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

FORM 10-K

(Mark One)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended January 6, 2002

OR

[ ] 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 63-1120122
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)

900 West Main Street, Dothan, Alabama 36301
(Address of principal executive offices) (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 _____ NO X

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. [ ]

The aggregate market value of the voting stock held by non-affiliates of the
registrant as of March 11, 2002, was approximately $225,856,654. The number of
shares of Common Stock outstanding on March 11, 2002, was 27,365,464 shares.

Documents incorporated by reference:

1. Notice of 2002 Annual Meeting and Proxy Statement (Part III of Form 10-K).

The exhibit index to this report appears at page 29.



ITEM 1. BUSINESS

Our Company

We are the leading home video specialty retailer in rural and secondary
markets. We own and operate 1,436 retail stores, located in 41 states and five
Canadian provinces, that rent and sell videocassettes ("VHS"), DVD 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
independently owned stores and small regional chains.

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 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 our two larger competitors 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 six fiscal years. Since our initial public offering in August 1994, we have
grown from 97 stores to our present size through acquisitions and the
development of new stores. Our compound annual growth rates for revenues and
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 fiscal 1995 to fiscal
2001 were 16.3% and 38.4%, respectively.

Movie Gallery, Inc. was incorporated in Delaware in June 1994. From March
1985 until the present time, substantially all of our operations have been
conducted through our wholly-owned subsidiary, M.G.A., 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 ("Adams"), the domestic
home video specialty retail industry grew from an estimated $15.3 billion in
revenue in 1996 to $20.6 billion in 2001, representing a 6.1% compound annual
growth rate, outpacing the 2.5% growth rate of the Consumer Price Index during
the same period. Adams predicts that this industry will reach $31.2 billion in
revenue by 2010, with growth driven primarily by the growth of DVD penetration.
Currently, 90% of all television households own a videocassette recorder ("VCR")
or DVD player. Additionally, households owning DVD players reached 24.8 million
at the end of 2001 and are projected to grow to 90.4 million households by 2010,
according to Adams.

Trends. The home video specialty retail industry is highly fragmented and
continues to experience consolidation, particularly in the smaller and rural
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 8,600 stores, or 32%
of total domestic stores, while capturing an estimated 49% of the total rental
market share. The remaining 68% of total stores are comprised of independent
operators, small chains and other rental outlets. We believe that the home video
specialty store industry will continue to consolidate into regional and national
chains. While many of the largest retail chains posted same store revenue growth
in the last three years, industry sources speculated that many independent
operators struggled to maintain market share. Over the 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 Specialty Retailers.
Historically, new technologies, including the development of the VCR and, more
recently, DVD, have led to the creation of additional distribution channels for


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movie studios beyond the traditional movie theatre 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) hotels
and airlines; (3) home video retailers; (4) pay-per-view; and (5) 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.
According to industry sources, home video is currently the largest single source
of domestic revenue for the movie studios, accounting for approximately 56% of
the estimated $19.7 billion of studio revenue in 2001. 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 near video on demand ("NVOD") and, eventually, video on demand
("VOD") become more readily available to consumers. We expect that VOD will most
likely be released in the traditional pay-per-view window.

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

o Rental Priced Movies. Under this pricing strategy, movie studios sell VHS
to video specialty stores at relatively high prices, typically between
$35 and $75 per copy. In certain circumstances, these prices can be
reduced through volume discounts offered by the movie studios. These
movies are promoted primarily as rental titles. DVD is not generally sold
under this pricing strategy.

o Sell-Through Movies. Under this pricing strategy, movie studios sell VHS
at relatively low prices, typically between $5 and $25 per copy. These
movies are generally promoted both for rental and sale. DVD is generally
sold under sell-through pricing.

o 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. Generally, retailers pay a small up-front fee for each
copy obtained (typically $0 to $8), or an agreed upon minimum cost per
unit (typically less than $30) that is substantially offset against the
studio's revenue share. 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.
Studios are using a revenue sharing structure with DVD on a limited
basis.

We believe that revenue sharing agreements for VHS provide significant
advantages to retailers, including:

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

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

o further interdependence of movie studios and video retailers.


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Video Game Industry

2001 was a transitional year for the video game industry with Sony
PlayStation 2 gaining market share as hardware and software became available.
Additionally, the game market was soft throughout the year in anticipation of
the release of both the Nintendo GameCube and the Microsoft Xbox in November
2001. Early performance and consumer acceptance of these new platforms have been
strong while the established 32-bit and 64-bit platforms (Sony PlayStation and
Nintendo 64) continue to maintain a solid market share. These factors combined
to give us the first positive quarter of game rental performance in over a year
during the fourth quarter of 2001.

According to indudstry estimates, domestic sales of video game software
approached $4.6 billion in 2001, an increase from just over $4.1 billion in
2000. Growth in domestic sales of video game hardware units has also been
reported in 2001, estimated at $3.7 billion versus $1.6 billion in 2000. These
increases were primarily attributable to sales of Sony PlayStation 2 hardware
and software, which was released in the fourth quarter of 2000. Increases in
sales were also driven by the introduction of two new video game platforms in
the fourth quarter of 2001: Microsoft Xbox and Nintendo GameCube.

Growth in this industry is driven by increases in the installed base of
video game hardware systems, the introduction of new hardware platforms and
continued improvement in systems technology leading to the development of new
game titles. At the end of 2001, the installed base of video game hardware
systems in the United States has been estimated at approximately 29.5 million
Sony PlayStation units, 16.5 million Nintendo 64 units, 8.2 million PlayStation
2 units, 1.4 million Microsoft Xbox units and 1.2 million Nintendo GameCube
units. We expect the video game industry to continue to grow as a result of
significant technological advancements 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

Concentration in 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. We target markets within states that are either
contiguous to states in which we already operate stores or states that have not
yet reached full market penetration. We believe our rural and secondary market
focus reduces competition from larger chains. Our principal competitors are
single store and small chain operators who have smaller advertising budgets,
limited inventory breadth and depth and less access to capital than we do. 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 will be the last markets able to support VOD. The typical plant
upgrades required to deliver VOD are costly, and as a result, cable and digital
subscriber line ("DSL") 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. We have developed a strategy to minimize operating expenses that
includes:

o lower initial investment costs;

o negotiating favorable lease terms in our markets;

o centralized purchasing;

o reduced labor costs;

o stringent expense controls; and

o sophisticated information systems.

Additionally, by concentrating our new store development in and around
existing markets, we are able to achieve operating efficiencies, primarily
consisting of cost savings relating to advertising, training and store
supervision.

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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:

o flexible store formats, which allow us to tailor the size, inventory and
look of each store to fit its locale; our stores range in size from
approximately 2,000 to 9,000 square feet, average approximately 4,600
square feet, and have inventories ranging from approximately 4,000 to
15,000 movies and 200 to 1,000 video games for rental;

o 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 three years with approximately 300 leases considered for renewal
each year;

o inventory management;

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

o minimal marketing expenditures.

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 disciplined and opportunistic acquisition
strategy. From 1999 through March 11, 2002, we acquired 519 stores in 25
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 certain
recently acquired locations.

Proprietary Technology Systems to Drive Revenue and 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 visit frequency. As part of our customer service initiatives, we maintain
a database of approximately 4.0 million 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.

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 Operating Margins. We focus on continuous
improvement of same store revenues and profit growth through:

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

o adopting merchandising and pricing initiatives; and

o 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 rapid 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 operations and produce returns on
investment within 24 to 30 months. We believe there are several thousand markets
available for further potential development that fit our typical market profile.
We currently expect to open at least 125 new stores in 2002 and annually for
several years thereafter.

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

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

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

o entry into new markets is facilitated.

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

o strategic fit and desirability of location;

o price;

o ability to improve productivity and profitability; and

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

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

The following table is a historical summary showing store openings,
acquisitions and store closings since January 1, 1996:



Fiscal Year Ended
------------------------------------------------------------------------- January 7 to
January 5, January 4, January 3, January 2, December 31, January 6, March 11,
1997 1998 1999 2000 2000 2002 2002
---------- ----------- ---------- --------- ----------- --------- ------------

New store openings. 75 50 18 53 110 77 12
Stores acquired.... 174 2 4 131 16 355 16
Stores closed...... 48 59 41 58 69 37 7
--- --- --- --- ----- ----- -----
Total stores at end of
period........... 863 856 837 963 1,020 1,415 1,436
=== === === === ===== ===== =====


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 by Video Update under a $6.5 million debtor-in-possession financing
agreement between Video Update and Movie Gallery. In addition, we purchased
certain senior secured debt of Video Update 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. Video Update operates over


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320 video specialty stores in the United States and Canada. Our acquisition of
Video Update was made as a strategic expansion of the Company's geographic
markets in accordance with the Company's growth plan. We believe it represents
the largest single domestic acquisition in the history of the industry.

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 2001, our revenues by product category were as follows:

o Movie rentals: 75% (VHS 65%; DVD 10%);

o Video game rentals: 9%;

o Previously viewed product sales (VHS, DVD and video games): 9%;

o Concessions, accessories and other: 5%; and

o New movie sales (VHS and DVD): 2%.

Depending upon location, our stores offer from 4,000 to 15,000 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."

In 2000 and 2001, we significantly increased our DVD inventory of both new
and older releases. Because of the ease of use and durability of DVD, it is
anticipated that eventually DVD will replace VHS. The acquisition costs of DVD
hardware have reached levels competitive with the VCR and it is estimated that
23% of domestic television households currently have 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 2001, DVD rental revenue represented approximately 18% of our total
movie rental revenue.

In 2001, we have significantly increased our offering of video game
inventory. We have expanded the selection of available titles for the 32-bit and
64-bit platforms (Sony PlayStation and Nintendo 64) to carry a broader base of
the most popular items. We have also increased the inventory of previously
played video games for sale. We offer basic video game hardware accessories in
all stores and we rent and sell video game hardware in a select base of stores.
We will monitor the acceptance and performance of the new 128-bit platforms
(Sony PlayStation 2, Microsoft Xbox and Nintendo GameCube) and make inventory
investments appropriately in order to maximize video game revenue.

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.

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 and to increase awareness of our
website. To date, our expenditures for advertising in excess of the allowances
from our suppliers and movie studios have been minimal.


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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:

o the number, timing and performance of new or acquired stores;

o public acceptance and interest in newly released movies;

o our mix of products rented and sold;

o marketing programs and new release acquisition costs;

o 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. Over the last
four years, the seasonality of our per store average revenue during the
first, second, third and fourth quarters has been 26.5%, 24.2%, 23.6% and
25.7%, respectively); and

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

Store Operations

As of March 11, 2002, we operated a total of 1,436 retail stores located in
41 states and five Canadian provinces.

We maintain a flexible store format, tailoring the size, inventory and look
of each of our stores to local demographics. Our stores range from approximately
2,000 to 9,000 square feet (averaging approximately 4,600 square feet), with
inventories ranging from approximately 4,000 to 15,000 movies and 200 to 1,000
video games for rental.

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, 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 fourteen 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 twelve Regional Managers,
who report directly to our Executive Vice President of Store 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 quality assurance function.

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

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We develop both freestanding stores and stores located in strip centers
anchored by major grocery or discount drug store chains. We view lease terms as
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 three years with approximately 300
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.

E-Commerce Initiative

We have developed a consumer-oriented web site, www.moviegallery.com, that
sells new and used movies and used video games. We have 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. Our e-commerce
channel provides us with the opportunity to broaden our reach with minimal sales
costs and to strengthen existing relationships with our customers. We do not
intend to invest large amounts of capital in our e-commerce business. Our online
business lost approximately $400,000 in fiscal 2001 and, we anticipate that it
will break even in fiscal 2002.

Inventory Suppliers

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 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 whereby 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 5% 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

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 VHS and
DVD 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. VHS, DVD 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.

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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 ("POS") system. The POS
system provides detailed information with respect to 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. The POS system is
installed in all developed stores prior to opening and in acquired stores
shortly after the closing of an acquisition.

Our POS 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. This POS system is linked to a management
information system ("MIS") at our support center. The POS system transmits store
data nightly into the MIS where all data is processed. The MIS 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. The POS 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.

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 national chains such as Blockbuster and Hollywood Entertainment. We
also compete with other businesses offering VHS, DVD and video games such as
mass merchants, supermarkets, pharmacies, convenience stores, bookstores, mail
order operations and other retailers. We believe the principal competitive
factors in the home video specialty retail industry are store location and
visibility, title availability and selection, 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, Internet related activities,
live theater, sporting events and family entertainment centers.

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
and NVOD, enable cable companies and other telecommunication companies to
broadcast a large assortment of movies to homes at scheduled intervals
throughout the day. Currently, NVOD does not offer full interactivity or VCR
functionality; however, further improvements in this and other technologies,
including VOD, 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 VCRs.

Studios are 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 NVOD and VOD do not represent a
near-term threat to our business because:

10


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

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

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

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

Employees

As of March 11, 2002, we employed approximately 13,200 persons, referred to
by us as "associates," including approximately 12,700 in retail stores and the
remainder in our support center, field management staff and distribution
facility. Of our retail associates, approximately 2,200 were full-time and
10,500 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 other associates. We believe our bonus
programs reward excellence in management, gives associates an incentive to
improve operations, and results 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.

Cautionary Statements

We make forward-looking statements in this Form 10-K which represent our
expectations or beliefs about future events and financial performance.
Forward-looking statements are identifiable by words such as "believe,"
"anticipate," "expect," "intend," "plan," "will," "may" and other similar
expressions. In addition, any statements that refer to expectations, projections
or other characterizations of future events or circumstances are forward-looking
statements. 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, which speak only as of
the date on which they are made. 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 will 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


11


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. We intend to open at least 125 new stores per year over
the next three years. Our ability to open new stores as planned may be adversely
affected by a number of factors, including:

o the availability of capital;

o our ability to identify and secure new sites;

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

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

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

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

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

o the reduction in the size of the pool of available sellers;

o our inability 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;

o more intensive competition to acquire the same video specialty stores we
seek to acquire;

o misrepresentations and breaches of contracts by sellers;

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

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

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

Our business may be negatively impacted by our failure to successfully integrate
Video Update

Our business may be adversely affected if we cannot successfully:

o increase revenues in the acquired stores;

o achieve lower operating costs including occupancy, labor, supplies, and
other store level expenses;

o retain and properly motivate store level operating staff and managers;

o compete effectively in new markets; or

o identify and close underperforming stores.

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) hotels and airlines; (3) home video
specialty retailers; (4) pay-per-view; and (5) all other sources, including
cable and syndicated television. Our industry has an early "window" that is


12


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 window in the future. We could be adversely affected if the movie studios
shorten or eliminate these exclusive windows, 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 video store distribution window to view these movies through other
distribution channels.

For example, the Walt Disney Company and News Corporation recently
announced a joint venture to offer video-on-demand ("VOD") movie services
through high-speed internet connections and cable television by mid-year 2002.
The planned release window is 45 to 60 days after a film's release in video
stores (although that time period could be further reduced) and before the film
is available on pay-per-view. We cannot assure you that this release window will
not be shortened in a manner that would negatively impact our rental revenues.
Five other studios (Sony, AOL Time Warner, Universal, Paramount and MGM)
recently formed a joint venture named "Moviefly" to pursue the same strategy,
offering downloadable movies in the traditional pay-per-view window.

Our business may be negatively impacted by new and existing technologies

New Technologies. New technologies, including VOD and single-play DVD,
represent a material risk to our company and the home video specialty retail
industry. A single play DVD is programmed to go black 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, at least two studios have
announced that they are exploring the use of this technology. We could see a
significant negative impact to the financial position and survival of our
company if these technologies can be developed and are widely accepted by
consumers.

Existing Technologies. Cable, satellite and pay-per-view television systems
(near-video-on-demand or "NVOD") continue to increase and expand offerings to
consumers. The additional channels on satellite and digital cable systems may
reduce demand for rentals from home video specialty retailers. If consumers more
widely accept direct broadcast satellite and digital cable, 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

Generally, studios price the majority of movies they distribute under the
VHS format at "rental" pricing, which is typically too high a price to generate
significant consumer demand to purchase these movies. The studios, however, at
times determine that consumers "want to own" certain titles within the VHS
format, and therefore price these titles at a lower price. This pricing method
is known as sell-through pricing. Additionally, almost all titles currently
released on DVD are priced at sell-through prices. These movies are purchased to
rent by home video specialty retailers and to sell by both home video specialty
retailers and mass merchants, among others. Our business could be adversely
affected if:

o studios decide to release more movies at sell-through versus rental
pricing, which could increase the satisfaction of consumer demand through
product sales that carry lower profit margins than rental revenues; and

o more consumers decide that they would rather purchase movies released at
sell-through prices than rent those movies.

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

Prior to studio revenue sharing programs, we would typically pay between
$60 and $75 per videocassette for major theatrical releases. 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. 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


13


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.

Our business could be adversely affected by increased competition

We cannot assure you that the two larger chains in our industry will not
focus more on the small and rural communities we predominantly serve. In
addition, there is no guarantee that smaller regional chains will not develop an
increased market share of the video rental industry in the markets we serve. If
any of our competitors, including large and regional chains, were to
substantially increase their presence in the markets we serve, the continued
success of our business would be challenged.

We are a defendant in various lawsuits that could adversely affect us

We are a defendant in two putative class action lawsuits in Alabama, one in
Texas and one in Tennessee regarding the extended viewing fees that we charge
our customers in those states. Each of these lawsuits alleges that the extended
viewing fees we charge for keeping our rental products beyond the initial rental
period are penalties in violation of certain common law and equitable
principles. The dollar amounts that the plaintiffs seek in each of the foregoing
four putative class action lawsuits is not set forth in the complaints.

We believe that our extended viewing fees do not violate any laws. As a
result, we intend to vigorously defend these lawsuits. However, we cannot
provide any assurance as to the outcome of these proceedings or provide any
assurance that other similar lawsuits regarding our extended viewing fee policy
will not be filed in any of the other states in which we operate. The amount of
extended viewing fees that we have collected to date in Alabama, Texas and
Tennessee is significant. Accordingly, an adverse outcome in any of these
lawsuits could have a material adverse effect upon our business, financial
condition or results of operations. Furthermore, even if we prevail in these
lawsuits, the legal fees paid by us to defend these lawsuits, and diversion of
management's attention resulting from the lawsuits may also have an adverse
effect on our operations.

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

We are highly dependent on the efforts and performance of our executive
officers. If we were to lose a significant number of these officers, our
business could be adversely affected. You should read the information under
"Management" for a detailed description of our management team.

The market price for our common stock may fluctuate substantially

Future developments concerning our business or our competitors, including
operating results, 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 price
fluctuations that have not necessarily been related to the operating performance
of these companies. 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.

14


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 11, 2002:



Name Age Position(s) Held

Joe Thomas Malugen(1)(2)........ 50 Chairman of the Board, President and Chief Executive Officer
William B. Snow(1)(3)(4)........ 70 Vice Chairman of the Board
J. Steven Roy................... 41 Executive Vice President and Chief Financial Officer
Jeffrey S. Stubbs............... 39 Executive Vice President - Operations
S. Page Todd.................... 40 Senior Vice President, Secretary and General Counsel
Keith A. Cousins................ 33 Senior Vice President - Real Estate/Development
Theodore L. Innes............... 52 Senior Vice President - Sales and Marketing
Richard R. Langford............. 45 Senior Vice President - Management Information
Systems and Chief Information Officer
Mark S. Loyd.................... 46 Senior Vice President - Purchasing and Product Management
Kenneth C. Motzenbecker......... 48 Senior Vice President - Support Operations
H. Harrison Parrish(1)(2)....... 54 Senior Vice President and Director
Sanford C. Sigoloff(3)(4)....... 71 Director
Philip B. Smith(3)(4)........... 66 Director
- -------------

(1) Member of our Executive Committee.
(2) Mr. Parrish resigned as President effective January 4, 2002, but will remain a director and an officer.
Mr. Malugen was appointed President following Mr. Parrish's resignation.
(3) Member of our Compensation Committee.
(4) Member of our Audit Committee.



Mr. Malugen co-founded Movie Gallery in 1985 and has been its 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. Snow was elected Vice Chairman of the Board in July 1994, and he served
as Chief Financial Officer from July 1994 until May 1996. Since May 1996, Mr.
Snow has continued to serve as Vice Chairman of the Board and has served as a
consultant to Movie Gallery. 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
director of Homeland Stores, Inc., a publicly held company. 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.

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 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.

15


Mr. Todd was elected Senior Vice President, Secretary and General Counsel
in December 1994. For more than the previous five years, 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. Cousins was elected Senior Vice President - Real Estate/Development in
March 1999. He joined Movie Gallery in August 1998 as Senior Director of
Development, Planning and Analysis. Prior to joining Movie Gallery, Mr. Cousins
acquired four years of management consulting experience with Computer Sciences
Corporation as Program Control Manager; Management Consulting and Research, Inc.
as Cost Analyst; and Tecolote Research, Inc. as Advanced Cost Estimator. He has
an additional seven years of real estate and property management experience as
Senior Director of Development for KinderCare Learning Centers, Inc. and Senior
Accountant with Aronov Realty Management Co., Inc. Mr. Cousins received a B.S.
degree in Business Administration from Auburn University at Montgomery.

Mr. Innes joined Movie Gallery in May 1999 and was elected Senior Vice
President - Sales and Marketing in June 1999. From October 1997 until he joined
Movie Gallery, Mr. Innes was a marketing consultant with Neighborhood Marketing
Institute, a neighborhood marketing and consulting firm specializing in
multi-unit restaurants and retailers, most recently serving as Executive Vice
President and Chief Operating Officer. From November 1989 to September 1997, Mr.
Innes was employed with Blockbuster, most recently serving as Vice President -
Marketing. Prior to joining Blockbuster, he was employed with Long John Silver's
Seafood Shoppe for fifteen years, most recently serving as Controller of Retail
Operations and Marketing. Mr. Innes is a Certified Public Accountant and a
Certified Management Accountant and received a B.S. degree in Business
Administration from the University of Kentucky.

Mr. Langford joined Movie Gallery in August 1995 as Vice President and was
elected Senior Vice President - Management Information Systems in October 1996,
and Chief Information Officer in April 2001. From August 1993 until he joined
Movie Gallery, Mr. Langford served as a Manager for Payroll, Fixed Assets and
Accounts Payable for Rocky Mountain Healthcare. From February 1990 to August
1993, he was Director of Support Operations for U. I. Video Stores, Inc. ("UIV")
of Denver, Colorado. UIV was one of the largest Blockbuster franchisees,
operating 110 stores in seven states in July 1993 when UIV was acquired by
Blockbuster. Mr. Langford received a B.A. degree in Communications from Brigham
Young University.

Mr. Loyd joined Movie Gallery in August 1986 and has served as the retail
store coordinator as well as Vice President - Purchasing and Product Management.
In October 1996, he was elected Senior Vice President - Purchasing and Product
Management. Mr. Loyd attended Southeast Missouri State University, where he
majored in Business Administration.

Mr. Motzenbecker was elected Senior Vice President - Support Operations in
June 2001. He joined Movie Gallery in November 1995, serving as Regional Manager
over Florida and Georgia, subsequently moving to Dothan, Alabama to serve as
Divisional Vice President in May 1996 and then Vice President - Retail
Coordinator in November 1997. Mr. Motzenbecker attended Catawba College,
receiving a B.S. degree in Education.

Mr. Parrish co-founded Movie Gallery in 1985 and has served as a Director
since that time. 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. 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. Mr. Sigoloff is a director of Kaufman and Broad Home Corporation,
a publicly held company. 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.



16


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, 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.

Directors are elected to serve until the next annual meeting of
stockholders of the Company or until their successors are elected and qualified.
Officers serve at the discretion of the Board of Directors, subject to any
contracts of employment. Non-employee directors receive an annual fee of
$16,000, a fee of $1,000 for each Board meeting attended and a fee of $500 for
each committee meeting attended. The Company has granted vested options to
purchase shares of 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.

ITEM 2. PROPERTIES

Stores. All but five 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 11, 2002:



United States: New Hampshire ............17
Alabama ................158 Michigan .................15
Florida ................123 Connecticut ..............13
Georgia .................97 Nebraska...................5
Texas ...................97 New York ..................5
Virginia ................78 South Dakota...............4
Ohio ....................76 Alaska.....................3
Tennessee ...............63 Arizona....................3
Missouri ................51 Colorado.................. 3
Indiana .................49 New Mexico ................3
S. Carolina............. 48 W. Virginia ...............3
Maine ...................47 Vermont ...................2
Mississippi .............43 Nevada.....................1
N. Carolina .............43 New Jersey.................1
Minnesota................37 Oregon.....................1
Kentucky ................34 Utah.......................1
Oklahoma ................31 -----
Wisconsin................30 Total United States 1,336
Illinois ................24
Pennsylvania.............21 Canada:
Massachusetts............19 British Columbia..........49
Washington... ...........19 Alberta...................46
Arkansas ................17 Manitoba...................3
Iowa.....................17 Ontario....................1
Kansas...................17 Yukon......................1
Louisiana ...............17 -----
Total Canada 100
-----
TOTAL 1,436
=====

Headquarters and Distribution Facility. Our corporate headquarters and
distribution facility are located in an approximately 90,000 square foot
building in Dothan, Alabama which we own.

17


ITEM 3. LEGAL PROCEEDINGS

We are a defendant in two putative class action lawsuits in Alabama (Sable
Denise Mack, et al. v. M.G.A., Inc., in the Circuit Court of Tuscaloosa County,
Alabama, and Laura F. Hicks, et al. v. M.G.A., Inc., in the Circuit Court of
Mobile County, Alabama) filed by customers on December 8, 2000 and August 21,
2001, respectively; one putative class action lawsuit filed on August 17, 2001
in the 71st 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 alleges that the
extended viewing fees we charge our customers for keeping our rental products
beyond the initial rental period are penalties in violation of certain common
law and equitable claims. The dollar amounts that plaintiffs seek as damages to
themselves and those similarly situated are not set forth in the complaints.
Similar class action lawsuits have been filed against our two major competitors.
Without admitting any fault, one of our competitors recently settled all of
these class action lawsuits pending against it. Under the settlement, our
competitor will make certificates available to class members for rentals and
cash discounts and will pay attorney's fees in connection with the settlement.
Our competitor was not required to make any change to its extended viewing fee
policy. We believe that our extended viewing fees do not violate any laws, and
we intend to vigorously defend these lawsuits.

Although we believe that all of the foregoing claims against us are
unwarranted and without merit, we cannot provide any assurance as to the outcome
of these proceedings. We cannot estimate the possible loss or range of loss that
may result from any of these claims and therefore have not recorded any related
accruals, other than accruals for legal fees expected to be incurred in defense
of these claims.

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, is material to our business or results of operations.

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

None.

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 the
common stock as reported on the Nasdaq National Market for the fiscal periods
indicated.

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

High Low
2002: ------- -------

First Quarter (through March 11, 2002)....... $ 16.75 $ 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

2000:
Fourth Quarter............................... 1.67 1.33
Third Quarter................................ 2.00 1.56
Second Quarter............................... 1.97 1.44
First Quarter................................ 1.95 1.28


On March 11, 2002, the last sale price of our common stock as reported on
the Nasdaq National Market was $14.52 per share. As of March 11, 2002, we had
approximately 4,300 stockholders, including 65 stockholders of record.

We do not expect to pay any cash dividends on our common stock in the
foreseeable future 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

18


pay dividends in the future will depend on a number of factors, including 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

Fiscal Year Ended (1)
--------------------------------------------------------------
January 4, January 3, January 2, December 31, January 6,
1998 1999 2000 2000 2002
--------------------------------------------------------------
(in thousands, except per share and store data)
Statement of Operations Data:

Revenues:
Rentals $ 220,787 $ 222,784 $ 235,452 $ 271,457 $ 313,852
Product sales 39,569 44,849 41,493 47,479 55,279
--------- --------- --------- --------- ---------
Total revenues 260,356 267,633 276,945 318,936 369,131

Cost of sales:
Cost of rental revenues 72,806 113,192(2) 69,716 81,958 91,445
Cost of product sales 24,597 29,744 25,884 31,213 35,002
--------- --------- --------- --------- ---------
Gross margin 162,953 124,697 181,345 205,765 242,684

Operating costs and expenses:
Store operating expenses 130,512 130,473 137,128 153,665 171,409
General and administrative 17,006 17,996 21,403 24,945 29,288(3)
Amortization of intangibles 7,206 7,068 8,452 7,465 6,656
Stock option compensation (4) -- -- -- -- 8,161
--------- --------- --------- --------- ---------
Operating income (loss) 8,229 (30,840) 14,362 19,690 27,170

Interest expense, net (6,326) (5,325) (3,349) (3,779) (2,736)
--------- --------- --------- --------- ---------

Income (loss) before income taxes, extraordinary
item and cumulative effect of accounting change 1,903 (36,165) 11,013 15,911 24,434
Income taxes 998 (13,089) 4,615 6,425 9,901
--------- --------- --------- --------- ---------
Income (loss) before extraordinary item and
cumulative effect of accounting change 905 (23,076) 6,398 9,486 14,533
Extraordinary loss on early extinguishment of debt -- -- (682) -- (177)
Cumulative effect of accounting change -- -- (699) -- --
--------- --------- --------- --------- ---------

Net income (loss) $ 905 $ (23,076) $ 5,017 $ 9,486 $ 14,356
========= ========= ========= ========= =========
Basic earnings (loss) per share (5):
Income (loss) before extraordinary item and
cumulative effect of accounting change $ 0.03 $ (0.77) $ 0.21 $ 0.37 $ 0.56
Extraordinary loss on early extinguishment of debt -- -- (0.02) -- --
Cumulative effect of accounting change -- -- (0.02) -- --
--------- --------- --------- --------- ---------
Net income (loss) per share - basic $ 0.03 $ (0.77) $ 0.17 $ 0.37 $ 0.56
========= ========= ========= ========= =========
Diluted earnings (loss) per share (5):
Income (loss) before extraordinary item and
cumulative effect of accounting change $ 0.03 $ (0.77) $ 0.21 $ 0.37 $ 0.53
Extraordinary loss on early extinguishment of debt -- -- (0.02) -- --
Cumulative effect of accounting change -- -- (0.02) -- --
--------- --------- --------- --------- ---------
Net income (loss) per share - diluted $ 0.03 $ (0.77) $ 0.17 $ 0.37 $ 0.53
========= ========= ========= ========= =========
Weighted average shares outstanding (5):
Basic 30,195 30,123 29,509 25,801 25,837
========= ========= ========= ========= =========
Diluted 30,197 30,123 30,083 25,868 27,220
========= ========= ========= ========= =========


19


Item 6. SELECTED FINANCIAL DATA (continued)



Fiscal Year Ended (1)
--------------------------------------------------------------
January 4, January 3, January 2, December 31, January 6,
1998 1999 2000 2000 2002
--------------------------------------------------------------
(in thousands, except per share and store data)

Balance Sheet Data (at end of period):

Cash and cash equivalents $ 4,459 $ 6,983 $ 6,970 $ 7,029 $ 16,349
Total assets 259,133 202,369 209,527 217,536 270,132
Long-term debt, less current maturities 63,479 46,212 44,377 40,600 26,000
Total liabilities 111,504 78,254 84,106 88,327 107,950
Stockholders' equity 147,629 124,115 125,421 129,209 162,182

Other Data:
Number of stores at end of period 856 837 963 1,020 1,415
Average revenues per store (6) $ 303 $ 317 $ 313 $ 328 $ 342
Adjusted EBITDA (7) $ 26,898 $ 37,378 $ 35,494 $ 39,744 $ 61,581
Increase in same store revenues (8) 1.1% 3.9% 0.4% 3.8% 2.7%
- ---------------------

(1) Results for the fiscal year ended January 6, 2002 reflect a 53-week year.
All other fiscal years presented reflect 52-week years.
(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) Includes a $1.6 million nonrecurring charge related to the amendment of our
supply agreement with Rentrak Corporation.
(4) Represents the non-cash compensation expense associated with certain stock
options that were repriced in March 2001 and are subsequently required to
be accounted for as variable stock options (see Note 6 to the Consolidated
Financial Statements).
(5) Earnings per share and weighted average shares outstanding have been
restated to reflect two three-for-two stock splits effected as stock
dividends paid on August 31, 2001 and January 3, 2002.
(6) Calculated as total revenue 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.
(7) Adjusted EBITDA is defined as earnings before interest, taxes, depreciation
and amortization, non-cash compensation and nonrecurring items
(extraordinary loss and cumulative effect account change in fiscal year
ended January 2, 2000; extraordinary loss and change to amend supply
agreement in fiscal year ended January 6, 2002), 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 service
debt.
(8) Same store revenues are calculated based on the aggregate revenues from
stores we have operated for at least thirteen months.



20


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, statement of
operations data expressed as a percentage of total revenue, Adjusted EBITDA and
the number of stores open at the end of each period. Results for the fiscal year
ended January 6, 2002 reflect a 53-week year.


Statement of Operations Data:

Fiscal Year Ended
--------------------------------------
January 2, December 31, January 6,
2000 2000 2002
--------------------------------------

Revenues:
Rentals 85.0% 85.1% 85.0%
Product sales 15.0 14.9 15.0
--------- --------- ---------
Total revenues 100.0 100.0 100.0

Cost of sales:
Cost of rental revenues 25.2 25.7 24.8
Cost of product sales 9.3 9.8 9.5
--------- --------- ---------
Gross margin 65.5 64.5 65.7

Operating costs and expenses:
Store operating expenses 49.5 48.2 46.4
General and administrative 7.7 7.8 7.9
Amortization of intangibles 3.1 2.3 1.8
Stock option compensation -- -- 2.2
--------- --------- ---------
Operating income 5.2 6.2 7.4

Interest expense, net (1.2) (1.2) (0.8)
--------- --------- ---------
Income before income taxes, extraordinary item
and cumulative effect of accounting change 4.0 5.0 6.6
Income taxes 1.7 2.0 2.7
--------- --------- ---------
Income before extraordinary item and
cumulative effect of accounting change 2.3 3.0 3.9
Extraordinary loss on early extinguishment of debt (0.2) -- --
Cumulative effect of accounting change (0.3) -- --
--------- --------- ---------
Net income 1.8% 3.0% 3.9%
========= ========= =========
Adjusted EBITDA (in thousands) $ 35,494 $ 39,744 $ 61,581
========= ========= =========
Number of stores at end of period 963 1,020 1,415
========= ========= =========


21


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
same store 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.

Cost of Sales. The gross margin on rental revenue for fiscal 2001 was
70.9%, versus 69.8% in fiscal 2000. The cost of rental revenues includes both
the amortization of rental inventory and revenue sharing expenses incurred. 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 the Consolidated Financial Statements).

Cost of product sales includes the unamortized value of previously viewed
rental inventory sold during the period, as well as the costs of new VHS and
DVD, confectionery items and other goods. The gross margin on product sales
increased to 36.7% for fiscal 2001 from 34.3% in fiscal 2000. The increase in
profitability of product sales reflects the impact of the continuing promotion
and availability of previously viewed movies with only limited levels of new
sell-through titles in inventory. The increase was offset partially by
significant discounting associated with the continued liquidation of older
sell-through titles and other slow moving inventory in certain stores early in
the year.

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, which include a nonrecurring charge of
$1.6 million related to an amendment of our supply agreement with Rentrak
Corporation in fiscal 2001 (see Note 7 to the Consolidated Financial
Statements), represent 7.9% of total revenue in fiscal 2001. Excluding this
nonrecurring charge, general and administrative expenses as a percentage of
revenue decreased to 7.5% for fiscal 2001 from 7.8% in fiscal 2000. The decrease
was primarily due to increased revenue levels, benefiting from an extra week of
revenues in fiscal 2001, 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 is 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. Effective in fiscal 2002,
amortization of intangibles will be significantly reduced due to the adoption of
Financial Accounting Standards Board ("FASB") Statement No. 142. (See Recently
Issued Accounting Pronouncements).

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 6 to the
Consolidated Financial Statements).

22


As a result of the impact of the above factors on revenues and expenses,
operating income increased by 38.0% in fiscal 2001 to $27.1 million. Excluding
the nonrecurring charge to amend a supply contract and non-cash stock
compensation expense, operating income increased by 87.6% for fiscal 2001 to
$36.9 million.

Pending the completion of final closing tax returns for Video Update, we
had net operating loss carryforwards at January 6, 2002 resulting from the Video
Update acquisition (see Note 2 to the Consolidated Financial Statements) of
approximately $67.0 million for income taxes that expire in years 2007 through
2021. We have recorded a valuation allowance of $18.4 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 realized.

Extraordinary Loss. During the second quarter of fiscal 2001, we incurred
an extraordinary loss on the early extinguishment of debt of $177,000 (net of
taxes of $113,000), or less than $0.01 per diluted share. The extraordinary loss
consisted of unamortized debt issue costs associated with the previous credit
facility and unamortized amounts associated with the termination of the interest
rate swap agreement (see Note 4 to the Consolidated Financial Statements).

Fiscal year ended December 31, 2000 compared to the fiscal year ended January 2,
2000

Revenue. Total revenue increased 15.2% to $318.9 million for fiscal 2000
from $276.9 million for fiscal 1999. The increase was due primarily to an
increase in same store revenues of 3.8%, as well as a 9.7% increase in the
average number of stores open during fiscal 2000 versus fiscal 1999. The
increase in same store revenues was primarily the result of: (i) increased
product availability for the customer; (ii) a strong slate of new title releases
versus the prior year, especially in the fourth quarter where box office
revenues on the titles released were approximately 40% higher than the fourth
quarter of 1999; (iii) successful, chain-wide internal marketing programs
designed to generate more consumer excitement and traffic in our base of stores;
(iv) an increase in the sale of previously viewed movies and previously played
games; (v) the return of the Christmas and New Year's holidays to a weekday
instead of a weekend day, as well as the absence of the "millennium effect"
experienced in 1999; and (vi) increases in other ancillary sales. The revenue
increase was partially offset by a decline in new movie sales as a result of
fewer titles being released at sell-through price points and a de-emphasis on
the sale of older sell-through titles in certain stores.

Cost of Sales. The gross margin on rental revenue for fiscal 2000 was
69.8%, a slight decrease from 70.4% in fiscal 1999, primarily due to the
significant concentration of product purchases in the fourth quarter of fiscal
2000. The cost of rental revenues includes both the amortization of rental
inventory and revenue sharing expenses incurred.

Cost of product sales includes the costs of new VHS and DVD, confectionery
items and other goods, as well as the unamortized value of previously viewed
rental inventory sold. The gross margin on product sales decreased to 34.3% in
fiscal 2000 from 37.6% in fiscal 1999. The decrease in profitability of product
sales is primarily the result of significant discounting in the fourth quarter
for the holiday season and continued liquidation of older sell-through titles in
certain stores.

Gross Margins. As a result of slightly lower margins on both rental
revenues and product sales, total gross margins declined from 65.5% in fiscal
1999 to 64.5% in fiscal 2000.

Operating Costs and Expenses. Store operating expenses, which include
store-level expenses such as lease payments and in-store payroll, decreased to
48.2% of total revenue for fiscal 2000 from 49.5% for fiscal 1999. The decrease
in store operating expenses as a percentage of revenue is primarily due to the
same store revenues increase in fiscal 2000, as well as the centralization of
certain functions at the general and administrative level, which have resulted
in store level expense savings, and the continued focus on closure of
underperforming stores.

23


Amortization of intangibles decreased as a percentage of revenues to 2.3%
in fiscal 2000 versus 3.1% in fiscal 1999. This decrease is primarily due to the
increase in same store revenues in fiscal 2000 and a reduction in goodwill
impairment write-offs during fiscal 2000 required by FASB Statement No. 121,
"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to
Be Disposed Of."

General and administrative expenses as a percentage of revenues was 7.8%
for fiscal 2000 compared to 7.7% for fiscal 1999. Increases in general and
administrative expenses due to increased staffing and travel costs associated
with our new store development which began to intensify in the latter half of
1999, as well as incremental expenses from the operation of our e-commerce
effort which was launched in September 1999, were offset by revenue increases in
fiscal 2000.

As a result of the impact of the above factors on revenues and expenses,
operating income increased by 37.1% to $19.7 million in fiscal 2000 from $14.4
million in fiscal 1999.

For fiscal 2000 our effective income tax rate was 40.4%, as compared to a
41.9% effective rate for fiscal 1999. The decrease in the income tax rate in
fiscal 2000 is primarily due to higher pre-tax income which leverages certain
permanently non-deductible items, therefore reducing the effective tax rate.

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. We fund inventory purchases, remodeling and
relocation programs, new store opening costs and acquisitions primarily from
cash flow from operations and loans under revolving credit facilities.

During fiscal 2001 we generated approximately $61.6 million in Adjusted
EBITDA, a 54.9% increase over the prior year. For fiscal 2000, our Adjusted
EBITDA increased to $39.7 million, a 12.0% increase over $35.5 million in fiscal
1999. These increases were primarily driven by the revenue increases during
those periods while leveraging expenses as discussed above. 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 service debt.

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 $126.9 million, $99.2 million and $84.4 million for
fiscal 2001, fiscal 2000 and fiscal 1999, respectively. Net cash provided by
operating activities continues to be sufficient to cover rental inventory
replenishment, capital resource and debt service needs.

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
(the "Facility"). This Facility replaces a similar revolving credit facility
with First Union National Bank of North Carolina, which was due to expire on
January 7, 2002. The new Facility is unsecured and provides for borrowings of up
to $65 million through July 6, 2002, $55 million through July 5, 2003 and $45
million until final maturity on July 4, 2004. The interest rate on the new
Facility is based on LIBOR plus an applicable margin percentage, which depends
on cash flow generation and borrowings outstanding. The terms of the new
Facility also required that we enter into a new interest rate swap agreement. In
December 2001, the Company entered into a new interest rate swap agreement with
SouthTrust Bank 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.

We grow our store base through internally developed and acquired stores. We
opened 77 internally developed stores during fiscal 2001 and remain on target to
open approximately 125 new stores in 2002. This follows a record of 110
internally developed stores during fiscal 2000. In addition to new store
development, we acquired 355 stores during fiscal 2001, including what we
believe to be the largest single domestic acquisition in the industry's history
as discussed below. To the extent


24


available, new stores and future acquisitions may be completed using funds
available under the new 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 filing on September 18, 2000. The acquisition of the
newly issued common stock of Video Update was in satisfaction of all amounts
owed by Video Update under a $6.5 million debtor-in-possession financing
agreement between Video Update and Movie Gallery. 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 the
confirmation of the plan of reorganization totaling approximately $6.3 million,
and assumed other post-bankruptcy filing liabilities of Video Update. Video
Update operates over 320 video specialty stores in the United States and Canada,
bringing our consolidated store count to over 1,400 stores in 41 states and five
Canadian provinces. We believe our acquisition of Video Update represents the
largest single domestic acquisition in the history of the industry. (See Note 2
to the Consolidated Financial Statements)

During the first quarter of fiscal 2000, we completed the $5 million stock
repurchase plan announced and begun in fiscal 1998, and announced a second $5
million stock repurchase plan which was completed in May 2000. During fiscal
1999 and fiscal 2000, we repurchased and retired a total of 4.9 million shares
for approximately $9.5 million, funded primarily through cash flow from
operations.

At January 6, 2002, we had a working capital deficit of $48.8 million, due
to the accounting treatment of rental inventory. Rental inventory is treated as
a noncurrent asset under accounting principles generally accepted in the United
States because it is a depreciable asset and a portion of this asset is not
reasonably expected to be completely realized in cash or sold in the normal
business cycle. Although the rental of this inventory generates the major
portion of our revenue, the classification of this asset as noncurrent results
in its exclusion from working capital. The aggregate amount payable for this
inventory, however, is reported as a current liability until paid and,
accordingly, is included in working capital. Consequently, we believe that
working capital is not an appropriate measure of our liquidity and we anticipate
that we will continue to operate with a working capital deficit.

The following table discloses our contractual obligations and commercial
commitments as of January 2, 2002 (see Notes 4 and 7 to the Consolidated
Financial Statements).



Payments Due by Period
(in thousands)
----------------------------------------------------------------
Less than 1-3 4-5 After 5
Contractual Obligations Total 1 year Years Years Years
- ----------------------- ----------------------------------------------------------------

Credit facility - outstanding(1) $ 26,000 $ - $ 26,000 $ - $ -
Operating leases 177,143 6,839 122,625 30,240 17,439
Unconditional purchase obligations 18,838 4,000 12,000 2,838 -
---------- ---------- ---------- --------- ---------
Total contractual cash obligations $ 221,981 $ 10,839 $ 160,625 $ 33,078 $ 17,439
========== ========== ========== ========= =========
- ------------------

(1) The total commercial commitment under the credit facility is $65 million,
with expiration as follows: $10 million in 2002, $10 million in 2003 and
$45 million in 2004. As of January 6, 2002, there were standby letters of
credit outstanding under the credit facility of $.5 million which expire in
2002.



We believe our projected cash flow from operations, borrowing capacity
under the Facility, cash on hand 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 at least fiscal 2002. However,
to fund a major acquisition, or to provide funds in the event that our need for
funds is greater than expected, or if certain of 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.

25


Our ability to fund our current plan of operations, our growth plans and
our debt service requirements will depend upon our future performance, which is
subject to general economic, financial, competitive and other factors that are
beyond our control. There can be no assurance that our business will continue to
generate sufficient cash flow from operations in the future to service our debt,
fund capital resource needs and cover the ongoing costs of operating the
business. If we are unable to satisfy these requirements with cash flow from
operations, we may be required to refinance all or a portion of our existing
debt, to sell assets or to obtain additional financing. There can be no
assurance that any such refinancing would be available or 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 the
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 the
recognition of extended viewing fee revenue, rental inventory amortization,
impairment of long-lived assets, purchase price allocation of acquired
businesses and deferred income taxes.

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.

Rental inventory is amortized to an estimated salvage value over an
estimated useful life of three years. Excess copies of rental inventory are sold
as previously viewed product and the unamortized cost is charged to cost of
sales. We amortize the cost of rental inventory using an accelerated method
designed to approximate the rate of revenue recognition. We believe that the
amortization rates, salvage values and useful lives are appropriate in our
existing operating environment. If revenue trends or other industry conditions
change, we may make changes to the existing amortization policy that could
result in a charge to write-down the net book value of rental inventory. We
currently maintain a reserve against rental inventory to reduce the amortized
cost of previously viewed VHS inventory to the estimated net realizable value.
We may adjust this reserve in future periods based on conditions in the market
for previously viewed VHS inventory.

We assess the fair value and recoverability of our long-lived assets,
including goodwill, 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 and goodwill 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 and goodwill 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. As a result of this review, we recorded impairment losses
of $1 million and $.7 million in fiscal 2000 and 2001, 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.

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


26


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 and the related Video Update
acquisition, we have established a valuation allowance against our deferred tax
assets related to the estimated utilization of the net operating losses.

Recently Issued Accounting Pronouncements

In June 2001, the FASB issued Statement No. 141, "Business Combinations,"
and Statement No. 142, "Goodwill and Other Intangible Assets." Statement 141
requires that all business combinations be accounted for by the purchase method,
and 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. 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.
Statement 142 is effective for us as of January 7, 2002. We do not expect the
adoption of Statement 142 to have any material impact on the classification of
intangible assets. Application of the nonamortization provisions of Statement
142 will result in an increase in net income of approximately $3.5 million per
year. We do not anticipate completion of the transitional impairment tests to
result in any impairment charge.

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
Disposal of a Segment of a Business." Statement 144 is effective for us
beginning January 7, 2002 and is not expected to have an impact on our financial
position or results of operations.

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). In order to manage this risk, we entered
into an interest rate swap agreement that effectively fixes our interest rate
exposure on $10 million of the amount outstanding under the Facility at 3.5%
plus an applicable margin percentage. Assuming a hypothetical 10% adverse change
in the LIBOR interest rate and assuming debt levels outstanding as of January 6,
2002, we would incur an immaterial amount of additional annual interest expense
on unhedged variable rate borrowings. These amounts are determined by
considering the impact of the hypothetical change in interest rates on our cost
of borrowing. The analysis does not consider the potential negative impact on
overall economic activity that could exist in such an environment. We believe
that our exposure to adverse interest rate changes and the impact on our total
cost of borrowing capital has been largely mitigated by the interest rate swap
agreement that is in place.

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.

27


ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

Reference is made to Part IV, Item 14 of this Form 10-K for the information
required by Item 8.

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

None.

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 Item 1 of Part I of
this Form 10-K) will be contained in the Company's definitive Proxy Statement
for its 2002 Annual Meeting of Stockholders, and is incorporated herein by
reference.

ITEM 11. EXECUTIVE COMPENSATION

The information required by this Item will be contained in the Company's
definitive Proxy Statement for its 2002 Annual Meeting of Stockholders, and is
incorporated herein by reference.

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

The information required by this Item will be contained in the Company's
definitive Proxy Statement for its 2002 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 the Company's
definitive Proxy Statement for its 2002 Annual Meeting of Stockholders, and is
incorporated herein by reference.

PART IV

ITEM 14. 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 December 31, 2000 January 6, 2002.

Consolidated Statements of Income for the Fiscal Years Ended January
2, 2000, December 31, 2000 and January 6, 2002.

Consolidated Statements of Stockholders' Equity for the Fiscal Years
Ended January 2, 2000, December 31, 2000 and January 6, 2002.

Consolidated Statements of Cash Flows for the Fiscal Years Ended
January 2, 2000, December 31, 2000 and January 6, 2002.

Notes to Consolidated Financial Statements.

(a)(2) Schedules:

Schedule II. Valuation and Qualifying Accounts

28



(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)
3.2 - Bylaws of the Company. (1)
4.1 - Specimen Common Stock Certificate. (2)
10.1 - 1994 Stock Option Plan, as amended and form of Stock Option Agreement.
(3)
10.2 - Form of Indemnity Agreement. (1)
10.3 - Employment Agreement between M.G.A., Inc. and Joe Thomas Malugen. (1)
10.4 - Employment Agreement between M.G.A., Inc. and H. Harrison Parrish. (1)
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. (5)
10.8 - Assignment Agreement between BNP Paribas and Movie Gallery, Inc. dated
May 2, 2001. (6)
10.9 - Chapter 11 Financing Agreement between Video Update, Inc. and Movie
Gallery, Inc. dated May 16, 2001. (6)
10.10 - Credit Agreement between Movie Gallery, Inc. and SouthTrust Bank dated
June 27, 2001. (6)
10.11 - Plan of Reorganization of Video Update, Inc., et al., as amended on
December 18, 2001. (7)
21 - List of Subsidiaries. (filed herewith)
23 - Consent of Ernst & Young LLP, Independent Auditors. (filed herewith)
- ---------------

(1) Previously filed with the Securities and Exchange Commission on June 10,
1994, as exhibits to the Company's 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 the Company's Registration
Statement on Form S-1.
(3) Previously filed with the Securities and Exchange Commission on April 7,
1997, as an exhibit to the Company's 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 the Company's Form 10-K for the fiscal year ended
January 4, 1998.
(5) Previously filed with the Securities and Exchange Commission on April 2,
2001, as an exhibit to the Company's Form 10-K for the fiscal year ended
December 31, 2000.
(6) Previously filed with the Securities and Exchange Commission on August 15,
2001, as an exhibit to the Company's Form 10-Q for the quarter ended July
1, 2001.
(7) Previously filed with the Securities and Exchange Commission on January 7,
2002, as an exhibit to the Company's Form 8-K/A dated December 21, 2001.

29


(b) Reports on Form 8-K:

The Company filed Form 8-K reporting on Items 2 and 7 on January 4, 2002.
This filing was amended with a Form 8-K/A on January 7, 2002.

(c) Exhibits:

See (a)(3) above.



SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this annual report on Form
10-K to be signed on its behalf by the undersigned, thereunto duly authorized.

MOVIE GALLERY, INC.


By /s/ JOE THOMAS MALUGEN
-------------------------------
Joe Thomas Malugen,
Chairman of the Board, President
and Chief Executive Officer

Date: April 2, 2002

Pursuant to the requirements of the Securities Exchange Act of 1934, this
annual report on Form 10-K 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/ JOE THOMAS MALUGEN Chairman of the Board, President April 2, 2002
- ----------------------- and Chief Executive Officer
Joe Thomas Malugen

/s/ WILLIAM B. SNOW Vice Chairman of the Board April 2, 2002
- --------------------
William B. Snow

/s/ H. HARRISON PARRISH Director April 2, 2002
- ------------------------
H. Harrison Parrish

/s/ PHILIP B. SMITH Director April 2, 2002
- -------------------
Philip B. Smith

/s/ J. STEVEN ROY Executive Vice President and April 2, 2002
- ----------------- Chief Financial Officer
J. Steven Roy

/s/ IVY M. JERNIGAN Vice President - Controller April 2, 2002
- -------------------
Ivy M. Jernigan


30


Movie Gallery, Inc.

Consolidated Financial Statements

Fiscal years ended January 2, 2000, December 31, 2000 and January 6, 2002


Contents

Report of Ernst & Young LLP, Independent Auditors........................F - 1

Audited Financial Statements

Consolidated Balance Sheets................................................F - 2
Consolidated Statements of Income..........................................F - 3
Consolidated Statements of Stockholders' Equity............................F - 4
Consolidated Statements of Cash Flows......................................F - 5
Notes to Consolidated Financial Statements................................ F - 6
Financial Statement Schedule...............................................F -20







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 December 31, 2000 and January 6, 2002, and the related consolidated
statements of income, stockholders' equity and cash flows for each of the three
years in the period ended January 6, 2002. Our audits also include the financial
statement schedule listed in the Index at Item 14(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 consolidated financial statements referred to above present
fairly, in all material respects, the consolidated financial position of Movie
Gallery, Inc. at December 31, 2000 and January 6, 2002, and the consolidated
results of its operations and its cash flows for each of the three years in the
period ended January 6, 2002, 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 1999
the Company changed its method of accounting for the costs of start-up
activities.

/s/ Ernst & Young, LLP



Birmingham, Alabama
February 14, 2002
F-1



Movie Gallery, Inc.
Consolidated Balance Sheets
(in thousands)



December 31, January 6,
2000 2002
----------- ---------

Assets
Current assets:
Cash and cash equivalents $ 7,029 $ 16,349
Merchandise inventory 9,264 6,739
Prepaid expenses 1,000 2,085
Store supplies and other 3,852 5,582
Deferred income taxes 502 1,159
--------- ---------
Total current assets 21,647 31,914

Rental inventory, net 61,773 88,424
Property, furnishings and equipment, net 53,124 71,739
Goodwill and other intangibles, net 77,926 75,838
Deposits and other assets 3,066 2,217
--------- ---------
Total assets $ 217,536 $ 270,132
========= =========

Liabilities and stockholders' equity
Current liabilities:
Accounts payable $ 31,111 $ 51,785
Accrued liabilities 11,631 28,935
--------- ---------
Total current liabilities 42,742 80,720

Long-term debt 40,600 26,000
Other accrued liabilities 253 606
Deferred income taxes 4,732 624

Stockholders' equity:
Preferred stock, $.10 par value; 2,000 shares
authorized, no shares issued or outstanding -- --
Common stock, $.001 par value; 35,000
shares authorized, 25,056 and 27,215
shares issued and outstanding, respectively 25 27
Additional paid-in capital 121,827 140,475
Retained earnings 7,357 21,713
Accumulated other comprehensive loss -- (33)
--------- ---------
Total stockholders' equity 129,209 162,182
--------- ---------
Total liabilities and stockholders' equity $ 217,536 $ 270,132
========= =========

See accompanying notes.

F-2



Movie Gallery, Inc.
Consolidated Statements of Income
(in thousands, except per share data)


Fiscal Year Ended
------------------------------------
January 2, December 31, January 6,
2000 2000 2002
------------------------------------

Revenues:
Rentals $ 235,452 $ 271,457 $ 313,852
Product sales 41,493 47,479 55,279
--------- --------- ---------
Total revenues 276,945 318,936 369,131

Cost of sales:
Cost of rental revenues 69,716 81,958 91,445
Cost of product sales 25,884 31,213 35,002
--------- --------- ---------
Gross margin 181,345 205,765 242,684

Operating costs and expenses:
Store operating expenses 137,128 153,665 171,409
General and administrative 21,403 24,945 29,288
Amortization of intangibles 8,452 7,465 6,656
Stock option compensation -- -- 8,161
--------- --------- ---------
Operating income 14,362 19,690 27,170

Interest expense, net (3,349) (3,779) (2,736)
--------- --------- ---------
Income before income taxes, extraordinary item
and cumulative effect of accounting change 11,013 15,911 24,434
Income taxes 4,615 6,425 9,901
--------- --------- ---------
Income before extraordinary item and
cumulative effect of accounting change 6,398 9,486 14,533
Extraordinary loss on early extinguishment of debt (682) -- (177)
Cumulative effect of accounting change (699) -- --
--------- --------- ---------
Net income $ 5,017 $ 9,486 $ 14,356
========= ========= =========
Basic earnings per share:
Income before extraordinary item and cumulative
effect of accounting change $ 0.21 $ 0.37 $ 0.56
Extraordinary loss on early extinguishment of debt (0.02) -- --
Cumulative effect of accounting change (0.02) -- --
--------- --------- ---------
Net income per share - basic $ 0.17 $ 0.37 $ 0.56
========= ========= =========

Diluted earnings per share:
Income before extraordinary item and cumulative
effect of accounting change $ 0.21 $ 0.37 $ 0.53
Extraordinary loss on early extinguishment of debt (0.02) -- --
Cumulative effect of accounting change (0.02) -- --
--------- --------- ---------
Net income per share - diluted $ 0.17 $ 0.37 $ 0.53
========= ========= =========
Weighted average shares outstanding:
Basic 29,509 25,801 25,837
Diluted 30,083 25,868 27,220

See accompanying notes.

F-3



Movie Gallery, Inc.
Consolidated Statements of Stockholders' Equity
(in thousands)


Accumulated
Additional Retained Other Total
Common Paid-in Earnings Comprehensive Stockholders'
Stock Capital (Deficit) Loss Equity
--------- ---------- --------- ------------- -------------


Balance at January 3, 1999 $ 30 $ 131,231 $ (7,146) $ - $ 124,115
Net income - - 5,017 - 5,017
Exercise of stock options for 28 shares - 48 - - 48
Tax benefit of stock options exercised - 7 - - 7
Repurchase and retirement of 1,752 shares (2) (3,764) - - (3,766)
--------- --------- --------- -------- ---------
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
========= ========= ========= ======== =========
See accompanying notes.

F-4



Movie Gallery, Inc.
Consolidated Statements of Cash Flows
(in thousands)

Fiscal Year Ended
--------------------------------------
January 2, December 31, January 6,
2000 2000 2002
--------------------------------------

Operating activities:
Net income $ 5,017 $ 9,486 $ 14,356
Adjustments to reconcile net income to net cash provided
by operating activities:
Extraordinary loss on early extinguishment of debt 682 -- 177
Cumulative effect of accounting change 699 -- --
Amortization of rental inventory 50,514 54,460 63,638
Depreciation and intangibles amortization 21,691 22,327 22,332
Stock option compensation -- -- 8,161
Tax benefit of stock options exercised 7 -- 5,273
Deferred income taxes 2,737 4,671 3,816
Changes in operating assets and liabilities:
Merchandise inventory (2,788) 5,884 3,436
Other current assets 348 (643) (2,731)
Deposits and other assets (1,104) (518) 471
Accounts payable 2,847 4,868 5,488
Accrued liabilities 3,740 (1,356) 2,484
--------- --------- ---------
Net cash provided by operating activities 84,390 99,179 126,901

Investing activities:
Business acquisitions (11,839) (3,085) (20,047)
Purchases of rental inventory, net (54,259) (63,211) (66,775)
Purchases of property, furnishings and equipment (12,573) (23,086) (21,342)
--------- --------- ---------
Net cash used in investing activities (78,671) (89,382) (108,164)

Financing activities:
Net proceeds from issuance of common stock 48 -- --
Purchases and retirement of common stock (3,766) (5,698) --
Proceeds from exercise of stock options -- -- 5,216
Principal payments on long-term debt (2,014) (4,040) (14,600)
--------- --------- ---------
Net cash used in financing activities (5,732) (9,738) (9,384)

Effect of exchange rate changes on cash and cash equivalents -- -- (33)
--------- --------- ---------

Increase (decrease) in cash and cash equivalents (13) 59 9,320
Cash and cash equivalents at beginning of fiscal year 6,983 6,970 7,029
--------- --------- ---------
Cash and cash equivalents at end of fiscal year $ 6,970 $ 7,029 $ 16,349
========= ========= =========

Supplemental disclosures of cash flow information:
Cash paid during the period for interest $ 3,076 $ 3,817 $ 3,434
Cash paid during the period for income taxes 2,705 1,688 1,461

See accompanying notes.

F-5



Movie Gallery, Inc.

Notes to Consolidated Financial Statements

January 2, 2000, December 31, 2000 and January 6, 2002

1. Accounting Policies

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

The Company owns and operates video specialty stores located in 41 states and
five Canadian provinces.

Fiscal Year

The Company's 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 January 2, 2000 ("Fiscal 1999") and December 31, 2000 ("Fiscal 2000")
reflect 52-week years. Results for the fiscal year ended January 6, 2002
("Fiscal 2001") reflect a 53-week year. The Company's 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.

Cash Equivalents

The Company considers 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.

Impairment of Long-Lived Assets

The Company periodically assesses the impairment of long-lived assets, including
allocated goodwill, to be held for use in operations based on expectations of
future undiscounted cash flows from the related operations, and when
circumstances dictate, adjusts the enterprise level assets to the extent
carrying value exceeds the estimated fair value of the assets. These factors,
along with management's plans with respect to the operations, are considered in
assessing the recoverability of goodwill, other purchased intangibles, rental
inventory and property and equipment. Amortization of intangibles for Fiscal
1999, 2000 and 2001 includes an impairment loss of $1,600,000, $1,000,000 and
$700,000, respectively, to write-off the net book value of goodwill in excess of
its estimated fair market value.

Rental Inventory

Rental inventory is stated at cost and amortized over its economic useful life.
Under the Company's policy, the cost of base stock movie inventory, consisting
of two copies per title for each store, is 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. The cost of non-base stock movie inventory, consisting of the
third and succeeding copies of each title per store, is amortized on an



F-6


Movie Gallery, Inc.

Notes to Consolidated Financial Statements (continued)

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

During the fourth quarter of Fiscal 2001, the Company established a $2.1 million
reserve against rental inventory to reduce the amortized cost of previously
viewed VHS inventory to its estimated net realizable value. This reserve
represents the continuing consumer transition to DVD from VHS and the resulting
impact on the sale prices of previously viewed VHS product.

Rental inventory consists of the following (in thousands):



December 31, January 6,
2000 2002
------------ ----------


Rental inventory $ 145,557 $ 174,647
Accumulated amortization (83,784) (86,223)
------------ ----------
$ 61,773 $ 88,424
============ ==========


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, generally
five to seven years.

Goodwill and Other Intangibles

Goodwill is being amortized on a straight-line basis over twenty years. Other
intangibles consist primarily of non-compete agreements and are amortized on a
straight-line basis over the lives of the respective agreements which generally
range from five to ten years. Accumulated amortization of goodwill and other
intangibles at December 31, 2000 and January 6, 2002 was $35,830,000 and
$41,314,000, respectively.

Income Taxes

The Company accounts for income taxes under the provisions of Financial
Accounting Standards Board ("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

Rental revenue is recognized when the movie or video game is rented by the
customer. Extended viewing fees on rentals are recognized when received from the
customer. Product sales revenue is recognized at the time of sale.

F-7

Movie Gallery, Inc.

Notes to Consolidated Financial Statements (continued)

Advertising Costs

Advertising costs, exclusive of cooperative reimbursements from vendors, are
expensed when incurred. Advertising expense for Fiscal 1999, 2000 and 2001
totaled $728,000, $1,563,000 and $2,219,000, respectively.

Store Opening and Start-up Costs

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

In April 1998, the American Institute of Certified Public Accountants issued
Statement of Position ("SOP") 98-5, "Reporting the Costs of Start-up
Activities," which requires that certain costs related to start-up activities be
expensed as incurred. Prior to January 4, 1999, the Company capitalized certain
costs incurred in connection with site selection for new video specialty store
locations. The Company adopted the provisions of SOP 98-5 in its financial
statements for the first quarter of Fiscal 1999. The effect of the adoption of
SOP 98-5 was to record a charge for the cumulative effect of an accounting
change of $699,000 (net of income taxes of $368,000), or $0.02 per share, to
expense the unamortized costs that had been capitalized prior to January 4,
1999.

Fair Value of Financial Instruments

At December 31, 2000 and January 6, 2002, 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 the Company's incremental borrowing rate.

Foreign Currency Translation

The Company's 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.

Hedging Activities

The Company adopted FASB Statement No. 133, "Accounting for Derivative
Instruments and Hedging Activities," as amended by Statements No. 137 and 138,
in its fiscal year beginning January 1, 2001. Statement 133 requires the Company
to recognize all derivatives on the balance sheet at fair value. Derivatives
that are not hedges must be adjusted to fair value through earnings. If the
derivative is a hedge, depending on the nature of the hedge, changes in the fair
value of derivatives will either be offset against the change in fair value of
the hedged assets, liabilities or firm commitments through earnings or
recognized in other comprehensive income until the hedged item is recognized in
earnings. The ineffective portion of a derivative's change in fair value will be
immediately recognized in earnings (see Note 4 - Long-Term Debt).

F-8

Movie Gallery, Inc.

Notes to Consolidated Financial Statements (continued)

Use of Estimates

The preparation of financial statements in conformity with accounting principles
generally accepted in the United States requires management 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, goodwill and other intangibles, rental inventory reserves and the
allocation of the purchase price of acquired businesses. These estimates and
assumptions could change and actual results could differ from these estimates.

Recently Issued Accounting Pronouncements

In June 2001, the FASB issued Statement No. 141, "Business Combinations," and
Statement No. 142, "Goodwill and Other Intangible Assets." Statement 141
requires that all business combinations be accounted for by the purchase method,
and requires all intangible assets acquired in a business combination to be
recognized as assets apart from goodwill if they meet certain contractual-legal
criterion or separability criterion. The provisions of Statement 141 apply to
all business combinations with an acquisition date subsequent to June 30, 2001.
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.
Statement 142 is effective for the Company as of January 7, 2002. The adoption
of Statement 142 is not expected to have any material impact on the
classification of intangible assets. Application of the nonamortization
provisions of Statement 142 will result in an increase in net income of
approximately $3.5 million per year. The Company does not anticipate completion
of the transitional impairment tests to result in any impairment charge.

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." Statement 144 is effective for
the Company beginning January 7, 2002 and is not expected to have an impact on
the Company's financial position or results of operations.

Employee Benefits

The Company has a 401(k) savings plan available to all active employees who are
over 21 years of age and have completed one year of service. The Company makes
discretionary and matching contributions based on employee compensation. The
matching contribution for Fiscal 1999, 2000 and 2001 was immaterial to the
Company's operating results.

2. Acquisitions

Effective December 21, 2001, the Company acquired 100% of the newly issued
common stock of the reorganized Video Update, Inc. ("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 filing on September 18, 2000.
The acquisition of the newly issued common stock of Video Update was in
satisfaction of all amounts owed by Video Update under a $6.5 million
debtor-in-possession financing agreement between Video Update and the Company.
In addition, the Company 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

F-9

Movie Gallery, Inc.

Notes to Consolidated Financial Statements (continued)

Update as disclosed in the following table. Video Update operates over 320 video
specialty stores in the United States and Canada. The Company's acquisition of
Video Update was made as a strategic expansion of the Company's geographic
markets in accordance with the Company's growth plan.

The following table summarizes the preliminary estimated fair values of the
assets acquired and liabilities assumed at the date of acquisition. Due to the
acquisition occurring near the end of the Company's fiscal year, the closing of
the final books and records of Video Update has not been completed. Final
determination of the purchase price allocation will be made as soon as
practicable upon completion of the final closing and adjustments to the purchase
price allocation, if any, will be recorded at that time.



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


Current assets $ 3,017
Rental inventory, net 21,801
Property, furnishings and equipment, net 12,596
Deferred income taxes 8,468
----------
Total assets acquired 45,882

Accruals for settlement of liabilities
subject to compromise 6,253
Current liabilities and accrued expenses 24,669
Notes payable to parent 8,460
----------
Total liabilities assumed 39,382
----------
Net investment in common stock $ 6,500
==========



The purchase price allocation for Video Update includes accrued expenses of
approximately $1.3 million to terminate the operations of the Video Update
corporate office and to transition those functions to the Company's corporate
offices. The accrual consists primarily of payroll costs, rent and utilities
during the transition period. The accrual is subject to change if the transition
period extends beyond that originally anticipated. Adjustments to the accrual,
if any, will be reported as an adjustment to the purchase price allocation.

The results of operations of Video Update have been included in the Company's
consolidated statement of income since December 21, 2001. The following
unaudited pro forma information presents the consolidated results of operations
of the Company 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.

F-10


Movie Gallery, Inc.

Notes to Consolidated Financial Statements (continued)



Fiscal Year Ended
--------------------------------
December 31, January 6,
2000 2002
--------------------------------
(in thousands, except per share data)

Revenue $ 426,426 $ 466,557
Income before extraordinary item 13,844 14,535
Net income 13,844 14,358
Income per share before extraordinary item:
Basic 0.54 0.56
Diluted 0.54 0.53
Net income per share:
Basic 0.54 0.56
Diluted 0.54 0.53


In addition to the Video Update acquisition, the Company purchased 31 stores in
five separate transactions for approximately $6.6 million during Fiscal 2001 and
recorded approximately $3.5 million of goodwill related to these transactions.

3. Property, Furnishings and Equipment

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



December 31, January 6,
2000 2002
----------- ---------


Land and buildings $ 4,006 $ 6,735
Furniture and fixtures 37,291 45,395
Equipment 33,616 44,364
Leasehold improvements and signs 36,860 48,342
----------- ---------
111,773 144,836
Accumulated depreciation (58,649) (73,097)
----------- ---------
$ 53,124 $ 71,739
=========== =========


4. Long-Term Debt

On June 27, 2001, the Company entered into a credit agreement with a syndicate
of banks, led by SouthTrust Bank, with respect to a new revolving credit
facility (the "Facility"). This Facility replaces a similar revolving credit
facility with First Union National Bank of North Carolina (the "First Union
Facility") which was due to expire on January 7, 2002. The new Facility is
unsecured and provides for borrowings of up to $65 million through July 6, 2002,
$55 million through July 5, 2003 and $45 million until final maturity on July 4,
2004. The interest rate on the Facility is based on LIBOR plus an applicable
margin percentage, which depends on the Company's cash flow generation and
borrowings outstanding. At January 6, 2002, $26 million was outstanding,
approximately $38.5 million was available for borrowing and the effective
interest rate was approximately 4.5%.

The terms of the new Facility required the Company to enter into a new interest
rate swap agreement. In December 2001, the Company entered into an interest rate
swap with SouthTrust Bank in order to hedge exposure to interest rate
fluctuations. The Company's interest rate swap pays a 3.5% fixed rate of
interest plus an applicable margin percentage and receives variable rates of
interest for two years on $10 million of debt outstanding under the new
Facility. The swap is considered a cash flow hedge and is accounted for pursuant
to Statement 133.

F-11


Movie Gallery, Inc.

Notes to Consolidated Financial Statements (continued)

As a result of the new Facility, the Company incurred an extraordinary loss on
the early extinguishment of debt of approximately $177,000 (net of taxes of
$113,000), or less than $0.01 per diluted share. The extraordinary loss consists
primarily of unamortized debt issue costs associated with the previous credit
facility and unamortized amounts associated with the termination of the interest
rate swap agreement.

The First Union Facility provided for borrowings of up to $65 million and
carried an interest rate based on LIBOR plus an applicable margin percentage,
dependant upon the Company's cash flow generation and borrowings outstanding.
Concurrent with the First Union Facility, the Company amended its then existing
interest rate swap to coincide with the maturity of the First Union Facility.
The amended interest rate swap was structured to fix the Company's interest rate
exposure on $37 million of the outstanding borrowings at 5.8% plus an applicable
margin percentage and was terminated prior to refinancing of the credit facility
in June 2001. Under the amended interest rate swap, the Company paid a fixed
rate of interest and received payment based on a variable rate of interest. The
difference in amounts paid and received under the contract was accrued and
recognized as an adjustment to interest expense on the debt, prior to the
adoption of Statement 133.

As a result of the First Union Facility and the amended interest rate swap
agreement, the Company recognized an extraordinary loss on the extinguishment of
debt of approximately $682,000 (net of income taxes of $359,000), or $.02 per
share, during the first quarter of Fiscal 1999. The extraordinary loss was
comprised primarily of unamortized debt issue costs associated with the
Company's previous credit facility and the negative value of the previous
interest rate swap at January 7, 1999.

5. Income Taxes

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



Fiscal Year Ended
-----------------------------------------------
January 2, December 31, January 6,
2000 2000 2002
-----------------------------------------------

Current payable:
Federal $ 1,673 $ 1,439 $ 5,548
State 198 315 653
--------- ---------- ---------
Total current 1,871 1,754 6,201


Deferred:
Federal 2,454 4,056 3,456
State 290 615 244
--------- ---------- ---------
Total deferred 2,744 4,671 3,700
--------- ---------- ---------
$ 4,615 $ 6,425 $ 9,901
========= ========== =========



F-12



Movie Gallery, Inc.

Notes to Consolidated Financial Statements (continued)

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



Fiscal Year Ended
---------------------------------------
January 2, December 31, January 6,
2000 2000 2002
---------------------------------------


Income tax expense at statutory rate $3,855 $5,569 $8,552
State income tax expense, net of
federal income tax benefit 317 604 583
Other, net (primarily goodwill not
deductible for tax purposes) 443 252 766
------ ------ ------
$4,615 $6,425 $9,901
====== ====== ======


Pending the completion of final closing tax returns for Video Update, the
Company had net operating loss carryforwards at January 6, 2002 resulting from
the Video Update acquisition (see Note 2 - Acquisitions) of approximately $67.0
million for income taxes that expire in years 2007 through 2021. The Company has
recorded a valuation allowance of $18.4 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.

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 the Company's
deferred tax assets and liabilities are as follows (in thousands):



December 31, January 6,
2000 2002
---------------------------

Deferred tax assets:
Non-compete agreements $ 4,979 $ 4,573
Alternative minimum tax credit carryforward 4,163 4,169
Net operating loss carryforwards - 25,490
Accrued liabilities 502 770
Other 731 1,357
----------- ---------
Total deferred tax assets 10,375 36,359
Valuation allowance - (18,412)
----------- ---------
Net deferred tax assets 10,375 17,947
Deferred tax liabilities:
Furnishings and equipment (6,003) (6,494)
Rental inventory (6,351) (6,473)
Goodwill (2,251) (1,986)
Other - (2,459)
----------- ---------
Total deferred tax liabilities (14,605) (17,412)
----------- ---------
Net deferred tax assets (liabilities) $ (4,230) $ 535
=========== =========



F-13


Movie Gallery, Inc.

Notes to Consolidated Financial Statements (continued)

6. Stockholders' Equity

Common Stock

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

In 1995, the Company registered shares of common stock with an aggregate public
offering price of $127,000,000. This common stock may be offered directly
through agents, underwriters or dealers or may be offered in connection with
business acquisitions. As of January 6, 2002, common stock of approximately
$83,000,000 was available to be issued from this registration.

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 (574,000, 67,000 and 1,383,000 for Fiscal 1999, 2000 and 2001,
respectively). No adjustments were made to net income in the computation of
basic or diluted earnings per share.

Stock Option Plan

In July 1994, the Board of Directors adopted, and the stockholders of the
Company approved, the 1994 Stock Option Plan (the "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, 2,553,458 of which have been exercised as of January 6, 2002. Options
granted under the Plan have a ten-year term and generally vest over three to
five years.

In accordance with the provisions of FASB Statement No. 123, "Accounting for
Stock-Based Compensation," the Company applies Accounting Principles Board
Opinion No. 25 and related interpretations in accounting for the Plan and,
accordingly, has not recognized compensation cost in connection with the Plan.
If the Company 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 reduced to the pro forma amounts
indicated in the table below. 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.

F-14



Movie Gallery, Inc.

Notes to Consolidated Financial Statements (continued)



Fiscal Year Ended
-----------------------------------------
January 2, December 31, January 6,
2000 2000 2002
-----------------------------------------
(in thousands, except per share data)


Pro forma net income $ 3,801 $ 8,496 $ 18,376
Pro forma earnings per share:
Basic 0.13 0.33 0.71
Diluted 0.13 0.33 0.68



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
-----------------------------------------
January 2, December 31, January 6,
2000 2000 2002
-----------------------------------------

Expected volatility 0.720 0.703 0.706
Risk-free interest rate 6.39% 5.15% 5.41%
Expected life of option in years 6.0 5.7 5.5
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
the Company's 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 management's
opinion, the existing models do not necessarily provide a reliable single
measure of the fair value of its 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. The Company 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, the Company 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-15



Movie Gallery, Inc.

Notes to Consolidated Financial Statements (continued)

A summary of the Company's stock option activity and related information is as
follows:



Weighted
Outstanding Average Exercise
Options Price Per Share
----------- ----------------

Outstanding at January 4, 1999 4,925,023 $4.32
Granted 999,000 1.94
Exercised (27,788) 1.72
Cancelled (773,014) 1.85
---------

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
=========

Exercisable at January 2, 2000 3,241,960 5.35
=========
Exercisable at December 31, 2000 3,755,941 5.02
=========
Exercisable at January 6, 2002 2,236,021 6.39
=========


Options outstanding as of January 6, 2002 had a weighted-average remaining
contractual life of 6.3 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 2,319,609 619,650 506,250
Weighted-average exercise price $1.64 $7.40 $15.50
Weighted-average remaining contractual life 7.6 years 3.5 years 3.5 years
Options exercisable 1,110,121 619,650 506,250
Weighted-average exercise price of
exercisable options $1.67 $7.40 $15.50


F-16

Movie Gallery, Inc.

Notes to Consolidated Financial Statements (continued)

7. Commitments and Contingencies

Rent expense for Fiscal 1999, 2000 and 2001 totaled $41,683,000, $45,132,000 and
$50,985,000, respectively. Future minimum payments under noncancellable
operating leases which contain renewal options and escalation clauses with
remaining terms in excess of one year consisted of the following at January 6,
2002 (in thousands):

2002 $ 48,584
2003 42,587
2004 31,454
2005 20,189
2006 10,051
Thereafter 17,439
---------
$ 170,304
=========

The Company has a supply contract with Rentrak Corporation ("Rentrak") which
requires the Company to order VHS rental inventory under lease sufficient to
require an aggregate minimum payment of $4 million per year in revenue sharing,
handling fees, sell through fees and end-of-term buyout fees. The agreement
expires in 2006. In March 2001, the Company and Rentrak amended the terms of the
Company's existing supply contract with Rentrak. The Company paid Rentrak $1.6
million in connection with the amendment to the contract. Additionally, the
Company prepaid approximately $.9 million to be applied over a three-year period
against future amounts due under the contract.

The Company is a defendant in certain putative class action lawsuits alleging
that the extended viewing fees charged for keeping rental products beyond the
initial rental period are penalties in violation of certain common law and
equitable principles. The dollar amounts that the plaintiffs seek is not set
forth in the complaints. The Company believes that the extended viewing fees do
not violate any laws and intends to vigorously defend these lawsuits.

The Company is occasionally involved in litigation in the ordinary course of its
business, none of which, individually or in the aggregate, is material to the
Company's business or results of operations.

F-17


Movie Gallery, Inc.

Notes to Consolidated Financial Statements (continued)


8. Foreign Operations

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


Fiscal Year Ended
-----------------
January 6,
2002
-----------------
(in thousands)

Revenues:
United States $ 367,637
Canada 1,494
------------
Total revenues $ 369,131
============
Operating income:
United States $ 26,696
Canada 474
------------
Total operating income $ 27,170
============
Assets (at end of fiscal year):
United States $ 258,691
Canada 11,441
------------
Total assets $ 270,132
============


F-18


Movie Gallery, Inc.

Notes to Consolidated Financial Statements (continued)

9. Summary of Quarterly Results of Operations (Unaudited)

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



Thirteen Weeks Ended
---------------------------------------------------------------
April 2, July 2, October 1, December 31,
2000 2000 2000 2000
---------------------------------------------------------------

Revenues $ 81,493 $ 77,345 $ 75,350 $ 84,748
Operating income $ 7,478 $ 4,237 $ 1,893 $ 6,082
Net income $ 3,900 $ 1,935 $ 561 $ 3,090
Basic and diluted earnings per share $ 0.14 $ 0.08 $ 0.02 $ 0.12

Fourteen
Thirteen Weeks Ended Weeks Ended
------------------------------------------------- ------------
April 1, July 1, September 30, January 6,
2001 2001 2001 2002
------------------------------------------------- ------------
Revenue $ 91,571 $ 82,987 $ 86,467 $ 108,106
Operating income $ 7,413 $ 2,600 $ 2,750 $ 14,407
Income before extraordinary item $ 4,019 $ 1,104 $ 1,271 $ 8,139
Extraordinary loss on early
extinguishment of debt - (177) - -
-------- -------- -------- ----------
Net income $ 4,019 $ 927 $ 1,271 $ 8,139
======== ======== ======== ==========

Basic earnings per share:
Income before extraordinary item $ 0.16 $ 0.04 $ 0.05 $ 0.30
Extraordinary loss on early
extinguishment of debt - - - -
-------- -------- -------- ----------
Net income $ 0.16 $ 0.04 $ 0.05 $ 0.30
======== ======== ======== ==========

Diluted earnings per share:
Income before extraordinary item $ 0.16 $ 0.04 $ 0.05 $ 0.28
Extraordinary loss on early
extinguishment of debt - - - -
-------- -------- --------- ----------
Net income $ 0.16 $ 0.04 $ 0.05 $ 0.28
======== ======== ========= ==========




F-19




Movie Gallery, Inc.

Schedule II -Valuation and Qualifying Accounts
(in thousands)


Balance at Additions Charged Balance at
December 31, to Costs and January 6,
Description 2000 Expenses Deductions(3) 2002
- ----------- ----------- ----------------- ------------- ----------


Rental inventory reserve (1) $ - $ 2,100 $ - $ 2,100
Exit cost reserve (2) $ - $ 1,257 $ (23) $ 1,234

- ------------------------------

(1) Reserve is deducted from net book value of rental inventory in the balance
sheet.
(2) Reserve established in conjunction with Video Update acquisition. Includes
employee termination costs, rent and utilities.
(3) Actual payments made against exit cost reserve.




F-20




Index to Exhibits


Exhibit No. Description
---------- -----------

21 List of Subsidiaries

23 Consent of Ernst & Young LLP, Independent Auditors