;



•

marketing programs and new release acquisition costs;

29

•

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 recent common stock offering and, if necessary, loans under revolving credit facilities. At January 5, 2003, we had cash and cash equivalents of $39.5 million, no long-term debt and $64.5 million in available borrowings under our credit facility.

        During fiscal 2002 we generated approximately $82.3 million in Adjusted EBITDA, a 33.6% increase over the prior year. For fiscal 2001, our Adjusted EBITDA increased to $61.6 million, a 54.9% increase over $39.7 million in fiscal 2000. These increases were primarily driven by the revenue increases during those periods while achieving economies of scale within our expense structure. Adjusted EBITDA is defined as earnings before interest, taxes, depreciation and amortization, non-cash compensation and nonrecurring 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 assuming rental inventory is expensed upon purchase instead of being capitalized and amortized. 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. (See Selected Financial Data in Part II, Item 6 of this Form 10-K for our calculation of Adjusted EBITDA.)

        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 $186.7 million, $144.0 million and $110.8 million for fiscal 2002, 2001 and 2000, respectively. Net cash provided by operating activities continues to be sufficient to cover rental inventory replenishment, capital resource and debt service needs.

        Net cash used in investing activities was $206.7 million, $125.2 million and $101.0 million for fiscal 2002, 2001 and 2000, respectively. The increase was due to increased acquisition activity and increased rental inventory purchases to support a larger store base, as well as significant increases in property, furnishings and equipment resulting from increased store activity for fiscal 2002.

        Net cash provided by financing activities was $43.4 million in fiscal 2002 resulting from the net proceeds of our stock offering, reduced by the repayment of amounts outstanding under our credit facility. Net cash used in financing activities was $9.4 million and $9.7 million in fiscal 2001 and 2000, respectively, representing payments against our credit facility offset by proceeds from stock option exercises in fiscal 2001 and increased by the purchase and retirement of outstanding common stock in fiscal 2000.

        In May 2002, we closed a public offering of our common stock priced at $18.25 per share. We sold 3,900,000 shares and received the proceeds from 350,000 stock options exercised in conjunction with

30

the offering for total proceeds, net of expenses of the offering, of approximately $67.6 million. A portion of the proceeds from the offering was used to repay outstanding borrowings under the credit facility. We are currently using 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. Our credit facility is unsecured and, as amended, currently 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. The costs to terminate the interest rate swap were expensed and were immaterial to our results of operations.

        We grow our store base through internally developed and acquired stores. We opened 145 internally developed stores during fiscal 2002 and expect to open between 175 and 200 new stores in 2003. We acquired 265 stores during fiscal 2002. We will continue to evaluate acquisition opportunities in 2003 as they arise. To the extent available, new stores and future acquisitions may be completed using 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.

        Effective December 21, 2001, we acquired 100% of the newly issued common stock of the reorganized Video Update, Inc. under its plan of reorganization which was confirmed by the United States Bankruptcy Court on December 20, 2001. Video Update had been operating under Chapter 11 of the United States Bankruptcy Code since its voluntary bankruptcy filing on September 18, 2000. The acquisition of the newly issued common stock of Video Update was in satisfaction of all amounts owed to us by Video Update under a $6.5 million debtor-in-possession financing agreement. In addition, we purchased certain senior secured debt of Video Update in May 2001 for $8.5 million, funded amounts due to secured and unsecured creditors in accordance with confirmation of the plan of reorganization totaling approximately $6.3 million, and assumed other post-bankruptcy filing liabilities of Video Update totaling approximately $20.4 million. Video Update operated 324 video specialty stores in the United States and Canada as of the time of the acquisition. (see Note 2 to our consolidated financial statements)

        In December 2002, our Board of Directors approved the expenditure of up to $25 million for repurchases of our common stock. We have not currently purchased any shares of our stock under this authorization.

        At January 5, 2003, we had a working capital deficit of $33.6 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.

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        The following table discloses our contractual obligations and commercial commitments as of January 5, 2003 (see Notes 5 and 8 to our consolidated financial statements):

	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		216,789		6,882		162,541		35,274		12,092
Unconditional purchase obligations		14,838		4,000		10,838		—		—
Total contractual cash obligations	$	231,627	$	10,882	$	173,379	$	35,274	$	12,092

(1)

The total commercial commitment under our credit facility is $65 million, which expires on July 4, 2004. As of January 5, 2003, there were standby letters of credit outstanding under the credit facility of $537,000, of which $325,000 expired on March 14, 2003 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 2003. 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 plan 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 the 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. 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.

        A major component of our cost structure is based upon the method by which we amortize our rental inventory. Rental inventory is amortized to an estimated salvage value over an estimated useful life of up to two years. We amortize the cost of rental inventory using an accelerated method designed

32

to approximate the rate of revenue recognition. This method is dependent upon the net realizable value of our inventory and the demand patterns of the rental products we provide. In the fourth quarter of 2002, we made a strategic decision to make a portion of our base stock VHS rental inventory available for sale as previously viewed inventory during the holiday period. The sale of base stock VHS rental inventory was designed to make room on our store shelves for a significant investment in base stock DVD rental inventory to arrive in stores in the first quarter of 2003. Our decision to make this investment in base stock DVD was primarily driven by the continued growth in consumer acceptance of the DVD platform in our core markets throughout the last year. DVD rental revenue represented approximately 50% of movie rental revenue as of the end of fiscal 2002 versus approximately 20% as of the end of fiscal 2001. As a result of the significant shift from VHS to DVD that will occur in our rental inventory base as the new product arrives, we changed the estimates used to amortize rental inventory. The revised estimates reflect a reduction in the estimated useful lives of the rental inventory and a reduced salvage value for both VHS and game inventory. We believe the revised estimated useful lives and salvage values are better matched to our current rental business and are consistent with industry trends.

        The changes in our estimates for rental inventory amortization have been applied to all inventory held at October 7, 2002. The changes have been accounted for as a change in accounting estimate during the fourth quarter ended January 5, 2003. The change in estimate decreased rental inventory and increased depreciation expense for the fiscal year ended January 5, 2003 by approximately $27.9 million and reduced net income by $16.7 million, or $0.53 per diluted share. The impact of the change is net of a $2.1 million reserve against rental inventory that was established in the fourth quarter of 2001 in order to reflect the impact of the consumer transition to DVD on the sale prices of previously viewed VHS product.

        We recognize revenue from extended viewing fees that we charge our customers for keeping our rental products beyond the initial rental period on a cash basis when the extended viewing fees are collected from the customer. If we recognized extended viewing fee revenue on an accrual basis, results of operations would reflect increased income for extended viewing fee revenue offset by an accrual to reserve for uncollectible accounts.

        We assess the fair value and recoverability of our long-lived assets, including property, furnishings and equipment and intangible assets with finite lives, whenever events and circumstances indicate the carrying value of an asset may not be recoverable from estimated future cash flows expected to result from its use and eventual disposition. In doing so, we make assumptions and estimates regarding future cash flows and other factors to make our determination. The fair value of our long-lived assets is dependent upon the forecasted performance of our business, changes in the video retail industry, the market valuation of our common stock and the overall economic environment. When we determine that the carrying value of our long-lived assets may not be recoverable, we measure any impairment based upon the excess of the carrying value that exceeds the estimated fair value of the assets. We have not recognized any impairment losses on long-lived assets in fiscal 2000, 2001 or 2002. If we do not meet our operating forecasts or if the market value of our stock declines significantly, we may have to record impairment charges not previously recognized.

        We test goodwill for impairment on an annual basis. Additionally, goodwill is tested for impairment between annual tests if an event occurs or circumstances change that would more likely than not reduce the fair value of an entity below its carrying value. These events or circumstances would include a significant change in the business climate, legal factors, operating performance indicators, competition, sale or disposition of a significant portion of the business or other factors. We recorded impairment losses of $1,000,000, $700,000 and $0 in fiscal 2000, 2001 and 2002, respectively. If we do not meet our operating forecasts or if the market value of our stock declines significantly, we may have to record additional impairment charges not previously recognized.

33

        We estimate the fair value of assets and liabilities of acquired businesses based on historical experience and available information at the acquisition date. We engage independent valuation specialists to assist when necessary. If information becomes available subsequent to the acquisition date that would materially impact the valuation of assets acquired or liabilities assumed in business combinations, we may be required to adjust the purchase price allocation.

        We recognize deferred tax assets and liabilities based on the differences between the financial statement carrying amounts and the tax bases of assets and liabilities. We regularly review our deferred tax assets for recoverability and establish a valuation allowance based upon historical losses, projected future taxable income and the expected timing of the reversals of existing temporary differences. As a result of this review, we have established a valuation allowance against our deferred tax assets related to the estimated utilization of the net operating losses resulting from the Video Update acquisition.

Related Party Transactions

        We hold a one-third interest in ECHO, LLC, a supply sales and distribution company. We purchase office and store supplies and other business products from ECHO. This relationship enables us to substantially reduce the retail mark-up that occurs between the wholesaler and the retailer. We paid ECHO approximately $422,000 and $6,422,000 during fiscal 2001 and 2002, respectively, and received distributions totaling $40,000 in fiscal 2002. We have a $125,000 outstanding line of credit due from ECHO. We have received approximately $2,900 and $6,400 in interest on the line of credit during fiscal 2001 and 2002, respectively. We had outstanding accounts payable to ECHO of approximately $24,000 and $469,000 as of January 6, 2002 and January 5, 2003, respectively.

        Air Conditioning Associates, Inc. ("ACA") is owned by the father-in-law and brother-in-law of our Chairman of the Board, President, and Chief Executive Officer. ACA administers the repair and maintenance function for our store base and corporate offices in addition to providing other HVAC materials and related services. We have achieved overall cost savings under this management agreement and have improved our system for managing company-wide repair and maintenance needs. We paid ACA approximately $382,000, $243,000 and $470,000 during fiscal 2000, 2001 and 2002, respectively. We had outstanding accounts payable to ACA of approximately $25,000 and $157,000 as of January 6, 2002 and January 5, 2003, respectively.

        J. Todd, Inc. d/b/a Todd & Sons, is owned by the brother of our Senior Vice President, Secretary and General Counsel. Todd & Sons supplies us with certain clothing and promotional items on an as needed basis. We have no minimum purchase requirements or contractual obligations with Todd & Sons. We paid Todd & Sons approximately $28,000, $127,000 and $49,000 during fiscal 2000, 2001 and 2002, respectively. We had outstanding accounts payable to Todd & Sons of approximately $3,000 and $1,000 as of January 6, 2002 and January 5, 2003, respectively.

        In February 2003, we entered into a lease with MEL, LLC for approximately 3,500 square feet of retail space in an existing shopping center to relocate one of our stores in Dothan, Alabama. Our Chairman of the Board, President and Chief Executive Officer holds a one-third interest in MEL, LLC. The initial lease term is five years with three, three-year renewal options. The lease payments required under the initial five-year term of the lease total approximately $144,000. The terms of this lease are more favorable than the terms available for the previous location.

        Each of these transactions is incurred in the normal course of business and purchases are pursuant to our established standard purchasing policies and practices. We believe that the terms of all transactions described above are no less favorable than terms that could have been obtained from third parties.

34

Recently Issued Accounting Pronouncements

        In October 2001, the FASB issued Statement No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets, which addresses financial accounting and reporting for the impairment or disposal of long-lived assets and supersedes Statement 121, Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of, and the accounting and reporting provisions of APB Opinion No. 30, Reporting the Results of Operations for the Effects of Disposal of a Segment of a Business. We adopted Statement 144 as of January 7, 2002. The adoption did not have any impact on our financial position or results of operations.

        In July 2002, the FASB issued Statement No. 146, Accounting for Costs Associated with Exit or Disposal Activities. Statement 146 nullifies Emerging Issues Task Force ("EITF") Issue No. 94-3, Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring) and requires that a liability for a cost associated with an exit or disposal activity be recognized and measured initially at fair value in the period in which the liability is incurred. Under EITF 94-3, a liability for an exit cost was recognized at the date of an entity's commitment to an exit plan. The adoption of Statement 146 is expected to result in delayed recognition for certain types of costs as compared to the provisions of EITF 94-3. Statement 146 is effective for new exit or disposal activities that are initiated after December 31, 2002, and does not affect amounts currently reported in our consolidated financial statements. Statement 146 will affect the types and timing of costs included in future restructuring programs, if any, but is not expected to have a material impact on our financial position or results of operations.

        In December 2002, the FASB issued Statement No. 148, Accounting for Stock-Based Compensation—Transition and Disclosure. Statement 148 amends FASB Statement No. 123, Accounting for Stock-Based Compensation, to provide alternative methods of transition to Statement 123's fair value method of accounting for stock-based employee compensation. Statement 148 also amends the disclosure provisions of Statement 123 and APB Opinion No. 28, Interim Financial Reporting, to require disclosure in the summary of significant accounting policies of the effects of an entity's accounting policy with respect to stock-based employee compensation on reported net income and earnings per share in annual and interim financial statements. We have adopted the amended disclosure provisions of Statement 148 in fiscal 2002. We do not expect Statement 148 to have any impact on our operating results as we continue to account for stock-based compensation in accordance with APB Opinion No. 25, Accounting for Stock Issued to Employees, and related Interpretations.

Forward-Looking Statements

        With respect to forward-looking statements, please refer to the disclosures set forth under "Cautionary Statements" in Item 1 above.

ITEM 7A.    QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

        The market risk inherent in our financial instruments represents the increased interest costs arising from adverse changes in interest rates (primarily LIBOR and prime bank rates). We currently have no amounts outstanding under our credit facility and, thus, no exposure to adverse interest rate changes.

        We are exposed to foreign exchange risks associated with our Canadian operations acquired in fiscal 2001. Historically, the Canadian exchange rates have been stable and we believe the impact of fluctuations in the currency exchange rates will be immaterial to our financial position and results of operations.

ITEM 8.    FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

        Reference is made to Part III, Item 15 of this Form 10-K for the information required by Item 8.

ITEM 9.    CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE

        None.

35

PART III

ITEM 10.    DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

        The information required by this Item (other than the information regarding directors and executive officers set forth at the end of Part 1, Item 1 of this Form 10-K) will be contained in our definitive Proxy Statement for our 2003 Annual Meeting of Stockholders, and is incorporated herein by reference.

ITEM 11.    EXECUTIVE COMPENSATION

        The information required by this Item will be contained in our definitive Proxy Statement for our 2003 Annual Meeting of Stockholders, and is incorporated herein by reference.

ITEM 12.    SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS

        The information required by this Item will be contained in our definitive Proxy Statement for our 2003 Annual Meeting of Stockholders, and is incorporated herein by reference.

ITEM 13.    CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

        The information required by this Item will be contained in our definitive Proxy Statement for our 2003 Annual Meeting of Stockholders, and is incorporated herein by reference.

ITEM 14.    CONTROLS AND PROCEDURES

        Within 90 days prior to the date of this annual report, we carried out an evaluation, under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures pursuant to Exchange Act Rule 13a-14. Based upon that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures effectively ensure that material information required to be in this annual report is made known to them by others in a timely manner. We have not made any significant changes to our internal controls, and no other factors have come to our attention that could significantly affect our internal controls, subsequent to the date of this most recent evaluation.

ITEM 15.    EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K

(a)(1)	Financial Statements:
	Report of Ernst & Young LLP, Independent Auditors.
	Consolidated Balance Sheets as of January 6, 2002 and January 5, 2003.
	Consolidated Statements of Income for the Fiscal Years Ended December 31, 2000, January 6, 2002 and January 5, 2003.
	Consolidated Statements of Stockholders' Equity for the Fiscal Years Ended December 31, 2000, January 6, 2002 and January 5, 2003.
	Consolidated Statements of Cash Flows for the Fiscal Years Ended December 31, 2000, January 6, 2002 and January 5, 2003.
	Notes to Consolidated Financial Statements.

36

(a)(2)	Schedules:
	Schedule II. Valuation and Qualifying Accounts
(a)(3)	Exhibits:

        The following exhibits, which are furnished with this Annual Report or incorporated herein by reference, are filed as part of this Annual Report:

Exhibit No.	Exhibit Description
3.1	Certificate of Incorporation of the Company.(1)
3.1.1	Certificate of Amendment of Certificate of Incorporation dated June 6, 1996.(5)
3.1.2	Certificate of Amendment of Certificate of Incorporation dated July 1, 1999.(5)
3.1.3	Certificate of Amendment of Certificate of Incorporation dated June 27, 2002. (filed herewith)
3.2	Amended and Restated Bylaws of the Movie Gallery, Inc. (filed herewith)
4.1	Specimen Common Stock Certificate.(2)
10.1	1994 Stock Option Plan, as amended and form of Stock Option Agreement.(3)
10.1.1	Amendment to Movie Gallery, Inc. 1994 Stock Plan, as amended dated June 13, 2000. (filed herewith)
10.1.2	Amendment to Movie Gallery, Inc. 1994 Stock Plan, as amended dated September 12, 2002.(12)
10.2	Form of Indemnity Agreement.(1)
10.3	Employment Agreement between M.G.A., Inc. and Joe Thomas Malugen.(1)
10.3.1	First Amendment to Employment Contract between M.G.A., Inc. and J. T. Malugen dated April 3, 2000.(6)
10.5	Employment Agreement between M.G.A., Inc. and J. Steven Roy.(4)
10.6	Employment Agreement between M.G.A., Inc. and S. Page Todd.(4)
10.7	Employment Agreement between M.G.A., Inc. and Jeffrey S. Stubbs.(7)
10.8	Assignment Agreement between BNP Paribas and Movie Gallery, Inc. dated May 2, 2001.(8)
10.9	Chapter 11 Financing Agreement between Video Update, Inc. and Movie Gallery, Inc. dated May 16, 2001.(8)
10.9.1	Amendment to Chapter 11 Financing Agreement between Movie Gallery, Inc. and Video Update, Inc. dated October 15, 2001.(10)
10.10	Credit Agreement between Movie Gallery, Inc. and SouthTrust Bank dated June 27, 2001.(8)
10.10.1	Amendment to Credit Agreement between Movie Gallery, Inc. and SouthTrust Bank dated September 25, 2001. (filed herewith)
10.10.2	Amendment to Credit Agreement between Movie Gallery, Inc. and SouthTrust Bank dated January 14, 2002. (filed herewith)
10.10.3	Amendment to Credit Agreement between Movie Gallery, Inc. and SouthTrust Bank dated August 15, 2002.(11)

37

10.11	Plan of Reorganization of Video Update, Inc., et al., as amended on December 18, 2001.(9)
21	List of Subsidiaries. (filed herewith)
23	Consent of Ernst & Young LLP, Independent Auditors. (filed herewith)
99.1	Certification Pursuant to 18 U.S.C. Section 1350, as adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. (filed herewith)
99.2	Certification Pursuant to 18 U.S.C. Section 1350, as adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. (filed herewith)

(1)

Previously filed with the Securities and Exchange Commission on June 10, 1994, as an exhibit to our Registration Statement on Form S-1 (File No. 33-80120).

(2)

Previously filed with the Securities and Exchange Commission on August 1, 1994, as an exhibit to Amendment No. 2 to our Registration Statement on Form S-1.

(3)

Previously filed with the Securities and Exchange Commission on April 7, 1997, as an exhibit to our Form 10-K for the fiscal year ended January 5, 1997.

(4)

Previously filed with the Securities and Exchange Commission on April 6, 1998, as an exhibit to our Form 10-K for the fiscal year ended January 4, 1998.

(5)

Previously filed with the Securities and Exchange Commission on August 17, 1999, as an exhibit to our Form 10-Q for the quarter ended July 4, 1999.

(6)

Previously filed with the Securities and Exchange Commission on May 17, 2000, as an exhibit to our Form 10-Q for the quarter ended April 2, 2000.

(7)

Previously filed with the Securities and Exchange Commission on April 2, 2001, as an exhibit to our Form 10-K for the fiscal year ended December 31, 2000.

(8)

Previously filed with the Securities and Exchange Commission on August 15, 2001, as an exhibit to our Form 10-Q for the quarter ended July 1, 2001.

(9)

Previously filed with the Securities and Exchange Commission on January 7, 2002, as an exhibit to our Form 8-K/A dated December 21, 2001.

(10)

Previously filed with the Securities and Exchange Commission on April 11, 2002, as an exhibit to our Registration Statement on Form S-1 (File No. 333-86016).

(11)

Previously filed with the Securities and Exchange Commission on August 21, 2002, as an exhibit to our Form 10-Q for the quarter ended July 7, 2002.

(12)

Previously filed with the Securities and Exchange Commission on November 20, 2002, as an exhibit to our Form 10-Q for the quarter ended October 6, 2002.

(b)  Reports on Form 8-K:

        None.

(c)  Exhibits:

        See (a)(3) above.

ITEM 16.    PRINCIPAL ACCOUNTANT FEES AND SERVICES

        The information required by this Item will be contained in our definitive Proxy Statement for our 2003 Annual Meeting of Stockholders, and is incorporated herein by reference.

38

SIGNATURES

        Pursuant to the requirements of Section 13 or 15(d) 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.
By:	/s/  J. T. MALUGEN J. T. Malugen Chairman of the Board, President and Chief Executive Officer

Date: April 7, 2003

        Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.

Signature	Title	Date
/s/  J. T. MALUGEN J. T. Malugen	Chairman of the Board, President and Chief Executive Officer	April 7, 2003
/s/  H. HARRISON PARRISH H. Harrison Parrish	Vice Chairman of the Board	April 7, 2003
/s/  WILLIAM B. SNOW William B. Snow	Director	April 7, 2003
/s/  PHILIP B. SMITH Philip B. Smith	Director	April 7, 2003
/s/  J. STEVEN ROY J. Steven Roy	Executive Vice President and Chief Financial Officer	April 7, 2003
/s/  IVY M. JERNIGAN Ivy M. Jernigan	Vice President—Controller	April 7, 2003

39

MOVIE GALLERY, INC.

CERTIFICATIONS PURSUANT TO SECTION 302 OF
THE SARBANES-OXLEY ACT OF 2002

CERTIFICATION

        I, J. T. Malugen, certify that:

1.

I have reviewed this annual report on Form 10-K of Movie Gallery, Inc.;

2.

Based on my knowledge, this annual report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this annual report;

3.

Based on my knowledge, the financial statements, and other financial information included in this annual report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this annual report;

4.

The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:

(a)

designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this annual report is being prepared;

(b)

evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this annual report (the "Evaluation Date"); and

(c)

presented in this annual report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;

5.

The registrant's other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent function):

(a)

all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and

(b)

any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and

6.

The registrant's other certifying officers and I have indicated in this annual report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.

Dated:  April 7, 2003

/s/  J. T. MALUGEN

J. T. Malugen
Chairman of the Board, President and
Chief Executive Officer

40

CERTIFICATION

        I, J. Steven Roy, certify that:

1.

I have reviewed this annual report on Form 10-K of Movie Gallery, Inc.;

2.

Based on my knowledge, this annual report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this annual report;

3.

Based on my knowledge, the financial statements, and other financial information included in this annual report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this annual report;

4.

The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:

(a)

designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this annual report is being prepared;



(b)

evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this annual report (the "Evaluation Date"); and



(c)

presented in this annual report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;

5.

The registrant's other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent function):

(a)

all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and



(b)

any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and

6.

The registrant's other certifying officers and I have indicated in this annual report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.

Dated:  April 7, 2003

/s/  J. STEVEN ROY

J. Steven Roy
Executive Vice President and
Chief Financial Officer

41

Movie Gallery, Inc.

Consolidated Financial Statements

Fiscal years ended December 31, 2000, January 6, 2002 and January 5, 2003

CONTENTS

Report of Ernst & Young LLP, Independent Auditors	F-2
Audited Financial Statements
Consolidated Balance Sheets	F-3
Consolidated Statements of Income	F-4
Consolidated Statements of Stockholders' Equity	F-5
Consolidated Statements of Cash Flows	F-6
Notes to Consolidated Financial Statements	F-7
Financial Statement Schedule	F-23

F-1

Report of Ernst & Young LLP, Independent Auditors

Board of Directors and Stockholders
Movie Gallery, Inc.

        We have audited the accompanying consolidated balance sheets of Movie Gallery, Inc. as of January 6, 2002 and January 5, 2003, and the related consolidated statements of income, stockholders' equity and cash flows for each of the three years in the period ended January 5, 2003. Our audits also include the financial statement schedule listed in the Index at Item 15(a)2. These financial statements and schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and schedule based on our audits.

        We conducted our audits in accordance with auditing standards generally accepted in the United States. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

        In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Movie Gallery, Inc. at January 6, 2002 and January 5, 2003, and the consolidated results of its operations and its cash flows for each of the three years in the period ended January 5, 2003, in conformity with accounting principles generally accepted in the United States. Also, in our opinion, the related financial statement schedule, when considered in relation to the basic financial statements taken as a whole, presents fairly in all material respects the information set forth therein.

        As discussed in Note 1 to the consolidated financial statements, in fiscal 2002 the Company changed its method of accounting for goodwill.

                                                                                                                            /s/ Ernst & Young LLP

Birmingham, Alabama
February 13, 2003

F-2

Movie Gallery, Inc.

Consolidated Balance Sheets

(in thousands)

		January 6, 2002			January 5, 2003
Assets
Current assets:
	Cash and cash equivalents	$	16,349		$	39,526
	Merchandise inventory		6,739			18,646
	Prepaid expenses		2,085			1,533
	Store supplies and other		5,582			7,585
	Deferred income taxes		1,159			—
Total current assets			31,914			67,290
Rental inventory, net			88,424			82,880
Property, furnishings and equipment, net			71,739			86,993
Goodwill, net			71,682			116,119
Other intangibles, net			4,156			6,677
Deposits and other assets			2,217			3,615
Total assets		$	270,132		$	363,574
Liabilities and stockholders' equity
Current liabilities:
	Accounts payable	$	51,785		$	66,996
	Accrued liabilities		24,853			23,524
	Deferred revenue		4,082			9,636
	Deferred income taxes		—			742
Total current liabilities			80,720			100,898
Long-term debt			26,000			—
Other accrued liabilities			606			249
Deferred income taxes			624			3,376
Stockholders' equity:
	Preferred stock, $.10 par value; 2,000 shares authorized, no shares issued or outstanding		—			—
	Common stock, $.001 par value; 65,000 shares authorized, 27,215 and 32,062 shares issued and outstanding, respectively		27			32
	Additional paid-in capital		140,475			216,631
	Retained earnings		21,713			42,647
	Accumulated other comprehensive loss		(33	)		(259	)
Total stockholders' equity			162,182			259,051
Total liabilities and stockholders' equity		$	270,132		$	363,574

See accompanying notes.

F-3

Movie Gallery, Inc.

Consolidated Statements of Income

(in thousands, except per share data)

		Fiscal Year Ended
		December 31, 2000			January 6, 2002			January 5, 2003
Revenues:
	Rentals	$	294,298		$	347,464		$	490,836
	Product sales		24,638			21,667			38,152
Total revenues			318,936			369,131			528,988
Cost of sales:
	Cost of rental revenues		94,105			108,732			164,818
	Cost of product sales		19,066			17,715			29,852
Gross margin			205,765			242,684			334,318
Operating costs and expenses:
	Store operating expenses		153,665			171,409			253,865
	General and administrative		24,945			29,288			40,995
	Amortization of intangibles		7,465			6,656			1,298
	Stock option compensation		—			8,161			2,279
Operating income			19,690			27,170			35,881
Interest expense, net			(3,779	)		(3,026	)		(1,024	)
Income before income taxes			15,911			24,144			34,857
Income taxes			6,425			9,788			13,923
Net income		$	9,486		$	14,356		$	20,934
Earnings per share:
	Basic	$	0.37		$	0.56		$	0.69
	Diluted	$	0.37		$	0.53		$	0.67
Weighted average shares outstanding:
	Basic		25,801			25,837			30,273
	Diluted		25,868			27,220			31,436

See accompanying notes.

F-4

Movie Gallery, Inc.

Consolidated Statements of Stockholders' Equity

(in thousands)

			Common Stock			Additional Paid-in Capital			Retained Earnings (Deficit)			Accumulated Other Comprehensive Loss			Total Stockholders' Equity
Balance at January 2, 2000			$	28		$	127,522		$	(2,129	)	$	—		$	125,421
	Net income			—			—			9,486			—			9,486
	Repurchase and retirement of 3,180 shares			(3	)		(5,695	)		—			—			(5,698	)
Balance at December 31, 2000				25			121,827			7,357			—			129,209
Comprehensive Income:
	Net income									14,356			—			14,356
	Foreign currency translation									—			(33	)		(33	)
		Total comprehensive income								14,356			(33	)		14,323
	Exercise of stock options for 2,129 shares			2			5,214			—			—			5,216
	Tax benefit of stock options exercised			—			5,273			—			—			5,273
	Stock option compensation			—			8,161			—			—			8,161
Balance at January 6, 2002				27			140,475			21,713			(33	)		162,182
Comprehensive Income:
	Net income									20,934			—			20,934
	Foreign currency translation									—			(226	)		(226	)
		Total comprehensive income								20,934			(226	)		20,708
Issuance of 3,900 shares of common stock, net of issuance cost, of $4,406				4			66,765			—			—			66,769
	Exercise of stock options for 947 shares			1			2,658			—			—			2,659
	Tax benefit of stock options exercised			—			4,454			—			—			4,454
	Stock option compensation			—			2,279			—			—			2,279
Balance at January 5, 2003			$	32		$	216,631		$	42,647		$	(259	)	$	259,051

See accompanying notes.

F-5

Movie Gallery, Inc.

Consolidated Statements of Cash Flows

(in thousands)

		Fiscal Year Ended
		December 31, 2000			January 6, 2002			January 5, 2003
Operating activities:
Net income		$	9,486		$	14,356		$	20,934
Adjustments to reconcile net income to net cash provided by operating activities:
Rental inventory amortization and non-cash cost of rental inventory sold			66,078			80,703			128,300
Depreciation and intangibles amortization			22,327			22,332			19,346
Stock option compensation			—			8,161			2,279
Tax benefit of stock options exercised			—			5,273			4,454
Deferred income taxes			4,671			3,703			4,653
Changes in operating assets and liabilities:
	Merchandise inventory		5,884			3,436			(10,972	)
	Other current assets		(643	)		(2,731	)		(466	)
	Deposits and other assets		(518	)		856			(1,222	)
	Accounts payable		4,868			5,493			15,446
	Accrued liabilities and deferred revenue		(1,356	)		2,384			3,967
Net cash provided by operating activities			110,797			143,966			186,719
Investing activities:
Business acquisitions			(3,085	)		(20,047	)		(57,675	)
Purchases of rental inventory			(74,829	)		(83,840	)		(117,753	)
Purchases of property, furnishings and equipment			(23,086	)		(21,342	)		(31,316	)
Net cash used in investing activities			(101,000	)		(125,229	)		(206,744	)
Financing activities:
Net proceeds from issuance of common stock			—			—			66,769
Purchases and retirement of common stock			(5,698	)		—			—
Proceeds from exercise of stock options			—			5,216			2,659
Net payments on long-term debt			(4,040	)		(14,600	)		(26,000	)
Net cash (used in) provided by financing activities			(9,738	)		(9,384	)		43,428
Effect of exchange rate changes on cash and cash equivalents			—			(33	)		(226	)
Increase in cash and cash equivalents			59			9,320			23,177
Cash and cash equivalents at beginning of fiscal year			6,970			7,029			16,349
Cash and cash equivalents at end of fiscal year		$	7,029		$	16,349		$	39,526
Supplemental disclosures of cash flow information:
Cash paid during the period for interest		$	3,817		$	3,434		$	905
Cash paid during the period for income taxes			1,688			1,461			2,716

See accompanying notes.

F-6

Movie Gallery, Inc.

Notes to Consolidated Financial Statements

December 31, 2000, January 6, 2002 and January 5, 2003

1.    Accounting Policies

Principles of Consolidation and Description of Business

        The accompanying financial statements present the consolidated financial position, results of operations and cash flows of Movie Gallery, Inc. and subsidiaries. All material intercompany accounts and transactions have been eliminated.

        We own and operate video specialty stores located in 43 states and six Canadian provinces.

Use of Estimates

        The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires us to make estimates and assumptions that affect the amounts reported in the consolidated financial statements and accompanying notes. The most significant estimates and assumptions relate to the amortization methods and useful lives of rental inventory, fixed assets and other intangibles, valuation allowances for deferred tax assets and the allocation of the purchase price of acquired businesses. These estimates and assumptions could change and actual results could differ from these estimates.

Reclassifications

        Certain reclassifications have been made to the prior year financial statements to conform to the current year presentation. These reclassifications had no impact on stockholders' equity or net income.

        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. Additionally, the non-cash cost (unamortized book value) of previously viewed rental inventory sold has been reclassified on the statement of cash flows to be reported with rental inventory amortization. These costs were previously netted against purchases of rental inventory as investing activities in the statement of cash flows. The current presentation is more consistent with the classification of these costs in the income statement and discloses the gross rental inventory purchases, before the write-off of previously viewed inventory sold, on the face of the statement of cash flows.

        The extraordinary loss on early extinguishment of debt reported in fiscal 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.

Fiscal Year

        Our fiscal year ends on the first Sunday following December 30, which periodically results in a fiscal year of 53 weeks. Results for the fiscal year ended December 31, 2000 and January 5, 2003 reflect 52-week years. Results for the fiscal year ended January 6, 2002 reflect a 53-week year. Our fiscal year includes revenues and certain operating expenses, such as salaries, wages and other miscellaneous expenses, on a daily basis. All other expenses, primarily depreciation, amortization, rent and utilities, are calculated and recorded monthly, with twelve months included in each fiscal year.

F-7

Cash Equivalents

        We consider all highly liquid investments with a maturity of three months or less when purchased to be cash equivalents.

Merchandise Inventory

        Merchandise inventory consists primarily of new videocassette tapes ("VHS"), DVD, video games, video accessories and concessions and is stated at the lower of cost, on a first-in first-out basis, or market.

Rental Inventory

        In the fourth quarter of 2002, we made a strategic decision to make a portion of our base stock VHS rental inventory available for sale as previously viewed inventory during the holiday period. The sale of base stock VHS rental inventory was designed to make room on our store shelves for a significant investment in base stock DVD rental inventory to arrive in stores in the first quarter of 2003. Our decision to make this investment in base stock DVD was primarily driven by the continued growth in consumer acceptance of the DVD platform in our core markets throughout the last year. DVD rental revenue represented approximately 50% of movie rental revenue as of the end of fiscal 2002 versus approximately 20% as of the end of fiscal 2001. As a result of the significant shift from VHS to DVD that will occur in our rental inventory base as the new product arrives, we changed the estimates used to amortize rental inventory. The revised estimates reflect a reduction in the estimated useful lives of the rental inventory and a reduced salvage value for both VHS and game inventory. We believe the revised estimated useful lives and salvage values are better matched to our current rental business and are consistent with industry trends.

        Rental inventory is stated at cost and amortized over its economic useful life. The up-front fees and minimum costs of rental product purchased under revenue-sharing arrangements are capitalized and amortized in accordance with our rental inventory amortization policy. Revenue-sharing payments are expensed as incurred and are included in cost of rental revenues. Effective October 7, 2002, the cost of base stock, or catalog, movie inventory is amortized on an accelerated basis over the first twelve months and then on a straight-line basis over the next twelve months to its salvage value, $4 for DVD and $2 for VHS. The cost of non-base stock, or new release, movie inventory is amortized to its salvage value on an accelerated basis over six months. Video games are amortized on a straight-line basis to a $5 salvage value over twelve months.

        The changes in our estimates for rental inventory amortization have been applied to all inventory held at October 7, 2002. The changes have been accounted for as a change in accounting estimate during the fourth quarter ended January 5, 2003. The change in estimate decreased rental inventory and increased depreciation expense for the fiscal year ended January 5, 2003 by approximately $27.9 million and reduced net income by $16.7 million, or $0.53 per diluted share. The impact of the change is net of a $2.1 million reserve against rental inventory that was established in the fourth quarter of 2001 in order to reflect the impact of the consumer transition to DVD on the sale prices of previously viewed VHS product.

        Prior to October 7, 2002, the cost of base stock movie inventory was amortized on an accelerated basis to a net book value of $8 over six months and to a $4 salvage value over the next thirty months.

F-8

The cost of non-base stock movie inventory was amortized on an accelerated basis over six months to a net book value of $4, which was then amortized on a straight-line basis over the next 30 months or until the movie was sold, at which time the unamortized book value was charged to cost of sales. Video games were amortized on a straight-line basis to a $10 salvage value over eighteen months or until the game was sold, at which time the unamortized book value was charged to cost of sales.

        Rental inventory consists of the following (in thousands):

	January 6, 2002			January 5, 2003
Rental inventory	$	174,647		$	202,012
Accumulated amortization		(86,223	)		(119,132	)
	$	88,424		$	82,880

Property, Furnishings and Equipment

        Property, furnishings and equipment are stated at cost and include costs incurred in the construction of new stores. Depreciation is provided on a straight-line basis over the estimated lives of the related assets.

Business Combinations, Goodwill and Other Intangible Assets

        In June 2001, the Financial Accounting Standards Board ("FASB") issued Statement of Accounting Standards ("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. We completed the transitional impairment test and determined that none of the goodwill recorded was impaired as of January 7, 2002. Application of the nonamortization provisions of Statement 142 as of January 3, 2000 would have increased net income by approximately $3,413,000 to $12,899,000, or $0.50 per diluted share, for fiscal 2000 and $3,418,000 to $17,774,000, or $0.65 per diluted share, for fiscal 2001.

        Amortization of intangibles for fiscal 2000 and 2001 includes an impairment loss of $1,000,000 and $700,000, respectively, to write-off the net book value of goodwill in excess of its estimated fair market value in accordance with the provisions of FASB Statement No. 121, Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of. No impairment loss was recognized in fiscal 2002 under the provisions of Statement 142.

F-9

Impairment of Long-Lived Assets

        Long-lived assets, including property, furnishings and equipment and intangible assets with finite lives, are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount may not be recoverable. We use the discounted cash flow method to estimate the fair value of our long-lived assets. We have not recognized any impairment losses on long-lived assets in fiscal 2000, 2001 or 2002.

        In October 2001, the FASB issued Statement No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets, which addresses financial accounting and reporting for the impairment or disposal of long-lived assets and supersedes Statement 121, Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of, and the accounting and reporting provisions of APB Opinion No. 30, Reporting the Results of Operations for the Effects of Disposal of a Segment of a Business. We adopted Statement 144 as of January 7, 2002. The adoption did not have any impact on our financial position or results of operations.

Income Taxes

        We account for income taxes under the provisions of FASB Statement No. 109, Accounting for Income Taxes. Under Statement 109, deferred tax assets and liabilities are determined based upon differences between financial reporting and tax bases of assets and liabilities and are measured at the enacted tax rates and laws that will be in effect when the differences are expected to reverse.

Revenue Recognition

        We recognize rental revenue when the movie or video game is rented by the customer. Revenue from extended viewing fees incurred on rentals when the customer chooses to keep the product beyond the initial rental period is recognized when payment is received from the customer. We recognize product sales revenue at the time of sale.

        We periodically sell stored value cards in the form of electronic gift cards or discount rental cards. We record deferred revenue from the sale of stored value cards at the time of sale to the customer. The liability is relieved and revenue is recognized when the cards are redeemed by the customers.

Advertising Costs

        Advertising costs, exclusive of cooperative reimbursements from vendors, are expensed when incurred. Advertising expense for fiscal 2000, 2001 and 2002 totaled $1,563,000, $2,219,000 and $2,703,000, respectively.

Store Opening and Start-up Costs

        Store opening costs, which consist primarily of payroll and advertising, and start-up costs are expensed as incurred.

F-10

Fair Value of Financial Instruments

        At January 6, 2002 and January 5, 2003, the carrying value of financial instruments such as cash and cash equivalents, accounts payable and long-term debt approximated their fair values, calculated using discounted cash flow analysis at our incremental borrowing rate.

Foreign Currency Translation

        Our foreign subsidiary records transactions using the local currency as the functional currency. In accordance with FASB Statement No. 52, Foreign Currency Translation, the assets and liabilities of the foreign subsidiary are translated into U. S. dollars using either the exchange rates in effect at the balance sheet dates or historical exchange rates, depending upon the account translated. Income and expenses are translated at average weekly exchange rates each fiscal period. The translation adjustments that result from translating the balance sheets at different rates than the income statements are included in accumulated other comprehensive loss, which is a separate component of consolidated stockholders' equity.

Derivatives

        We recognize all derivatives as either assets or liabilities in the consolidated balance sheets and measure those instruments at fair value in accordance with FASB Statement No. 133, Accounting for Derivative Instruments and Hedging Activities, as amended by Statements No. 137 and 138. Gains and losses resulting from changes in the fair values of those derivative instruments will be recorded to earnings or other comprehensive income depending on the use of the derivative instrument and whether it qualifies for hedge accounting.

F-11

Stock Option Plan

        At January 5, 2003, we have a stock-based employee compensation plan, which is described more fully in Note 7. We account for the plan under the recognition and measurement principles of APB Opinion No. 25, Accounting for Stock Issued to Employees, and related Interpretations. Stock option compensation is reflected in net income for variable options outstanding under the plan (see Note 7). No stock option compensation is reflected in net income for the remaining options outstanding under the plan, as the exercise price was equal to the market value of the underlying common stock on the date of grant. The following table illustrates the effect on net income and earnings per share if we had applied the fair value recognition provision of FASB Statement No. 123, Accounting for Stock-Based Compensation, to stock-based employee compensation.

		Fiscal Year Ended
		December 31, 2000			January 6, 2002			January 5, 2003
Net income, as reported		$	9,486		$	14,356		$	20,934
Add: Stock option compensation included
	in reported net income, net of tax		—			4,919			1,367
Deduct: Stock option compensation
	determined under fair value based
	methods for all awards, net of tax		(990	)		(899	)		(1,147	)
Pro forma net income		$	8,496		$	18,376		$	21,154
Earnings per share:
	Basic	$	0.37		$	0.56		$	0.69
	Diluted	$	0.37		$	0.53		$	0.67
Pro forma earnings per share:
	Basic	$	0.33		$	0.71		$	0.70
	Diluted	$	0.33		$	0.68		$	0.67

Employee Benefits

        We have a 401(k) savings plan available to all active employees who are over 21 years of age and have completed one year of service. We make discretionary and matching contributions based on employee compensation. The matching contribution for fiscal 2000, 2001 and 2002 was immaterial to our operating results.

Recently Issued Accounting Pronouncements

        In July 2002, the FASB issued Statement No. 146, Accounting for Costs Associated with Exit or Disposal Activities. Statement 146 nullifies Emerging Issues Task Force ("EITF") Issue No. 94-3, Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring) and requires that a liability for a cost associated with an exit or disposal activity be recognized and measured initially at fair value in the period in which

F-12

the liability is incurred. Under EITF 94-3, a liability for an exit cost was recognized at the date of an entity's commitment to an exit plan. The adoption of Statement 146 is expected to result in delayed recognition for certain types of costs as compared to the provisions of EITF 94-3. Statement 146 is effective for new exit or disposal activities that are initiated after December 31, 2002, and does not affect amounts currently reported in our consolidated financial statements. Statement 146 will affect the types and timing of costs included in future restructuring programs, if any, but is not expected to have a material impact on our financial position or results of operations.

        In December 2002, the FASB issued Statement No. 148, Accounting for Stock-Based Compensation—Transition and Disclosure. Statement 148 amends FASB Statement No. 123, Accounting for Stock-Based Compensation, to provide alternative methods of transition to Statement 123's fair value method of accounting for stock-based employee compensation. Statement 148 also amends the disclosure provisions of Statement 123 and APB Opinion No. 28, Interim Financial Reporting, to require disclosure in the summary of significant accounting policies of the effects of an entity's accounting policy with respect to stock-based employee compensation on reported net income and earnings per share in annual and interim financial statements. We have adopted the amended disclosure provisions of Statement 148 in fiscal 2002. We do not expect Statement 148 to have any impact on our operating results as we continue to account for stock-based compensation in accordance with APB Opinion No. 25, Accounting for Stock Issued to Employees, and related Interpretations.

2.    Acquisitions

        During fiscal 2002, we purchased 265 stores in 34 separate transactions for approximately $60.7 million and recorded approximately $44.0 million in goodwill, $3.3 million for customer lists and $1.0 million for non-compete agreements related to these transactions.

        Effective December 21, 2001, we acquired 100% of the newly issued common stock of the reorganized Video Update, Inc. under its plan of reorganization which was confirmed by the United States Bankruptcy Court on December 20, 2001. Video Update had been operating under Chapter 11 of the United States Bankruptcy Code since its voluntary filing on September 18, 2000. The acquisition of the newly issued common stock of Video Update was in satisfaction of all amounts owed to us by Video Update under a $6.5 million debtor-in-possession financing agreement. In addition, we purchased certain senior secured debt of Video Update in May 2001 for $8.5 million, funded amounts due to secured and unsecured creditors in accordance with confirmation of the plan totaling approximately $6.3 million, and assumed other post-bankruptcy filing liabilities of Video Update as disclosed in the following table. At the time of acquisition, Video Update operated 324 video specialty stores in the United States and Canada. Our acquisition of Video Update was made as a strategic expansion of our geographic markets in accordance with our growth plan.

        Due to the Video Update acquisition occurring near the end of fiscal 2001, the closing of the final books and records of Video Update had not been completed as of the time our fiscal 2001 consolidated financial statements were prepared. As a result, we posted adjustments to the purchase price allocation during fiscal 2002 to reduce the liabilities by $4.3 million. This includes an adjustment of $0.1 million to the $1.3 million accrual for costs incurred during fiscal 2002 to transition the corporate functions of Video Update to our corporate office. The following table summarizes the preliminary estimated fair values of the assets acquired and liabilities assumed at the date of acquisition, the purchase price

F-13

allocation adjustments made in fiscal 2002 and the final resulting purchase price allocation. Any future adjustments to the purchase price allocation will be reflected as a component of net income.

Video Update, Inc.
Condensed Balance Sheet
As of December 21, 2001
(in thousands)

	Preliminary		Adjustments			Final
Current assets	$	3,017	$	10		$	3,027
Rental inventory, net		21,801		(2,801	)		19,000
Property, furnishings and equipment, net		12,596		(1,514	)		11,082
Deferred income taxes		8,468		—			8,468
Total assets acquired		45,882		(4,305	)		41,577
Accruals for settlement of liabilities subject to compromise		6,253		—			6,253
Current liabilities and accrued expenses		24,669		(4,305	)		20,364
Notes payable to parent		8,460		—			8,460
Total liabilities assumed		39,382		(4,305	)		35,077
Net investment in common stock	$	6,500	$	—		$	6,500

        The results of operations of Video Update have been included in our consolidated statements of income since December 21, 2001. The following unaudited pro forma information presents our consolidated results of operations as though the acquisition of Video Update had occurred as of the beginning of fiscal 2000. The pro forma information is not indicative of the results of operations that actually would have been obtained if the transaction had occurred at the beginning of fiscal 2000. Additionally, the pro forma information is not intended to be a projection of future results.

		Fiscal Year Ended
		December 31, 2000		January 6, 2002
		(in thousands, except per share data)
Revenue		$	426,426	$	466,557
Net income			13,844		14,358
Net income per share:
	Basic		0.54		0.56
	Diluted		0.54		0.53

        In addition to the Video Update acquisition, we purchased 31 stores in five separate transactions for approximately $6.6 million during fiscal 2001 and recorded approximately $3.5 million in goodwill and $1.0 million in other intangibles related to these transactions.

F-14

3.    Property, Furnishings and Equipment

        Property, furnishings and equipment consists of the following (in thousands):

	Useful Life	January 6, 2002			January 5, 2003
Land	—	$	1,819		$	1,959
Buildings	40 years		4,916		$	6,547
Furniture and fixtures	7 years		45,395			53,585
Equipment	5 years		44,364			52,382
Leasehold improvements and signs	7 years		48,342			61,947
			144,836			176,420
Accumulated depreciation			(73,097	)		(89,427	)
		$	71,739		$	86,993

4.    Intangible Assets

        The components of goodwill and other intangibles are as follows (in thousands):

		January 6, 2002					January 5, 2003
	Weighted-Average Amortization Period	Gross Carrying Amount		Accumulated Amortization			Gross Carrying Amount		Accumulated Amortization
Goodwill	—	$	103,093	$	(31,411	)	$	116,119	$	—
Non-compete agreements	9 years	$	8,688	$	(5,662	)	$	9,492	$	(6,493	)
Customer lists	7 years		1,130		—			3,996		(318	)
Total other intangibles		$	9,818	$	(5,662	)	$	13,488	$	(6,811	)

        Estimated amortization expense for other intangible assets for the five succeeding fiscal years is as follows (in thousands):

2003	$	1,601
2004		1,546
2005		1,073
2006		811
2007		705

        The changes in the carrying amounts of goodwill for the year ended January 5, 2003, are as follows (in thousands):

Balance as of January 6, 2002	$	71,682
Goodwill acquired		44,437
Balance as of January 5, 2003	$	116,119

5.    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 revolving credit facility. 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

F-15

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 7) and terminated the interest rate swap agreement. The costs to terminate the interest rate swap were expensed and were immaterial to our results of operations. As of January 5, 2003, there were standby letters of credit outstanding under our credit facility of $537,000, of which $325,000 expires on March 14, 2003 and $212,000 expires on June 27, 2003.

6.    Income Taxes

        The following reflects actual income tax expense (in thousands):

		Fiscal Year Ended
		December 31, 2000		January 6, 2002		January 5, 2003
Current payable:
	Federal	$	1,439	$	5,447	$	7,090
	State		315		641		2,180
Total current			1,754		6,088		9,270
Deferred:
	Federal		4,056		3,456		5,212
	State		615		244		(559	)
Total deferred			4,671		3,700		4,653
		$	6,425	$	9,788	$	13,923

        A reconciliation of income tax expense at the federal income tax rate to our effective income tax provision is as follows (in thousands):

	Fiscal Year Ended
	December 31, 2000		January 6, 2002		January 5, 2003
Income tax expense at statutory rate	$	5,569	$	8,450	$	12,200
State income tax expense, net of federal income tax benefit		604		576		1,054
Other, net		252		762		669
	$	6,425	$	9,788	$	13,923

        We had net operating loss carryforwards at January 6, 2002 resulting from the Video Update acquisition (see Note 2) of approximately $84.1 million U.S. and $6.5 million foreign for income taxes that expire in years 2007 through 2021. We have recorded a valuation allowance of $24.9 million related to its net deferred tax assets as management is uncertain as to whether sufficient taxable income will be generated to allow the net deferred tax assets to be realized.

F-16

        Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income taxes. Components of our deferred tax assets and liabilities are as follows (in thousands):

		January 6, 2002			January 5, 2003
Deferred tax assets:
	Non-compete agreements	$	4,573		$	4,946
	Alternative minimum tax credit carryforward		4,169			682
	Net operating loss carryforwards		25,490			31,944
	Accrued liabilities		770			1,456
	Other tax credit carryforwards		—			687
	Other		1,357			2,232
Total deferred tax assets			36,359			41,947
Valuation allowance			(18,412	)		(24,953	)
Net deferred tax assets			17,947			16,994
Deferred tax liabilities:
	Furnishings and equipment		(6,494	)		(11,573	)
	Rental inventory		(6,473	)		(4,635	)
	Goodwill		(1,986	)		(2,621	)
	Other		(2,459	)		(2,283	)
Total deferred tax liabilities			(17,412	)		(21,112	)
Net deferred tax assets (liabilities)		$	535		$	(4,118	)

7.    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.

Earnings Per Share

        Basic earnings per share and basic pro forma earnings per share are computed based on the weighted average number of shares of common stock outstanding during the periods presented. Diluted earnings per share and diluted pro forma earnings per share are 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 (67,000, 1,383,000 and 1,163,000 for fiscal 2000, 2001 and 2002, respectively). No adjustments were made to net income in the computation of basic or diluted earnings per share.

Stock Offering

        In May 2002, we closed a public offering of our common stock priced at $18.25 per share. We sold 3,900,000 shares and received the proceeds from 350,000 stock options exercised in conjunction with

F-17

the offering for total proceeds, net of expenses of the offering, of approximately $67.6 million. A portion of the proceeds from the offering were used to repay outstanding borrowings under our credit facility. We are currently using the balance of the proceeds from the offering for new store openings, selective acquisitions, working capital and other general corporate purposes.

Stock Option Plan

        In July 1994, our Board of Directors adopted, and our stockholders approved, the 1994 Stock Option Plan. The plan provides for the award of incentive stock options, stock appreciation rights, bonus rights and other incentive grants to employees, independent contractors and consultants. Currently 6,750,000 shares are reserved for issuance under the plan, 3,500,393 of which have been exercised as of January 5, 2003. Options granted under the plan have a ten-year term and generally vest over four years.

        In accordance with the provisions of FASB Statement No. 123, Accounting for Stock-Based Compensation, we apply Accounting Principles Board Opinion No. 25 and related Interpretations in accounting for the plan and, accordingly, have not recognized compensation cost in connection with the plan, except for the variable options described below. If we had elected to recognize compensation cost based on the fair value of the options granted at grant date as prescribed by Statement 123, net income and earnings per share would have been adjusted to the pro forma amounts indicated in Note 1. The effect on net income and earnings per share is not expected to be indicative of the effects on net income and earnings per share in future years.

        The fair value of each option grant was estimated at the date of grant using the Black-Scholes option pricing model with the following weighted-average assumptions:

	Fiscal Year Ended
	December 31, 2000		January 6, 2002		January 5, 2003
Expected volatility	0.703		0.706		0.705
Risk-free interest rate	5.15	%	5.41	%	5.26	%
Expected life of option in years	5.7		5.5		5.1
Expected dividend yield	0.0	%	0.0	%	0.0	%

        The Black-Scholes option valuation model was developed for use in estimating the fair value of traded options which have no vesting restrictions and are fully transferable. In addition, option valuation models require the input of highly subjective assumptions including the expected stock price volatility. Because our employee stock options have characteristics significantly different from those of traded options, and because changes in the subjective input assumptions can materially affect the fair value estimate, in our opinion, the existing models do not necessarily provide a reliable single measure of the fair value of our employee stock options.

        In March 2000, the FASB issued Interpretation No. 44, Accounting for Certain Transactions involving Stock Compensation, an interpretation of APB Opinion No. 25. The Interpretation requires that stock options that have been modified to reduce the exercise price be accounted for as variable. We repriced 864,000 stock options in March 2001, and reduced the exercise price to $1.78 per share. Assuming all repriced stock options are exercised, we will receive $.6 million less than if no repricing had occurred. Under Interpretation 44, the repriced stock options are accounted for as variable until the stock options are exercised, forfeited or expire unexercised.

F-18

        A summary of our stock option activity and related information is as follows:

		Outstanding Options			Weighted- Average Exercise Price Per Share
Outstanding at January 2, 2000			5,123,221		$	4.25
	Granted		911,250			1.42
	Exercised		—			—
	Cancelled		(313,830	)		2.28
Outstanding at December 31, 2000			5,720,641			3.91
	Granted		—			—
	Exercised		(2,128,927	)		2.26
	Cancelled		(146,205	)		4.99
Outstanding at January 6, 2002			3,445,509			4.71
	Granted		456,250			14.61
	Exercised		(946,935	)		2.81
	Cancelled		(43,531	)		3.25
Outstanding at January 5, 2003			2,911,293			6.90
Exercisable at December 31, 2000			3,755,941			5.02
Exercisable at January 6, 2002			2,236,021			6.39
Exercisable at January 5, 2003			1,873,068			6.92
Weighted-average fair value of options granted:
Fiscal year ended December 3, 2000		$	2.10
Fiscal year ended January 6, 2002			—
Fiscal year ended January 5, 2003			7.62

        Options outstanding as of January 5, 2003 had a weighted-average remaining contractual life of 5.8 years and exercise prices ranging from $1.00 to $18.00 as follows:

	Exercise price of
	$1.00 to $2.00	$6.00 to $11.00	$13.00 to $18.00
Options outstanding	1,484,293	515,000	912,000
Weighted-average exercise price	$1.62	$7.63	$15.08
Weighted-average remaining contractual life	6.9 years	2.5 years	5.8 years
Options exercisable	866,818	515,000	491,250
Weighted-average exercise price of exercisable options	$1.66	$7.63	$15.47

8.    Commitments and Contingencies

        Rent expense for fiscal 2000, 2001 and 2002 totaled $45,132,000, $50,985,000 and $82,597,000, respectively. Future minimum payments under noncancellable operating leases which contain renewal

F-19

options and escalation clauses with remaining terms in excess of one year consisted of the following at January 5, 2003 (in thousands):

2003	$	65,643
2004		57,725
2005		39,173
2006		22,370
2007		12,904
Thereafter		12,092
	$	209,907

        We have a supply contract with Rentrak Corporation which requires us to order 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, we amended the terms of our existing supply contract with Rentrak. We paid Rentrak $1.6 million in connection with the amendment to the contract. Additionally, we prepaid approximately $.9 million to be applied over a three-year period against future amounts due under the contract.

        In the second quarter of fiscal 2002, we obtained a preliminary court order approving a settlement agreement in certain putative class action lawsuits filed against us alleging that the extended viewing fees charged to our customers for keeping rental products beyond the initial rental period were penalties in violation of certain common law and equitable principles. Under the terms of the settlement agreement, we were 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 also agreed to pay the plaintiffs' attorneys up to $850,000 in fees. The terms of the settlement were approved in a fairness hearing on November 22, 2002. The settlement released all claims made by all class members in all the pending class actions, other than a de minimis number of members who chose not to participate in the settlement. The court's order approving the settlement has become final and non-appealable. We incurred a one-time charge to our earnings of approximately $4 million in the second quarter of 2002 as a result of the settlement, which amount includes $850,000 of plaintiffs' attorneys' fees.

        We are occasionally involved in litigation in the ordinary course of business, none of which, individually or in the aggregate, is material to our business or results of operations.

9.    Related Party Transactions

        We hold a one-third interest in ECHO, LLC, a supply sales and distribution company. We purchase office and store supplies and other business products from ECHO. This relationship enables us to substantially reduce the retail mark-up that occurs between the wholesaler and the retailer. We paid ECHO approximately $422,000 and $6,422,000 during fiscal 2001 and 2002, respectively, and received distributions totaling $40,000 in fiscal 2002. We have a $125,000 outstanding line of credit due from ECHO. We have received approximately $2,900 and $6,400 in interest on the line of credit during fiscal 2001 and 2002, respectively. We had outstanding accounts payable to ECHO of approximately $24,000 and $469,000 as of January 6, 2002 and January 5, 2003, respectively.

F-20

        Air Conditioning Associates, Inc. ("ACA") is owned by the father-in-law and brother-in-law of our Chairman of the Board, President, and Chief Executive Officer. ACA administers the repair and maintenance function for our store base and corporate offices in addition to providing other HVAC materials and related services. We have achieved overall cost savings under this management agreement and have improved our system for managing company-wide repair and maintenance needs. We paid ACA approximately $382,000, $243,000 and $470,000 during fiscal 2000, 2001 and 2002, respectively. We had outstanding accounts payable to ACA of approximately $25,000 and $157,000 as of January 6, 2002 and January 5, 2003, respectively.

        J. Todd, Inc. d/b/a Todd & Sons, is owned by the brother of our Senior Vice President, Secretary and General Counsel. Todd & Sons supplies us with certain clothing and promotional items on an as needed basis. We have no minimum purchase requirements or contractual obligations with Todd & Sons. We paid Todd & Sons approximately $28,000, $127,000 and $49,000 during fiscal 2000, 2001 and 2002, respectively. We had outstanding accounts payable to Todd & Sons of approximately $3,000 and $1,000 as of January 6, 2002 and January 5, 2003, respectively.

10.    Foreign Operations

        Beginning in fiscal 2001, we operated in both the United States and Canada. The following table sets forth our consolidated revenues, operating income and assets by geographic area. All intercompany balances and transactions have been eliminated.

		Fiscal Year Ended
		January 6, 2002		January 5, 2003
		(in thousands)
Revenues:
	United States	$	367,637	$	505,807
	Canada		1,494		23,181
Total revenues		$	369,131	$	528,988
Operating income:
	United States	$	26,696	$	36,111
	Canada		474		(230	)
Total operating income		$	27,170	$	35,881
Assets (at end of fiscal year):
	United States	$	258,691	$	342,787
	Canada		11,441		20,787
Total assets		$	270,132	$	363,574

F-21

11.    Summary of Quarterly Results of Operations (Unaudited)

        The following is a summary of our unaudited quarterly results of operations (in thousands, except per share data):

	Thirteen Weeks Ended						Fourteen Weeks Ended
	April 1, 2001		July 1, 2001		September 30, 2001		January 6, 2002
Revenues	$	91,571	$	82,987	$	86,467	$	108,106
Operating income	$	7,413	$	2,600	$	2,750	$	14,407
Net income	$	4,019	$	927	$	1,271	$	8,139
Basic earnings per share	$	0.16	$	0.04	$	0.05	$	0.30
Diluted earnings per share	$	0.16	$	0.04	$	0.05	$	0.28

	Thirteen Weeks Ended
	April 7, 2002		July 7, 2002		October 6, 2002		January 5, 2003
Revenue	$	123,130	$	122,578	$	130,435	$	152,845
Operating income (loss)	$	16,869	$	9,728	$	15,737	$	(6,453	)
Net income (loss)	$	9,874	$	5,600	$	9,392	$	(3,932	)
Basic earnings (loss) per share	$	0.36	$	0.19	$	0.29	$	(0.12	)
Diluted earnings (loss) per share	$	0.35	$	0.18	$	0.29	$	(0.12	)

F-22

Movie Gallery, Inc.

Schedule II—Valuation and Qualifying Accounts

(in thousands)

Description	Balance at December 31, 2002		Additions Charged to Costs and Expenses		Deductions			Balance at January 6, 2002		Deductions			Balance at January 5, 2003
Rental inventory reserve(1)	$	—	$	2,100	$	—		$	2,100	$	(2,100	)	$	—
Exit cost reserve(2)	$	—	$	1,257	$	(23	)	$	1,234	$	(1,234	)	$	—

(1)

Reserve is deducted from net book value of rental inventory in the balance sheet. Reserve was reversed in conjunction with change in estimate for rental inventory amortization in fiscal 2002.

(2)

Reserve established in conjunction with Video Update acquisition. Includes employee termination costs, rent and utilities. Deduction represents actual payments made against exit cost reserve and purchase price allocation adjustment to reverse excess accrual of $125 in fiscal 2002.

F-23

Index to Exhibits

Exhibit No.	Description
3.1.3	Certificate of Amendment of Certificate of Incorporation
3.2	Amended and Restated Bylaws of Movie Gallery, Inc.
10.1.1	Amendment to Movie Gallery, Inc. 1994 Stock Plan, as amended
10.10.1	Amendment to Credit Agreement between Movie Gallery, Inc. and SouthTrust Bank dated September 25, 2001
10.10.2	Amendment to Credit Agreement between Movie Gallery, Inc. and SouthTrust Bank dated January 14, 2002
21	List of Subsidiaries
23	Consent of Ernst & Young LLP, Independent Auditors
99.1	Certification Pursuant to 18 U.S.C. Section 1350, as adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
99.2	Certification Pursuant to 18 U.S.C. Section 1350, as adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

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ITEM 1. BUSINESS

ITEM 2. PROPERTIES
ITEM 3. LEGAL PROCEEDINGS
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

PART II

ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
ITEM 6. SELECTED FINANCIAL DATA

ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE

PART III

ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
ITEM 11. EXECUTIVE COMPENSATION
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
ITEM 14. CONTROLS AND PROCEDURES
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
ITEM 16. PRINCIPAL ACCOUNTANT FEES AND SERVICES

SIGNATURES
MOVIE GALLERY, INC. CERTIFICATIONS PURSUANT TO SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002 CERTIFICATION
Report of Ernst & Young LLP, Independent Auditors
Movie Gallery, Inc. Consolidated Balance Sheets (in thousands)
Movie Gallery, Inc. Consolidated Statements of Income (in thousands, except per share data)
Movie Gallery, Inc. Consolidated Statements of Stockholders' Equity (in thousands)
Movie Gallery, Inc. Consolidated Statements of Cash Flows (in thousands)
Movie Gallery, Inc. Notes to Consolidated Financial Statements
Movie Gallery, Inc. Schedule II—Valuation and Qualifying Accounts (in thousands)
Index to Exhibits

EX-3.1-3

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Exhibit 3.1.3

CERTIFICATE OF AMENDMENT

OF

CERTIFICATE OF INCORPORATION OF

MOVIE GALLERY, INC.

        Movie Gallery, Inc. (the "Corporation"), a corporation organized and existing under and by virtue of the General Corporation Law of the State of Delaware, does hereby certify:

        1.    That at a meeting of the board of directors of the Corporation held on March 26, 2002, resolutions were duly adopted setting forth a proposed amendment to the Certificate of Incorporation of the Corporation, declaring said amendment to be advisable, and providing that such amendment be submitted for approval by the stockholders of the Corporation at the annual meeting of the stockholders. The resolution setting forth such proposed amendment is as follows:

        Resolved, that Paragraph 1 of Article "FOURTH" of the Certificate of Incorporation of the Corporation be amended and restated in its entirety as follows:

        "1. The Corporation is authorized to issue two classes of stock, to be designated "Common Stock" and "Preferred Stock", respectively. The total number of shares which the Corporation is authorized to issue is sixty-seven million (67,000,000) shares. The number of shares of Common Stock authorized to be issued is sixty-five million (65,000,000), with a par value of $0.001 per share. The number of shares of Preferred Stock authorized to be issued is two million (2,000,000), with a par value of $0.10 per share."

        2.    That thereafter, pursuant to said resolutions of the board of directors of the Corporation, an annual meeting of the stockholders of the Corporation was duly called and held on June 13, 2002, upon notice duly given in accordance with Section 222 of the General Corporation Law of the State of Delaware, at which meeting the necessary number of shares as required by statute were voted in favor of the amendment.

        3.    That said amendment was duly adopted in accordance with the provisions of Section 242 of the General Corporation Law of the State of Delaware.

        4.    That the capital of the Corporation shall not be reduced under or by reason of said amendment.

        IN WITNESS WHEREOF, the Corporation has caused this Certificate of Amendment to be signed by Joe T. Malugen, its President and S. Page Todd, its Secretary this 27th day of March, 2003.

/s/  JOE T. MALUGEN Joe T. Malugen, President

/s/  S. PAGE TODD S. Page Todd, Secretary

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CERTIFICATE OF AMENDMENT OF CERTIFICATE OF INCORPORATION OF MOVIE GALLERY, INC.

EX-3.2

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Exhibit 3.2

AMENDED AND RESTATED BYLAWS

OF

MOVIE GALLERY, INC.

ARTICLE I		OFFICES	1
	Section 1	Registered Office.	1
	Section 2	Other Offices.	1
ARTICLE II		MEETINGS OF STOCKHOLDERS	1
	Section 1	Place of Meetings.	1
	Section 2	Annual Meeting.	1
	Section 3	Special Meetings.	1
	Section 4	Notice of Meetings of Stockholders.	1
	Section 5	Manner of Giving Notice; Affidavit of Notice.	2
	Section 6	Quorum.	2
	Section 7	Adjourned Meeting; Notice.	2
	Section 8	Voting.	2
	Section 9	Consent of Stockholders in Lieu of Meeting.	3
	Section 10	List of Stockholders Entitled to Vote.	3
	Section 11	Stock Ledger.	3
	Section 12	Waiver of Notice or Consent by Absent Stockholders.	3
	Section 13	Inspectors of Election.	3
	Section 14	Advance Notice Provisions for Election of Directors.	4
	Section 15	Advance Notice Provisions for Business to be Transacted at Annual Meeting.	5
ARTICLE III		DIRECTORS	6
	Section 1	Number, Election and Term of Directors.	6
	Section 2	Vacancies.	6
	Section 3	Duties and Powers.	6
	Section 4	Meetings.	6
	Section 5	Quorum.	6
	Section 6	Actions of Board.	6
	Section 7	Meetings by Means of Conference Telephone.	7
	Section 8	Committees.	7
	Section 9	Compensation.	7
	Section 10	Interested Directors.	7
ARTICLE IV		OFFICERS	8
	Section 1	Officers.	8
	Section 2	Election.	8
	Section 3	Voting Securities Owned by the Corporation.	8
	Section 4	Chief Executive Officer	8
	Section 5	President.	9
	Section 6	Vice Presidents.	9
	Section 7	Secretary.	9
	Section 8	Chief Financial Officer.	9
	Section 9	Delegation of Authority.	9
	Section 10	Removal and Resignation of Officers.	9
	Section 11	Vacancies in Offices.	10
ARTICLE V		STOCK	10
	Section 1	Form of Certificates.	10
	Section 2	Signatures.	10
	Section 3	Lost Certificates.	10

i

	Section 4	Transfers.	10
	Section 5	Record Date.	10
	Section 6	Beneficial Owners.	11
ARTICLE VI		NOTICES	11
	Section 1	Notices.	11
	Section 2	Waivers of Notice.	11
ARTICLE VII		GENERAL PROVISIONS	11
	Section 1	Dividends.	11
	Section 2	Disbursements.	11
	Section 3	Fiscal Year.	12
	Section 4	Corporate Seal.	12
ARTICLE VIII		INDEMNIFICATION	12
	Section 1	Power to Indemnify in Actions, Suits or Proceedings Other Than Those by or in the Right of the Corporation.	12
	Section 2	Power to Indemnify in Actions, Suits or Proceedings by or in the Right of the Corporation.	12
	Section 3	Authorization of Indemnification.	12
	Section 4	"Good Faith" Defined.	13
	Section 5	Indemnification by a Court.	13
	Section 6	Expenses Payable in Advance.	13
	Section 7	Nonexclusivity of Indemnification and Advancement of Expenses.	13
	Section 8	Insurance.	14
	Section 9	Meaning of "Corporation" for Purposes of Article VIII.	14
	Section 10	Survival of Indemnification and Advancement of Expenses.	14
ARTICLE IX		AMENDMENTS	14
	Section 1	Amendments by Stockholders or Board.	14

ii

AMENDED AND RESTATED BYLAWS

OF

MOVIE GALLERY, INC.

(the "Corporation")

ARTICLE I

OFFICES

        Section 1    Registered Office.

        The registered office of the Corporation shall be in the City of Wilmington, County of New Castle, State of Delaware.

        Section 2    Other Offices.

        The Corporation also may have offices at such other places both within and outside the State of Delaware as the Board of Directors may from time to time determine.

ARTICLE II

MEETINGS OF STOCKHOLDERS

        Section 1    Place of Meetings.

        Meetings of stockholders shall be held at any place within or outside the State of Delaware designated by the Board of Directors. In the absence of any such designation, meetings of stockholders shall be held at the principal executive office of the Corporation.

        Section 2    Annual Meeting.

        The annual meeting of stockholders shall be held on such date and time as the Board of Directors may determine. However, if this day falls on a legal holiday, the meeting shall be held at the same time and place on the next succeeding full business day. The annual meeting shall be held at the Corporation's principal offices or at any other location as may be determined by the Board of Directors. At each annual meeting, directors shall be elected and any other proper business may be transacted.

        Section 3    Special Meetings.

        Unless otherwise required by law, special meetings of the stockholders may only be called by (i) any officer at the request of a majority of the Board of Directors, (ii) the Chairman of the Board of Directors, (iii) the President, or (iv) the Chief Executive Officer.

        Section 4    Notice of Meetings of Stockholders.

        All notices of meetings of stockholders shall be sent or otherwise given in accordance with Section 5 of this Article II not fewer than 10 or more than 60 days before the date of the meeting. Such notice shall specify the place, date and hour of the meeting and (i) in the case of a special meeting, the general nature of the business to be transacted, or (ii) in the case of the annual meeting, those matters that the Board of Directors, at the time of giving the notice, intends to present for action by the stockholders. The notice of any meeting at which directors are to be elected shall include the name of any nominee or nominees whom, at the time of the notice, management intends to present for election. Business transacted at any special meetings of stockholders shall be limited to the purposes stated in the notice.

1

        Section 5    Manner of Giving Notice; Affidavit of Notice.

        Notice of any meeting of stockholders shall be given either personally or by mail or telegraphic or other written communication, charges prepaid, addressed to each stockholder at the address of such stockholder appearing on the books of the Corporation or given by the stockholder to the Corporation for the purpose of notice. Notice shall be deemed to have been given at the time when delivered personally or deposited in the mail or sent by telegram or other means of written communication.

        Whenever notice is required to be given, under any provision of these Bylaws or the Certificate of Incorporation, to any stockholder to whom (i) notice of two consecutive annual meetings, and all notices of meetings or of the taking of action by written consent without a meeting to such person during the period between such two consecutive annual meetings, or (ii) all, and at least two, payments (if sent by first class mail) of dividends or interest on securities during a twelve month period, have been mailed addressed to such person at such person's address as shown on the records of the corporation and have been returned undeliverable, the giving of such notice to such person shall not be required. Any action or meeting which shall be taken or held without notice to such person shall have the same force and effect as if such notice had been duly given. If any such person shall deliver to the corporation a written notice setting forth such person's then current address, the requirement that notice be given to such person shall be reinstated.

        An affidavit of the mailing or other means of giving any notice of any meeting of stockholders shall be executed by the Secretary, Assistant Secretary or any transfer agent of the Corporation giving the notice and shall be filed and maintained in the minute book of the Corporation.

        Section 6    Quorum.

        The presence in person or by proxy of the holders of a majority of the shares entitled to vote at a meeting of stockholders shall constitute a quorum for the transaction of business at such meeting. The stockholders present at a duly called or held meeting at which a quorum is present may continue to do business until adjournment, notwithstanding the withdrawal of enough stockholders to leave less than a quorum, if any action taken (other than adjournment) is approved by at least a majority of the shares required to constitute a quorum.

        Section 7    Adjourned Meeting; Notice.

        Any meeting of stockholders, annual or special, whether or not a quorum is present, may be adjourned from time to time by the vote of the majority of the shares represented at such meeting either in person or by proxy; but in the absence of a quorum, no other business may be transacted at such meeting, except as provided in Section 6 of this Article II.

        When any meeting of stockholders, annual or special, is adjourned to another time or place, notice need not be given of the adjourned meeting if the time and place are announced at a meeting at which the adjournment is taken, unless a new record date for the adjourned meeting is fixed or unless the adjournment is for more than 45 days from the date set for the original meeting, in which case the Board of Directors shall set a new record date. Notice of any such adjourned meeting shall be given to each stockholder of record entitled to vote at the adjourned meeting in accordance with the provisions of Sections 4 and 5 of this Article II. At any adjourned meeting, the Corporation may transact any business that might have been transacted at the original meeting.

        Section 8    Voting.

        Any action required or permitted to be taken by the stockholders must be effected at a duly called annual or special meeting of such holders and may not be effected by any consent in writing by such holders.

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        Section 9    No Stockholder Action by Written Consent.

        Any action required or permitted to be taken by the stockholders must be effected at a duly called annual or special meeting of such holders and may not be effected by any consent in writing by such holders.

        Section 10    List of Stockholders Entitled to Vote.

        The officer of the Corporation who has charge of the stock ledger of the Corporation shall prepare and make, at least ten days before every meeting of stockholders, a complete list of the stockholders entitled to vote at the meeting, arranged in alphabetical order, and showing the address of each stockholder and the number of shares registered in the name of each stockholder. Such list shall be open to the examination of any stockholder, for any purpose germane to the meeting, during ordinary business hours, for a period of at least ten days prior to the meeting, either at a place within the city where the meeting is to be held, which place shall be specified in the notice of the meeting, or, if not so specified, at the place where the meeting is to be held. The list shall also be produced and kept at the time and place of the meeting during the whole time thereof, and may be inspected by any stockholder of the Corporation who is present.

        Section 11    Stock Ledger.

        The stock ledger of the Corporation shall be the only evidence as to which stockholders are entitled to examine the stock ledger, the list required by Section 10 of this Article II or the books of the Corporation, or to vote in person or by proxy at any meeting of stockholders.

        Section 12    Waiver of Notice or Consent by Absent Stockholders.

        The transactions of any meeting of stockholders, annual or special, however called and noticed and wherever held, shall be as valid as though they had occurred at a meeting duly held after regular call and notice, if a quorum is present either in person or by proxy, and if, either before or after such meeting, each person entitled to vote who was not present in person or by proxy signs a written waiver of notice or a consent to a holding of such meeting or an approval of the minutes thereof. Such waiver of notice or consent need not specify either the business to be transacted or the purpose of any annual or special meeting of stockholders. All such waivers, consents or approvals shall be filed with the corporate records or made a part of the minutes of the meeting.

        Attendance by a person at a meeting shall also constitute a waiver of notice of such meeting, except that when such person objects at the beginning of the meeting to the transaction of any business thereat because such meeting was not lawfully called or convened, and except that attendance at a meeting is not a waiver of any right to object to the consideration of matters not included in the notice of such meeting if an objection is expressly made at such meeting.

        Section 13    Inspectors of Election.

        Before any meeting of stockholders, the Board of Directors may appoint any persons other than nominees for office to act as inspectors of election at the meeting or its adjournment. If no inspectors of election are so appointed, the chairman of the meeting may, and on the request of any stockholder or a stockholder's proxy shall, appoint inspectors of election at the meeting. The number of such inspectors shall be either one or three. If such inspectors are appointed at a meeting on the request of one or more stockholders or proxies, the holders of a majority of shares or their proxies present at the meeting shall determine whether one or three inspectors are to be appointed. If any person appointed as inspector fails to appear or fails or refuses to act, the chairman of the meeting may, and upon the request of any stockholder or a stockholder's proxy shall, appoint a person to fill that vacancy.

        Such inspectors shall:

        (a)  Determine the number of shares outstanding and the voting power of each, the shares represented at the meeting, the existence of a quorum, and the authenticity, validity, and effect of proxies;

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        (b)  Receive votes, ballots or consents;

        (c)  Hear and determine all challenges and questions in any way arising in connection with the right to vote;

        (d)  Count and tabulate all votes or consents;

        (e)  Determine when the polls shall close;

        (f)    Determine the result; and

        (g)  Do any other acts that may be proper to conduct the election or vote with fairness to all stockholders.

        Section 14    Advance Notice Provisions for Election of Directors.

        Only persons who are nominated in accordance with the following procedures shall be eligible for election as directors of the Corporation. Nominations of persons for election to the Board of Directors may be made, (a) by or at the direction of the Board of Directors (or any duly authorized committee thereof) or (b) by any stockholder of the Corporation (i) who is a stockholder of record on the date of the giving of the notice provided for in this Section 14 and on the record date for the determination of stockholders entitled to vote at the applicable annual meeting and (ii) who complies with the notice procedures set forth in this Section 14.

        In addition to any other applicable requirements, for a nomination to be made by a stockholder such stockholder must have given timely notice thereof in proper written form to the Secretary of the Corporation.

        To be timely, a stockholder's notice to the Secretary must be delivered to or mailed and received at the principal executive offices of the Corporation (i) not less than 120 calendar days before the date the Corporation's proxy statement was released to stockholders in connection with the previous year's annual meeting or such other time period as may be required or permitted by applicable law or (ii) if no annual meeting was held in the previous year or the date of the applicable annual meeting has been changed by more than 30 days from the date of the previous year's annual meeting, not less than a reasonable time prior to the date the Corporation begins to print and mail its proxy materials, as determined by the Board of Directors.

        To be in proper written form, a stockholder's notice to the Secretary must set forth (a) as to each person whom the stockholder proposes to nominate for election as a director (i) the name, age, business address and residence address of the person, (ii) the principal occupation or employment of the person, (iii) the class or series and number of shares of capital stock of the Corporation which are owned beneficially or of record by the person and (iv) any other information relating to the person that would be required to be disclosed in a proxy statement or other filings required to be made in connection with solicitations of proxies for election of directors pursuant to Section 14 of the Securities Exchange Act of 1934, as amended (the "Exchange Act"), and the rules and regulations promulgated thereunder; and (b) as to the stockholder giving the notice (i) the name and record address of such stockholder, (ii) the class or series and number of shares of capital stock of the Corporation which are owned beneficially or of record by such stockholder, (iii) a description of all arrangements or understandings between such stockholder and each proposed nominee and any other person or persons (including their names) pursuant to which the nomination(s) are to be made by such stockholder, (iv) a representation that such stockholder intends to appear in person or by proxy, at the meeting to nominate the persons named in its notice and (v) any other information relating to such stockholder that would be required to be disclosed in a proxy statement or other filings required to be made in connection with solicitations of proxies for election of directors pursuant to Section 14 of the Exchange Act and the rules and regulations promulgated thereunder. Such notice must be accompanied by a written consent of each proposed nominee to being named as a nominee and to serve as a director if elected.

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        No person shall be eligible for election as a director of the Corporation unless nominated in accordance with the procedures set forth in this Section 14. If the Chairman of the meeting determines that a nomination was not made in accordance with the foregoing procedures, the Chairman shall declare to the meeting that the nomination was defective and such defective nomination shall be disregarded.

        Section 15    Advance Notice Provisions for Business to be Transacted at Annual Meeting.

        No business may be transacted at an annual meeting of stockholders, other than business that is either (a) specified in the notice of meeting (or any supplement thereto) given by or at the direction of the Board of Directors (or any duly authorized committee thereof), (b) otherwise properly brought before the annual meeting by or at the direction of the Board of Directors (or any duly authorized committee thereof) or (c) otherwise properly brought before the annual meeting by any stockholder of the Corporation (i) who is a stockholder of record on the date of the giving of the notice provided for in this Section 15 and on the record date for the determination of stockholders entitled to vote at such annual meeting and (ii) who complies with the notice procedures set forth in this Section 15.

        In addition to any other applicable requirements, for business to be properly brought before an annual meeting by a stockholder, such stockholder must have given timely notice thereof in proper written form to the Secretary of the Corporation.

        To be timely, a stockholder's notice to the Secretary must be delivered to or mailed and received at the principal executive offices of the Corporation (i) not less than 120 calendar days before the date the Corporation's proxy statement was released to stockholders in connection with the previous year's annual meeting or such other time period as may be required or permitted by applicable law or (ii) if no annual meeting was held in the previous year or the date of the applicable annual meeting has been changed by more than 30 days from the date of the previous year's annual meeting, not less than a reasonable time prior to the date the Corporation begins to print and mail its proxy materials, as determined by the Board of Directors.

        To be in proper written form, a stockholder's notice to the Secretary must set forth as to each matter such stockholder proposes to bring before the annual meeting (i) a brief description of the business desired to be brought before the annual meeting, including the completed text of any resolutions to be presented at the annual meeting, and the reasons for conducting such business at the annual meeting, (ii) the name and record address of such stockholder, (iii) the class or series and number of shares of capital stock of the Corporation which are owned beneficially or of record by such stockholder, (iv) a description of all arrangements or understandings between such stockholder and any other person or persons (including their names) in connection with the proposal of such business by such stockholder and any material interest of such stockholder in such business and (v) a representation that such stockholder intends to appear in person or by proxy at the annual meeting to bring such business before the meeting. In addition, the stockholder making such proposal shall promptly provide any other information required by law or otherwise reasonably requested by the Corporation.

        No business shall be conducted at the annual meeting of stockholders except business brought before the annual meeting in accordance with the procedures set forth in this Section 15, provided, however that, once business has been properly brought before the annual meeting in accordance with such procedures, nothing in this Section 15 shall be deemed to preclude discussion by any stockholder of any such business; provided further, however, that if the stockholder bringing such matter before the meeting withdraws such matter, such matter shall no longer be properly before the meeting. If the Chairman of an annual meeting determines that business was not properly brought before the annual meeting in accordance with the foregoing procedures, the Chairman shall declare to the meeting that the business was not properly brought before the meeting and such business shall not be transacted.

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ARTICLE III

DIRECTORS

        Section 1    Number, Election and Term of Directors.

        The number of directors of the Corporation shall not be less than five nor more than nine. The exact number of directors shall be fixed, within the limits specified above, by a resolution duly approved by the Board of Directors. Except as provided in Section 2 of this Article III, directors shall be elected by a plurality of the votes cast at annual meetings of stockholders, and each director so elected shall hold office until the next annual meeting and until his successor is duly elected and qualified, or until his earlier resignation or removal. Any director may resign at any time upon notice to the Corporation. Directors need not be stockholders.

        Section 2    Vacancies.

        Vacancies and newly created directorships resulting from any increase in the authorized number of directors shall be filled by a majority vote or consent of the directors then in office, though less than a quorum, or by a sole remaining director, and the directors so chosen shall hold office until the next annual election and until their successors are duly elected and qualified, or until their earlier resignation or removal. The stockholders shall have no right or power to fill any such vacancies or newly created directorships.

        Section 3    Duties and Powers.

        The business of the Corporation shall be managed by or under the direction of the Board of Directors, which may exercise all such powers of the Corporation and do all such lawful acts and things as are not by statute or by the Certificate of Incorporation or by these Bylaws directed or required to be exercised or done by the stockholders.

        Section 4    Meetings.

        The Board of Directors may hold meetings, both regular and special, either within or outside the State of Delaware. Regular meetings of the Board of Directors may be held without notice at such time and at such place as may from time to time be determined by the Board of Directors. Special meetings of the Board of Directors may be called by the Chairman, if there is one, the President or a majority of the directors. Notice thereof stating the place, date and hour of the meeting shall be given to each director either by mail not less than 48 hours before the date of the meeting, by telephone or by telegram on 24 hours' notice, or on such shorter notice as the person or persons calling such meeting may deem necessary or appropriate in the circumstances.

        Section 5    Quorum.

        Except as may be otherwise specifically provided by law, the Certificate of Incorporation or these Bylaws, at all meetings of the Board of Directors, a majority of the entire Board of Directors shall constitute a quorum for the transaction of business and the act of a majority of the directors present at any meeting at which there is a quorum shall be the act of the Board of Directors. If a quorum shall not be present at any meeting of the Board of Directors, the directors present thereat may adjourn the meeting from time to time, without notice other than announcement at the meeting, until a quorum shall be present.

        Section 6    Actions of Board.

        Unless otherwise provided by the Certificate of Incorporation or these Bylaws, any action required or permitted to be taken at any meeting of the Board of Directors or of any committee thereof may be taken without a meeting, if all the members of the Board of Directors or any committee designated by

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the Board of Directors, as the case may be, consent thereto in writing, and the writing or writings are filed with the minutes of proceedings of the Board of Directors or any such designated committee.

        Section 7    Meetings by Means of Conference Telephone.

        Unless otherwise provided by the Certificate of Incorporation or these Bylaws, members of the Board of Directors or any committee designated by the Board of Directors may participate in a meeting of the Board of Directors or such committee by means of a conference telephone or similar communications equipment by means of which all persons participating in the meeting can hear each other, and participation in a meeting pursuant to this Section 7 shall constitute presence in person at such meeting.

        Section 8    Committees.

        The Board of Directors may, by resolution passed by a majority of the entire Board of Directors, designate one or more committees, each committee to consist of one or more of the directors of the Corporation. The Board of Directors may designate one or more directors as alternate members of any committee, who may replace any absent or disqualified member at any meeting of any such committee. In the absence or disqualification of a member of a committee, and in the absence of a designation by the Board of Directors of an alternate member, the member or members thereof present at any meeting and not disqualified from voting, whether or not he or they constitute a quorum, may unanimously appoint another member of the Board of Directors to act at the meeting in the place of any absent or disqualified member. Any committee, to the extent allowed by law and provided in the resolution establishing such committee, shall have and may exercise all the powers and authority of the Board of Directors in the management of the business and affairs of the Corporation. Each committee shall keep regular minutes and report to the Board of Directors when required.

        Section 9    Compensation.

        The directors may be paid their expenses, if any, of attendance at each meeting of the Board of Directors and may be paid a fixed sum for attendance at each meeting of the Board of Directors or a stated salary as director. No such payment shall preclude any director from serving the Corporation in any other capacity and receiving compensation therefor. Members of special or standing committees may be allowed like compensation for attending committee meetings.

        Section 10    Interested Directors.

        No contract or transaction between the Corporation and one or more of its directors or officers, or between the Corporation and any other corporation, partnership, association or other organization in which one or more of its directors or officers are directors or officers, or have a financial interest, shall be void or voidable solely for this reason, or solely because the director or officer is present at or participates in the meeting of the Board of Directors or committee thereof which authorizes the contract or transaction, or solely because his or their votes are counted for such purpose if (i) the material facts as to his or their relationship or interest and as to the contract or transaction are disclosed or are known to the Board of Directors or the committee, and the Board of Directors or the committee in good faith authorizes the contract or transaction by the affirmative vote of a majority of the disinterested directors, even though the disinterested directors are less than a quorum; or (ii) the material facts as to his or their relationship or interest and as to the contract or transaction are disclosed or are known to the stockholders entitled to vote thereon, and the contract or transaction is specifically approved in good faith by the vote of the stockholders; or (iii) the contract or transaction is fair as to the Corporation as of the time it is authorized, approved or ratified by the Board of Directors, a committee thereof or the stockholders. Common or interested directors may be counted in determining the presence of a quorum at a meeting of the Board of Directors or of a committee which authorizes the contract or transaction.

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ARTICLE IV

OFFICERS

        Section 1    Officers.

        The officers of the Corporation shall be chosen by the Board of Directors and shall include a Chief Executive Officer, a President, a Secretary and a Chief Financial Officer. The Board of Directors, in its discretion, also may choose a Chairman of the Board of Directors (who must be a director) and one or more Vice-Presidents, Assistant Secretaries, Assistant Treasurers and other officers. Any number of offices may be held by the same person, unless otherwise prohibited by law, the Certificate of Incorporation or these Bylaws. The officers of the Corporation need not be stockholders of the Corporation nor, except in the case of the Chairman of the Board of Directors, need such officers be directors of the Corporation. Except as otherwise provided herein, the officers of the Corporation shall perform such duties as the Board of Directors shall determine.

        Section 2    Election.

        The Board of Directors at its first meeting held after each annual meeting of stockholders shall elect the officers of the Corporation, who shall hold their offices for such terms and shall exercise such powers and perform such duties as shall be determined from time to time by the Board of Directors. All officers of the Corporation shall hold office until their successors are chosen and qualified or until their earlier resignation or removal. Any officer elected by the Board of Directors may be removed at any time by the affirmative vote of a majority of the Board of Directors. Any vacancy occurring in any office of the Corporation shall be filled by the Board of Directors. The salaries of all officers of the Corporation shall be fixed by the Board of Directors.

        Section 3.    Voting Securities Owned by the Corporation.

        Powers of attorney, proxies, waivers of notice of meeting, consents and other instruments relating to securities owned by the Corporation may be executed in the name of and on behalf of the Corporation by the Chief Executive Officer, or the President. Any such officer may, in the name of and on behalf of the Corporation, take all such actions as any such officer may deem advisable to vote in person or by proxy at any meeting of security holders of any corporation in which the Corporation may own securities and at any such meeting shall possess and may exercise any and all rights and power incident to the ownership of such securities and which, as the owner thereof, the Corporation might have exercised and possessed if present. The Board of Directors may from time to time confer, by resolution, like powers upon any other person or persons.

        Section 4    Chief Executive Officer

        The Chief Executive Officer shall, subject to the control of the Board of Directors and, if there is one, the Chairman of the Board of Directors, have general supervision of the business of the Corporation and shall see that all orders and resolutions of the Board of Directors are effected. He shall execute all bonds, mortgages, contracts and other instruments of the Corporation requiring a seal, under the seal of the Corporation, except where required or permitted by law to be otherwise signed and executed and except that the other officers of the Corporation may sign and execute documents when so authorized by these Bylaws, the Board of Directors or the Chief Executive Officer. In the absence or disability of the Chairman of the Board of Directors, or if there is none, the Chief Executive Officer shall preside at all meetings of the stockholders and the Board of Directors. The Chief Executive Officer also shall perform such other duties and may exercise such other powers as from time to time may be assigned to him by these Bylaws or by the Board of Directors.

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        Section 5    President.

        In the absence of the Chief Executive Officer, the President shall preside at all meetings of the stockholders and at all meetings of the Board of Directors (unless the Chairman of the Board of Directors has been appointed and is present) and shall be the Chief Executive Officer of the corporation during such absence. The President shall perform other duties commonly incident to his office and shall also perform such other duties and have such other powers as the Board of Directors shall designate from time to time.

        Section 6    Vice Presidents.

        The Vice Presidents, in the order of their seniority, may assume and perform the duties of the President in the absence or disability of the Chief Executive Officer and the President or whenever the offices of Chief Executive Officer and President are vacant. The Vice Presidents shall perform other duties commonly incident to their office and shall also perform such other duties and have such other powers as the Board of Directors or the Chief Executive Officer shall designate from time to time.

        Section 7    Secretary.

        The Secretary shall attend all meetings of the stockholders and of the Board of Directors and shall record all acts and proceedings thereof in the minute book of the corporation. The Secretary shall give notice in conformity with these Bylaws of all meetings of the stockholders and of all meetings of the Board of Directors and any committee thereof requiring notice. The Secretary shall perform all other duties given him in these Bylaws and other duties commonly incident to his office and shall also perform such other duties and have such other powers as the Board of Directors shall designate from time to time. The Chief Executive Officer and the President may direct any Assistant Secretary to assume and perform the duties of the Secretary in the absence or disability of the Secretary, and each Assistant Secretary shall perform other duties commonly incident to his office and shall also perform such other duties and have such other powers as the Board of Directors or the Chief Executive Officer shall designate from time to time.

        Section 8    Chief Financial Officer.

        The Chief Financial Officer shall keep or cause to be kept the books of account of the corporation in a thorough and proper manner and shall render statements of the financial affairs of the corporation in such form and as often as required by the Board of Directors, the Chief Executive Officer, or the President. The Chief Financial Officer, subject to the order of the Board of Directors, shall have the custody of all funds and securities of the corporation. The Chief Financial Officer shall perform other duties commonly incident to his office and shall also perform such other duties and have such other powers as the Board of Directors or the President shall designate from time to time. The Chief Executive Officer may direct the Treasurer or any Assistant Treasurer, or the Controller or any Assistant Controller to assume and perform the duties of the Chief Financial Officer in the absence or disability of the Chief Financial Officer, and each Treasurer and Assistant Treasurer and each Controller and Assistant Controller shall perform other duties commonly incident to his office and shall also perform such other duties and have such other powers as the Board of Directors or the Chief Executive Officer shall designate from time to time.

        Section 9    Delegation of Authority.

        The Board of Directors may from time to time delegate the powers or duties of any officer to any other officer or agent, notwithstanding any provision hereof.

        Section 10    Removal and Resignation of Officers.

        Subject to the rights, if any, of an officer under any contract of employment, any officer may be removed, either with or without cause, by the Board of Directors at any regular or special meeting of

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the Board or, except in the case of any officer chosen by the Board of Directors, by any officer upon whom such power of removal may be conferred by the Board of Directors.

        Any officer may resign at any time by giving written notice to the Corporation. Any resignation shall take effect at the date of the receipt of such notice or at any later time specified in such notice; and, unless otherwise specified in such notice, the acceptance of such resignation shall not be necessary to make it effective. Any resignation is without prejudice to the rights, if any, of the Corporation under any contract to which the resigning officer is a party.

        Section 11    Vacancies in Offices.

        A vacancy in any office because of death, resignation, removal, disqualification or any other cause shall be filled in the manner prescribed in these Bylaws for regular appointments to such office.

ARTICLE V

STOCK

        Section 1    Form of Certificates.

        Every holder of stock in the Corporation shall be entitled to have a certificate signed, in the name of the Corporation, (i) by the Chairman of the Board of Directors, the President or a Vice-President, and (ii) by the Treasurer or an Assistant Treasurer, or the Secretary or an Assistant Secretary, certifying the number of shares owned by him in the Corporation.

        Section 2    Signatures.

        Where a certificate is countersigned by (i) a transfer agent other than the Corporation or its employee, or (ii) a registrar other than the Corporation or its employee, any other signature on the certificate may be a facsimile. In case any officer, transfer agent or registrar who has signed or whose facsimile signature has been placed upon a certificate shall have ceased to be such officer, transfer agent or registrar before such certificate is issued, it may be issued by the Corporation with the same effect as if he were such officer, transfer agent or registrar at the date of issue.

        Section 3    Lost Certificates.

        The Board of Directors may direct a new certificate to be issued in place of any certificate theretofore issued by the Corporation alleged to have been lost, stolen or destroyed, upon the making of an affidavit of that fact by the person claiming the certificate of stock to be lost, stolen or destroyed. When authorizing such issue of a new certificate, the Board of Directors may, in its discretion and as a condition precedent to the issuance thereof, require the owner of such lost, stolen or destroyed certificate, or his legal representative, to advertise the same in such manner as the Board of Directors shall require and/or to give the Corporation a bond in such sum as it may direct as indemnity against any claim that may be made against the Corporation with respect to the certificate alleged to have been lost, stolen or destroyed.

        Section 4    Transfers.

        Stock of the Corporation shall be transferable in the manner prescribed by law and in these Bylaws. Transfers of stock shall be made on the books of the Corporation only by the person named in the certificate or by his attorney lawfully constituted in writing and upon the surrender of the certificate therefor, which shall be cancelled before a new certificate shall be issued.

        Section 5    Record Date.

        In order that the Corporation may determine the stockholders entitled to notice of or to vote at any meeting of stockholders or any adjournment thereof, or entitled to express consent to corporate action in writing without a meeting, or entitled to receive payment of any dividend or other distribution

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or allotment of any rights, or entitled to exercise any rights with respect to any change, conversion or exchange of stock, or for the purpose of any other lawful action, the Board of Directors may fix, in advance, a record date, which shall not be more than 60 days or less than 10 days before the date of such meeting, nor more than 60 days prior to any other action. A determination of stockholders of record entitled to notice of or to vote at a meeting of stockholders shall apply to any adjournment of the meeting; provided, however, that the Board of Directors may fix a new record date for the adjourned meeting.

        Section 6    Beneficial Owners.

        The Corporation shall be entitled to recognize the exclusive right of a person registered on its books as the owner of shares to receive dividends, to vote as such owner, and to hold liable for calls and assessments a person registered on its books as the owner of shares. The Corporation shall not be bound to recognize any equitable or other claim to or interest in such share or shares on the part of any other person, whether or not it shall have express or other notice thereof, except as otherwise provided by law.

ARTICLE VI

NOTICES

        Section 1    Notices.

        Whenever written notice is required by law, the Certificate of Incorporation or these Bylaws, to be given to any director, member of a committee or stockholder, such notice may be given by mail, addressed to such director, member of a committee or stockholder, at his address as it appears on the records of the Corporation, with postage thereon prepaid, and such notice shall be deemed to be given at the time when the same shall be deposited in the United States mail. Written notice also may be given personally or by telegram, telex or cable.

        Section 2    Waivers of Notice.

        Whenever any notice is required by law, the Certificate of Incorporation or these Bylaws to be given to any director, member of a committee or stockholder, a waiver thereof in writing, signed by the person or persons entitled to said notice, whether before or after the time stated therein, shall be deemed equivalent thereto.

ARTICLE VII

GENERAL PROVISIONS

        Section 1    Dividends.

        Dividends upon the capital stock of the Corporation, subject to the provisions of the Certificate of Incorporation, if any, may be declared by the Board of Directors at any regular or special meeting, and may be paid in cash, in property or in shares of the capital stock. Before payment of any dividend, there may be set aside out of any funds of the Corporation available for dividends such sum or sums as the Board of Directors from time to time, in its absolute discretion, deems proper as a reserve or reserves to meet contingencies, or for equalizing dividends, or for repairing or maintaining any property of the Corporation, or for any proper purpose, and the Board of Directors may modify or abolish any such reserve.

        Section 2    Disbursements.

        All checks or demands for money and notes of the Corporation shall be signed by such officer or officers or such other person or persons as the Board of Directors may from time to time designate.

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        Section 3    Fiscal Year.

        The fiscal year of the Corporation shall be fixed by resolution of the Board of Directors.

        Section 4    Corporate Seal.

        The corporate seal, if any, shall have inscribed thereon the name of the Corporation, the year of its organization and the words "Corporate Seal, Delaware." The seal may be used by causing it or a facsimile thereof to be impressed or affixed or otherwise reproduced.

ARTICLE VIII

INDEMNIFICATION

        Section 1    Power to Indemnify in Actions, Suits or Proceedings Other Than Those by or in the Right of the Corporation.

        Subject to Section 3 of this Article VIII, the Corporation shall indemnify any person who was or is a party or is threatened to be made a party to any threatened, pending or completed action, suit or proceeding, whether civil, criminal, administrative or investigative (other than an action by or in the right of the Corporation) by reason of the fact that he is or was a director, officer, employee or agent of the Corporation, or is or was serving at the request of the Corporation as a director, officer, employee or agent of another corporation, partnership, joint venture, trust or other enterprise, against expenses (including attorneys' fees), judgments, fines and amounts paid in settlement actually and reasonably incurred by him in connection with such action, suit or proceeding if he acted in good faith and in a manner he reasonably believed to be in or not opposed to the best interests of the Corporation, and, with respect to any criminal action or proceeding, had no reasonable cause to believe his conduct was unlawful. The termination of any action, suit or proceeding by judgment, order, settlement, conviction or upon a plea of nolo contendere or its equivalent shall not, of itself, create a presumption that the person did not act in good faith and in a manner that he reasonably believed to be in or not opposed to the best interests of the Corporation, and, with respect to any criminal action or proceeding, had reasonable cause to believe that his conduct was unlawful.

        Section 2    Power to Indemnify in Actions, Suits or Proceedings by or in the Right of the Corporation.

        Subject to Section 3 of this Article VIII, the Corporation shall indemnify any person who was or is a party or is threatened to be made a party to any threatened, pending or completed action or suit by or in the right of the Corporation to procure a judgment in its favor by reason of the fact that he is or was a director, officer, employee or agent of the Corporation, or is or was serving at the request of the Corporation as a director, officer, employee or agent of another corporation, partnership, joint venture, trust or other enterprise against expenses (including attorneys' fees) actually and reasonably incurred by him in connection with the defense or settlement of such action or suit if he acted in good faith and in a manner he reasonably believed to be in or not opposed to the best interests of the Corporation; except that no indemnification shall be made with respect to any claim, issue or matter as to which such person shall have been adjudged to be liable to the Corporation unless and only to the extent that the Court of Chancery or the court in which such action or suit was brought shall determine upon application that, despite the adjudication of liability but in view of all the circumstances of the case, such person is fairly and reasonably entitled to indemnity for such expenses which the Court of Chancery or such other court shall deem proper.

        Section 3    Authorization of Indemnification.

        Any indemnification under this Article VIII (unless ordered by a court) shall be made by the Corporation only as authorized in the specific case upon a determination that indemnification of the director, officer, employee or agent is proper in the circumstances because he has met the applicable standard of conduct set forth in Section 1 or Section 2 of this Article VIII, as the case may be. Such

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determination shall be made (i) by the Board of Directors by a majority vote of a quorum consisting of directors who were not parties to such action, suit or proceeding, or (ii) if such quorum is not obtainable, or, even if obtainable, a quorum of disinterested directors so directs, by independent legal counsel in a written opinion, or (iii) by the stockholders. To the extent, however, that a director, officer, employee or agent of the Corporation has been successful on the merits or otherwise in defense of any action, suit or proceeding described above, or in defense of any claim, issue or matter therein, he shall be indemnified against expenses (including attorneys' fees) actually and reasonably incurred by him in connection therewith, without the necessity of authorization in the specific case.

        Section 4    "Good Faith" Defined.

        For purposes of any determination under Section 3 of this Article VIII, a person shall be deemed to have acted in "good faith" and in a manner he reasonably believed to be in or not opposed to the best interests of the Corporation, or, with respect to any criminal action or proceeding, to have had no reasonable cause to believe his conduct was unlawful, if his action is based on the records or books of account of the Corporation or another enterprise, or on information supplied to him by the officers of the Corporation or another enterprise in the course of their duties, or on the advice of legal counsel for the Corporation or another enterprise or on information or records given or reports made to the Corporation or another enterprise by an independent certified public accountant or by an appraiser or other expert selected with reasonable care by the Corporation or another enterprise. The term "another enterprise" as used in this Section 4 shall mean any other corporation or any partnership, joint venture, trust or other enterprise of which such person is or was serving at the request of the Corporation as a director, officer, employee or agent. The provisions of this Section 4 shall not be deemed to be exclusive or to limit in any way the circumstances in which a person may be deemed to have met the applicable standard of conduct set forth in Section 1 or Section 2 of this Article VIII, as the case may be.

        Section 5    Indemnification by a Court.

        Notwithstanding any contrary determination in the specific case under Section 3 of this Article VIII, and notwithstanding the absence of any determination thereunder, any director, officer, employee or agent may apply to any court of competent jurisdiction in the State of Delaware for indemnification to the extent otherwise permissible under Sections 1 and 2 of this Article VIII. The basis of such indemnification by a court shall be a determination by such court that indemnification of the director, officer, employee or agent is proper in the circumstances because he has met the applicable standards of conduct set forth in Section 1 or Section 2 of this Article VIII, as the case may be. Notice of any application for indemnification pursuant to this Section 5 shall be given to the Corporation promptly upon the filing of such application.

        Section 6    Expenses Payable in Advance.

        Expenses incurred in defending or investigating a threatened or pending action, suit or proceeding may be paid by the Corporation in advance of the final disposition of such action, suit or proceeding upon receipt of an undertaking by or on behalf of the director, officer, employee or agent to repay such amount if it shall ultimately be determined that he is not entitled to be indemnified by the Corporation as authorized in this Article VIII.

        Section 7    Nonexclusivity of Indemnification and Advancement of Expenses.

        The indemnification and advancement of expenses provided by or granted pursuant to this Article VIII shall not be deemed exclusive of any other rights to which those seeking indemnification or advancement of expenses may be entitled under any Bylaw, agreement, contract, vote of stockholders or disinterested directors or pursuant to the direction (howsoever embodied) of any court of competent jurisdiction or otherwise, both as to action in his official capacity and as to action in another capacity while holding such office. It is the policy of the Corporation that indemnification of

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the persons specified in Sections 1 and 2 of this Article VIII shall be made to the fullest extent permitted by law. The provisions of this Article VIII shall not be deemed to preclude the indemnification of any person who is not specified in Section 1 or 2 of this Article VIII but whomever the Corporation has the power or obligation to indemnify under the provisions of the General Corporation Law of the State of Delaware, or otherwise.

        Section 8    Insurance.

        The Corporation may purchase and maintain insurance on behalf of any person who is or was a director, officer, employee or agent of the Corporation, or is or was serving at the request of the Corporation as a director, officer, employee or agent of another corporation, partnership, joint venture, trust or other enterprise against any liability asserted against him and incurred by him in any such capacity, or arising out of his status as such, whether or not the Corporation would have the power or the obligation to indemnify him against such liability under the provisions of this Article VIII.

        Section 9    Meaning of "Corporation" for Purposes of Article VIII.

        For purposes of this Article VIII, references to "the Corporation" shall include, in addition to the resulting corporation, any constituent corporation (including any constituent of a constituent) absorbed in a consolidation or merger which, if its separate existence had continued, would have had power and authority to indemnify its directors, officers, and employees or agents so that any person who is or was a director, officer, employee or agent of such constituent corporation, or is or was serving at the request of such constituent corporation as a director, officer, employee or agent of another corporation, partnership, joint venture, trust or other enterprise, shall stand in the same position under the provisions of this Article VIII with respect to the resulting or surviving corporation as he would have with respect to such constituent corporation if its separate existence had continued.

        Section 10    Survival of Indemnification and Advancement of Expenses.

        The indemnification and advancement of expenses provided by, or granted pursuant to, this Section 10 shall, unless otherwise provided when authorized or ratified, continue as to a person who has ceased to be a director, officer, employee or agent and shall inure to the benefit of the heirs, executors and administrators of such person.

ARTICLE IX

AMENDMENTS

        Section 1    Amendments by Stockholders or Board.

        These Bylaws may be altered, amended or repealed, in whole or in part, or new Bylaws may be adopted by the majority vote or written consent of the stockholders or the Board of Directors.

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CERTIFICATE OF SECRETARY

        I, the undersigned, do hereby certify that:

        (1)  I am the duly elected and acting Senior Vice President, Secretary and General Counsel of Movie Gallery, Inc., a Delaware corporation;

        (2)  The attached Exhibit A is a true and correct copy of the Amended and Restated Bylaws of Movie Gallery, Inc. as duly adopted by the Board of Directors at a meeting duly noticed and held on March 26, 2003.

        IN WITNESS WHEREOF, I have hereunto subscribed my name and affixed the seal of said corporation this 26th day of March, 2003.

/s/  S. PAGE TODD S. Page Todd, Senior Vice President,
Secretary and General Counsel

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AMENDED AND RESTATED BYLAWS OF MOVIE GALLERY, INC.
AMENDED AND RESTATED BYLAWS OF MOVIE GALLERY, INC. (the "Corporation")
CERTIFICATE OF SECRETARY

EX-10.1-1

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Exhibit 10.1.1

AMENDMENT TO MOVIE GALLERY, INC.
1994 STOCK PLAN, AS AMENDED

June 13, 2000

        Section 4 of the Movie Gallery, Inc. 1994 Stock Plan, as amended, is hereby deleted in its entirety and replaced with a new Section 4 as follows:

        "4.    Stock Subject to Plan.    There shall be reserved for issuance under the Plan 3,000,000 shares of Common Stock of the Company ("Stock") or the number of shares of Stock, which, in accordance with the provisions of Section 13 hereof, shall be substituted therefore. Such shares may be treasury shares. If an option or stock appreciation right granted under the Plan shall expire or terminate for any reason without having been exercised in full, shares subject to the unexercised portion thereof shall again be available for the purposes of the Plan."

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AMENDMENT TO MOVIE GALLERY, INC. 1994 STOCK PLAN, AS AMENDED June 13, 2000

EX-10.10-1

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Exhibit 10.10.1

FIRST AMENDMENT TO CREDIT AGREEMENT

THIS FIRST AMENDMENT TO CREDIT AGREEMENT (the "First Amendment") is made effective as of the 25th day of September, 2001, 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 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, Agent and Borrower have agreed to amend the Credit Agreement in order to amend Section 8.8 of the Credit Agreement, pertaining to Hedge Agreements, 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 is hereby amended as follows:

        1.    The Credit Agreement is hereby amended by deleting Section 8.8 in its entirety, and by substituting the following new Section 8.8 in lieu thereof:

        8.8    Interest Rate Protection.    At December 1, 2001, Borrower shall have entered into or obtained, and Borrower will thereafter maintain in full force and effect, Hedge Agreements in form and substance reasonably satisfactory to the Agent the effect of which shall be to fix or limit interest rates payable by Borrower as to at least thirty-three and one-third percent (33¹/3%) of all principal amounts outstanding at such date under all Funded Debt of Borrower and its Subsidiaries for a period of not less than two (2) years after such date. Borrower will deliver to the Agent, promptly upon receipt thereof, copies of such Hedge Agreements (and any supplements or amendments thereto), and promptly upon request therefor, any other information reasonably requested by the Agent to evidence its compliance with the provision of this Section.

        2.    As a condition to the effectiveness of this First Amendment: (a) 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 First Amendment, the Credit Agreement, and any and all documents executed and delivered in connection herewith or therewith; (b) 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 (c) Borrower shall have delivered to Agent such other documentation, if any, as may be requested by Agent to satisfy Agent that this First Amendment, and all other documents and instruments executed by Borrower in connection with this First 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.

        3.    Borrower represents and warrants to Agent that all representations and warranties given by Borrower in Article VII of the Credit Agreement are true and correct as of the date hereof, except to the extent affected by this First 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, except to the extent affected by this First Amendment.

        4.    Except as heretofore or herein expressly modified, or as may otherwise be inconsistent with the terms of this First Amendment (in which case the terms and conditions of this First Amendment shall govern), all terms of the Credit Agreement 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.

        5.    The undersigned Guarantors execute this First Amendment to expressly evidence their assent to all the terms of the Credit Agreement and this First 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 by this First Amendment.

[THE REMAINDER OF THIS PAGE INTENTIONALLY LEFT BLANK]

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

BORROWER:
MOVIE GALLERY, INC.
By:	/s/  J. STEVEN ROY
Its:	Executive Vice President and Chief Financial Officer
GUARANTORS:
M.G.A., INC.
By:	/s/  J. STEVEN ROY
Its:	Executive Vice President and Chief Financial Officer
MOVIEGALLERY.COM, INC.
By:	/s/  J. STEVEN ROY
Its:	Senior Vice President and Chief Financial Officer
MOVIE GALLERY FINANCE, INC.
By	/s/  J. STEVEN ROY
Its:	President
AGENT:
SOUTHTRUST BANK, as Agent
By:	/s/  STUART JOHNSON
Its:	Commercial Loan Officer

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FIRST AMENDMENT TO CREDIT AGREEMENT

EX-10.10-2

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Exhibit 10.10.2

SECOND AMENDMENT TO CREDIT AGREEMENT

THIS SECOND AMENDMENT TO CREDIT AGREEMENT (the "Second Amendment") is made effective as of the 14th day of January, 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 (the Credit Agreement, as amended by the First 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 amend the definition of "Permitted Acquisition", 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 deleting the definition of "Permitted Acquisition" in its entirety, and by substituting the following new definition in lieu thereof:

        "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 (provided that, with respect to the Video Update Acquisition, Borrower shall be allowed a period of up to 30 days (or such longer period of time of up to 90 days if approved by Agent) for the business so acquired to be wholly-owned by Borrower or a wholly-owned Subsidiary of Borrower, provided that immediately after the Acquisition, Borrower shall own or control at least 90% of the Voting Power of the entity owing the assets the subject of the Video Update Acquisition); (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; (v) other than the Video Update Acquisition, the Acquisition Amount paid or payable in connection therewith, together with the consideration paid for all other Acquisitions during the applicable Trailing Reference Period, shall not exceed $35,000,000 (excluding therefrom the Video Update Acquisition); and (vi) other than the Video Update Acquisition, to the extent paid or payable in cash, the Acquisition Amount paid with respect thereto, together with the consideration paid for all other Acquisitions during the applicable Trailing Reference Period, shall not exceed $22,500,000 (excluding therefrom the Video Update Acquisition).

        2.    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 Second Amendment.

        3.    As a condition to the effectiveness of this Second Amendment: (a) 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 Second Amendment, the Credit Agreement, as amended, and any and all documents executed and delivered in connection herewith or therewith; (b) 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 (c) Borrower shall have delivered to Agent such other documentation, if any, as may be requested by Agent to satisfy Agent that this Second Amendment, and all other documents and instruments executed by Borrower in connection with this Second 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.

        4.    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 Second 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 Second Amendment.

        5.    Except as heretofore or herein expressly modified, or as may otherwise be inconsistent with the terms of this Second Amendment (in which case the terms and conditions of this Second 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.

        6.    The undersigned Guarantors execute this Second Amendment to expressly evidence their assent to all the terms of the Credit Agreement, as amended, and this Second 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 Second Amendment.

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

BORROWER:
MOVIE GALLERY, INC.
By:	/s/  S. PAGE TODD
Its:	Senior Vice President
GUARANTORS:
M.G.A., INC.
By:	/s/  S. PAGE TODD
Its:	Senior Vice President
MOVIEGALLERY.COM, INC.
By:	/s/  S. PAGE TODD
Its:	Senior Vice President
MOVIE GALLERY FINANCE, INC.
By:	/s/  S. PAGE TODD
Its:	Vice President
AGENT:
SOUTHTRUST BANK, as Agent
By:	/s/  STUART JOHNSON
Its:	Commercial Loan Officer

EXHIBIT B

COMPLIANCE CERTIFICATE

To: SouthTrust Bank
P.O. Box 2554
Birmingham, Alabama 35290
Attention: Corporate Banking Department

        Reference is made to that certain Credit Agreement dated as of June 27, 2001 (as amended, supplemented or otherwise modified from time to time, the "Credit Agreement") among Movie Gallery, Inc. (the "Borrower"), the Agent and the other Lender Parties (both as defined in the Credit Agreement). Terms defined in the Credit Agreement are used herein with the same meaning.

A.

Set forth below (and on the attached covenant compliance worksheets) is the financial data and computation evidencing Borrower's compliance with the financial covenants set forth in the Credit Agreement.

(1)	Leverage Ratio	(1)
(2)	Interest Coverage Ratio	(2)
(3)	Fixed Charge Coverage	(3)
(4)	Net Worth	(4)
(5)	Permitted Acquisitions	(5)

B.

Attached hereto are copies of the financial statements required under Section 8.1 of the Credit Agreement.

C.

The undersigned is the chief financial officer of the Borrower, and hereby certifies that the information contained herein and attached hereto is true and correct, and that I have individually reviewed the provisions of the Credit Agreement and the activities of the Borrower and its Subsidiaries through the period covered by this report with a view to determining whether the Borrower has kept, observed, performed and fulfilled all of its obligations under the Credit Agreement, and to the best of my knowledge, the Borrower has observed and performed each and every undertaking contained in the Credit Agreement, there has occurred no Material Adverse Change since the date of the Credit Agreement, and there does not exist on the date hereof a Default, except as follows:

        Executed this            day of                        , 20    .

Print Name:                                                         

(1)

Requirement - - Not more than 2.5 to 1.0 through 1/6/2002 and 2.0 to 1.0 thereafter.

(2)

Requirement - - Not less than 3.5 to 1.0 through 1/6/2002 and 4.0 to 1.0 thereafter.

(3)

Requirement - - Not less than 1.05 to 1.0.

(4)

Requirement - - $125,000,000 plus 75% of Net Income per quarter, plus 100% of increases in capital, less 100% of stock repurchases, but not less than $109,000,000.

(5)

Requirement - - Limited to $22,500,000 cash and $35,000,000 total during each Trailing Reference Period.

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SECOND AMENDMENT TO CREDIT AGREEMENT
EXHIBIT B
COMPLIANCE CERTIFICATE

EX-21

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Exhibit 21

Movie Gallery, Inc.

List of Subsidiaries

Name of Subsidiary	State or Province of Incorporation
M.G.A., Inc.	Delaware
Movie Gallery Finance, Inc.	Delaware
M.G. Midwest, Inc.	Delaware
Movie Gallery Canada, Inc.	New Brunswick

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Movie Gallery, Inc. List of Subsidiaries

EX-23

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Exhibit 23

CONSENT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS

        We consent to the incorporation by reference in the Registration Statements (Form S-8 Nos. 33-82968, 33-98896, 333-04633, 333-82183, and 333-58192) pertaining to the Movie Gallery, Inc. 1994 Stock Plan, as amended, and in the Registration Statement (Form S-3 No. 33-95854) of Movie Gallery, Inc. and the related Prospectus, of our report dated February 13, 2003 with respect to the consolidated financial statements and schedule of Movie Gallery, Inc. included in the Annual Report (Form 10-K) for the fiscal year ended January 5, 2003.

/s/ Ernst & Young LLP

Birmingham, Alabama
April 3, 2003

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CONSENT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS

EX-99.1

Exhibit 99.1

CERTIFICATION PURSUANT TO
18 U.S.C. SECTION 1350,
AS ADOPTED PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002

        In connection with the Annual Report of Movie Gallery, Inc. (the "Company") on Form 10-K for the period ending January 5, 2003 as filed with the Securities and Exchange Commission on the date hereof (the "Report"), I, J. T. Malugen, Chief Executive Officer of the Company, certify, pursuant to 18 U.S.C. 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that:

        (1)  The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and

        (2)  The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company.

Date: April 7, 2003

/s/ J. T. Malugen Name: J. T. Malugen
Its: Chief Executive Officer

A signed original of this written statement required by Section 906 has been provided to Movie Gallery, Inc. and will be retained by Movie Gallery, Inc. and furnished to the Securities and Exchange Commission or its staff upon request.

EX-99.2

Exhibit 99.2

CERTIFICATION PURSUANT TO
18 U.S.C. SECTION 1350,
AS ADOPTED PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002

        In connection with the Annual Report of Movie Gallery, Inc. (the "Company") on Form 10-K for the period ending January 5, 2003 as filed with the Securities and Exchange Commission on the date hereof (the "Report"), I, J. Steven Roy, Chief Financial Officer of the Company, certify, pursuant to 18 U.S.C. 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that:

        (1)  The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and

        (2)  The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company.

Date: April 7, 2003

/s/ J. Steven Roy Name: J. Steven Roy
Its: Chief Financial Officer

A signed original of this written statement required by Section 906 has been provided to Movie Gallery, Inc. and will be retained by Movie Gallery, Inc. and furnished to the Securities and Exchange Commission or its staff upon request.