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

                                    FORM 10-K

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

              For the fiscal year ended January 3, 1999

                                       OR

     [ ]      TRANSITION  REPORT  PURSUANT  TO  SECTION  13 OR  15(d)  OF THE
              SECURITIES EXCHANGE ACT OF 1934

              For the transition period from _______________ to _______________.

                         Commission file number: 0-24548

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

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

   739 W. Main Street, Dothan, Alabama                     36301
 (Address of principal executive offices)               (Zip Code)

                                 (334) 677-2108
              (Registrant's Telephone Number, Including Area Code)

        Securities registered pursuant to Section 12(b) of the Act: None

           Securities registered pursuant to Section 12(g) of the Act:
                          Common Stock, $.001 par value
                                (Title of class)

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

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

     The aggregate  market value of the voting stock held by  non-affiliates  of
the registrant as of March 12, 1999, was approximately  $34,937,024.  The number
of shares of Common Stock outstanding on March 12, 1999, was 13,230,915 shares.

     Documents incorporated by reference:

  1. Notice of 1999 Annual Meeting and Proxy Statement (Part III of Form 10-K).

--------------------------------------------------------------------------------
              The exhibit index to this report appears at page 29.

<PAGE>


ITEM 1.  BUSINESS

General

     As of March  12,  1999,  Movie  Gallery,  Inc.  (the  "Company")  owned and
operated 828 video specialty  stores and had 94 licensees  located in 22 states,
primarily  in the  eastern  half  of the  United  States,  that  rent  and  sell
videocassettes  and video games.  Since the Company's initial public offering in
August  1994,  the Company has grown from 97 stores to its present  size through
acquisitions  and the development of new stores.  The Company is among the three
largest video specialty retailers in the United States.

     The Company was  incorporated in Delaware in June 1994 under the name Movie
Gallery,  Inc. From March 1985 until the present time,  substantially all of the
Company's  operations have been conducted  through its wholly-owned  subsidiary,
M.G.A.,  Inc. The Company's executive offices are located at 739 W. Main Street,
Dothan, Alabama 36301, and its telephone number is (334) 677-2108.

Video Industry Overview

     Video Retail  Industry.  According to Paul Kagan  Associates,  Inc.  ("Paul
Kagan"), the home video rental and sales industry has grown from $0.7 billion in
revenue in 1982 to a projected  $16.8  billion in 1998 and is projected to reach
$24.3  billion  by 2008.  Paul Kagan  estimates  that in 1998  consumers  rented
approximately  3.2 billion  videos,  a 4% increase over 1997, and purchased more
than 600 million videos.  In fact, at the end of 1998 over 83% of all television
households  owned a videocassette  recorder ("VCR") and total VCR penetration is
expected to approach 90% within the next ten years,  according to Paul Kagan. In
addition,  total VCR sales in the U.S.  have  increased  in each year during the
decade of the 1990s and are  anticipated  to reach their  highest  level ever in
1999, according to Paul Kagan.

     The concept of revenue sharing and risk sharing between major retailers and
the movie  studios was  embraced by the industry in 1998.  Revenue  sharing is a
concept whereby  retailers and movie studios share the risks associated with the
rental  performance  of  individual  titles.  Generally,  retailers  pay a small
upfront fee for each copy leased under revenue sharing,  typically $0 to $10. As
the movies are rented by  consumers,  the movie studio  receives a percentage of
the revenue generated based on a predetermined  formula, which is generally less
than  fifty  percent.  After a period of time,  generally  six months to a year,
these  movies  are no longer  subject to revenue  sharing  and are either  owned
outright by the Company, purchased from the movie studio for a nominal amount or
returned to the studio. Revenue sharing allows retailers to vastly increase both
copy depth and  breadth  for the  consumers.  The  increased  product  serves to
potentially  recapture  lost customers who had become  disenfranchised  with the
movie  rental  experience  due to the  unavailability  of the  most  recent  new
releases of movies.  Paul Kagan  projects that total  revenues for the industry,
including both rental and sell-through,  increased by 6.8% in 1998 to nearly $17
billion.  In fact,  Paul  Kagan  estimates  that the  combination  of rental and
sell-through  revenue  for both VHS tapes and DVD disks  will grow at a compound
annual rate of over 3% for the next ten years.

     The video retail industry is highly  fragmented and continues to experience
consolidation  pressures.  Trends toward  consolidation  have been fueled by the
competitive  impact of superstores on smaller  retailers,  the need for enhanced
access to working capital and  efficiencies of scale.  The Company believes that
the video  specialty  store industry is continuing to consolidate  into regional
and national chains.  While many of the largest retail chains posted  same-store
revenue growth,  industry  sources  speculated that many  independent  operators
struggled to maintain market share. The combination of revenue sharing and other
copy  depth   opportunities  and  increased  marketing  efforts  solidified  the
positions of the largest retail chains versus independent operators.

                                       2
<PAGE>

     The  domestic  video  retail  industry  includes  both rentals and sales of
videocassettes; however, the majority of revenue is generated through the rental
of prerecorded  videocassettes.  There are three primary pricing strategies that
the movie studios use to influence the relative levels of videocassette  rentals
versus sales.  First,  videocassettes  can be priced at relatively  high levels,
typically  between  $60 and $75  ("rental  priced  movies").  These  movies  are
purchased by video specialty stores and are promoted primarily as rental titles.
Second, videocassettes can be priced at relatively low levels, typically between
$5 and  $25  ("sell-through  movies").  These  movies  are  purchased  by  video
specialty  stores and generally  promoted for both rental and new  videocassette
sales.  Third,  in an effort to  enhance  customer  satisfaction  with the video
rental experience, movie studios have developed revenue sharing programs. Movies
under revenue sharing programs,  as previously  discussed,  result in quantities
purchased that are similar to  sell-through  movies.  During late 1997 and 1998,
movie studios greatly  increased their revenue sharing  programs.  Movie studios
attempt to maximize total revenue from  videocassette  releases via the combined
utilization of all three pricing structures.

     The increase in sell-through priced movies and revenue sharing programs has
greatly increased the availability of previously viewed movies. These movies are
made available to the consumer for sale once initial rental demand is met.

     Movie Studio Dependence on Video Rental Industry.  The videocassette rental
and sales  industry is the largest  single  source of domestic  revenue to movie
studios and independent suppliers of theatrical and direct-to-video  movies and,
according to Paul Kagan, represented  approximately $6.7 billion, or 49%, of the
$13.8  billion of revenue  generated in 1998.  The Company  believes that of the
many movies  produced by major  studios and  released in the United  States each
year,  relatively few are profitable for the studios based on box office revenue
alone. In addition to purchasing box office hits, video specialty stores provide
the movie studios with a reliable  source of revenue for a large number of their
movies by purchasing movies on videocassette that were not successful at the box
office.  The Company  believes  the consumer is more likely to view movies which
were not box  office  hits on a rented  videocassette  than on any other  medium
because video  specialty  stores  provide an inviting  opportunity to browse and
make impulse choices among a very broad selection of movie titles.  In addition,
the  Company  believes  the  relatively  low  cost of video  rentals  encourages
consumers to rent films they might not pay to view at a theater.

     Historically,  new  technologies  have led to the  creation  of  additional
distribution  channels for movie  studios.  Movie studios seek to maximize their
revenue by releasing  movies in  sequential  release  date  "windows" to various
movie  distribution  channels.  These  distribution  channels  include,  in  the
customary  order of release date,  movie  theaters,  airlines and hotels,  video
specialty   stores,   pay-per-view   satellite  and  cable  television   systems
("Pay-Per-View"), premium cable television, basic cable television and, finally,
network  and  syndicated   television.   (See   "Business  --  Competition   and
Technological Obsolescence") The Company believes that this method of sequential
release  has  allowed  movie  studios  to  increase  their  total  revenue  with
relatively  little  adverse  effect  on  the  revenue  derived  from  previously
established  distribution channels and it is anticipated that movie studios will
continue  the  practice  of  sequential  release  even as near  video on  demand
("NVOD") and, eventually,  video on demand ("VOD") become more readily available
to the consumer.  According to Paul Kagan,  most movie studios release hit movie
videocassettes to the home video market from 30 days to 80 days (extending up to
120 days for certain  titles  priced for sale rather than  rental)  prior to the
Pay-Per-View  release date. A mid-1998 study  conducted by Paul Kagan found that
movie studios and other independent suppliers of movies to the home video market
had increased their average  exclusive  windows for home video by 10% to 55 days
in 1998  versus 50 days in 1997.  This  level of  commitment  to the home  video
industry is indicative of the importance of this channel of  distribution to the
overall profitability of movie studios and other independent movie suppliers.


                                       3
<PAGE>

Growth Strategy

     During  the  fiscal  years  1994  through  1996,  approximately  78% of the
Company's  growth in total number of stores occurred  through the acquisition of
stores and the balance  occurred  through  the  development  of new stores.  The
Company spent all of 1997 and much of 1998  absorbing the large  increase in the
number of stores  which began in 1994.  The Company  expects to  accelerate  its
growth  rate in 1999  and is  currently  planning  to open up to 100 new  stores
during the year  primarily in secondary and rural  markets.  It is expected that
development  of  new  stores  will  account  for a  substantial  portion  of the
Company's  growth  although  the  Company  may  make  selective,  accretive  and
strategically  consistent  acquisitions,   provided  these  acquisitions  exceed
targeted  levels of return on  capital.  The  Company's  ability to execute  its
stated growth  strategy will be dependent upon its ability to generate cash flow
from operations.  The key elements of the Company's  development and acquisition
strategy include the following:

     Development.  From January 1, 1994 through March 12, 1999,  the Company has
developed 237 stores.  The Company utilizes store  development to complement its
existing base of stores in rural and secondary markets where it finds attractive
locations and a sufficient  population  to support  additional  video  specialty
stores.  The Company  attempts to develop  real estate in 3,000 to 5,000  square
foot  locations  primarily  in towns  with  populations  from  3,000 to  60,000.
Although  developed stores generally require  approximately one year for revenue
to reach the level of a mature store,  they typically become  profitable  within
the first six months of  operations  and produce  greater  returns on investment
than acquired stores.

     The Company's real estate and construction  departments are responsible for
new store  development,  including  site  selection,  market  evaluation,  lease
negotiation and construction. The Company usually acts as the general contractor
with respect to the construction of its new stores and, in that regard,  employs
full-time  construction  managers who have  significant  video  specialty  store
construction experience.

     Set  forth  below  is  a  historical   summary   showing  store   openings,
acquisitions and store closings by the Company since January 1, 1994.

<TABLE>
<CAPTION>

                                               
                          Year Ended           Fiscal Year Ended
                         December 31,   ---------------------------------    January 4,
                         -----------    January 5,  January 4, January 3,   to March 12,
                          1994  1995       1997       1998        1999         1999
                         -----  ----    ---------   ---------  ----------   ------------

<S>                        <C>   <C>        <C>        <C>         <C>          <C>
New Store Openings          25    66         75         50          18            3
Stores Acquired            196   327        174(1)       2           4            0
Stores Closed                2    23         48         59          41           12
Total Stores at End
   of Period               292   662        863        856         837          828
<FN>
________________________
(1)  Includes  98  stores  acquired  on  July  1,  1996  and  accounted  for  as
     poolings-of-interests. Store counts, prior to the fiscal year ended January
     5, 1997, have not been restated for purposes of this table. For total store
     counts at the end of the fiscal years 1994 through 1996,  see "Overview" in
     Item 7.
</FN>
</TABLE>

     Acquisitions.  From  January 1, 1994 through  March 12,  1999,  the Company
acquired 703 stores.  Acquisitions  permitted the Company to quickly gain market
share and  experienced  management  in markets  that the  Company  believed  had
potential for growth. Through a combination of volume purchase discounts, larger
advertising credits, more efficient inventory management and lower average labor
costs,  the Company  believes it is  generally  able to operate  these  acquired
stores more profitably than their prior owners,  typically single store or small
chain  operators.  During the latter  portion of the third quarter of 1996,  the


                                       4
<PAGE>

Company suspended its acquisition program,  primarily in order to concentrate on
improving  operations  at the stores it had acquired and  developed  from August
1994 through July 1996.  The Company  acquired four stores in new markets during
1998.  Additionally,  the  Company  purchased  the  business of nine other video
stores within  existing  Company  markets,  and  subsequently  consolidated  the
acquired and existing stores in each market into one location.  During 1999, the
Company  intends to  carefully  evaluate  strategic  acquisitions  that are both
accretive and provide for market  penetration  or increased  market share within
cities and towns that are consistent with its strategy.

     Future store acquisitions will be selected based upon location,  quality of
operations and financial  criteria as determined by the Company to be consistent
with its growth strategy.  In connection with future  acquisitions,  the Company
anticipates  that  some of the  owners  and  most of the key  personnel  will be
employed by the Company.  Historically, the owners of the stores acquired by the
Company have entered into  noncompetition  agreements with the Company which are
generally for a five- to ten-year term.

     The Company  recently  entered into a definitive  agreement to purchase the
assets  and assume the leases of  approximately  90 stores  operated  by Blowout
Entertainment, Inc. ("Blowout") for an aggregate purchase price of approximately
$2.4  million,  subject to  adjustments  under  certain  circumstances.  Blowout
operates video stores within large  retailers such as Wal-Mart.  The acquisition
is expected to close within the second quarter of 1999. The  consummation of the
acquisition is subject to a number of closing conditions,  including the receipt
of an order from a  bankruptcy  court  approving  the  transaction.  The Company
anticipates  that other  acquisition  opportunities  will  arise in the  future.
However, there can be no assurance that future acquisition opportunities will be
available or that the integration of future acquisitions will not materially and
adversely affect the Company.

Operating Strategy

     Focus on Smaller  Markets.  Generally,  the Company's stores are located in
small towns or suburban areas surrounding  mid-sized cities. In these areas, the
Company's principal  competition usually consists of single store or small chain
operators who have less buying power,  smaller advertising budgets and generally
offer fewer copies of new release videocassettes. The Company attempts to become
the leading  video  retailer in its markets and  believes  that it can achieve a
higher return on invested  capital in these smaller markets than it could in the
larger  urban  areas  because  of the  reduced  level of  competition  and lower
operating costs.

     Market  Concentration.  By concentrating  its new store  development in and
around existing markets, the Company is able to achieve operating  efficiencies,
primarily consisting of cost savings relating to advertising, training and store
supervision.

     New Release  Purchases.  The Company actively manages its new videocassette
purchases  in  order  to  balance  customer  demand  with  the  maximization  of
profitability.  Buying  decisions are made centrally which allows the Company to
obtain volume discounts,  market  development funds and cooperative  advertising
credits  that are  generally  not  available  to  single  store  or small  chain
operators.

     Centralized  Operations.  In order to increase  operating  efficiency,  the
Company centrally  manages labor costs,  real estate costs,  accounting and cash
management and utilizes  centralized  purchasing,  advertising  and  information
systems.  A  Company-wide  quality  assurance  program  insures a high degree of
customer  service and  visually  appealing  stores.  The Company  believes  this
program increases customer satisfaction and loyalty.

     Store Location and Format.  The Company  maintains a flexible store format,
tailoring the size, inventory and look of each store to local demographics.  The
Company's stores generally range from  approximately  2,000 to 9,000 square feet
(averaging  approximately  4,800 square  feet),  with  inventories  ranging from
approximately 4,000 to 15,000 videocassettes. Substantially all of the Company's
stores are located in strip centers,  anchored by major grocery or discount drug
store chains, which provide easy access, good visibility and high traffic.

                                       5
<PAGE>

Movie Gallery Stores

     At March 12, 1999,  the Company owned and operated 828 stores,  all but one
of  which  were  located  in  leased  premises.  The  following  table  provides
information  at March 12, 1999 regarding the number of Company stores located in
each state.

                                                                        Number
                                                                          Of
                                                                        Stores
                                                                        ------

    Alabama............................................................. 137
    Florida............................................................. 108
    Texas ..............................................................  83
    Georgia.............................................................  65
    Virginia............................................................  53
    Ohio................................................................  47
    Maine...............................................................  43
    Tennessee...........................................................  41
    Indiana.............................................................  34
    Mississippi ........................................................  33
    Wisconsin...........................................................  32
    South Carolina .....................................................  30
    Missouri............................................................  23
    North Carolina......................................................  21
    Kentucky............................................................  17
    Kansas..............................................................  16
    Louisiana...........................................................  13
    New Hampshire.......................................................  12
    Illinois............................................................  10
    Massachusetts.......................................................   5
    Iowa................................................................   3
    Michigan............................................................   2
                                                                         ---
                      TOTAL............................................. 828
                                                                         ===

     The Company's  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.  The
store  fixtures,  equipment  and layout are  designed by the Company to create a
visually-appealing,  up-beat  ambiance,  which is augmented  by a background  of
television  monitors  displaying  MGTV (Movie Gallery  Television),  which shows
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.

     The Company has a quality  assurance  program to ensure compliance with the
Company's  customer  service  and store  operating  policies.  A team of quality
assurance auditors located in different  geographic regions make periodic visits
to monitor  compliance  and report  results to the  Company's  Vice  President -
Support  Operations.  District  Managers and  Regional  Managers are expected to
quickly address and resolve any compliance problems.


                                       6
<PAGE>

     The Company's  policy is to constantly  evaluate its existing store base to
determine where improvements may benefit the Company's  competitive position. In
negotiating its leases and renewals,  the Company attempts to obtain short lease
terms to allow for the mobility necessary to react to changing  demographics and
other market  conditions.  The current  average  remaining life of the Company's
leases is  approximately  two years with over 200 leases  considered for renewal
each year. The Company  actively  pursues  relocation  opportunities to adapt to
market shifts. Similarly, the Company may elect to expand and/or remodel certain
of its stores in order to improve facilities,  meet customer demand and maintain
the visual  appeal of each  store.  In order to  maximize  profits,  the Company
varies the  quantity of its new release  inventory,  the rental and sales prices
for videocassettes and video games and the rental period for catalog titles from
location to location to meet competition and demographic demand in the area. The
Company  generally has a one-day rental term for new release movies less than 90
days  old  (five  days for new  releases  greater  than 90 days old and  catalog
titles),  which tends to keep new releases  more readily  available and requires
the purchase of fewer copies of new releases than a two-day rental policy. Video
games  generally  have a  five-day  rental  term for both  the most  recent  new
releases and older, catalog titles.

Licensees

     In connection with certain of its acquisitions, the Company assumed certain
obligations and benefits under license agreements.  The Company has entered into
additional  license agreements with certain former owners of acquired stores and
with  existing  licensees.  As of March 12,  1999,  the Company had 94 licensees
operating under such agreements  pursuant to which the Company  receives various
royalty and license  payments and has certain  non-monetary  obligations  to the
licensees.  For the fiscal year ended January 3, 1999,  revenues from  licensees
were not material to the Company.

Products

     For the fiscal year ended January 3, 1999, over 85% of the Company's rental
revenue was derived from the rental of videocassettes,  with the remainder being
derived  primarily  from the  rental of video  games.  Substantially  all of the
Company's  revenue  from  product  sales during this period was derived from the
sale of new and previously viewed videocassettes,  confectionery items and video
accessories, such as blank cassettes, cleaning equipment and movie memorabilia.

     The Company's  stores  generally offer from 4,000 to 15,000  videocassettes
and from 200 to 1,000 video games for rental and sale,  depending upon location.
New release movies are displayed alphabetically and catalog titles are displayed
alphabetically by category,  such as "Action," "Comedy," "Drama" and "Children."
A typical  store's  inventory  consists of 4,750 catalog movies plus new release
titles and older titles which continue to be in strong demand.  Each store has a
few special  interest  titles,  covering  such  subjects  as  hunting,  golf and
education,  selected by management to appeal to the customer base in the store's
market area.  Buying  decisions  are made  centrally and are based on box office
results,  actual  rental  history of  comparable  titles  within  each store and
industry research.

     Management  believes  that  internal  factors  which most  affect a typical
store's revenues are its new release title selection and the number of copies of
each new  release  available  for rental as  compared  to the  competition.  The
Company is  committed to offering as many copies of new releases as necessary to
be competitive within a market,  while at the same time keeping its costs as low
as possible.  New  videocassettes  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.

     In an effort to provide more depth of copy on hit titles to better  satisfy
initial  customer  demand,  certain  movie  studios in late 1997 began  offering


                                       7
<PAGE>

incentives and expanded revenue sharing plans which have lowered the average per
unit cost of rental inventory. These programs permit the Company to carry larger
levels  of  new  release   inventory.   Thus,   the  Company  has  pursued  such
opportunities  and believes that during late 1997 and 1998 these  programs had a
positive  impact  on  revenues.  There can be no  assurance  that  studios  will
continue to offer such  programs  or that such  programs  will  continue to have
positive results.

     The Company  rents and sells video games,  which are licensed  primarily by
"Nintendo,"  "Sony" and "Sega." Game rentals as a  percentage  of the  Company's
total  revenues  have  increased  since  early 1997 due to the  increase  in the
installed base of 32-bit and 64-bit game  platforms.  Sony and Sega released new
platforms in late 1995, while Nintendo  released its N64 platform in the fall of
1996.  The Sony and  Nintendo  platforms  continued  to grow during 1998 as more
households in their markets  acquired video game hardware.  The Company  expects
that the video game rental and sales  portion of its business  will  continue to
grow during 1999.

Videocassette and Video Game Suppliers

     In August 1997, the Company  executed a contract with Major Video Concepts,
Inc.  ("MVC")  by which MVC  became  the  Company's  primary  supplier  of video
inventory  requirements.  The contract was effective through March 31, 1999. The
Company is in the process of negotiating a new contract for the primary sourcing
of its  videocassette  inventory.  During  Fiscal  1998,  the Company  purchased
approximately  70% of its video  inventory  from MVC.  The Company  also sourced
product from three other major vendors during 1998.

     The  Company's  contract  with MVC  provides  for the  direct  purchase  of
videocassettes and video games at varying prices. These prices are a function of
the  wholesale  prices set by the movie  studios,  which  depend upon  whether a
videocassette  is  initially  priced to  encourage  rental or sale.  The Company
currently receives  marketing funds and an advertising  allowance from MVC based
in part upon a percentage of videocassette and video game purchases.

     If the relationship with MVC were terminated,  the Company believes that it
could readily obtain its required  inventory of  videocassettes  and video games
from alternative  suppliers at prices and on terms comparable to those available
from MVC. However, the number of alternative  suppliers has diminished in recent
years and the termination of the Company's  present  relationship with MVC could
adversely   affect  the  Company's   results  of  operations  until  a  suitable
replacement  was found.  There can be no assurance  that the  replacement  would
provide service, support or payment terms as favorable as those provided by MVC.

     Several  companies  acquired  by the  Company  had  pre-existing  long-term
contracts with Rentrak Corporation ("Rentrak") whereby product would be provided
under  pay-per-transaction  revenue sharing arrangements.  During late 1996, the
Company   consolidated   existing  contracts  with  Rentrak  into  one  national
agreement.  Under this  ten-year  agreement,  the Company  has a minimum  annual
purchase  commitment in revenue  share,  handling  fees,  sell-through  fees and
end-of-term  buyout fees. The Company  utilizes  Rentrak on a selective title by
title basis.

Marketing and Advertising

     With advertising credits and market development funds that it receives from
its video suppliers and the movie studios, the Company uses radio and television
advertising,   direct  mail,   newspaper   advertising,   discount  coupons  and
promotional  materials to promote new releases,  its video specialty  stores and
its trade name. Using copy prepared by the Company and the studios,  advertising
is placed by in-house media buyers.  Expenditures  for marketing and advertising
above the amount of the  Company's  advertising  credits from its  suppliers and
movie studios have been minimal.  The Company  anticipates that it will continue
to make  substantial  marketing  and  advertising  expenditures,  but that movie
studios  will  continue to support most of such  expenditures.  The Company also
benefits  from  the  advertising  and  marketing  by  studios  and  theaters  in


                                       8
<PAGE>

connection  with their efforts to promote films and increase box office revenue.
The  Company  prepares  a monthly  consumer  magazine  called  Video  Buzz and a
customized  video  program  (MGTV),  both of  which  feature  Company  programs,
promotions and new releases.

Inventory

     The  videocassette  and video game  inventory in each store consists of its
catalog titles (those in release for more than one year) and new release titles.
New releases of  videocassettes  and video games  purchased  from  suppliers for
existing stores are drop-shipped to the stores.

     Videocassettes  and  video  games  utilized  as  initial  inventory  in the
Company's  developed  stores  consist of excess copies of catalog titles and new
release  titles from  existing  stores,  supplemented  as necessary by purchases
directly from suppliers.  This inventory for developed stores is packaged at the
Company's processing and distribution facility located in Dothan,  Alabama. Each
videocassette  and video game is removed  from its  original  packaging,  and an
optical bar code label, used in the Company's  computerized inventory system, is
applied to the plastic  rental case.  The cassette is placed in the rental case,
and a display carton is created by inserting foam or cardboard into the original
packing and  shrink-wrapping  the carton. The repackaged  videocassettes,  video
games and display cartons are then shipped to the developed store ready for use.

Information Systems

     In  November  1995,  the  Company  began  development  of  its  proprietary
point-of-sale ("POS") system. On January 10, 1996, the first Beta test store was
installed  with the new system.  Additional  Beta test sites were tested through
March 31, 1996. On April 1, 1996, the Company began the rapid  deployment of the
POS system in its Company stores. By July 1997, the Company had converted all of
its stores to the new POS system.  The POS system provides detailed  information
with respect to store  operations  (including  the rental  history of titles and
daily  operations  for each store) which is  telecommunicated  to the  corporate
office on a daily basis.  The POS system is installed  in all  developed  stores
prior to opening,  and the Company installs the system in all acquired stores as
soon after the closing of the acquisition as practicable.

     The  Company's  POS system  records  all rental and sale  information  upon
customer checkout using scanned bar code information and updates the information
when the videocassettes and video games are returned.  This POS system is linked
to a management  information system ("MIS") at the corporate office.  Each night
the POS system  transmits  store data into the MIS where all data is  processed,
generating   reports  which  allow  management  to  effectively   monitor  store
operations  and  inventory,  as well as to review  rental  history  by title and
location to assist in making purchasing  decisions with respect to new releases.
The POS  system  also  enables  the  Company  to perform  its  monthly  physical
inventory using bar code recognition.

     In  addition,  during the last three  years the  Company  has  installed  a
financial reporting system relating to the general ledger,  revenue and accounts
payable  functions  capable  of  handling  the  Company's   anticipated  growth.
Additional  systems  which have been  developed and  implemented  by the Company
include a Collections system and a Processing/Distribution Center system.

Competition and Technological Obsolescence

     The video retail industry is highly  competitive,  and the Company competes
with other video specialty  stores,  including stores operated by other regional
chains and national chains such as Blockbuster Video  ("Blockbuster"),  and with
other businesses  offering  videocassettes and video games such as supermarkets,
pharmacies,   convenience  stores,   bookstores,   mass  merchants,  mail  order
operations  and  other  retailers.  Approximately  33% of the  Company's  stores
compete with stores operated by Blockbuster.  In addition,  the Company competes


                                       9
<PAGE>

with all  forms of  entertainment,  such as movie  theaters,  network  and cable
television, direct broadcast satellite television,  Internet-related activities,
live theater,  sporting  events and family  entertainment  centers.  Some of the
Company's   competitors  have  significantly  greater  financial  and  marketing
resources and name recognition than the Company.

     The Company believes the principal  competitive factors in the video retail
industry  are store  location and  visibility,  title  selection,  the number of
copies of each new release available,  customer service and, to a lesser extent,
pricing. The Company believes it generally offers superior service,  more titles
and more copies of new releases than most of its competitors.

     The Company also competes with  Pay-Per-View in which subscribers pay a fee
to view a movie selected by the  subscriber.  Recently  developed  technologies,
referred to as NVOD, permit certain cable companies,  direct broadcast satellite
companies (such as Direct TV), telephone companies and other  telecommunications
companies to transmit a much greater  number of movies to homes  throughout  the
United  States at more  frequent  intervals  (often as  frequently as every five
minutes)  throughout  the day.  NVOD does not offer  full  interactivity  or VCR
functionality,  such as allowing  consumers  to control the playing of the movie
(i.e., starting,  stopping and rewinding).  Ultimately,  further improvements in
these  technologies  could lead to the  availability  to the consumer of a broad
selection  of movies on  demand,  referred  to as VOD,  at a price  which may be
competitive with the price of videocassette  rentals and with the  functionality
of VCRs.  Certain cable and other  telecommunications  companies have tested and
are  continuing  to test  limited  versions  of NVOD and VOD in various  markets
throughout the United States and Europe.

     Movies  recorded  on digital  video discs  ("DVD"),  the same size as audio
discs, were introduced  during the summer of 1997.  Playback machines which play
both audio discs and DVD have also been  introduced.  Because of the ease of use
and  durability  of DVD,  it is  anticipated  that  eventually  DVD may begin to
replace  videocassettes.  During the  transition  period,  the Company's cost to
maintain its  inventory  may  increase.  Currently,  the Company  offers DVD for
rental and sale in limited, primarily metropolitan, markets. The Company expects
to expand its DVD software availability to other markets once the installed base
will  support  such an  investment.  Technology  has been  developed to offer an
alternative  digital disk platform called Digital Video Express  ("Divx").  Divx
disks  permit 48 hours of  viewing  from the time  playback  begins.  Subsequent
viewings  would be  available  at an  additional  charge with access and payment
handled via modem.

     The advent of DVD and Divx may result in  consumers  purchasing  more films
than in the past,  which could have a material  adverse  effect on the Company's
rental  volume  and,  as a result,  on its profit  margins.  For the  near-term,
however,  hardware  costs for digital disk  technologies  are expected to remain
high,  recordability  is likely several years away and products on digital disks
remain  available on VHS,  typically at an earlier date. While both DVD and Divx
have begun to receive varying  degrees of support from the movie studios,  it is
yet to be  determined  which of these  alternatives  will  become  the  dominant
alternative  to VHS.  The  Company  anticipates  that it will react to  changing
consumer  format  demands and intends to provide its  customers  with the rental
medium demanded.  During 1998, the Company substantially increased its offerings
of the DVD technology in select markets.

     The  Company  believes  movie  studios  have  a  significant   interest  in
maintaining a viable movie rental business because the sale of videocassettes to
video retail stores currently represents the studios' largest source of domestic
revenue.  As a result, the Company  anticipates that movie studios will continue
to make movie  titles  available  to  Pay-Per-View,  cable  television  or other
distribution  channels  only after  revenues  have been derived from the sale of
videocassettes,  and perhaps  digital disks, to video stores.  In addition,  the
Company  believes  that for  Pay-Per-View  television  to match  the low  price,
viewing  convenience and selection  available through video rental,  substantial
capital  expenditures  and further  technological  advances  will be  necessary.
Although  the  Company  does  not  believe  NVOD or VOD  represent  a  near-term
competitive  threat to its business,  technological  advances and broad consumer


                                       10
<PAGE>

availability  of NVOD and VOD or  changes  in the  manner  in which  movies  are
marketed,  including the earlier release of movie titles to Pay-Per-View,  cable
television or other distribution channels,  could have a material adverse effect
on the Company's business.

Employees

     As of March 12, 1999,  the Company  employed  approximately  6,100 persons,
referred to by the Company as  "associates,"  including  approximately  5,800 in
retail  stores  and  the  remainder  in  the  Company's  corporate  offices  and
distribution  facility  ("Support  Center  Staff").  Of the  retail  associates,
approximately  1,500  were  full-time  and  4,300  were  part-time.  None of the
Company's  associates is represented by a labor union,  and the Company believes
that its relations with its associates are good.

     Each of the Company's  stores  typically  employs five to fifteen  persons,
including one Store Manager and, in larger stores, one Assistant Manager.  Store
Managers  report to District  Managers who supervise the  operations of 10 to 15
stores.  The District  Managers  report to one of nine  Regional  Managers,  who
report directly to the Company's  Senior Vice President - Store  Operations.  As
the Company has grown,  it has  increased  the number of District  Managers  and
Regional  Managers,  often by  employing  owners or key  employees  of  acquired
stores.  The Support  Center  Staff has regular and periodic  meetings  with the
Regional  Managers and District Managers to review  operations.  Compliance with
the Company's  policies,  procedures and regulations is regularly monitored on a
store-to-store basis by members of the Company's Quality Assurance department.

     The  Company  has an  incentive  bonus  program  pursuant  to which  retail
management  personnel  receive  quarterly  bonuses  when  stores  meet or exceed
criteria  established  under the program.  Management  believes that its program
rewards  excellence  in  management,  gives  associates  an incentive to improve
operations  and results in an overall  reduction in the cost of  operations.  In
addition,  District Managers, Regional Managers and certain Support Center Staff
are eligible to receive discretionary  bonuses,  based on individual and Company
performance,  and  options to  purchase  shares of the  Company's  Common  Stock
(exercisable at the fair market value on the date of grant),  subject to service
requirements.

Cautionary Statements

     The  "BUSINESS"  and  "MANAGEMENT'S  DISCUSSION  AND  ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF  OPERATIONS"  sections of this Report  contain  certain
forward-looking  statements  regarding the Company.  The Company desires to take
advantage of the "safe harbor" provisions of the Private  Securities  Litigation
Reform Act of 1995 and in that regard is  cautioning  the readers of this Report
that the following important factors,  among others,  could affect the Company's
actual  results of operations  and may cause  changes in the Company's  strategy
with the result that the Company's  operations and results may differ materially
from those expressed in any forward-looking statements made by, or on behalf of,
the Company.

     Growth  Strategy.  The Company's  long-term  strategy is to grow  primarily
through new store  openings and  secondarily  through  acquisitions  of existing
stores.  Successful  implementation  of the strategy is  contingent  on numerous
conditions,  some of which are  described  below,  and there can be no assurance
that the Company's  business plan can be executed.  The  acquisition of existing
stores and the opening of new stores require  significant amounts of capital. In
the past,  the  Company's  growth  strategy  has been  funded  through  proceeds
primarily from public  offerings of common stock,  and secondarily  through bank
debt, seller financing,  internally generated cash flow and use of the Company's
common stock as acquisition  consideration.  These and other sources of capital,
including  public  or  private  sales of debt or equity  securities,  may not be
available to the Company in the future.


                                       11
<PAGE>


     New  Store  Openings.  The  Company's  ability  to open new  stores  may be
adversely affected by the following factors,  among others: (i) its availability
of  capital;  (ii) its  ability to  identify  new sites  where the  Company  can
successfully  compete;  (iii) its  ability to  negotiate  acceptable  leases and
implement  cost-effective  development plans for new stores; (iv) its ability to
hire, train and assimilate new store managers and other  personnel;  and (v) its
ability  to  compete  effectively  against  competitors  for prime  real  estate
locations.

     Acquisitions.  The Company's ability to consummate acquisitions and operate
acquired  stores  at the  desired  levels  of  sales  and  profitability  may be
adversely affected by: (i) the inability to consummate identified  acquisitions,
which may result from a lack of  available  capital;  (ii) the  reduction in the
size  of the  pool  of  available  sellers;  (iii)  the  inability  to  identify
acquisition  candidates that fit the Company's criteria (such as size,  location
and  profitability)  and who are willing to sell at prices the Company considers
reasonable;  (iv) more intensive competition to acquire the same video specialty
stores the Company seeks to acquire;  (v) an increase in price for acquisitions;
(vi)  misrepresentations  and  breaches  of  contracts  by  sellers;  (vii)  the
Company's limited knowledge and operating history of the acquired stores; (viii)
the replacement of purchasing and marketing systems of acquired stores; and (ix)
the  integration  of acquired  stores'  systems into the  Company's  systems and
procedures.

     Same-Store  Revenues  Increases.  The  Company's  ability  to  maintain  or
increase  same-store revenues during any period will be directly impacted by the
following  factors,  among  others,  which are often  beyond the  control of the
Company:  (i) increased  competition  from other video stores,  including  large
national or regional chains, supermarkets,  convenience stores, pharmacies, mass
merchants and other  retailers,  which might include  significant  reductions in
pricing to gain market share;  (ii) the weather  conditions in the selling area;
(iii) the timing of the  release of new hit movies by the  studios for the video
rental market;  (iv)  competition from special events such as the Olympics or an
ongoing major news event of significant  public  interest;  (v) competition from
other  forms  of  entertainment  such  as  movie  theaters,   cable  television,
Internet-related  activities  and  Pay-Per-View  television,   including  direct
satellite television;  and (vi) a reduction in, or elimination of, the period of
time (the "release  window") between the release of hit movie  videocassettes to
the home video  market and the  release of these hit movies to the  Pay-Per-View
markets (currently 30 to 80 days).

     Income Estimates.  The Company's ability to meet its income projections for
any period are dependent  upon many  factors,  including  the  following,  among
others:  (i) reductions in revenues caused by factors such as those listed under
"Same-Store  Revenues  Increases"  above;  (ii) the extent to which the  Company
experiences an increase in the number of new competitive  openings,  which tends
to divide market share and reduce profitability in a given trade area; (iii) the
extent to which the  Company  experiences  any  increase in the number of titles
released from studios  priced for  sell-through,  which may tend to increase the
satisfaction  of demand  through  product sales which carry lower profit margins
than rental revenues; (iv) changes in the prices for the Company's products or a
reduction in, or elimination of, the videocassette release window as compared to
Pay-Per-View,  as determined by the movie studios, could result in a competitive
disadvantage for the Company  relative to other forms of  distribution;  (v) the
Company's  ability to control costs and expenses,  primarily rent, store payroll
and general and administrative expenses; (vi) the Company's ability to react and
obtain  other  distribution  sources  for its  products in the event that MVC or
other primary suppliers are unable to meet the terms of their contracts with the
Company; and (vii) advancements and cost reductions in various new technological
delivery systems such as (a) Pay-Per-View  cable television  systems and digital
satellite systems offering NVOD or VOD; (b) universal acceptance of DVD and Divx
technology  which  might  result in lower  profit  margins and  increased  costs
associated  with  higher  inventory  requirements;  and (c)  other  forms of new
technology, which could affect the Company's profit margins.

     Year 2000.  The Company  believes that all  operating  systems will be year
2000  compliant  prior to December 31, 1999, and does not believe that the costs
incurred  to address  the year 2000 issue have been or will be  material  to the
Company.  However,  the Company can provide no assurance that its systems or its


                                       12
<PAGE>

major vendors will be adequately  prepared for the year 2000. Failure to resolve
year 2000 issues could have a material  adverse  impact on the operations of the
Company.

Directors and Executive Officers of the Company

Name                        Age   Position(s) Held
----                        ---   ----------------
Joe Thomas Malugen(1)        47   Chairman of the Board and Chief Executive
                                   Officer
H. Harrison Parrish(1)       51   President and Director
William B. Snow(1)(2)        67   Vice Chairman of the Board
Robert L. Sirkis             47   Executive Vice President and Chief Operating
                                   Officer
J. Steven Roy                38   Executive Vice President and Chief Financial
                                   Officer
S. Page Todd                 37   Senior Vice President, Secretary and General
                                   Counsel
Keith A. Cousins             30   Senior Vice President - Real Estate/
                                   Development
William G. Guerrette, Jr.    39   Senior Vice President - Sales
Steven M. Hamil              30   Senior Vice President,  Chief Accounting
                                   Officer and Controller
Richard R. Langford          42   Senior Vice President - Management Information
                                    Systems
Mark S. Loyd                 43   Senior Vice President - Purchasing and Product
                                   Management
Jeffrey S. Stubbs            36   Senior Vice President - Store Operations
Sanford C. Sigoloff(2)(3)    68   Director
Philip B. Smith(2)(3)        63   Director
Joseph F. Troy (1)(3)        60   Director
________________________
(1) Member of Executive Committee.
(2) Member of Compensation Committee.
(3) Member of Audit Committee.

     Mr. Malugen co-founded the Company in 1985 and has been its Chairman of the
Board and Chief  Executive  Officer  since  that  time.  Prior to the  Company's
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 the Company  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 the Company in 1985 and has been its President and a
Director of the Company since that time.  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 from the University of
Alabama in Business Administration.

     Mr. Snow was elected Vice Chairman of the Board in July 1994, and he served
as Chief  Financial  Officer  from July 1994 until May 1996.  In 1996,  Mr. Snow
entered  into a two-year  consulting  agreement  with the  Company  and upon its
expiration,  Mr.  Snow  and  the  Company  entered  into a  one-year  consulting
agreement  commencing January 1, 1999. Mr. Snow was the Executive Vice President
and Chief Financial Officer and a Director of Consolidated Stores Corporation, a
publicly held specialty  retailer,  from 1985 until he retired in June 1994. Mr.
Snow is a director of Homeland Stores, Inc. and Lot$ Off Stores,  Inc., publicly
held companies.  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.

                                       13
<PAGE>

     Mr. Sirkis was elected Executive Vice President and Chief Operating Officer
in September 1997. From 1994 until he joined the Company, Mr. Sirkis founded and
served as President and Chief Executive Officer of Finest  Foodservice,  L.L.C.,
which  developed and operated  Boston  Market  stores in seven states.  Prior to
1994,  he served as  President  and Chief  Executive  Officer of Silo,  Inc.,  a
nationwide  retailer of consumer  electronics  and  subsidiary  of  London-based
Dixons  Group,  plc.  Mr.  Sirkis  received a B.A.  degree  from  Johns  Hopkins
University  and his Masters in Business  Administration  from  Harvard  Business
School.

     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
the Company, most recently as a Senior Manager in the Audit Department.  Mr. Roy
is a  Certified  Public  Accountant  and  received  a B.S.  degree  in  Business
Administration from the University of Alabama.

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

     Mr. Cousins joined the Company in August 1998 and served as Senior Director
of  Development,  Planning  and  Analysis  until  March 1999 when he was elected
Senior Vice President - Real  Estate/Development.  Prior to joining the Company,
Mr.  Cousins  acquired  four  years of  management  consulting  experience  with
Computer Sciences Corporation as Program Control Manager;  Management Consulting
and Research, Inc. as Cost Analyst; and Tecolote Research, Inc. as Advanced Cost
Estimator.  He has seven years of real estate and property management experience
as Senior  Director of Development  for KinderCare  Learning  Centers,  Inc. and
Senior Accountant with Aronov Realty Management Co., Inc. Mr. Cousins received a
B.S. degree in Business Administration from Auburn University at Montgomery.

     Mr.  Guerrette  joined the Company in April 1997 and, after serving as Vice
President - Retail Sales,  was elected Senior Vice President - Sales in December
1997.  Mr.  Guerrette was President of Sounds Easy Video when it was acquired by
Home Vision Entertainment,  Inc. ("Home Vision") in September 1994 and served as
Executive Vice President and Chief Operating Officer of Home Vision until it was
acquired by the Company.  He was elected to the Maine House of  Representatives,
where he served from November 1994 to 1996. Mr. Guerrette attended Brigham Young
University and majored in Accounting.

     Mr. Hamil was elected  Vice  President  and  Controller  in June 1996,  was
elected  Chief  Accounting  Officer in October 1996 and was elected  Senior Vice
President in March 1998.  From July 1994,  after receiving a Masters in Business
Administration from Duke University's Fuqua School of Business,  until he joined
the Company,  Mr. Hamil was an Investment  Banking  Associate  with  NationsBanc
Capital  Markets,  Inc. He has also served as a Staff Auditor with Ernst & Young
LLP. Mr. Hamil is a Certified  Public  Accountant and received a B.S.  degree in
Business Administration from the University of Alabama.

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

                                       14
<PAGE>

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

     Mr. Stubbs was elected Senior Vice President - Store Operations in November
1997. He joined the Company in November 1995 as a District Manager and served as
a Regional Manager prior to his current position.  Mr. Stubbs attended Texas A &
M University and Southwest Texas State University,  where he received his B.B.A.
degree in Business Administration and Marketing.

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

     Mr. Smith became a director of the Company in September  1994.  Since 1991,
Mr. Smith has been Vice  Chairman of the Board of Spencer Trask & Co., and since
June 1998,  Mr.  Smith has been the Vice  Chairman  of the Board of Laird & Co.,
LLC.  He was  formerly a  Managing  Director  of  Prudential  Securities  in its
merchant  bank.  Mr.  Smith is a founding  General  Partner of Lawrence  Venture
Associates,  a venture capital  limited  partnership  headquartered  in New York
City.  From 1981 to 1984,  he  served  as  Executive  Vice  President  and Group
Executive of the worldwide  corporations group at Irving Trust Company. Prior to
joining Irving Trust Company,  he was at Citibank for 15 years, where he founded
Citicorp Venture Capital as President and Chief Executive Officer. Since 1988 he
has also been the managing general partner of Private Equity  Partnership,  L.P.
Mr. Smith is a director of Digital Video Systems,  Inc. and KLS EnviroResources,
Inc.,  publicly held  companies.  Mr. Smith is an adjunct  professor at Columbia
University Graduate School of Business.

     Mr. Troy became a director of the Company in  September  1994.  Mr. Troy is
the founder  and has been a member of the law firm of Troy & Gould  Professional
Corporation since May 1970.

     Directors   are  elected  to  serve  until  the  next  annual   meeting  of
stockholders of the Company or until their successors are elected and qualified.
Officers  serve at the  discretion  of the Board of  Directors,  subject  to any
contracts  of  employment.  Non-employee  directors  receive  an  annual  fee of
$16,000,  a fee of $1,000 for each Board meeting  attended and a fee of $500 for
each  committee  meeting  attended.  The Company has granted  vested  options to
purchase  105,000 shares of Common Stock to each of Messrs.  Sigoloff and Smith,
vested  options to purchase  130,000  shares to Mr.  Troy and vested  options to
purchase  140,000  shares to Mr. Snow,  in each case at or above the fair market
value of the Common Stock on the date of grant.

ITEM 2.  PROPERTIES

     At March 12, 1999,  all but one of the Company's 828 stores were located on
premises  leased from  unaffiliated  persons  pursuant to leases with  remaining
terms which generally vary from one month to six years. The Company is generally
responsible for taxes,  insurance and utilities  under its leases.  Rental rates
often  increase  upon  exercise  of any  renewal  option,  and some  leases have
percentage rental arrangements pursuant to which the Company is obligated to pay
a base rent plus a  percentage  of the  store's  revenues  in excess of a stated


                                       15
<PAGE>

minimum.  In  general,  the  stated  minimums  are set at such a high  level  of
revenues  that the Company does not pay  additional  rents based on reaching the
required revenue levels and does not anticipate  paying such additional rents in
the future.  The Company  anticipates that future stores will also be located in
leased premises.  The Company owns a family  entertainment  center,  including a
video specialty store, in Meridian, Mississippi.

     The Company's  corporate campus is located in four buildings at 739 W. Main
Street,  Dothan,  Alabama,  consisting of an aggregate of  approximately  13,000
square  feet of space,  and a portion of an office  building  located at 2323 W.
Main Street, Dothan, Alabama,  consisting of approximately 10,000 square feet of
space.  Two of these buildings with an aggregate of  approximately  6,500 square
feet of space  are  owned by the  Company  and are  used for  general  corporate
offices.  Two of these  buildings  which are used  primarily  for  executive and
general corporate  offices have an aggregate of approximately  6,500 square feet
of space and are leased from Messrs.  Malugen and Parrish. In Fiscal 1998, these
payments  totaled  $43,800.  The  remaining  office  building  space is used for
general corporate  offices and is leased from an unaffiliated  third party for a
one-year term with multiple one-year renewal options.  The Company also leases a
41,730 square foot videocassette processing, distribution and warehouse facility
in Dothan,  Alabama,  from an unaffiliated  third party pursuant to a three-year
lease with three, three-year renewal options.

ITEM 3.  LEGAL PROCEEDINGS

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

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

     None.





                                       16
<PAGE>

                                     PART II


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

     The Company's  Common Stock began trading on the Nasdaq  National Market on
August 2, 1994 under the symbol  "MOVI." The following  table sets forth for the
periods  indicated  the high and low last sale  prices of the  Company's  Common
Stock as reported on the Nasdaq National Market.
<TABLE>
<CAPTION>

                                                     High           Low
                                                    ------         ------
<S>                                                 <C>            <C>
1999
First Quarter (through March 12, 1999) ..........   $7.500         $4.156


1998
First Quarter ...................................    8.125          2.875
Second Quarter ..................................    8.063          5.500
Third Quarter ...................................    7.625          3.625
Fourth Quarter ..................................    8.000          2.813


1997
First Quarter ...................................   13.750          7.500
Second Quarter ..................................    8.000          5.000
Third Quarter ...................................    6.875          3.500
Fourth Quarter ..................................    4.125          2.500
</TABLE>

     The last sale price of the  Company's  Common Stock on March 12,  1999,  as
reported  on the Nasdaq  National  Market  was $4.50 per share.  As of March 12,
1999,  there were  approximately  2,700 holders of the  Company's  Common Stock,
including 115 stockholders of record.

     The payment of dividends is within the discretion of the Company's Board of
Directors and will depend on the earnings, capital requirements, restrictions in
future  credit  agreements  and the  operating  and  financial  condition of the
Company,  among  other  factors.  The  Company  presently  expects to retain its
earnings to finance the expansion and further development of its business. There
can be no assurance that the Company will ever pay a dividend in the future.

                                       17
<PAGE>

 ITEM 6.  SELECTED FINANCIAL DATA

<TABLE>
<CAPTION>
                                                                        Fiscal Year Ended                        Year Ended
                                                              --------------------------------------     -------------------------
                                                              January 3,    January 4,     January 5,    December 31,  December 31,
                                                                1999          1998         1997(3)(4)       1995         1994 (6)
                                                              ---------------------------------------------------------------------
                                                                        (dollars in thousands, except per share data)

Statement of Income Data(1):
<S>                                                           <C>           <C>            <C>           <C>           <C>
Revenues:
  Rentals                                                     $ 222,784     $ 220,787      $ 219,002     $ 130,353     $ 47,782
  Product sales                                                  44,849        39,569         35,393        18,848        5,441
                                                              ---------     ---------      ---------     ---------     --------
                                                                267,633       260,356        254,395       149,201       53,223

Operating costs and expenses:
  Store operating expenses                                      137,158       134,141        124,456        67,758       24,119
  Amortization of videocassette rental inventory                106,507(2)     69,177         63,544(5)     29,102       10,263
  Amortization of intangibles                                     7,068         7,206          7,160         3,380          606
  Cost of product sales                                          29,744        24,597         21,143        12,600        4,018
  General and administrative                                     17,996        17,006         20,266        13,525        5,647
  Restructuring and other charges                                    --            --          9,595            --           --
                                                              ---------     ---------      ---------     ---------     --------
Operating income (loss)                                         (30,840)        8,229          8,231        22,836        8,570
  Interest expense, net                                          (5,325)       (6,326)        (5,619)       (1,528)        (486)
  Other, net                                                         --            --             --            --           58
                                                              ---------     ---------      ---------     ---------     --------
Income (loss) before income taxes                               (36,165)        1,903          2,612        21,308        8,142
Income taxes(7)                                                 (13,089)          998          1,006         7,871        2,991
                                                              =========     =========      =========     =========     ========
Net income (loss)                                             $ (23,076)    $     905      $   1,606     $  13,437     $  5,151
                                                              =========     =========      =========     =========     ========
Basic earnings (loss) per share                               $   (1.72)    $     .07      $     .12     $    1.14     $    .64
                                                              =========     =========      =========     =========     ========
Diluted earnings (loss) per share                             $   (1.72)    $     .07      $     .12     $    1.11     $    .63
                                                              =========     =========      =========     =========     ========
Cash dividends declared per share                             $      --     $      --      $      --     $      --     $    .39
                                                              =========     =========      =========     =========     ========
Shares used in computing earnings (loss) per share:
   Basic                                                         13,388        13,420         13,241        11,795        8,083
                                                              =========     =========      =========     =========     ========
   Diluted                                                       13,388        13,421         13,368        12,153        8,152
                                                              =========     =========      =========     =========     ========

Operating Data:
Number of stores at end of period(1)                                837           856            863           750          352
Adjusted EBITDA(8)                                            $  37,378     $  26,898      $  26,232     $   8,766     $  3,902
Increase (decrease) in same-store revenues(9)                       3.9%          1.1%          (1.0)%         0.0%        14.3%


                                                                                                               December 31,
                                                              January 3,    January 4,     January 5,    -----------------------
                                                                1999          1998           1997           1995         1994
                                                              ------------------------------------------------------------------
Balance Sheet Data(1):
Cash and cash equivalents                                     $   6,983      $  4,459       $  3,982     $   6,255      $  3,723
Videocassette rental inventory, net                              44,998        92,183         89,929        72,979        27,138
Total assets                                                    202,369       259,133        261,577       233,479        76,647
Long-term debt, less current maturities                          46,212        63,479         67,883        19,622         6,681
Total liabilities                                                78,254       111,504        114,853        97,340        29,652
Stockholders' equity                                            124,115       147,629        146,724       136,139        46,995



                                       18
<PAGE>

<FN>
_________________________
(1)  Statement  of income data for all periods  presented  has been  restated to
     include the results of Home Vision Entertainment,  Inc. ("Home Vision") and
     Hollywood  Video,  Inc.  ("Hollywood  Video"),  which were  acquired in two
     separate  pooling-of-interests  transactions  on July 1, 1996.  Home Vision
     reported on a fiscal year ending  September 30 and Hollywood Video reported
     on a calendar year basis.  The Company's  results for the fiscal year ended
     January 5, 1997 are  combined  with  results of Home  Vision and  Hollywood
     Video for the period January 1, 1996 to the date of the  acquisitions.  The
     results of the Company and  Hollywood  Video for the years ending  December
     31, 1995 and 1994 are  combined  with Home  Vision's  results for the years
     ending  September 30, 1995 and 1994,  respectively.  Balance sheet data has
     also been restated  consistent with the statement of income data except the
     December  31,  1995  balance  sheet data  includes  that of Home  Vision at
     December 31, 1995 instead of September  30, 1995.  In order to conform with
     the fiscal year end of the Company,  Home  Vision's net loss of  $2,082,000
     for the quarter  ended  December 31, 1995 is not reflected in the statement
     of income data but is  reflected  in  stockholders'  equity at December 31,
     1995.  The  ending  number of stores  for each  period  presented  has been
     restated to include the store counts of Home Vision and Hollywood Video
(2)  Effective  July 6, 1998,  the  Company  changed  its  method of  amortizing
     videocassette  rental  inventory  resulting  in  non-recurring,   non-cash,
     pre-tax charge of approximately $43.6 million.
(3)  On July 1, 1996,  the  Company  adopted a fiscal  year  ending on the first
     Sunday following December 30, which  periodically  results in a fiscal year
     of 53 weeks.  The 1996 fiscal  year,  ended on January 5, 1997,  reflects a
     53-week year.
(4)  Includes a non-recurring  charge of  approximately  $10.4 million for store
     closures, corporate restructuring and merger-related expenses.
(5)  Effective  April 1, 1996,  the  Company  changed  its method of  amortizing
     videocassette rental inventory resulting in a one-time,  non-cash charge of
     approximately $7.7 million.
(6)  General and  administrative  expenses  and income  taxes  include pro forma
     adjustments for the change in  compensation  levels arising from employment
     contracts with two stockholders who are executive officers of the Company.
(7)  The  provision  for income tax  includes pro forma  adjustments  to reflect
     income tax expense which would have been  recognized  if the Company,  Home
     Vision and Hollywood Video had been taxed as C corporations for all periods
     presented.  Historical  operating  results of the Company,  Home Vision and
     Hollywood  Video do not include  any  provision  for income  taxes prior to
     August 2,  1994,  October 1, 1994 and July 1,  1996,  respectively,  due to
     their S corporation status prior to those dates.
(8)  "Adjusted  EBITDA" is earnings before  interest,  taxes,  depreciation  and
     amortization,  excluding non-recurring charges, less the Company's purchase
     of videocassette  rental  inventory.  For purposes of calculating  Adjusted
     EBITDA,  the Company's  videocassette  rental  inventory  purchases for the
     fiscal  years  ended  January 3, 1999,  January 4, 1998 and January 5, 1997
     have  been  reduced  by  $1.2  million,  $1.3  million  and  $5.7  million,
     respectively,  associated  with inventory  purchases  specifically  for new
     store openings. New store inventory purchases are not separately identified
     for the years ended  December 31, 1995 and 1994.  Adjusted  EBITDA does not
     take  into  account   capital   expenditures,   other  than   purchases  of
     videocassette rental inventory,  and does not represent cash generated from
     operating  activities  in accordance  with  generally  accepted  accounting
     principles  ("GAAP"),  is not to be  considered  as an  alternative  to net
     income or any other GAAP measurements as a measure of operating performance
     and is not  indicative  of cash  available  to fund  all  cash  needs.  The
     Company's  definition of Adjusted  EBITDA may not be identical to similarly
     titled measures of other  companies.  The Company believes that in addition
     to cash  flows  and net  income,  Adjusted  EBITDA  is a  useful  financial
     performance  measurement  for assessing the  operating  performance  of the
     Company because,  together with net income and cash flows,  Adjusted EBITDA
     is widely used in the videocassette specialty retailing industry to provide
     investors  with an additional  basis to evaluate the ability of the Company
     to  incur  and  service  its  debt and to fund  acquisitions.  To  evaluate
     Adjusted  EBITDA and the trends it  depicts,  the  components  of  Adjusted
     EBITDA,  such as net  revenues,  cost of  services  and sales,  general and
     administrative expenses, should be considered. See "Management's Discussion
     and Analysis of Financial Condition and Results of Operations."
(9)  Same-store  revenue  is  defined  as the  aggregate  revenues  from  stores
     operated by the Company for at least 13 months. Same-store revenues for the
     Company have not been restated to include the  same-store  revenues of Home
     Vision and Hollywood Video.
</FN>
</TABLE>


                                       19
<PAGE>

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

Overview

From August 1994 through July 1, 1996, the Company  experienced  rapid growth in
revenue and  operating  income  primarily  as a result of  acquiring  stores and
opening  new  stores.  Since  the fall of 1996,  the  Company's  store  base has
remained relatively  constant as the Company has internally  developed a similar
number of stores as have been closed. The number of stores owned and operated by
the Company at the end of each of the following periods is as follows:

               December 31, 1994             352
               December 31, 1995             750
               January 5, 1997               863
               January 4, 1998               856
               January 3, 1999               837

The results of operations  for the fiscal year ended January 5, 1997 include the
combined results of the Company, Home Vision Entertainment, Inc. ("Home Vision")
and Hollywood Video, Inc.  ("Hollywood  Video"). The acquisitions of Home Vision
and Hollywood  Video were  consummated on July 1, 1996 and were accounted for as
poolings-of-interests.  The above store count totals reflect the combined totals
of Movie  Gallery,  Inc.,  Home  Vision  and  Hollywood  Video  for all  periods
presented.  During the fiscal year ended  January 3, 1999  ("Fiscal  1998"),  18
stores were developed by the Company, 4 stores were acquired and 41 were closed.

As a result of the 507 store  acquisitions  during the  periods  January 1, 1995
through  January 3, 1999,  the Company  recorded  $84.9  million in goodwill and
other  intangibles.  Goodwill is amortized on a straight-line  basis over twenty
years. Other intangibles, which consist primarily of non-compete agreements, are
amortized on a straight-line basis over two to ten years.

On July 1, 1996, the Company adopted a fiscal year that ends on the first Sunday
following  December  30.  This  change  results in the  Company  having a 52- or
53-week year. The year ended January 5, 1997 ("Fiscal 1996") was a 53-week year,
while the fiscal year ended January 4, 1998 ("Fiscal 1997") and Fiscal 1998 were
52-week years.

Effective July 6, 1998, the Company changed its  amortization  policy for rental
inventory,  which was accounted for as a change in accounting  estimate effected
by a change  in  accounting  principle.  The  major  impetus  for the  change in
amortization policy is the changing purchasing economics within the industry and
the Company, which have resulted in a significant increase in new release videos
available  for  rental.   Revenue  sharing   agreements  and  other   copy-depth
initiatives have increased customer satisfaction of the video rental experience,
especially with respect to new release videos, and, thus, the overall demand for
each new release is  satisfied  sooner.  In order to match more  accurately  the
valuation of tape inventory with accelerated  consumer  demand,  the Company has
changed its amortization policy for rental inventory. The application of the new
method of amortizing  videocassette  and video game rental  inventory  decreased
rental inventory and increased  depreciation  expense for the year ended January
3, 1999 by  approximately  $43.6 million and reduced net income and earnings per
diluted share by $27.7 million and $2.06, respectively.

Under  the new  amortization  method,  the  cost of base  stock  videocassettes,
consisting  of  two  copies  per  title  for  each  store,  is  amortized  on an
accelerated  basis to a net book  value of $8 over the first six months and to a
$4  salvage  value  over the next  thirty  months.  The cost of  non-base  stock


                                       20
<PAGE>

videocassettes,  consisting of the third and succeeding copies of each title per
store,  is amortized on an accelerated  basis over the first six months to a net
book value of $4, which is then fully  amortized on a  straight-line  basis over
the next 30  months  or until  the  videocassette  is  sold,  at which  time the
unamortized book value is charged to cost of sales. Video games are amortized on
a straight-line  basis to a $10 salvage value over eighteen months.  The Company
will  continue  to expense  revenue  sharing  payments  as  revenues  are earned
pursuant to contractual arrangements.

Prior to July 6, 1998, and pursuant to an accounting  change  effective April 1,
1996,  videocassette  and video game rental  inventory  was recorded at cost and
amortized over its economic  useful life.  Videocassettes  considered to be base
stock were amortized over  thirty-six  months on a  straight-line  basis to a $5
salvage value.  New release  videocassettes  were amortized as follows:  (i) the
fourth and any  succeeding  copies of each title per store were  amortized  on a
straight-line basis over the first six months to an average net book value of $5
which was then fully  amortized  on a  straight-line  basis over the next thirty
months or until the  videocassette  was sold, at which time the unamortized book
value was  charged to cost of sales and (ii)  copies one  through  three of each
title per store were amortized as base stock.

During Fiscal 1996, the Company adopted a business  restructuring  plan to close
approximately  50  stores  and  reduce  the  corporate  organizational  staff by
approximately  15%. The  restructuring  plan  resulted in a $9.6 million  pretax
restructuring  charge  recorded  in  the  third  quarter  of  Fiscal  1996.  The
components of the restructuring  charge included  approximately  $5.4 million in
reserves for future cash outlays for lease terminations,  miscellaneous  closing
costs and legal and accounting  costs, as well as approximately  $4.2 million in
asset write  downs.  Approximately  $3.2  million of costs were paid and charged
against  the  liability  as  of  January  3,  1999.   The  store  closures  were
substantially  completed  by the end of Fiscal  1997.  Additionally,  during the
third  quarter  of Fiscal  1996 the  Company  incurred  merger-related  costs of
approximately  $757,000  related to the acquisition of Home Vision and Hollywood
Video.

The provision for income taxes includes pro forma  adjustments to reflect income
tax expense which would have been  recognized if Hollywood  Video had been taxed
as a C corporation for all periods  presented.  Historical  operating results of
Hollywood  Video do not include any  provision for income taxes prior to July 1,
1996 due to their S corporation status prior to this date.

The  Company  currently  has a net  deferred  tax  asset of  approximately  $2.6
million.  The Company  anticipates  the generation of sufficient  future taxable
income, based on its current operations, to utilize these deferred tax assets.

With  respect to  forward-looking  statements  contained  in this Item 7, please
review the disclosures set forth under "Cautionary Statements" in Item 1 above.

                                       21
<PAGE>

Results of Operations

The following table sets forth, for the periods  indicated,  statement of income
data,  expressed as a percentage of total revenue, and the number of stores open
at the end of each period. The store count and the operating results reflect the
combined operations of Movie Gallery,  Inc., Home Vision and Hollywood Video for
all periods.
<TABLE>

Statement of Operations Data:
<CAPTION>
                                                                                    53 Weeks
                                                            52 Weeks Ended            Ended
                                                       --------------------------------------
                                                       January 3,     January 4,    January 5,
                                                          1999           1998          1997
                                                       --------------------------------------
<S>                                                     <C>            <C>            <C>
Revenues:
  Rentals                                                83.2%          84.8%          86.1%
  Product sales                                          16.8           15.2           13.9
                                                        -----          -----          -----
                                                        100.0          100.0          100.0
Operating costs and expenses:
  Store operating expenses                               51.2           51.5           48.9
  Amortization of videocassette rental inventory:
      Recurring                                          23.5           26.6           22.0
      Policy change                                      16.3             --            3.0
  Amortization of intangibles                             2.7            2.8            2.8
  Cost of  product sales                                 11.1            9.4            8.3
  General and administrative                              6.7            6.5            8.0
  Restructuring and other charges                          --             --            3.8
                                                        -----          -----          -----
                                                        111.5           96.8           96.8
                                                        -----          -----          -----
Operating income (loss)                                 (11.5)           3.2            3.2
Interest expense, net                                    (2.0)          (2.5)          (2.2)
                                                        -----          -----          -----
Income (loss) before income taxes                       (13.5)           0.7            1.0
Income taxes (1)                                         (4.9)           0.4            0.4
                                                        -----          -----          -----
Net income (loss)                                        (8.6)%          0.3%           0.6%
                                                        =====          =====          =====
Number of stores at end of period                         837            856            863
                                                        =====          =====          =====
<FN>
_____________________
(1)  The provision for income taxes  includes pro forma  adjustments  to reflect
     income tax expense which would have been  recognized if Hollywood Video had
     been  taxed  as a C  corporation  for  all  periods  presented.  Historical
     operating  results of  Hollywood  Video do not  include any  provision  for
     income taxes prior to July 1, 1996 due to its S corporation status prior to
     this date.
</FN>
</TABLE>

Fiscal year ended  January 3, 1999  compared to the fiscal year ended January 4,
1998

     Revenue.  Total revenue  increased  2.8% to $267.6  million for Fiscal 1998
from $260.4  million for Fiscal  1997.  The  increase  was due  primarily  to an
increase in  same-store  revenues of 3.9%,  offset in part due to fewer  average
stores open during  Fiscal 1998 versus  Fiscal 1997.  The increase in same-store
revenues was  primarily the result of (i) an increase in the number of copies of
new release  videocassettes  available to  customers  as a result of  copy-depth
initiatives, including revenue sharing programs and other depth of copy programs
available from movie studios; (ii) an increase in the video game rental business
due to  both  increasing  consumer  acceptance  of  the  Nintendo  64  and  Sony
Playstation  game  platforms  and an  increase  in the  number  of  game  titles
available  for  these  platforms;  and  (iii)  successful,  chain-wide  internal
marketing programs designed to generate more consumer  excitement and traffic in
the Company's base of stores.  Product sales  increased as a percentage of total
revenues to 16.8% for Fiscal  1998 from 15.2% for Fiscal  1997,  primarily  as a
result  of an  increase  in the sales of  previously  viewed  rental  inventory.

                                       22
<PAGE>

     Operating  Costs and  Expenses.  Store  operating  expenses,  which include
store-level  expenses such as lease payments and in-store payroll,  decreased to
51.2% of total revenue for Fiscal 1998 from 51.5% for Fiscal 1997.  The decrease
in store  operating  expenses as a percentage  of revenues was  primarily due to
same-store revenue  increases,  offset in part by an increase in revenue sharing
expense of approximately $3.0 million in Fiscal 1998 versus Fiscal 1997.

Recurring   amortization  of  videocassette  rental  inventory,   excluding  the
non-recurring charge related to the change in amortization policy,  decreased in
Fiscal 1998 as a percentage of total revenue to 23.5% from 26.6% in Fiscal 1997.
Amortization of  videocassette  rental inventory for all periods ending prior to
July 6, 1998, was calculated  under the previous  policy  described in Note 1 of
the "Notes to the Consolidated Financial Statements." Significantly reduced tape
purchase  dollars in Fiscal 1998 versus Fiscal 1997, an increased use of revenue
sharing,  as well as the  same-store  revenue  increases in Fiscal 1998, are the
main reasons that the  amortization  of inventory as a percentage  of revenue in
Fiscal 1998 has declined versus Fiscal 1997.

Cost of product sales  includes the costs of new  videocassettes,  confectionery
items and other goods,  as well as the  unamortized  value of previously  viewed
rental inventory sold in the Company's  stores.  Cost of product sales increased
with the increase in product  sales  revenue and  increased  as a percentage  of
product  sales  revenue from 62.2% in Fiscal 1997 to 66.3% in Fiscal  1998.  The
decrease  in  product  sales  gross  margins is  primarily  the result of: (i) a
concentrated  effort by the Company to reduce inventory levels through discounts
on  selected  inventory  during the first  half of 1998;  and (ii) the impact of
Titanic,  which the Company sold at a below average  profit margin and for which
the Company sold more units than any sell-through priced title in its history.

General and  administrative  expenses increased as a percentage of revenues from
6.5% for Fiscal 1997 to 6.7% for Fiscal 1998.  The increase is primarily  due to
Fiscal 1998 increases in fixed asset depreciation,  marketing expenses, salaries
and wages and other  personnel  costs,  in part  associated with the increase in
personnel in the Company's real estate department in anticipation of its planned
new store development during the fiscal year 1999.

As a result of the  above  factors,  excluding  the  impact of the  amortization
policy change, operating income increased by 55% to $12.8 million in Fiscal 1998
from $8.2 million in Fiscal 1997.

Fiscal year ended  January 4, 1998  compared to the fiscal year ended January 5,
1997

     Revenue.  Total revenue  increased  2.3% to $260.4  million for Fiscal 1997
from $254.4  million for Fiscal  1996.  The  increase  was due  primarily  to an
increase in same-store  revenues of 1.1%, as well as the net positive  effect of
closing  lower  volume  stores  while  internally  developing  stores  that have
generated  revenue  results  greater  than the closed  stores.  The  increase in
same-store  revenues was primarily a result of (i) the Company's emphasis in the
last half of Fiscal 1997 to increase the depth of copies of "hit titles"  within
its store base;  (ii) an increase in the game rental  business due to the advent
and consumer  acceptance of the Nintendo 64 and Sony Playstation game platforms;
and (iii) a decrease in the number of competitive  store openings,  particularly
in the last half of Fiscal 1997.  Product  sales  increased  as a percentage  of
total  revenues to 15.2% for Fiscal 1997 from 13.9% for Fiscal 1996, as a result
of (i) the Company's  continued and increased emphasis on the sale of previously
viewed rental  inventory;  and (ii) an increase in the variety of other products
sold in stores, such as video accessories and confectionery items.

     Operating  Costs and  Expenses.  Store  operating  expenses,  which reflect
direct store expenses such as lease payments and in-store payroll,  increased to
51.5% of total revenue for Fiscal 1997 from 48.9% for Fiscal 1996.  The increase
in store operating expenses was primarily due to (i) strategic  responses in the
Company's most competitive  markets,  which affected certain  expenses,  such as
labor hours used and advertising costs; (ii) the national minimum wage increases


                                       23
<PAGE>

that were  implemented  on  September 1, 1996 and  September 1, 1997;  and (iii)
increases in rent in  connection  with the normal  renewal of leases in existing
stores.

Amortization  of  videocassette  rental  inventory  increased as a percentage of
revenue to 26.6% for Fiscal 1997 from 25.0% for Fiscal 1996 due primarily to (i)
a  decision  by the  Company to  increase  its level of  expenditures  on rental
inventory  during  the  fourth  quarter  of 1996 and the  first  half of 1997 in
response to industry-wide  competitive  issues; (ii) an increase in the depth of
hit new release titles  purchased  during the year,  which results in more tapes
being  substantially  amortized over six months versus three years;  and (iii) a
marked increase in the quantity of new game release  purchases,  which is due to
the  buildup  of  inventory  related  to the  consumer  acceptance  of new  game
platforms (i.e., Nintendo 64 and Sony Playstation).

Cost of product sales  includes the costs of new  videocassettes,  confectionery
items and other goods,  as well as the  unamortized  value of previously  viewed
rental inventory sold in the Company's  stores.  Cost of product sales increased
with the  increased  revenue from product sales and increased as a percentage of
revenues from product sales from 59.7% for Fiscal 1996 to 62.2% for Fiscal 1997.
The  decrease in product  sales gross  margins  resulted  primarily  from (i) an
increase in new tape sales which carry lower margins than other sales items; and
(ii) an  effort  by the  Company  to  market  more  aggressively  its  new  tape
inventory.  These  factors were offset,  in part,  by an increase in the sale of
previously viewed rental  inventory,  the unamortized value of which is expensed
to cost of product  sales and  generally  generates  higher  margins  than other
product categories.

General and  administrative  expenses decreased as a percentage of revenues from
8.0%  for  Fiscal  1996  to  6.5%  for  Fiscal  1997.   Excluding   $757,000  in
merger-related  expenses  associated  with the  acquisitions  of Home Vision and
Hollywood  Video,  general and  administrative  expenses would have been 7.7% of
revenues for Fiscal 1996.  The  decrease is  primarily  due to the  efficiencies
gained from the leveraging of overhead  associated with acquisition  activity in
1996 and a reduction in corporate overhead over the past year.

As a result of the above,  operating income was essentially flat at $8.2 million
in both  Fiscal  1997 and Fiscal  1996.  However,  excluding  the effects of the
business   restructuring   plan,   the  one-time,   non-recurring   increase  in
amortization of videocassette rental inventory due to the change in amortization
policy and the merger-related  expenses from the Home Vision and Hollywood Video
acquisitions, operating income would have been $26.2 million in Fiscal 1996.

Liquidity and Capital Resources

Historically,  the  Company's  primary  capital  needs have been for opening and
acquiring  new stores and for the  purchase of  videocassette  inventory.  Other
capital needs include the  refurbishment,  remodeling and relocation of existing
stores.  The Company has funded inventory  purchases,  remodeling and relocation
programs, new store opening costs and acquisitions primarily from cash flow from
operations,  the proceeds of two public equity offerings,  loans under revolving
credit facilities and seller financing.

During  Fiscal 1998,  the Company  generated  $37.4  million in Adjusted  EBITDA
versus  $26.9  million for Fiscal  1997.  The  increase  in  Adjusted  EBITDA is
attributable  primarily to both the same-store  revenue increase of 3.9% and the
Company's  leveraging of rental  inventory  purchases  during Fiscal 1998 versus
Fiscal 1997. "Adjusted EBITDA" is earnings before interest,  taxes, depreciation
and amortization,  less the Company's purchase of videocassette rental inventory
which excludes inventory purchases specifically for new store openings. Adjusted
EBITDA does not take into account capital expenditures,  other than purchases of
videocassette  rental  inventory,  and does not represent  cash  generated  from
operating activities in accordance with generally accepted accounting principles
("GAAP"),  is not to be considered as an  alternative to net income or any other
GAAP measurements as a measure of operating performance and is not indicative of


                                       24
<PAGE>

cash available to fund cash needs.  The Company's  definition of Adjusted EBITDA
may not be  identical  to  similarly  titled  measures of other  companies.  The
Company believes that in addition to cash flows and net income,  Adjusted EBITDA
is a useful  financial  performance  measurement  for  assessing  the  operating
performance  of the Company  because,  together  with net income and cash flows,
Adjusted EBITDA is widely used in the videocassette specialty retailing industry
to provide  investors  with an  additional  basis to evaluate the ability of the
Company to incur and service its debt and to fund acquisitions.

Net cash provided by operating  activities  was $90.9 million for Fiscal 1998 as
compared to $83.9  million for Fiscal 1997.  Net income was lower in Fiscal 1998
versus Fiscal 1997 because of the impact of the change in  amortization  policy.
However,  cash  provided by operating  activities  increased  primarily due to a
decrease in merchandise  inventory and an increase in accounts payable,  as well
as higher depreciation and amortization in Fiscal 1998 versus Fiscal 1997. These
items were offset,  in part,  due to a decrease in deferred  income taxes and an
increase in other current assets in Fiscal 1998 versus Fiscal 1997.

Net cash used in  investing  activities  was $66.3  million  for Fiscal  1998 as
compared  to $83.2  million  for Fiscal  1997.  This  decrease in funds used for
investing  activities is primarily the result of a decrease in the  expenditures
of capital for both videocassette rental inventory and property, furnishings and
equipment during Fiscal 1998 versus Fiscal 1997.

Net cash used by  financing  activities  was $22.0  million  for Fiscal  1998 as
compared to $0.2 million for Fiscal 1997. This change resulted directly from the
Company's increased Adjusted EBITDA generated in Fiscal 1998 versus Fiscal 1997,
which  allowed the Company to decrease its debt  outstanding  during the year by
$21.6 million.

During Fiscal 1996, the Company entered into a $125 million  reducing  revolving
credit facility (the "Original Facility").  During 1997, the Company voluntarily
reduced the commitment to $90 million.  The available  amount under the Original
Facility began to reduce  quarterly on March 31, 1998 with a final maturity date
of June 30, 2000. The interest rate of the Original  Facility was based on LIBOR
plus an applicable margin percentage,  which depended on the Company's cash flow
generation  and  borrowings  outstanding.  At January 3, 1999,  $46  million was
outstanding and  approximately $17 million was available for borrowing under the
Original Facility.

The  Original  Facility  was  replaced  on  January  7, 1999  with a new  Credit
Agreement with First Union National Bank of North Carolina (the "New Facility").
The New Facility  provides  for  borrowings  up to $65 million,  is an unsecured
revolving  credit  facility  and  matures on January 7, 2002.  The  Company  may
increase  the amount of the New  Facility to $85 million  after April 8, 1999 if
existing  banks  increase  their  commitments  or a new bank(s) enter the Credit
Agreement.  The  interest  rate of the New  Facility  is based on LIBOR  plus an
applicable  margin  percentage,   which  depends  on  the  Company's  cash  flow
generation and borrowings outstanding. The Company may repay the New Facility at
any time without  penalty.  The more  restrictive  covenants of the New Facility
restrict borrowings based upon cash flow levels.

The Company  grows its store base  through  internally  developed  and  acquired
stores and may require  capital in excess of internally  generated  cash flow to
achieve its desired growth.  The Company has announced a planned increase in its
unit growth in 1999, which will be accomplished via opening up to 100 internally
developed stores and making selective,  accretive and  strategically  consistent
acquisitions,  if available to the Company on  reasonable  terms.  To the extent
available,  future acquisitions may be completed using funds available under the
New Facility,  financing provided by sellers, alternative financing arrangements
such as funds raised in public or private debt or equity  offerings or shares of
the Compan's stock issued to sellers.  However,  there can be no  assurance that
financing will be available to the Company on terms which will be acceptable, if
at all.

                                       25
<PAGE>

At January 3, 1999, the Company had a working  capital  deficit of $7.6 million,
due  to  the  accounting   treatment  of  its  videocassette  rental  inventory.
Videocassette  rental inventory is treated as a noncurrent asset under generally
accepted  accounting  principles because it is a depreciable asset and is not an
asset which is 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 the Company's  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, the Company
believes that working capital is not an appropriate measure of its liquidity and
it anticipates that it will continue to operate with a working capital deficit.

The Company believes its projected cash flow from operations, borrowing capacity
with the New Facility,  cash on hand and trade credit will provide the necessary
capital to fund its current plan of  operations  for Fiscal 1999,  including its
anticipated new store openings.  However,  to fund a resumption of the Company's
acquisition  program,  or to provide funds in the event that the Company's  need
for funds is greater  than  expected,  or if certain  of the  financing  sources
identified  above are not available to the extent  anticipated or if the Company
increases  its  growth  plan,  the  Company  will  need  to seek  additional  or
alternative  sources of financing.  This financing may not be available on terms
satisfactory to the Company.  Failure to obtain  financing to fund the Company's
expansion  plans or for other purposes  could have a material  adverse effect on
the Company.

Other Matters

Recently Issued Accounting Standards

In April 1998, the AICPA issued Statement of Position (SOP) 98-5, "Reporting the
Costs of Start-up Activities." The SOP is effective for the Company beginning on
January 4, 1999, and requires that certain start-up costs  capitalized  prior to
January 4, 1999 be written off and any such future start-up costs to be expensed
as incurred.  The  unamortized  balance of start-up  costs as of January 3, 1999
(approximately $650,000 after tax) will be written off as a cumulative effect of
an accounting  change as of January 4, 1999. The Company estimates the impact of
adopting this SOP will not be material to 1999 earnings.

Impact of Year 2000

The Company has  performed  an analysis of its  operating  systems to  determine
systems'  compatibility  with the upcoming year 2000.  Substantially  all of the
Company's operating systems are year 2000 compliant, including its point-of-sale
system.  While the  Company  has begun to  actively  replace  or modify  certain
software and hardware so that they will properly function on January 1, 2000 and
thereafter,  the costs associated with these  modifications or replacements have
not been  material to the Company nor does the Company  believe these costs will
be material in the future.

The Company's  payroll  software is not currently year 2000 compliant.  However,
the Company is in the process of replacing  its payroll  system with a year 2000
compliant  package that will provide  management with better  functionality  and
reporting. While the current payroll software is the Company's largest year 2000
issue to resolve,  the Company  believes that its planned  software and hardware
modifications,  as well as its replacement efforts will result in no significant
operational  problems.  However,  if such  modifications and conversions are not
made,  or are not  completed  timely,  the year 2000 issue could have a material
adverse impact on the operations of the Company.

                                       26
<PAGE>

The Company is  currently  not aware of any major  vendor  that is not  actively
managing the process of being year 2000  compliant  by December 31, 1999.  Thus,
the Company  does not believe  that there are any vendors with a year 2000 issue
that would  materially  impact the results of operations or the liquidity of the
Company.  However,  the Company has no means of ensuring  that  vendors  will be
adequately prepared for the year 2000.

The Company is developing  contingency plans in the event it experiences  system
failure  related to the year 2000.  The Company  plans to evaluate the status of
year 2000 compliance throughout 1999 to determine whether such contingency plans
are  adequate,  although  at this  time  the  Company  knows  of no  reason  its
modifications  and  replacements of operating  systems will not be effective and
completed in a timely manner.

Market Risk Sensitive Instruments

The market risk inherent in the Company's financial  instruments  represents the
increased  interest  costs  arising  from  adverse  changes  in  interest  rates
(primarily  LIBOR and prime  bank  rates).  In order to manage  this  risk,  the
Company entered into an interest rate swap agreement that effectively  fixes the
Company's  interest rate exposure on $37 million of the amount outstanding under
the New  Facility  at 5.8% plus an  applicable  margin  percentage.  Assuming  a
hypothetical  10% adverse  change in the LIBOR  interest  rate and assuming debt
levels  outstanding as of January 3, 1999, the Company would incur an immaterial
amount  of  additional   annual  interest  expense  on  unhedged  variable  rate
borrowings.  These  amounts  are  determined  by  considering  the impact of the
hypothetical  change in interest rates on the Company's  cost of borrowing.  The
analysis does not consider the  potential  negative  impact on overall  economic
activity that could exist in such an environment.  The Company believes that its
exposure to adverse  interest  rate  changes and its impact on its total cost of
borrowing capital has been largely mitigated by the interest rate swap agreement
that is in place.


ITEM 7A.  QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

        Reference  is  made  to  Part  II,  Item  7,   "Market  Risk   Sensitive
Instruments" of this Form 10-K for the information required by Item 7A.

ITEM 8.  FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

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

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

        None.


                                       27
<PAGE>

                                    PART III

ITEM 10.  DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

          The  information  required by this Item  (other  than the  information
regarding  executive  officers  set forth at the end of Item 1 of Part I of this
Form 10-K) will be contained in the Company's definitive Proxy Statement for its
1999 Annual Meeting of Stockholders, and is incorporated herein by reference.

ITEM 11.  EXECUTIVE COMPENSATION

          The  information  required  by  this  Item  will be  contained  in the
Company's   definitive   Proxy   Statement  for  its  1999  Annual   Meeting  of
Stockholders, and is incorporated herein by reference.

ITEM 12.  SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

          The  information  required  by  this  Item  will be  contained  in the
Company's   definitive   Proxy   Statement  for  its  1999  Annual   Meeting  of
Stockholders, and is incorporated herein by reference.

ITEM 13.  CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

          The  information  required  by  this  Item  will be  contained  in the
Company's   definitive   Proxy   Statement  for  its  1999  Annual   Meeting  of
Stockholders, and is incorporated herein by reference.


                                     PART IV

ITEM 14.  EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K

       (a)(1) Financial Statements:

           Report of Ernst & Young LLP, Independent Auditors.

           Consolidated  Balance  Sheets as of  January  3, 1999 and  January 4,
           1998.

           Consolidated  Statements  of  Operations  for the Fiscal  Years Ended
           January 3, 1999, January 4, 1998 and January 5, 1997.

           Consolidated  Statements of Stockholders' Equity for the Fiscal Years
           Ended January 3, 1999, January 4, 1998 and January 5, 1997.

           Consolidated  Statements  of Cash  Flows for the Fiscal  Years  Ended
           January 3, 1999, January 4, 1998 and January 5, 1997.

           Notes to Consolidated Financial Statements.

       (a)(2) Schedules:

           None.


                                       28
<PAGE>

       (a)(3) Exhibits:

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

Exhibit
  No.   Exhibit Description
------- -------------------
 3.1  - Certificate of Incorporation of the Company. (1)
 3.2  - Bylaws of the Company. (1)
 4.1  - Specimen Common Stock Certificate. (2)
10.1  - 1994 Stock Option Plan,as amended and form of Stock Option Agreement.(3)
10.2  - Form of Indemnity Agreement. (1)
10.3  - Employment Agreement between M.G.A., Inc. and Joe Thomas Malugen. (1)
10.4  - Employment Agreement between M.G.A., Inc. and H. Harrison Parrish. (1)
10.5  - Consulting Agreement between M.G.A., Inc. and William B. Snow dated
        December 21, 1998. (filed herewith)
10.6  - Employment Agreement between M.G.A., Inc. and J. Steven Roy. (4)
10.7  - Employment Agreement between M.G.A., Inc. and S. Page Todd. (4)
10.8  - Employment Agreement between M.G.A., Inc. and Steven M. Hamil. (4)
10.9  - Employment Agreement between M.G.A., Inc. and Robert L. Sirkis dated
        September 12, 1997. (filed herewith)
10.10 - Agreement dated March 13, 1997 between Sight & Sound Distributors, Inc.
        and Movie Gallery, Inc. (3) (portions were omitted pursuant to a request
        for confidential treatment)
10.11 - Agreement dated August 15, 1997 between Major Video Concepts, Inc. and
        Movie Gallery, Inc.(5) (portions were omitted pursuant to a request for
        confidential treatment)
10.12 - Real estate lease dated June 1, 1994 between J. T. Malugen, H. Harrison
        Parrish and M.G.A., Inc.(1)
10.13 - Real estate lease dated June 1, 1994 between H. Harrison Parrish and
        M.G.A., Inc.(1)
10.14 - Tax Agreement between M.G.A., Inc. and Joe T. Malugen and Harrison
        Parrish.(1)
10.15 - Certificate of Title dated October 6, 1992 and United States Patent and
        Trademark Office Notice of Recordation of Assignment Document dated
        January 27, 1993 (relating to the Company's acquisition of the "Movie
        Gallery" service mark, trade name and goodwill associated therewith) (6)
10.16 - Credit Agreement between First Union National Bank of North Carolina and
        Movie Gallery, Inc. dated July 10, 1996. (7)
10.17 - Credit Agreement between First Union National Bank of North Carolina and
        Movie Gallery, Inc. dated January 7, 1999. (filed herewith)
10.18 - Asset Purchase Agreement between Blowout Entertainment, Inc. and M.G.A.,
        Inc. dated March 22, 1999. (filed herewith)
18    - Change in Accounting Principle.(8)
18.1  - Change in Accounting Principle.(9)
21    - List of Subsidiaries. (filed herewith)
23    - Consent of Ernst & Young LLP, Independent Auditors. (filed herewith)
27    - Financial Data Schedule. (filed herewith)



                                       29


<PAGE>
_______________
(1)  Previously  filed with the Securities  and Exchange  Commission on June 10,
     1994, as exhibits to the Company's Registration Statement on Form S-1 (File
     No. 33-80120).
(2)  Previously  filed with the Securities and Exchange  Commission on August 1,
     1994,  as an  exhibit  to  Amendment  No. 2 to the  Company's  Registration
     Statement on Form S-1.
(3)  Previously  filed with the Securities  and Exchange  Commission on April 7,
     1997,  as an exhibit to the  Company's  Form 10-K for the fiscal year ended
     January 5, 1997.
(4)  Previously  filed with the Securities  and Exchange  Commission on April 6,
     1998,  as an exhibit to the  Company's  Form 10-K for the fiscal year ended
     January 4, 1998.
(5)  Previously  filed with the Securities  and Exchange  Commission on November
     19, 1997 as an exhibit to the  Company's  Form 10-Q for the  quarter  ended
     October 5, 1997.
(6)  Previously  filed with the Securities  and Exchange  Commission on July 14,
     1994,  as  exhibits  to  Amendment  No.  1 to  the  Company's  Registration
     Statement on Form S-1.
(7)  Previously  filed with the Securities  and Exchange  Commission on July 15,
     1996, as an exhibit to the Company's Current Report on Form 8-K.
(8)  Previously filed with the Securities and Exchange  Commission on August 14,
     1996, as an exhibit to the  Company's  Form 10-Q for the quarter ended June
     30, 1996.
(9)  Previously  filed with the Securities  and Exchange  Commission on November
     18, 1998,  as an exhibit to the  Company's  Form 10-Q for the quarter ended
     October 4, 1998.

        (b) Reports on Form 8-K:

            The Company did not file any reports on Form 8-K during the  quarter
        ended January 3, 1999.

        (c) Exhibits:

            See (a)(3) above.


                                       30
<PAGE>

SIGNATURES

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

                                             MOVIE GALLERY, INC.

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

Date:  April 5, 1999


            Pursuant to the requirements of the Securities Exchange Act of 1934,
this annual report on Form 10-K has been signed below by the  following  persons
on behalf of the Registrant and in the capacities and on the dates indicated.

     Signature                       Title                         Date
     ---------                       -----                         ----

/s/ JOE THOMAS MALUGEN     Chairman of the Board and           April 5, 1999
-----------------------    Chief Executive Officer
Joe Thomas Malugen

/s/ WILLIAM B. SNOW        Vice Chairman of the Board          April 5, 1999
-----------------------
William B. Snow

/s/ H. HARRISON PARRISH    Director and President              April 5, 1999
-----------------------
H. Harrison Parrish

/s/ SANFORD C. SIGOLOFF    Director                            April 5, 1999
-----------------------
Sanford C. Sigoloff

/s/ J. STEVEN ROY          Executive Vice President and        April 5, 1999
-----------------------    Chief Financial Officer
J. Steven Roy

/s/ STEVEN M. HAMIL        Senior Vice President and           April 5, 1999
-----------------------    Chief Accounting Officer
Steven M. Hamil


                                       31
<PAGE>

                               Movie Gallery, Inc.

                              Financial Statements

     Fiscal years ended January 3, 1999, January 4, 1998 and January 5, 1997

                                    Contents

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

Audited Financial Statements

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


<PAGE>

                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 3, 1999 and January 4, 1998,  and the  related  consolidated
statements of  operations,  stockholders'  equity and cash flows for each of the
three years in period ended January 3, 1999. These financial  statements are the
responsibility of the Company's management.  Our responsibility is to express an
opinion on these financial statements based on our audits.

We  conducted  our  audits  in  accordance  with  generally   accepted  auditing
standards.  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.

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 3, 1999 and January 4, 1998, and the consolidated results of its
operations  and its cash  flows  for each of the  three  years in  period  ended
January 3, 1999, in conformity with generally accepted accounting principles.

As discussed in Note 1 to the financial statements, in 1998 and 1996 the Company
changed  its method of  accounting  for  amortization  of  videocassette  rental
inventory.


                                                 /s/ Ernst & Young, LLP



Birmingham, Alabama
February 12, 1999



                                      F-1

<PAGE>

<TABLE>

                              Movie Gallery, Inc.

                           Consolidated Balance Sheets
                                 (in thousands)
<CAPTION>

                                                                 January 3,       January 4,
                                                                    1999             1998
                                                                 ---------------------------
<S>                                                              <C>              <C>
Assets
Current assets:
   Cash and cash equivalents                                     $  6,983         $  4,459
   Merchandise inventory                                           11,824           13,512
   Prepaid expenses                                                   779            1,341
   Store supplies and other                                         3,772            2,561
   Deferred income taxes                                              312              531
                                                                 --------         --------
Total current assets                                               23,670           22,404
Videocassette rental inventory, net                                44,998           92,183
Property, furnishings and equipment, net                           43,920           50,321
Goodwill and other intangibles, net                                85,743           92,321
Deposits and other assets                                           1,799            1,904
Deferred income taxes                                               2,239               --
                                                                 --------         --------
Total assets                                                     $202,369         $259,133
                                                                 ========         ========

Liabilities and stockholders' equity
Current liabilities:
   Accounts payable                                              $ 23,396         $ 21,517
   Accrued liabilities                                              7,426            7,014
   Current portion of long-term debt                                  442            4,751
                                                                 --------         --------
Total current liabilities                                          31,264           33,282
Long-term debt                                                     46,212           63,479
Other accrued liabilities                                             778            1,899
Deferred income taxes                                                  --           12,844
Stockholders' equity:
   Preferred stock, $.10 par value; 2,000,000 shares
     authorized, no shares issued and outstanding                      --               --
   Common stock, $.001 par value; 60,000,000
     shares authorized, 13,315,915 and 13,418,885
     shares issued and outstanding                                     13               13
   Additional paid-in capital                                     131,743          131,686
   Retained earnings (deficit)                                     (7,146)          15,930
   Treasury stock (115,200 shares)                                   (495)              --
                                                                 --------         --------
Total stockholders' equity                                        124,115          147,629
                                                                 --------         --------
Total liabilities and stockholders' equity                       $202,369         $259,133
                                                                 ========         ========

See accompanying notes.

</TABLE>
                                       F-2

<PAGE>
<TABLE>

                               Movie Gallery, Inc.

                      Consolidated Statements of Operations
                      (in thousands, except per share data)
<CAPTION>

                                                                         Fiscal Year Ended
                                                           ---------------------------------------------
                                                           January 3,         January 4,       January 5,
                                                              1999               1998             1997
                                                           ---------------------------------------------

<S>                                                        <C>               <C>               <C>
Revenues:
   Rentals                                                 $ 222,784         $ 220,787         $ 219,002
   Product sales                                              44,849            39,569            35,393
                                                           ---------         ---------         ---------
                                                             267,633           260,356           254,395

Operating costs and expenses:
   Store operating expenses                                  137,158           134,141           124,456
   Amortization of videocassette rental inventory            106,507            69,177            63,544
   Amortization of intangibles                                 7,068             7,206             7,160
   Cost of  product sales                                     29,744            24,597            21,143
   General and administrative                                 17,996            17,006            20,266
   Restructuring and other charges                              --                --               9,595
                                                           ---------         ---------         ---------
Operating income (loss)                                      (30,840)            8,229             8,231

   Interest income                                                44                45                99
   Interest expense                                           (5,369)           (6,371)           (5,718)
                                                           ---------         ---------         ---------
Income (loss) before income taxes                            (36,165)            1,903             2,612

Income taxes                                                 (13,089)              998             1,131
                                                           ---------         ---------         ---------
Net income (loss)                                          $ (23,076)        $     905         $   1,481
                                                           =========         =========         =========
Basic and diluted earnings (loss) per share                $   (1.72)        $     .07
                                                           =========         =========

Pro forma earnings per share (unaudited):
Income before income taxes                                                                     $   2,612
Pro forma income taxes                                                                             1,006
                                                                                               ---------
Pro forma net income                                                                           $   1,606
                                                                                               =========
Basic and diluted pro forma earnings per share                                                 $     .12
                                                                                               =========

Weighted average shares outstanding (in thousands):
  Basic                                                       13,388            13,420            13,241
  Diluted                                                     13,388            13,421            13,368

See accompanying notes.
</TABLE>


                                   F-3
<PAGE>

<TABLE>
                               Movie Gallery, Inc.

                 Consolidated Statements of Stockholders' Equity
                                 (in thousands)

<CAPTION>

                                                                  Additional    Retained                         Total
                                                        Common      Paid-in     Earnings       Treasury       Stockholders'
                                                         Stock      Capital     (Deficit)       Stock            Equity
                                                        ------------------------------------------------------------------

<S>                                                     <C>        <C>          <C>             <C>            <C>
Balance at December 31, 1995                            $   13     $ 122,582    $  13,544       $   --         $136,139
    Net income                                              --            --        1,481           --            1,481
    Issuance of 508,455 shares of common
      stock  for acquisitions, net of issuance
      costs of $322                                         --         8,386           --           --            8,386
    Exercise of stock options for 35,100
      shares                                                --           524           --           --              524
    Tax benefit of stock options exercised                  --           218           --           --              218
    Other transactions by pooled companies                  --           (24)          --           --              (24)
                                                        ------     ---------    ---------       ------         --------
Balance at January 5, 1997                                  13       131,686       15,025           --          146,724

    Net income                                              --            --          905           --              905
                                                        ------     ---------    ---------       ------         --------
Balance at January 4, 1998                                  13       131,686       15,930           --          147,629

    Net loss                                                --            --      (23,076)          --          (23,076)
    Exercise of stock options for
      12,230 shares                                         --            48           --           --               48
    Tax benefit of stock options exercised                  --             9           --           --                9
    Purchases of treasury stock
      (115,200 shares)                                      --            --           --         (495)            (495)
                                                        ------     ---------    ---------       ------        ---------
Balance at January 3, 1999                              $   13     $ 131,743    $  (7,146)      $ (495)       $ 124,115
                                                        ======     =========    =========       ======        =========

See accompanying notes.
</TABLE>

                                      F-4

<PAGE>
<TABLE>

                               Movie Gallery, Inc.

                      Consolidated Statements of Cash Flows
                                 (in thousands)

<CAPTION>
                                                                                Fiscal Year Ended
                                                                ---------------------------------------------------
                                                                 January 3,          January 4,          January 5,
                                                                    1999                1998                1997
                                                                ---------------------------------------------------


<S>                                                             <C>                 <C>                 <C>                 
Operating activities
Net income (loss)                                               $ (23,076)          $     905           $   1,481
Adjustments to reconcile net income (loss) to net cash
  provided by operating activities:
    Depreciation and amortization                                 126,257              88,140              79,625
    Deferred income taxes                                         (14,855)                998                 822
    Restructuring and other charges                                  --                  --                 9,595
    Changes in operating assets and liabilities:
       Merchandise inventory                                        1,911              (3,493)                203
       Other current assets                                          (649)                435               1,365
       Deposits and other assets                                      105                 834                (978)
       Accounts payable                                             1,879              (2,804)             (1,649)
       Accrued liabilities                                           (709)             (1,134)              1,336
                                                                ---------           ---------           ---------
Net cash provided by operating activities                          90,863              83,881              91,800

Investing activities
Business acquisitions                                                (799)               (474)             (8,662)
Purchases of videocassette rental inventory, net                  (59,266)            (70,801)            (77,666)
Purchases of property, furnishings and equipment                   (6,251)            (13,072)            (18,438)
Proceeds from disposal of  equipment                                   --               1,170                  --
                                                                ---------           ---------           ---------
Net cash used in investing activities                             (66,316)            (83,177)           (104,766)

Financing activities
Net proceeds from issuance of common stock                             48                  --                 524
Purchases of treasury stock                                          (495)                 --                  --
Net payments on notes payable                                        (200)                 --             (32,052)
Proceeds from issuance of  long-term debt                              --                  --              72,938
Principal payments on long-term debt                              (21,376)               (227)            (30,717)
                                                                ---------           ---------           ---------
Net cash (used in) provided by financing activities               (22,023)               (227)             10,693
                                                                ---------           ---------           ---------
Increase (decrease) in cash and cash equivalents                    2,524                 477              (2,273)
Cash and cash equivalents at beginning of fiscal year               4,459               3,982               6,255
                                                                ---------           ---------           ---------
Cash and cash equivalents at end of fiscal year                 $   6,983           $   4,459           $   3,982
                                                                =========           =========           =========

Supplemental disclosures of cash flow
   information
Cash paid during the period for interest                        $   5,066           $   5,777           $   5,377
Cash paid during the period for income taxes                          478                  --                 203
Noncash investing and financing information:
   Assets acquired by issuance of notes payable                        --                 200                  --
   Assets acquired by issuance of common stock                         --                  --               8,708
   Tax benefit of stock options exercised                               9                  --                 218

See accompanying notes.
</TABLE>

                                     F-5

<PAGE>

                               Movie Gallery, Inc.

                   Notes to Consolidated Financial Statements

              January 3, 1999, January 4, 1998 and January 5, 1997

1. Accounting Policies

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

The Company's  historical financial statements for the fiscal year ended January
5, 1997 have been  restated  to  include  the  financial  position,  results  of
operations and cash flows of Home Vision Entertainment, Inc. ("Home Vision") and
Hollywood Video, Inc.  ("Hollywood  Video"),  merger  transactions in 1996 which
were accounted for as poolings-of-interests (see Note 2).

The Company owns and operates  video  specialty  stores in 22 states,  generally
located in the eastern half of the United States.

Fiscal Year

On July 1, 1996,  the Company  adopted a fiscal year ending on the first  Sunday
following December 30, which periodically  results in a fiscal year of 53 weeks.
Results for 1996 reflect a 53-week  year.  The  Company's  fiscal year  includes
revenues  and certain  operating  expenses,  such as  salaries,  wages and other
miscellaneous  expenses,  on  a  daily  basis.  All  other  expenses,  primarily
depreciation and amortization,  are calculated and recorded monthly, with twelve
months included in each fiscal year.

Cash Equivalents

The Company  considers  all highly liquid  investments  with a maturity of three
months or less when purchased to be cash equivalents.

Merchandise Inventory

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

Long-Lived Assets

During  the first  quarter  of 1996,  the  Company  adopted  the  provisions  of
Financial  Accounting  Standards Board (FASB) Statement No. 121, "Accounting for
the  Impairment of Long-Lived  Assets and for  Long-Lived  Assets to Be Disposed
Of," which requires  impairment  losses to be recorded on long-lived assets used
in operations  and intangible  assets when  indicators of impairment are present
and the  undiscounted  cash flows  estimated to be generated by those assets are
less  than the  assets'  carrying  amounts.  Statement  121 also  addresses  the
accounting for long-lived assets that are expected to be disposed of. The effect
of adoption of Statement 121 was not material.

                                      F-6

<PAGE>
                               Movie Gallery, Inc.

             Notes to Consolidated Financial Statements (continued)

1.  Accounting Policies (continued)

Videocassette Rental Inventory

Effective  July  6,  1998,   the  Company   changed  its  method  of  amortizing
videocassette and video game rental inventory.  This new method  accelerates the
rate of amortization  and has been adopted as a result of both an industry and a
Company trend toward significant increases in copy-depth availability from movie
studios,  which  have  resulted  in earlier  satisfaction  of  consumer  demand,
thereby, accelerating the rate of revenue recognition. Under the new method, the
cost of base stock  videocassettes,  consisting of two copies per title for each
store,  is amortized on an accelerated  basis to a net book value of $8 over the
first six months and to a $4 salvage value over the next thirty months. The cost
of non-base stock videocassettes,  consisting of the third and succeeding copies
of each title per store, is amortized on an accelerated basis over the first six
months  to  a  net  book  value  of  $4  which  is  then  fully  amortized  on a
straight-line  basis over the next 30 months or until the videocassette is sold,
at which time the  unamortized  book  value is  charged to cost of sales.  Video
games  are  amortized  on a  straight-line  basis to a $10  salvage  value  over
eighteen  months.  The Company will continue to expense revenue sharing payments
as revenues are earned pursuant to contractual arrangements.

The new method of amortization has been applied to all inventory held at July 6,
1998. The adoption of the new method of amortization has been accounted for as a
change in  accounting  estimate  effected  by a change in  accounting  principle
during the quarter ended October 4, 1998.  The  application of the new method of
amortizing  videocassette  and video  game  rental  inventory  decreased  rental
inventory and increased  depreciation  expense for the fiscal year ended January
3, 1999 by approximately  $43.6 million and reduced net income by $27.7 million,
or $2.06 per basic and diluted share.

Prior to July 6, 1998, and pursuant to an accounting  change  effective April 1,
1996,  videocassette  and video game rental  inventory  was recorded at cost and
amortized over its economic  useful life.  Videocassettes  considered to be base
stock were amortized over  thirty-six  months on a  straight-line  basis to a $5
salvage value.  New release  videocassettes  were amortized as follows:  (i) the
fourth and any  succeeding  copies of each title per store were  amortized  on a
straight-line basis over the first six months to an average net book value of $5
which was then fully  amortized  on a  straight-line  basis over the next thirty
months or until the  videocassette  was sold, at which time the unamortized book
value was  charged to cost of sales and (ii)  copies one  through  three of each
title per store were amortized as base stock.  The application of this method of
amortization  increased  depreciation  expense and cost of sales for the quarter
ended June 30, 1996 by  approximately  $7.7  million.  For the fiscal year ended
January 5, 1997,  the  adoption of this  method of  amortization  decreased  net
income by approximately $4.9 million or $0.37 per diluted share.

Videocassette rental inventory consists of the following (in thousands):
<TABLE>
<CAPTION>

                                                         January 3,   January 4,
                                                            1999         1998
                                                         ----------------------

<S>                                                      <C>          <C>      
Videocassette rental inventory                           $ 180,858    $ 175,922
Less accumulated amortization                             (135,860)     (83,739)                                         
                                                         ---------    ---------
                                                         $  44,998    $  92,183
                                                         =========    =========
</TABLE>


                                       F-7

<PAGE>
                               Movie Gallery, Inc.

             Notes to Consolidated Financial Statements (continued)


1.   Accounting Policies (continued)

Property, Furnishings and Equipment

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

Goodwill and Other Intangibles

Goodwill is being  amortized on a straight-line  basis over twenty years.  Other
intangibles  consist primarily of non-compete  agreements and are amortized on a
straight-line basis over the lives of the respective agreements which range from
two to ten years.  Accumulated amortization of goodwill and other intangibles at
January  3,  1999  and  January  4,  1998  was  $25,245,000   and   $18,261,000,
respectively.

Income Taxes

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

Videocassette Rental Revenue

Rental revenue is recognized when the  videocassette  or video game is rented by
the customer.

Advertising Costs

Advertising costs,  exclusive of cooperative  reimbursements  from vendors,  are
expensed when incurred. Advertising costs were $896,000, $728,000 and $1,512,000
for the fiscal years ended January 3, 1999, January 4, 1998 and January 5, 1997,
respectively.

Store Opening Costs

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

Earnings Per Share

Effective January 4, 1998, the Company adopted FASB Statement No. 128, "Earnings
per Share." This Statement is effective for fiscal periods ending after December
15, 1997 and requires  restatement  of prior  periods'  earnings per share data.
Under this Statement the  calculation of primary and fully diluted  earnings per
share is  replaced  with  basic and  diluted  earnings  per  share and  requires
presentation of both amounts on the income  statement.  Unlike primary  earnings
per share,  basic  earnings per share  excludes  any dilutive  effects of common
stock  equivalents.  Diluted  earnings  per share is similar  to the  previously
reported  fully diluted  earnings per share.  Adoption of this  Statement had no
significant  impact  on  the  earnings  per  share  calculations  for  any  year
presented.

                                      F-8

<PAGE>
                               Movie Gallery, Inc.

             Notes to Consolidated Financial Statements (continued)

1.  Accounting Policies (continued)

Fair Value of Financial Instruments

At  January  3, 1999 and  January  4,  1998,  the  carrying  value of  financial
instruments such as cash and cash equivalents,  accounts payable,  notes payable
and long-term debt approximated  their fair values,  calculated using discounted
cash flow analysis at the Company's incremental borrowing rate.

Use of Estimates

The preparation of financial  statements in conformity  with generally  accepted
accounting principles requires management to make estimates and assumptions that
affect  the  amounts  reported  in the  consolidated  financial  statements  and
accompanying notes. The most significant estimates and assumptions relate to the
provision for business  restructuring (see Note 3) and the amortization  methods
and  useful  lives  of  videocassette  rental  inventory,   goodwill  and  other
intangibles.  These  estimates and  assumptions  could change and actual results
could differ from these estimates.

Recently Issued Accounting Standards

In April 1998, the AICPA issued Statement of Position (SOP) 98-5, "Reporting the
Costs of Start-up Activities." The SOP is effective for the Company beginning on
January 4, 1999, and requires that certain start-up costs  capitalized  prior to
January 4, 1999 be written off and any such future start-up costs to be expensed
as incurred.  The  unamortized  balance of start-up  costs as of January 3, 1999
(approximately $650,000 after tax) will be written off as a cumulative effect of
an accounting  change as of January 4, 1999. The Company estimates the impact of
adopting this SOP will not be material to 1999 earnings.

In June 1997,  the FASB  issued  Statement  No.  130,  "Reporting  Comprehensive
Income," which is effective for the Company's fiscal year ended January 3, 1999.
Comprehensive  income is defined as the  change in equity  during a period  from
transactions  and  other  events  and  circumstances   from  non-owner  sources.
Statement 130 establishes  standards for reporting and display of  comprehensive
income and its  components and requires that an enterprise (a) classify items of
other  comprehensive  income by their  nature in a financial  statement  and (b)
display the accumulated  balance of other  comprehensive  income separately from
retained  earnings and  additional  paid-in  capital in the equity  section of a
statement of financial  position.  Statement 130 has no impact on the Company as
there have been no transactions resulting in items of comprehensive income.

In June 1998,  the FASB issued  Statement No. 133,  "Accounting  for  Derivative
Instruments  and Hedging  Activities,"  which is required to be adopted in years
beginning after June 15, 1999.  Management does not anticipate that the adoption
of the new Statement will have a significant effect on earnings or the financial
position of the Company.

Unaudited Pro Forma Information

Pro forma  income  taxes  reflect  income  tax  expense  which  would  have been
recognized  by the  Company  as a C  corporation  if  the  1996  acquisition  of
Hollywood  Video  (see Note 2) had been  consummated  prior to  January 1, 1996.
Hollywood Video's historical  operating results do not include any provision for
income taxes as Hollywood  Video was taxed as an S  corporation  for all periods
prior to the merger.

                                      F-9

<PAGE>

                               Movie Gallery, Inc.

             Notes to Consolidated Financial Statements (continued)

1.   Accounting Policies (continued)

Employee Benefits

The Company has a 401(k) savings plan available to all active  employees who are
over 21 years of age and have  completed one year of service.  The Company makes
discretionary and matching  contributions  based on employee  compensation.  The
matching  contribution  for the fiscal year ended January 3, 1999 was immaterial
to the Company.

2.  Acquisitions

On July 1, 1996,  the Company  acquired Home Vision and  Hollywood  Video in two
separate merger transactions accounted for as poolings-of-interests, pursuant to
which the Company  issued  approximately  769,000  shares of its common stock to
Home Vision and  Hollywood  Video  shareholders  and assumed  approximately  $24
million in  liabilities.  At the time of the merger,  Home Vision and  Hollywood
Video  operated 98 video  specialty  stores in six  northeastern  and midwestern
states.

Separate  results of operations of the merged  entities for the periods prior to
the merger date are as follows (in thousands) (unaudited):
<TABLE>
<CAPTION>

                                                               Six Months Ended
                                                                June 30, 1996
                                                               -----------------
<S>                                                                <C> 
Revenues:
  Movie Gallery                                                    $ 106,307
  Home Vision                                                         11,191
  Hollywood Video                                                      5,307
                                                                   ---------
Combined                                                           $ 122,805
                                                                   =========

Net income (loss):
  Movie Gallery                                                    $   3,106
  Home Vision                                                            (97)
  Hollywood Video                                                       (986)
                                                                   ---------
Combined                                                           $   2,023
                                                                   =========

</TABLE>

Costs of approximately  $757,000  incurred by the Company in connection with the
Home  Vision and  Hollywood  Video  mergers  have been  included  in general and
administrative  expenses in the  consolidated  statement of  operations  for the
fiscal year ended January 5, 1997.

During 1996, the Company  acquired 76 video specialty  stores in 20 transactions
with unrelated sellers for $21,447,000, including the issuance of 505,094 shares
of common stock.  The goodwill  recorded in connection  with these purchases was
$9,726,000.  These  acquisitions were accounted for under the purchase method of
accounting and are included in the Company's  consolidated  financial statements

                                      F-10
<PAGE>

                              Movie Gallery, Inc.

             Notes to Consolidated Financial Statements (continued)

2. Acquisitions (continued)

from the dates of acquisition.  The following pro forma information presents the
consolidated  results of operations of the Company as though these  acquisitions
had occurred as of the beginning of the 1996 fiscal year (in  thousands,  except
per share data) (unaudited):
<TABLE>
<CAPTION>

                                                              Fiscal Year Ended
                                                               January 5, 1997
                                                              -----------------

<S>                                                            <C>             
Revenues                                                       $        261,223
Net income                                                                2,521
Earnings per share                                                         0.19

</TABLE>

3.  Provision for Business Restructuring

During the third  quarter of 1996,  the Company began and completed an extensive
analysis of both its store base  performance  and  organizational  structure and
adopted a business  restructuring  plan to close  approximately 50 stores.  This
analysis resulted in the Company  recording a $9.6 million pretax  restructuring
charge in the third quarter of 1996. The components of the restructuring  charge
included  approximately  $5.4  million in reserves  for future cash  outlays for
lease terminations,  miscellaneous closing costs and legal and accounting costs,
as well as  approximately  $4.2 million in asset write downs. The store closures
were  substantially  completed  by the end of the fiscal  year ended  January 4,
1998.  Approximately  $3.2 million of restructuring  costs were paid and charged
against the liability as of January 3, 1999.  The stores  identified for closure
had  revenues  and  operating  losses of  approximately  $0.8  million  and $0.4
million,   respectively,   for  the  fiscal  year  ended  January  4,  1998  and
approximately $6.2 million and $1.6 million,  respectively,  for the fiscal year
ended January 5, 1997.

4.  Property, Furnishings and Equipment

Property, furnishings and equipment consists of the following (in thousands):
<TABLE>
<CAPTION>

                                                      January 3,      January 4,
                                                         1999            1998
                                                      -------------------------

<S>                                                   <C>              <C>     
Land and buildings                                    $  1,889         $  1,879
Furniture and fixtures                                  29,688           29,030
Equipment                                               24,755           23,516
Leasehold improvements and signs                        24,661           22,339
                                                      --------         --------
                                                        80,993           76,764
Accumulated depreciation                               (37,073)         (26,443)
                                                      --------         --------
                                                      $ 43,920         $ 50,321
                                                      ========         ========

</TABLE>


                                      F-11
<PAGE>

                               Movie Gallery, Inc.

             Notes to Consolidated Financial Statements (continued)

5.  Long-Term Debt

On July 10, 1996, the Company  entered into a Credit  Agreement with First Union
National  Bank of North  Carolina  with respect to a reducing  revolving  credit
facility  (the  "Original  Facility").  The Original  Facility was unsecured and
originally provided borrowings for up to $125 million.  During 1997, the Company
voluntarily  reduced the commitment to $90 million.  The available  amount under
the  Original  Facility  began to reduce  quarterly on March 31, 1998 and was to
mature on June 30, 2000. The interest rate of the Original Facility was based on
LIBOR plus an applicable margin percentage, which depended on the Company's cash
flow generation and borrowings outstanding.  At January 3, 1999, $46 million was
outstanding,  approximately  $17 million was  available  for  borrowing  and the
effective interest rate was approximately 7.3% under the Original Facility.

The  Original  Facility  was  replaced  on  January  7, 1999  with a new  Credit
Agreement with First Union National Bank of North Carolina (the "New Facility").
The New Facility is an unsecured  revolving  credit facility that will mature in
its entirety on January 7, 2002. The New Facility  provides for borrowings up to
$65 million,  and the Company may increase the amount of the New Facility to $85
million after April 8, 1999 if existing banks  increase  their  commitments or a
new bank(s) enter the Credit Agreement. The interest rate of the New Facility is
based on LIBOR  plus an  applicable  margin  percentage,  which  depends  on the
Company's  cash  flow  generation  and  borrowings  outstanding.  The  effective
interest rate of the New Facility was approximately 6.7% at January 7, 1999. The
Company  may  repay  the New  Facility  at any time  without  penalty.  The more
restrictive  covenants of the New Facility  restrict  borrowings based upon cash
flow levels.

Concurrent with the New Facility, the Company amended its existing interest rate
swap to coincide  with the maturity of the New  Facility.  The amended  interest
rate swap agreement  effectively  fixes the Company's  interest rate exposure on
$37  million of the amount  outstanding  under the New  Facility at 5.8% plus an
applicable  margin  percentage.  The  interest  rate  swap  reduces  the risk of
increases  in interest  rates during the life of the New  Facility.  The Company
accounts  for its  interest  rate  swap as a hedge of its debt  obligation.  The
Company pays a fixed rate of interest and receives  payment  based on a variable
rate of interest. The difference in amounts paid and received under the contract
is accrued and  recognized  as an  adjustment  to interest  expense on the debt.
There  are no  termination  penalties  associated  with the  interest  rate swap
agreement;  however,  if the swap  agreement  was  terminated  at the  Company's
option,  the  Company  would  either pay or  receive  the  present  value of the
remaining hedge payments at the then  prevailing  interest rates for the time to
maturity of the swap agreement.  The interest rate swap agreement  terminates at
the time the New Facility matures.

As a result of the New Facility and the amended  interest  rate swap  agreement,
the Company will recognize an extraordinary  loss on the  extinguishment of debt
of  approximately  $1 million,  or $.05 per share,  during the first  quarter of
1999. The  extraordinary  loss will be comprised  primarily of unamortized  debt
issue costs associated with the Original  Facility and the negative value of the
original interest rate swap at the time of the amendment.

In connection  with certain  acquisitions,  the Company  issued or assumed notes
payable which had outstanding  balances of $654,000 and $1,230,000 at January 3,
1999 and January 4, 1998,  respectively.  Generally,  these notes are unsecured,
require  monthly or annual  payments and have fixed or variable  interest  rates
ranging from 7% to 9%.

                                      F-12
<PAGE>

                               Movie Gallery, Inc.

             Notes to Consolidated Financial Statements (continued)

5.   Long-Term Debt (continued)

Scheduled  maturities  of  long-term  debt  are as  follows:  $442,000  in 1999,
$212,000 in 2000 and $46,000,000 in 2002.

6.  Income Taxes

The following  reflects actual income tax expense (benefit) for the fiscal years
ended  January 3, 1999 and January 4, 1998,  and  unaudited pro forma income tax
expense that the Company would have  incurred had  Hollywood  Video (see Note 2)
been subject to federal and state income taxes for the entire  fiscal year ended
January 5, 1997 (in thousands):
<TABLE>
<CAPTION>

                                                Fiscal Year Ended
                                      ------------------------------------------------
                                      January 3,       January 4,      January 5,
                                         1999             1998            1997
                                      ------------------------------------------------
                                                                      (unaudited pro
                                                                    forma information)
<S>                                    <C>              <C>             <C>
Current payable:
  Federal                              $  1,275         $     --        $     90
  State                                     491               --              --
                                       --------         --------        --------
Total current                             1,766               --              90

Deferred:
  Federal                               (13,423)             903             831
  State                                  (1,432)              95              85
                                       --------         --------        --------
Total deferred                          (14,855)             998             916
                                       --------         --------        --------
                                       $(13,089)        $    998        $  1,006
                                       ========         ========        ========
</TABLE>

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

                                                        Fiscal Year Ended
                                               ----------------------------------------
                                               January 3,   January 4,   January 5,
                                                  1999         1998         1997
                                               ----------------------------------------
                                                                       (unaudited pro
                                                                     forma information)
<S>                                            <C>          <C>          <C>
Income tax expense (benefit)
 at statutory rate                             $(12,658)    $    647     $    888
State income tax expense (benefit),
 net of federal income tax benefit                 (612)          63           85
Other, net (primarily goodwill not
 deductible for tax purposes)                       181          288           33
                                               --------     --------     --------
                                               $(13,089)    $    998     $  1,006
                                               ========     ========     ========
</TABLE>

                                      F-13

<PAGE>

                               Movie Gallery, Inc.

             Notes to Consolidated Financial Statements (continued)

6.  Income Taxes (continued)

At January  3,  1999,  the  Company  had net  operating  loss  carryforwards  of
approximately  $12.6  million for income taxes that expire in years 2010 through
2012.  Approximately  $5.5  million  of these  carryforwards  resulted  from the
Company's  acquisition  of Home  Vision  (see  Note 2).  Utilization  of the net
operating  loss  carryforwards  related to the Home  Vision  acquisition  may be
subject to a substantial  annual  limitation due to the statutory  provisions of
the Internal  Revenue Code.  The Company has not recorded a valuation  allowance
related to its deferred tax assets as  management  considers it more likely than
not that  available  tax  strategies  and future  taxable  income will allow the
deferred tax assets to be realized.

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

<TABLE>
<CAPTION>

                                                          January 3,    January 4,
                                                            1999          1998
                                                          ------------------------
<S>                                                       <C>           <C>
Deferred tax liabilities:
  Videocassette rental inventory                          $    788      $ 17,800
  Furnishings and equipment                                  5,740         5,340
  Goodwill                                                   2,295         1,864
  Other                                                        997         1,214
                                                          --------      --------
    Total deferred tax liabilities                           9,820        26,218
Deferred tax assets:
  Non-compete agreements                                     4,839         4,522
  Net operating loss carryforwards                           4,806         7,870
  Accrued liabilities                                          828         1,493
  Other                                                        438          --
  Alternative minimum tax credit carryforward                1,460            20
                                                          --------      --------
    Total deferred tax assets                               12,371        13,905
                                                          --------      --------
Net deferred tax (assets) liabilities                     $ (2,551)     $ 12,313
                                                          ========      ========
</TABLE>

7.  Stockholders' Equity

Common Stock

In 1995, the Company  registered shares of common stock with an aggregate public
offering  price of  $127,000,000.  This  common  stock may be  offered  directly
through  agents,  underwriters  or dealers or may be offered in connection  with
business  acquisitions.  As of January 3, 1999,  common  stock of  approximately
$83,000,000 was available to be issued from this registration.

As of January  3,  1999,  the  Company  had  warrants  outstanding  to  purchase
approximately 100,000 shares of the Company's common stock,  exercisable through
June 30, 2000 at an exercise price of $30.11.

                                      F-14
<PAGE>


                               Movie Gallery, Inc.

             Notes to Consolidated Financial Statements (continued)

7.  Stockholders' Equity (continued)

Earnings Per Share

Basic  earnings  per share and basic pro forma  earnings  per share are computed
based on the  weighted  average  number of shares  of common  stock  outstanding
during the periods  presented.  Diluted earnings per share and diluted pro forma
earnings per share are computed  based on the weighted  average number of shares
of common stock outstanding  during the periods  presented,  increased solely by
the effects of shares to be issued from the  exercise of dilutive  common  stock
options  (0,  1,000 and  127,000  for the fiscal  years  ended  January 3, 1999,
January 4, 1998 and January 5, 1997, respectively).  No adjustments were made to
net  income or pro  forma net  income  in the  computation  of basic or  diluted
earnings per share.

Stock Option Plan

In July  1994,  the Board of  Directors  adopted,  and the  stockholders  of the
Company approved, the 1994 Stock Option Plan (the "Plan"). The Plan provides for
the award of incentive stock options,  stock appreciation  rights,  bonus rights
and  other   incentive   grants  to  employees,   independent   contractors  and
consultants. During 1998, the Company increased the shares reserved for issuance
under the Plan from 2,250,000 to 2,600,000.  Options granted under the Plan have
a 10-year term and generally vest over 3 to 5 years.

In October 1995, the FASB issued Statement No. 123,  "Accounting for Stock-Based
Compensation."  In accordance with the  provisions of Statement 123, the Company
applies Accounting  Principles Board Opinion No. 25 and related  Interpretations
in accounting  for its stock option plan and,  accordingly,  has not  recognized
compensation  cost in  connection  with the Plan.  If the Company had elected to
recognize  compensation  cost based on the fair value of the options  granted at
grant date as  prescribed  by  Statement  123, net income and earnings per share
(pro forma  amounts for the 1996 fiscal year) would have been reduced to the pro
forma  amounts  indicated  in the table  below.  The  effect on net  income  and
earnings per share is not expected to be indicative of the effects on net income
and earnings per share in future years.
<TABLE>
<CAPTION>

                                                         Fiscal Year Ended
                                                ---------------------------------
                                                 January 3, January 4, January 5,
                                                    1999       1998       1997
                                                ---------------------------------
                                              (in thousands, except per share data)
<S>                                             <C>          <C>         <C>
Pro forma net income (loss)                     $(24,324)    $  (890)    $   218
Pro forma earnings (loss) per share:
  Basic and diluted                                (1.82)       (.07)        .02

</TABLE>




                                      F-15
<PAGE>

                               Movie Gallery, Inc.

             Notes to Consolidated Financial Statements (continued)

7.  Stockholders' Equity (continued)

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

<CAPTION>

                                                          Fiscal Year Ended
                                                 ---------------------------------
                                                 January 3,  January 4,  January 5,
                                                   1999        1998        1997
                                                 ---------------------------------

<S>                                                <C>         <C>         <C>
Expected volatility                                0.733       0.649       0.607
Risk-free interest rate                            4.70%       6.28%       6.34%
Expected life of option in years                   6.0         6.0         6.0
Expected dividend yield                            0.0%        0.0%        0.0%
</TABLE>

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

A summary of the  Company's  stock option  activity and related  information  is
detailed  below.  During 1997, the Company  modified  505,100 stock options with
exercise prices ranging from $6.00 to $42.63 by cancelling the stock options and
issuing  378,827  new  stock  options  at  an  exercise  price  of  $3.88.  This
modification excluded directors and certain senior management.

<TABLE>
<CAPTION>
                                                                       Fiscal Year Ended
                                  -----------------------------------------------------------------------------------------------
                                        January 3, 1999                 January 4, 1998                  January 5, 1997
                                  -----------------------------------------------------------------------------------------------
                                              Weighted-Average                Weighted-Average                   Weighted-Average
                                   Options     Exercise Price      Options     Exercise Price        Options      Exercise Price
                                  ---------   ----------------    ---------   ----------------      ---------    ----------------
<S>                               <C>            <C>              <C>            <C>                <C>                 <C>      
Outstanding-beginning
  of year                         1,895,537      $10.62           1,318,650      $21.98             1,107,450           $24.63
Granted                             363,000        5.13           1,256,087        4.04               379,500            14.15
Exercised                            12,230        3.88                  --          --                35,100            14.92
Forfeited                            57,408       11.32             679,200       20.50               133,200            23.58

Outstanding-end of year           2,188,899        9.73           1,895,537       10.62             1,318,650            21.98

Exercisable at end of year        1,206,397       12.68             916,908       14.43               622,125            21.28

Weighted-average fair value
  of options granted during
  the year                          $3.43                            $2.62                             $8.84
</TABLE>

                                      F-16

<PAGE>


                               Movie Gallery, Inc.

             Notes to Consolidated Financial Statements (continued)

7.  Stockholders' Equity (continued)

Options  outstanding  as of  January  3, 1999 had a  weighted-average  remaining
contractual  life of 8.2 years and exercise  prices ranging from $3.00 to $40.00
as follows:
<TABLE>
<CAPTION>

                                                                 Exercise price of
                                             -------------------------------------------------------
                                             $3.00 to $6.00    $14.00 to $22.00     $24.00 to $40.00
                                             -------------------------------------------------------

<S>                                            <C>                 <C>                  <C>
Options outstanding                            1,530,399            390,500              268,000
Weighted-average exercise price                  $4.24               $15.13               $33.22
Weighted-average remaining contractual life    8.9 years           6.4 years            6.4 years
Options exercisable                             633,447             347,200              225,750
Weighted-average exercise price of
  exercisable options                            $4.13               $15.27               $32.67
</TABLE>


8.  Commitments and Contingencies

Rent  expense for the fiscal  years ended  January 3, 1999,  January 4, 1998 and
January 5, 1997 totaled $40,959,000, $40,788,000 and $37,266,000,  respectively.
Future minimum  payments  under  noncancellable  operating  leases which contain
renewal  options and escalation  clauses with  remaining  terms in excess of one
year consisted of the following at January 3, 1999 (in thousands):

          1999                                        $26,065
          2000                                         22,114
          2001                                         13,475
          2002                                          8,018
          2003                                          5,255
          Thereafter                                    7,322
                                                      -------
                                                      $82,249
                                                      =======
                                                                               
The Company has an agreement with Rentrak Corporation which requires the Company
to order  videocassette  rental  inventory under lease  sufficient to require an
aggregate  minimum  payment of $4,000,000  per year in revenue  share,  handling
fees,  sell through fees and end-of-term  buyout fees. The agreement  expires in
2006.

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


                                      F-17

<PAGE>

                               Movie Gallery, Inc.

             Notes to Consolidated Financial Statements (continued)

9.  Summary of Quarterly Results of Operations (Unaudited)

The  following is a summary of unaudited  quarterly  results of  operations  (in
thousands,  except per share  data).  Earnings  per share  amounts for the first
three quarters of 1997 have been restated to comply with FASB Statement No. 128,
"Earnings per Share" (see Note 1).

<TABLE>
<CAPTION>

                                                     Thirteen Weeks Ended
                                       --------------------------------------------
                                       April 5,   July 5,    October 4,   January 3,
                                         1998      1998         1998         1999
                                       --------------------------------------------

<S>                                    <C>       <C>         <C>           <C>
Revenue                                $70,491   $ 63,662    $ 64,397      $69,083
Operating income (loss)                  4,613        495     (42,969)       7,021
Net income (loss)                        1,882       (555)    (28,046)       3,643
Basic and diluted earnings (loss)
  per share                                .14       (.04)      (2.09)         .27



                                                   Thirteen Weeks Ended
                                       --------------------------------------------
                                       April 6,   July 6,    October 5,   January 4,
                                         1997      1997         1997         1998
                                       --------------------------------------------

Revenue                                $65,678   $ 61,328    $ 62,560      $70,790
Operating income (loss)                  4,716       (233)       (901)       4,647
Net income (loss)                        1,996     (1,203)     (1,669)       1,781
Basic and diluted earnings (loss)
  per share                                .15       (.09)       (.12)         .13

</TABLE>

                                      F-18


<PAGE>


                                Index to Exhibits


Exhibit No.         Description
-----------         -----------
10.5                Consulting  Agreement  between  M.G.A.,  Inc. and William B.
                    Snow dated December 21, 1998

10.9                Employment  Agreement  between  M.G.A.,  Inc.  and Robert L.
                    Sirkis dated September 12, 1997

10.17               Credit Agreement  between First Union National Bank of North
                    Carolina and Movie Gallery, Inc. dated January 7, 1999

10.18               Asset Purchase Agreement between Blowout Entertainment, Inc.
                    and M.G.A., Inc. dated March 22, 1999

21                  List of Subsidiaries

23                  Consent of Ernst & Young LLP, Independent Auditors

27                  Financial Data Schedule