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


                                   FORM 10-Q

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

                For The Quarterly Period Ended October 4, 1998

                                       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 West Main Street, Dothan, Alabama      36301
               (Address of principal executive offices) (Zip Code)

                                 (334) 677-2108
              (Registrant's telephone number, including area code)

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


The number of shares outstanding of the registrant's common stock as of November
12, 1998 was 13,427,980.

<PAGE>


                              Movie Gallery, Inc.

                                     Index



Part I.  Financial Information

Item 1.  Consolidated Financial Statements (Unaudited)

Consolidated Balance Sheets - October 4, 1998 and January 4, 1998.............1

Consolidated Statements of Operations - Thirteen weeks and
thirty-nine weeks ended October 4, 1998 and October 5, 1997...................2

Consolidated Statements of Cash Flows - Thirty-nine weeks
ended October 4, 1998 and October 5, 1997.....................................3

Notes to Consolidated Financial Statements - October 4, 1998..................4

Item 2.  Management's Discussion and Analysis of Results
of Operations and Financial Condition.........................................6

Part II.  Other Information

Item 6.  Exhibits and Reports on Form 8-K....................................11

<PAGE>


                               Movie Gallery, Inc.

                           Consolidated Balance Sheets
                                 (in thousands)
<TABLE>
<CAPTION>

                                                        October 4,  January 4,
                                                           1998       1998
                                                       ---------    ---------
                                                      (Unaudited)
<S>                                                    <C>          <C>                                                           
Assets
Current assets:
   Cash and cash equivalents                           $   1,201    $   4,459
   Merchandise inventory                                  11,010       13,512
   Prepaid expenses                                        1,267        1,341
   Store supplies and other                                3,438        2,561
   Deferred income taxes                                     273          531
                                                       ---------    ---------
Total current assets                                      17,189       22,404

Videocassette rental inventory, net                       44,423       92,183
Property, furnishings and equipment, net                  44,973       50,321
Goodwill and other intangibles, net                       87,086       92,321
Deposits and other assets                                  1,917        1,904
Deferred  income taxes                                     2,735         --
                                                       ---------    ---------
Total assets                                           $ 198,323    $ 259,133
                                                       =========    =========

Liabilities and stockholders' equity 
Current liabilities:
   Accounts payable                                    $  18,894    $  21,517
   Accrued liabilities                                     6,402        7,014
   Current portion of long-term debt                       6,074        4,751
                                                       ---------    ---------
Total current liabilities                                 31,370       33,282

Long-term debt                                            45,631       63,479
Other accrued liabilities                                    881        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, 13,425,530 and 13,418,885
       shares issued and outstanding, respectively            13           13
   Additional paid-in capital                            131,712      131,686
   Retained earnings (deficit)                           (10,789)      15,930
   Treasury stock (115,200 shares)                          (495)        --
                                                       ---------    ---------
Total stockholders' equity                               120,441      147,629
                                                       ---------    ---------
Total liabilities and stockholders' equity             $ 198,323    $ 259,133
                                                       =========    =========

See accompanying notes.
</TABLE>


                                       1
<PAGE>


                               Movie Gallery, Inc.

                      Consolidated Statements of Operations
                                   (Unaudited)
                     (in thousands, except per share data)

<TABLE>
<CAPTION>
  
                                         Thirteen weeks ended     Thirty-nine weeks ended
                                        October 4,   October 5,   October 4,   October 5,
                                           1998         1997        1998         1997
                                        ---------    ---------    ---------    ---------
<S>                                     <C>          <C>          <C>          <C>      
Revenues:
   Rentals                              $  53,104    $  53,776    $ 166,127    $ 161,404
   Product sales                           11,293        8,784       32,423       28,162
                                        ---------    ---------    ---------    ---------
                                           64,397       62,560      198,550      189,566

Operating costs and expenses:
   Store operating expenses                35,190       33,939      103,581       99,953
   Amortization of videocassette
       rental inventory                    58,066       17,593       92,462       51,169
   Amortization of intangibles              1,741        1,739        5,235        5,275
   Cost of  product sales                   7,790        5,762       21,987       17,028
   General and administrative               4,579        4,428       13,146       12,559
                                        ---------    ---------    ---------    ---------
Operating income (loss)                   (42,969)        (901)     (37,861)       3,582
Interest expense, net                      (1,211)      (1,590)      (4,179)      (4,632)
                                        ---------    ---------    ---------    ---------
Loss before income taxes                  (44,180)      (2,491)     (42,040)      (1,050)
Income taxes                              (16,134)        (822)     (15,321)        (174)
                                        ---------    ---------    ---------    ---------
Net loss                                $ (28,046)   $  (1,669)   $ (26,719)   $    (876)
                                        =========    =========    =========    =========
Basic and diluted  loss per share       $   (2.09)   $    (.12)   $   (1.99)   $    (.07)
                                        =========    =========    =========    =========
Weighted average shares outstanding -
    basic and diluted                      13,424       13,419       13,421       13,420
                                        =========    =========    =========    =========
See accompanying notes.

</TABLE>

                                       2
<PAGE>




                               Movie Gallery, Inc.

                      Consolidated Statements of Cash Flows
                                   (Unaudited)
                                 (in thousands)

<TABLE>
<CAPTION>

                                                      Thirty-nine weeks ended                                         
                                                      October 4,   October 5,
                                                         1998         1997
                                                      ---------    ---------
<S>                                                   <C>          <C>   
Operating activities
Net loss                                              $ (26,719)   $    (876)
Adjustments to reconcile net loss to  net cash
  provided by operating activities:
   Depreciation and amortization                        107,207       64,601
   Deferred income taxes                                (15,321)        (174)
Changes in operating assets and liabilities:
   Merchandise inventory                                  2,502       (3,091)
   Other current assets                                    (803)        (404)
   Deposits and other assets                                (13)         497
   Accounts payable                                      (2,623)      (1,987)
   Accrued liabilities                                   (1,630)        (610)
                                                      ---------    ---------
Net cash provided by operating activities                62,600       57,956

Investing activities
Business acquisitions                                      --           (262)
Purchases of videocassette rental inventory, net        (44,702)     (55,071)
Purchases of property, furnishings and equipment         (4,162)     (10,688)
                                                      ---------    ---------
Net cash used in investing activities                   (48,864)     (66,021)

Financing activities
Net proceeds from issuance of common stock                   26         --
Purchases of treasury stock                                (495)        --
Payments on notes payable                                  (200)        --
Proceeds from issuance of  long-term debt                  --          5,400
Principal payments on long-term debt                    (16,325)        (180)
                                                      ---------    ---------
Net cash (used in) provided by financing activities     (16,994)       5,220
                                                      ---------    ---------
Decrease in cash and cash equivalents                    (3,258)      (2,845)
Cash and cash equivalents at beginning of period          4,459        3,982
                                                      ---------    ---------
Cash and cash equivalents at end of period            $   1,201    $   1,137
                                                      =========    =========
See accompanying notes.
</TABLE>

                                       3
<PAGE>

                              Movie Gallery, Inc.

             Notes to Consolidated Financial Statements (Unaudited)

                                October 4, 1998


1.  Basis of Presentation

The accompanying unaudited condensed consolidated financial statements have been
prepared in accordance with generally accepted accounting principles for interim
financial  information and with the  instructions to Form 10-Q and Article 10 of
Regulation S-X. Accordingly,  the financial statements do not include all of the
information and footnotes required by generally accepted  accounting  principles
for complete financial statements. In the opinion of management, all adjustments
(consisting  of  normal  recurring  accruals)  considered  necessary  for a fair
presentation  have been included.  Operating  results for the  thirty-nine  week
period ended October 4, 1998 are not necessarily  indicative of the results that
may be  expected  for the  fiscal  year  ended  January  3,  1999.  For  further
information,  refer  to the  consolidated  financial  statements  and  footnotes
thereto  included in Movie  Gallery,  Inc.'s  annual report on Form 10-K for the
fiscal year ended January 4, 1998.

2.  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 an  industry  trend
towards significant increases in copy-depth availability from Hollywood 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 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 six months to a net book value
of $4 which is then amortized on a  straight-line  basis over the next 30 months
or until the  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.  The
application of the new method of amortizing  videocassette and video game rental
inventory decreased rental inventory and increased  depreciation expense for the
quarter ended October 4, 1998 by  approximately  $43.6 million and increased the
net  loss  and  the  loss  per  diluted   share  by  $27.7  million  and  $2.06,
respectively.

Prior to July 6, 1998,  videocassette  rental inventory  (including video games)
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 six months to an average net
book value of $5 which was then 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.

                                       4
<PAGE>
                   

                               Movie Gallery, Inc.

        Notes to Consolidated Financial Statements (Unaudited)(continued)


3.  Financing Obligations

The  Company has a Credit  Agreement  with First  Union  National  Bank of North
Carolina with respect to a reducing  revolving credit facility (the "Facility").
At October  4,  1998,  $51.0  million  was  outstanding  and $18.8  million  was
available for borrowing under the Facility. The available amount of the Facility
reduces  quarterly  with a final maturity of June 30, 2000. The interest rate of
the  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 Facility at any time without penalty. The more restrictive
covenants  of the  Facility  restrict  borrowings  based upon cash flow  levels.
Currently,  the  Company is in default of a minimum  net worth  covenant  in the
Facility as a result of the $27.7 million  after-tax charge  associated with the
change in amortization  policy.  The Company has obtained a temporary  waiver of
this  covenant  and is  currently  in  negotiations  to  refinance  the existing
Facility.

4.  Earnings Per Share

Effective January 4, 1998, the Company adopted Statement of Financial Accounting
Standards 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 earnings per share calculations for
any period presented.

Basic  earnings per share is computed  based on the weighted  average  number of
shares of  common  stock  outstanding  during  the  periods  presented.  Diluted
earnings per share is computed based on the weighted average number of shares of
common stock outstanding during the periods  presented,  increased solely by the
effects  of shares to be issued  from the  exercise  of  dilutive  common  stock
options (none for the thirteen weeks and thirty-nine weeks ended October 4, 1998
and October 5, 1997). No adjustments were made to net loss in the computation of
basic or diluted earnings per share.

5.  Recently Issued Accounting Standard

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 start-up costs  capitalized  prior to January
4, 1999 be written-off and any future start-up costs to be expensed as incurred.
The unamortized  balance of start-up costs as of January 3, 1998 will be written
off as a cumulative  effect of an accounting  change as of January 4, 1999.  The
impact of adopting this SOP has not yet been determined.

                                       5
<PAGE>

                              Movie Gallery, Inc.

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


The  following  table  sets  forth,  for the  periods  indicated,  statement  of
operations  data  expressed as a percentage  of total  revenue,  the  percentage
increase or decrease from the comparable period and the number of stores open at
the end of each period.

<TABLE>
<CAPTION>


                                                Thirteen weeks ended                  Thirty-nine weeks ended
                                        ------------------------------------    -----------------------------------
                                        October 4,   October 5,     Increase    October 4,   October 5,    Increase
                                           1998         1997       (Decrease)      1998        1997       (Decrease)
                                         --------     --------      --------     --------     --------     --------
<S>                                      <C>          <C>           <C>          <C>          <C>          <C>   
Revenues:
   Rentals                                  82.5%        86.0%         (3.5)%       83.7%        85.1%        (1.4)%
   Product sales                            17.5         14.0           3.5         16.3         14.9          1.4
                                         --------     --------      --------     --------     --------     --------
                                           100.0        100.0            --        100.0        100.0           --
Operating costs and expenses:
   Store operating expenses                 54.6         54.2           0.4         52.2         52.7         (0.5)
   Amortization of rental inventory:
      Recurring                             22.5         28.1          (5.6)        24.6         27.0         (2.4)
      Policy change                         67.7           --          67.7         22.0           --         22.0
   Amortization of intangibles               2.7          2.8          (0.1)         2.6          2.8         (0.2)
   Cost of  product sales                   12.1          9.2           2.9         11.1          9.0          2.1
   General and administrative                7.1          7.1            --          6.6          6.6           --
                                         --------     --------      --------     --------     --------     --------
Total                                      166.7        101.4          65.3        119.1         98.1         21.0
                                         --------     --------      --------     --------     --------     --------
Operating  income (loss)                   (66.7)        (1.4)        (65.3)       (19.1)         1.9        (21.0)
Interest expense, net                       (1.9)        (2.6)          0.7         (2.1)        (2.5)         0.4
                                         --------     --------      --------     --------     --------     --------
Loss before income taxes                   (68.6)        (4.0)        (64.6)       (21.2)        (0.6)       (20.6)
Income taxes                               (25.0)        (1.3)        (23.7)        (7.7)        (0.1)        (7.6)
                                         --------     --------      --------     --------     --------     --------
                                                                                     
Net loss                                   (43.6)%       (2.7)%       (40.9)%      (13.5)%       (0.5)%      (13.0)%
                                         ========     ========      ========     ========     ========     ========

Adjusted EBITDA                            5,979        3,624         2,355       25,376       14,250       11,126
                                         ========     ========      ========     ========     ========     ========

Number of stores open at end of period       834          856           (22)         834          856          (22)
                                         ========     ========      ========     ========     ========     ========
</TABLE>

For the thirteen  weeks and  thirty-nine  weeks ended October 4, 1998,  revenues
were $64.4 million and $198.6 million, respectively,  increases of 2.9% and 4.7%
over the  comparable  periods in 1997.  The  increase  was due to an increase in
same-store  sales of 4.6% and 5.5% for the thirteen  week and  thirty-nine  week
periods, respectively, partially offset by fewer stores in operation during 1998
versus  1997.  The  increase  in  same-store  sales  for the third  quarter  and
year-to-date  period of 1998 was 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 Hollywood  studios;  (ii) an increase in the 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;  (iii) the release of "Titanic",  the largest box
office movie of all time; and (iv)  successful,  chain-wide  internal  marketing
programs  designed  to  generate  more  consumer  excitement  and traffic in the
Company's base of stores.
                                       6
<PAGE>

                               Movie Gallery, Inc.

         Management's Discussion and Analysis of Results of Operations
                            and Financial Condition (continued)

Product  sales as a  percentage  of total  revenue  for the  thirteen  weeks and
thirty-nine  weeks  ended  October 4, 1998 were  17.5% and 16.3%,  respectively,
compared to 14.0% and 14.9% for the  comparable  periods in 1997,  respectively.
This increase for the thirty-nine  weeks ended October 4, 1998 was primarily the
result  of (i)  the  Company's  increasing  sale  of  previously  viewed  rental
inventory  due, in part, to greater  quantities of rental  product  available to
consumers;  and (ii) the  impact  of the  release  of  "Titanic",  for which the
Company sold more quantities of than any other sell-through  priced title in its
history.

Store  operating  expenses,  which reflect  direct store  expenses such as lease
payments and in-store  payroll,  increased as a percentage  of revenues to 54.6%
from 54.2% for the  thirteen  weeks  ended  October 4, 1998 and October 5, 1997,
respectively,  and decreased as a percentage of revenues to 52.2% from 52.7% for
the thirty-nine  weeks ended October 4, 1998 and October 5, 1997,  respectively.
The changes in store  operating  expenses as a  percentage  of revenues  for the
third quarter and year-to-date  period of 1998 versus 1997 were primarily due to
(i) an increase in revenue  sharing  expense of  approximately  $1.2 million and
$2.9  million for the quarter and  year-to-date  period  ended  October 4, 1998,
respectively, versus the comparable  periods in fiscal year 1997; (ii) increases
in store  level  costs of  approximately  $400,000  and  $800,000  for the third
quarter and year-to-date period in 1998, respectively, due to the implementation
of the Company's  Operation:  Excellence  program, a program designed to elevate
the  standards  of  customer  service  and  store  presentation  throughout  the
Company's store base; and (iii) same-store sales increases.

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 change  resulted in a  non-recurring,
non-cash,  pre-tax charge of $43.6 million.  The major impetus for the change in
amortization  policy is the changing  purchasing  economics within the industry,
which have resulted in a significant  increase in new release  videos  available
for rental.  While revenue sharing  agreements and other copy-depth  initiatives
have increased  customer  satisfaction and driven increased rental revenue,  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.

Amortization  of  videocassette  rental  inventory for the third quarter and the
year-to-date  period  ended  October  4, 1998 was  22.5%  and 24.6% of  revenue,
excluding the non-recurring charge related to the change in amortization policy.
Both percentages  declined from the comparable periods in 1997.  Amortization of
videocassette rental inventory for all periods ending prior to July 6, 1998, was
calculated  under  the  previous  policy  described  in Note 2 of the  "Notes to
Consolidated Financial Statements."  Significantly reduced tape purchase dollars
in 1998  versus  1997,  an  increased  use of  revenue  sharing,  as well as the
same-store  sales  increases in the current year,  are the main reasons that the
amortization of inventory as a percentage of revenue in 1998 has declined versus
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  increased  revenue from product sales and increased as a percentage of
revenues  from  product  sales  from 65.6% and 60.5% for the third  quarter  and
year-to-date  period  of 1997,  respectively,  to 69.0%  and 67.8% for the third
quarter and year-to-date period of 1998,  respectively.  The decrease in product
sales gross margins resulted primarily from (i) an intense effort by the Company
to reduce  inventory levels through  discounts on selected  inventory during the
first half of 1998; and (ii) the negative impact of "Titanic", which the Company
sold at a below average  profit margin and for which the Company sold more units
of than any sell-through priced title in its history.

                                       7
<PAGE>

                               Movie Gallery, Inc.

          Management's Discussion and Analysis of Results of Operations
                       and Financial Condition (continued)


Net interest expense as a percentage of revenues  decreased to 1.9% and 2.1% for
the third  quarter  and  year-to-date  period of 1998 from 2.6% and 2.5% for the
third quarter and  year-to-date  period of 1997,  respectively.  These decreases
were due primarily to lower total debt outstanding in 1998 versus 1997.

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  remodeling of existing  stores,  the  relocation of
existing  stores and the  continued  maintenance  and upgrading of the Company's
management  information  systems.  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 the thirty-nine  weeks ended October 4, 1998, the Company generated $25.4
million in Adjusted  EBITDA  versus $14.3 million for the  comparable  period in
1997, an increase of  approximately  78.0%.  The increase in Adjusted  EBITDA is
attributable  primarily  to the  same-store  sales  increase  of  5.5%  and  the
Company's  leveraging of rental inventory  purchases in the first three quarters
of 1998 versus the  comparable  periods in 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 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 growth.

Net cash provided by operating  activities was $62.6 million for the thirty-nine
weeks  ended  October 4, 1998 as compared  to $58.0  million for the  comparable
period in 1997.  The increase was primarily due to (i) an increase in net income
before  the  $27.7  million  non-cash,   after-tax  charge  for  the  change  in
amortization  policy;  and (ii) a decrease in merchandise  inventory,  offset in
part by a decrease in accounts payable and other accrued  liabilities.  Over the
past three quarters,  the Company's  merchandise  inventory and accounts payable
have been reduced by 18.5% and 12.2%, respectively.  Some of these decreases are
associated with seasonal  changes;  however,  much of the merchandise  inventory
reduction is  attributable  to the Company  attempting  to reduce and refine its
sell-through inventory presentation by selling older,  less-attractive titles to
consumers  at a  discount  and  replacing  this  merchandise  with  fewer,  more
attractive  product  offerings.  The  accounts  payable  decrease is due both to
seasonality  as well as the fact that the Company  has lowered its overall  tape
purchases versus a year ago through copy depth  initiatives and revenue sharing,
which has lowered its outstanding payables amount at quarter end.

Net cash used in  investing  activities  was $48.9  million for the  thirty-nine
weeks  ended  October 4, 1998 as compared  to $66.0  million for the  comparable
period in 1997,  primarily  as a result of a  decrease  in the  expenditures  of
capital for both  videocassette  rental inventory and property,  furnishings and
equipment.

                                       8
<PAGE>

                               Movie Gallery, Inc.

          Management's Discussion and Analysis of Results of Operations
                       and Financial Condition (continued)


Net cash used in  financing  activities  was $17.0  million for the  thirty-nine
weeks  ended  October 4, 1998 as  compared  to net cash  provided  by  financing
activities  of $5.2  million  for the  comparable  period in 1997.  This  change
resulted directly from the Company's  improved Adjusted EBITDA  performance that
allowed  the  Company to decrease  its debt  outstanding  during the first three
quarters  of 1998 versus an  increase  in debt in the  comparable  period of the
prior year.

The  Company has a Credit  Agreement  with First  Union  National  Bank of North
Carolina  ("First Union") with respect to a reducing  revolving  credit facility
(the  "Facility").  At October 4, 1998,  $51.0 million was outstanding and $18.8
million was available for borrowing under the Facility.  The available amount of
the Facility  reduces  quarterly  with a final  maturity of June 30,  2000.  The
interest  rate of the  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 Facility at any time without penalty. The
more restrictive  covenants of the Facility restrict  borrowings based upon cash
flow levels.

The Company was in default of a minimum net worth  covenant in the Facility as a
result of the $27.7  million  after-tax  charge  associated  with the  change in
amortization  policy.  The  Company  has  obtained  a  temporary  waiver of this
covenant.  In  addition,  the Company is  currently  working with First Union to
refinance its existing  facility.  The contemplated new credit facility would be
an $85 million senior credit facility with a three-year maturity and which would
have covenants similar in type to the Company's existing facility.  There can be
no assurance  that the Company will be able to refinance its existing  Facility,
or that the minimum net worth covenant,  as currently in place, will be revised.
The failure to accomplish  either of the foregoing would have a material adverse
effect on the Company.

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. To the extent available,  future acquisitions may be
completed  using  funds  available  under the  Facility,  financing  provided by
sellers,  alternative  financing  arrangements such as funds raised in public or
private  debt or equity  offerings  or shares of the  Company's  stock issued to
sellers.  However, there can be no assurance that financing will be available to
the Company on terms that will be acceptable, if at all.

At October 4, 1998, the Company had a working  capital deficit of $14.2 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 not an asset that 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.

During  the latter  half of 1998,  the  Company  has  accelerated  its new store
opening  program and currently  intends to develop up to 100 new stores in 1999.
The Company believes its projected cash flow from operations, borrowing capacity
with the  Facility,  cash on hand and trade  credit will  provide the  necessary
capital to fund its current plan of operations  for the remainder of Fiscal 1998
and the fiscal year 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




                                       9
<PAGE>

                               Movie Gallery, Inc.

          Management's Discussion and Analysis of Results of Operations
                       and Financial Condition (continued)

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

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,  and the Company does not
believe  that  there  will  be  any  material  exposure  related  to  year  2000
compatibility.

This report contains 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 a number of  important  risk factors
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.  These risk factors  include  competitive
factors and weather conditions within the Company's geographic markets, adequate
product  availability from Hollywood,  the ability of the Company to restructure
the current Facility and obtain  refinancing on terms acceptable to the Company,
the Company's ability to successfully  execute its new store opening program and
the risk factors that are  discussed  from  time-to-time  in the  Company's  SEC
reports,  including,  but not limited to, the report on Form 10-K for the fiscal
year ended January 4, 1998.



                                       10
<PAGE>



                          Part II - Other Information


Item 6.   Exhibits and Reports on Form 8-K

          a) Exhibits

             18     Change in Accounting Principle

             27     Financial Data Schedule

             27.1   Financial Data Schedule - Restated for October 5, 1997

          b) Reports on Form 8-K

             None.


                                   Signatures

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




                                                  Movie Gallery, Inc.
                                       ---------------------------------------- 



Date:  November 18, 1998               /s/ J. Steven Roy
                                       ---------------------------------------- 
                                       J. Steven Roy, Executive Vice President
                                       and Chief Financial Officer



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