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

FORM 10-K

Commission file number 0-24548

MOVIE GALLERY, INC.
(Exact name of registrant as specified in its charter)

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

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

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

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

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

Documents incorporated by reference:

1.

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

The exhibit index to this report appears on page 37.

ITEM 1.    BUSINESS

Our Company

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

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

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

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

Industry Overview

Home Video Industry

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

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

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

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

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

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

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



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



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



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



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further interdependence of movie studios and video retailers.

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

Video Game Industry

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

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

Competitive Strengths

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

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

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

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

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negotiating favorable lease terms;



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centralized purchasing;



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reduced labor costs;



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stringent expense controls; and



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sophisticated information systems.

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

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



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



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inventory management; and



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

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

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

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

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

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

Growth Strategy

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

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

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



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adopting merchandising and pricing initiatives; and



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achieving targeted cost savings.

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

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

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



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



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



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entry into new markets is facilitated.

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

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strategic fit and desirability of location;



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price;



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ability to improve productivity and profitability; and



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

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

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

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

Products

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

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



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Video game rentals: 10%;



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



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Concessions, accessories and other: 4%; and



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

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

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

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

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

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

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

Store Operations

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

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

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

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

Site Selection

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

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

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

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

Marketing and Advertising

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

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

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

E-Commerce

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

Studio and Distribution Relationships

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

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

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

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

Inventory Management and Distribution Facility

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

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

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

Management Information Systems

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

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

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

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Competition

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

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

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

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

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



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



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



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

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Seasonality

        There is a distinct seasonal pattern to the home video business. Compared to other months during the year, we experience peak revenues during the months of November, December and January due to the holidays in these months as well as inclement weather conditions. Additionally, revenues generally rise in the months of June, July and August when most schools are out of session, providing people with additional discretionary time to spend on entertainment.

Intellectual Property

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

Foreign Operations

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

Employees

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

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

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

Available Information

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

Cautionary Statements

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

12

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

We may be unable to successfully implement our growth strategy

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

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

•

our ability to identify and secure new sites;



•

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



•

the availability of capital; and



•

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

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

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

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

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

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•

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



•

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



•

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



•

increased competition for acquisitions;



•

misrepresentations and breaches of contracts by sellers;



•

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



•

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



•

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

Our business could be adversely affected by increased competition

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

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

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

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

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

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

14

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

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

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

•

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



•

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



•

control shrinkage resulting from theft, loss or obsolescence.

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

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

Our business may be negatively impacted by new and existing technologies

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

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

15

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

•

consumer demand for our products;



•

prices at which we can rent or sell our products;



•

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



•

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



•

seasonality;



•

acquisitions by us of existing stores;



•

variations in the timing and number of store openings;

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•

profitability of new stores;



•

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



•

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

The market price for our common stock may fluctuate substantially

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

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

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

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

Directors and Executive Officers

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

(1)

Member of our Executive Committee.

(2)

Member of our Compensation Committee.

(3)

Member of our Audit Committee.

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

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

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

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

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

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

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

19

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

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

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

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ITEM 2.    PROPERTIES

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

21

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

ITEM 3.    LEGAL PROCEEDINGS

        We were a defendant in one putative class action lawsuit in Alabama, Sable Denise Mack, et. al. v. M.G.A., Inc., filed on December 8, 2000 in the Circuit Court of Tuscaloosa County, Alabama; one putative class action lawsuit filed on August 17, 2001 in the 71^st Judicial District Court, Harrison County, Texas, Shannon Thompson, et. al. v. M.G.A., Inc.; and one putative class action lawsuit filed on December 3, 2001, in the Chancery Court of Fayette County, Tennessee, Michael McCullar, et al. v. Movie Gallery, Inc., et al. Each of these lawsuits alleged, on behalf of a nationwide class of all customers, that the extended viewing fees we charged our customers for keeping our rental products beyond the initial rental period were penalties in violation of common law and equitable theories. The dollar amounts that plaintiffs sought in each of the foregoing three putative class action lawsuits was not set forth in the complaints.

        In April 2002, we obtained a court order preliminarily approving a settlement agreement between us and the plaintiffs in the Tennessee case, by which we agreed to settle claims of all of the members of the nationwide class of customers. Under the terms of the settlement agreement, we were required to give class members certificates with values ranging from $9 to $16, redeemable between January 30, 2003 and June 30, 2003, for movie rentals, game rentals, and non-food purchases in our stores. We also agreed to pay the plaintiffs' attorneys up to $850,000 in fees. A fairness hearing regarding this settlement was held on November 22, 2002. At this hearing, the court determined that the settlement was fair, and the court approved the terms of the settlement. The settlement released all claims made by all class members in all the pending class actions, other than a de minimis number of members who chose not to participate in the settlement. The court's order approving the settlement has become final and non-appealable. We are currently implementing the terms of the settlement.

        We incurred a one-time charge to our earnings of approximately $4 million in the second quarter of 2002, as a result of the settlement agreement described above, which amount includes $850,000 of plaintiffs' attorneys' fees.

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

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

        None.

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PART II

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

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

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

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

ITEM 6.    SELECTED FINANCIAL DATA

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

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(1)

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

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(2)

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

(3)

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

(4)

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

(5)

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

(6)

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

(7)

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

(8)

Adjusted EBITDA is defined as earnings before interest, taxes, depreciation and amortization, non-cash compensation and nonrecurring items, less purchases of rental inventory exclusive of rental inventory purchases specifically for new store openings. Adjusted EBITDA is presented not as an alternative measure of operating results or cash flow from operations (as determined in accordance with accounting principles generally accepted in the United States), but because it is a widely accepted financial indicator in the home video specialty retail industry of a company's ability to incur and service debt assuming rental inventory is expensed upon purchase instead of being capitalized and amortized. Our calculation of Adjusted EBITDA is not necessarily comparable to reported EBITDA and/or Adjusted EBITDA of other companies due to lack of uniform definitions of EBITDA and Adjusted EBITDA. Our calculation of Adjusted EBITDA for the periods indicated is set forth below:

(9)

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

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

Results of Operations

        The following table sets forth, for the periods indicated, statements of income data and Adjusted EBITDA expressed as a percentage of total revenue. Results for fiscal 2001 reflect a 53-week year.

Statements of Income Data:

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

        Revenue.    For fiscal 2002, total revenues increased 43.3% to $529.0 million from $369.1 million in fiscal 2001. The increase for the year was due primarily to a 3.2% increase in same store revenues and a 45.5% increase in the average number of stores operated during fiscal 2002 versus fiscal 2001. The increase in same store revenues was the result of: (i) continued growth of DVD rental and sales revenue; (ii) increases in the sales of previously viewed movies and previously played games; (iii) higher video game rental revenues driven by growth in the video game industry and consumer acceptance of new platforms released late in 2001; and (iv) a favorable new movie release schedule in fiscal 2002 versus fiscal 2001. The revenue increase was partially offset by (i) a significant decline in rental revenue from VHS product due to the continued consumer transition to DVD; (ii) unfavorable weather during the first half of 2002 as compared to the first half of 2001; (iii) the broadcast of the Winter Olympics during the first quarter of 2002; and, (iv) an extra week of revenues (totaling approximately $10.0 million) in fiscal 2001.

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        In the first quarter of 2002, we began reporting the sale of previously viewed rental inventory as rental revenue and the related cost as cost of rental revenue. The sales and costs associated with previously viewed rental inventory were previously reported as product sales and cost of product sales, respectively. The sales and costs of previously viewed rental inventory in prior periods have been reclassified to conform to the current year presentation for comparative purposes. The reclassifications had no impact on total revenues, gross margins or net income as previously reported. Additionally, the non-cash cost (unamortized book value) of previously viewed rental inventory sold has been reclassified on the statement of cash flows to be reported with rental inventory amortization. These costs were previously netted against purchases of rental inventory as investing activities in the statement of cash flows. The current presentation is more consistent with the classification of these costs in the income statement and discloses the gross rental inventory purchases, before the write-off of previously viewed inventory sold, on the face of the statement of cash flows. The amounts reclassified on the statements of cash flows for fiscal 2000 and 2001 are as follows (in thousands):

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

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

        Operating Costs and Expenses.    Store operating expenses, which include store-level expenses such as lease payments and in-store payroll, increased to 48.0% of total revenue for fiscal 2002 from 46.4% in fiscal 2001. The increase in store operating expenses as a percentage of total revenue was primarily due to a higher cost structure associated with the 324 Video Update stores acquired in December 2001 and the benefits in fiscal 2001 of an extra week of revenues. The increase was offset partially by: (i) continued initiatives to reduce operating costs; (ii) strong performance of new stores; (iii) continued closure of under-performing units; and (iv) the same store revenues increase of 3.2% in fiscal 2002.

        General and administrative expenses as a percentage of revenue decreased to 7.8% in fiscal 2002 from 7.9% in fiscal 2001. General and administrative expenses include a legal settlement charge of $4.0 million in the second quarter of 2002 regarding our extended viewing fee policy and a charge of $1.6 million related to an amendment of our supply agreement with Rentrak Corporation in the first

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

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

        Stock option compensation expense represents the non-cash charge associated with certain stock options that were repriced during the first quarter of fiscal 2001 and are subsequently accounted for as variable stock options under FASB Interpretation No. 44, Accounting for Certain Transactions involving Stock Compensation, an interpretation of APB Opinion No. 25 (see Note 7 to our consolidated financial statements). We expect to continue to record adjustments to income from stock option compensation in future periods.

        Interest expense includes fees for the unused borrowings available under our credit facility and amortization of the associated debt issue costs, as well as the costs of any outstanding borrowings under our credit facility, net of interest income. Interest expense as a percentage of total revenue decreased to 0.2% in fiscal 2002 from 0.8% in fiscal 2001. The decrease was primarily due to the repayment of all outstanding debt in May 2002.

        As a result of the impact of the above factors on revenues and expenses, operating income increased by 32.1% in fiscal 2002 to $35.9 million from $27.2 million in fiscal 2001. The increase includes the benefit of lower stock option compensation expense in fiscal 2002 and was partially offset by the legal settlement charge and the charge to amend a supply contract.

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

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

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

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

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

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

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

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

        Stock option compensation expense represents the non-cash charge associated with certain stock options that were repriced during the first quarter of fiscal 2001 and are subsequently accounted for as variable stock options under FASB Interpretation No. 44, Accounting for Certain Transactions involving Stock Compensation, an interpretation of APB Opinion No. 25 (see Note 7 to our consolidated financial statements). We expect to record adjustments to income from stock option compensation in future periods.

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

General Economic Trends, Quarterly Results of Operations and Seasonality

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

•

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



•

public acceptance of, interest in, and availability of, newly released movies;



•

our mix of products rented versus sold;



•

marketing programs and new release acquisition costs;

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•

seasonality—compared to other months during the year, we experience peak revenues during the months of November, December and January due to the holidays in these months as well as inclement weather conditions. Additionally, revenues generally rise in the months of June, July and August when most schools are out of session, providing people with additional discretionary time to spend on entertainment; and



•

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

Liquidity and Capital Resources

        Our primary capital needs are for opening and acquiring new stores and for purchasing inventory. Other capital needs include refurbishing, remodeling and relocating existing stores and refreshing, rebranding and supplying new computer hardware for acquired stores. We fund inventory purchases, remodeling, rebranding and relocation programs, new store opening costs and acquisitions primarily from cash flow from operations, proceeds from our recent common stock offering and, if necessary, loans under revolving credit facilities. At January 5, 2003, we had cash and cash equivalents of $39.5 million, no long-term debt and $64.5 million in available borrowings under our credit facility.

        During fiscal 2002 we generated approximately $82.3 million in Adjusted EBITDA, a 33.6% increase over the prior year. For fiscal 2001, our Adjusted EBITDA increased to $61.6 million, a 54.9% increase over $39.7 million in fiscal 2000. These increases were primarily driven by the revenue increases during those periods while achieving economies of scale within our expense structure. Adjusted EBITDA is defined as earnings before interest, taxes, depreciation and amortization, non-cash compensation and nonrecurring items, less our purchases of rental inventory which excludes rental inventory purchases specifically for new store openings. Adjusted EBITDA is presented not as an alternative measure of operating results or cash flow from operations (as determined in accordance with accounting principles generally accepted in the United States), but because, in the home video specialty retail industry, it is a widely accepted financial indicator of a company's ability to incur and service debt assuming rental inventory is expensed upon purchase instead of being capitalized and amortized. Our calculation of Adjusted EBITDA is not necessarily comparable to reported EBITDA and/or Adjusted EBITDA of other companies due to the lack of uniform definitions of EBITDA and Adjusted EBITDA. (See Selected Financial Data in Part II, Item 6 of this Form 10-K for our calculation of Adjusted EBITDA.)

        We fund short-term working capital needs, including the purchase of rental inventory, primarily through cash flow from operations. Net cash provided by operating activities was $186.7 million, $144.0 million and $110.8 million for fiscal 2002, 2001 and 2000, respectively. Net cash provided by operating activities continues to be sufficient to cover rental inventory replenishment, capital resource and debt service needs.

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

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

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

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

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

        We grow our store base through internally developed and acquired stores. We opened 145 internally developed stores during fiscal 2002 and expect to open between 175 and 200 new stores in 2003. We acquired 265 stores during fiscal 2002. We will continue to evaluate acquisition opportunities in 2003 as they arise. To the extent available, new stores and future acquisitions may be completed using funds available under our credit facility, financing provided by sellers, alternative financing arrangements such as funds raised in public or private debt or equity offerings or shares of our stock issued to sellers. However, we cannot assure you that financing will be available to us on terms which will be acceptable, if at all.

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

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

        At January 5, 2003, we had a working capital deficit of $33.6 million, due to the accounting treatment of rental inventory. Rental inventory is treated as a noncurrent asset under accounting principles generally accepted in the United States because it is a depreciable asset and a portion of this asset is not reasonably expected to be completely realized in cash or sold in the normal business cycle. Although the rental of this inventory generates the major portion of our revenue, the classification of this asset as noncurrent results in its exclusion from working capital. The aggregate amount payable for this inventory, however, is reported as a current liability until paid and, accordingly, is included in working capital. Consequently, we believe that working capital is not an appropriate measure of our liquidity and we anticipate that we will continue to operate with a working capital deficit.

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

(1)

The total commercial commitment under our credit facility is $65 million, which expires on July 4, 2004. As of January 5, 2003, there were standby letters of credit outstanding under the credit facility of $537,000, of which $325,000 expired on March 14, 2003 and $212,000 expires on June 27, 2003.

        We believe our projected cash flow from operations, cash on hand, borrowing capacity under our credit facility and trade credit will provide the necessary capital to fund our current plan of operations, including our anticipated new store openings and acquisition program, through fiscal 2003. However, to fund a major acquisition, or to provide funds in the event that our need for funds is greater than expected, or if the financing sources identified above are not available to the extent anticipated or if we increase our growth plan, we may need to seek additional or alternative sources of financing. This financing may not be available on satisfactory terms. Failure to obtain financing to fund our expansion plans or for other purposes could have a material adverse effect on our operating results.

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

Critical Accounting Policies

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

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

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

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

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

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

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

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

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

Related Party Transactions

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

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

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

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

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

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Recently Issued Accounting Pronouncements

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

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

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

Forward-Looking Statements

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

ITEM 7A.    QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

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

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

ITEM 8.    FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

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

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

        None.

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PART III

ITEM 10.    DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

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

ITEM 11.    EXECUTIVE COMPENSATION

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

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

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

ITEM 13.    CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

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

ITEM 14.    CONTROLS AND PROCEDURES

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

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

36

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

37

(1)

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

(2)

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

(3)

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

(4)

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

(5)

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

(6)

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

(7)

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

(8)

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

(9)

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

(10)

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

(11)

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

(12)

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

(b)  Reports on Form 8-K:

        None.

(c)  Exhibits:

        See (a)(3) above.

ITEM 16.    PRINCIPAL ACCOUNTANT FEES AND SERVICES

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

38

SIGNATURES

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

Date: April 7, 2003

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

39

MOVIE GALLERY, INC.

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

CERTIFICATION

        I, J. T. Malugen, certify that:

1.

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

2.

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

3.

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

4.

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

(a)

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

(b)

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

(c)

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

5.

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

(a)

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

(b)

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

6.

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

40

CERTIFICATION

        I, J. Steven Roy, certify that:

1.

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

2.

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

3.

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

4.

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

(a)

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



(b)

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



(c)

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

5.

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

(a)

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



(b)

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

6.

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

41

Movie Gallery, Inc.

Consolidated Financial Statements

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

CONTENTS

F-1

Report of Ernst & Young LLP, Independent Auditors

Board of Directors and Stockholders
Movie Gallery, Inc.

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

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

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

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

                                                                                                                            /s/ Ernst & Young LLP

Birmingham, Alabama
February 13, 2003

F-2

Movie Gallery, Inc.

Consolidated Balance Sheets

(in thousands)

See accompanying notes.

F-3

Movie Gallery, Inc.

Consolidated Statements of Income

(in thousands, except per share data)