**UNITEDSTATESSECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C.  20549**

 

**FORM 10-Q**

 

**(Mark One)**

**ý**      QUARTERLY REPORT PURSUANT TOSECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

## **For the quarterly period endedOctober 5, 2003**

 

# **OR**

 

**o**                        TRANSITION REPORTPURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

## **For the transition periodfrom                          to                        **

 

### **Commissionfile number 0-24548**

 

**MovieGallery, Inc.**

(Exact name ofregistrant as specified in its charter)

 

| **Delaware**                                                     |   | **63-1120122**                        |
|------------------------------------------------------------------|--------|---------------------------------------|
| (State or other  jurisdiction of  incorporation or organization) |   | (I.R.S. Employer  Identification No.) |
|                                                             |   |                                  |
| **900 West Main Street, Dothan, Alabama**                        |   | **36301**                             |
| (Address of  principal executive offices)                        |   | (Zip Code)                            |
|                                                             |   |                                  |
| **(334) 677-2108**                                               |
| (Registrant’s  telephone number, including area code)       |

 

Indicate by checkmark whether the registrant (1) has filed all reports required to be filed bySection 13 or 15(d) of the Securities Exchange Act of 1934 during thepreceding 12 months (or for such shorter period that the registrant wasrequired to file such reports), and (2) has been subject to filing requirementsfor the past 90 days.  YES  ý  NO  o

 

Indicate by checkmark whether the registrant is an accelerated filer (as defined in Rule 12b-2of the Exchange Act).

YES  ý  NO  o

 

The number ofshares outstanding of the registrant’s common stock as of November 12,2003 was 32,663,705.

 

 

----

 

#### **MovieGallery, Inc.**

#### **Index**

 
| Part I.                                                                                                                             | Financial Information                                                                       |   |
|-------------------------------------------------------------------------------------------------------------------------------------|---------------------------------------------------------------------------------------------|--------|
|                                                                                                                                |                                                                                        |
| Item 1.                                                                                                                             | Consolidated  Financial Statements (Unaudited)                                              |   |
|                                                                                                                                |                                                                                        |
| Consolidated Balance  Sheets  – January 5, 2003 and  October 5, 2003                                            | 1                                                                                           |
|                                                                                                                                |                                                                                        |
| Consolidated Statements  of Income – Thirteen weeks and thirty-nine weeks ended October 6, 2002  and October 5, 2003 | 2                                                                                           |
|                                                                                                                                |                                                                                        |
| Consolidated  Statements of Cash Flows – Thirty-nine weeks ended October 6, 2002 and  October 5, 2003                | 3                                                                                           |
|                                                                                                                                |                                                                                        |
| Notes  to Consolidated Financial Statements – October 5, 2003                                                             | 4                                                                                           |
|                                                                                                                                |                                                                                        |
| Item  2.                                                                                                                            | Management’s  Discussion and Analysis of Financial Condition and Results of Operations | 8      |
|                                                                                                                                |                                                                                        |   |
| Item  3.                                                                                                                            | Quantitative  and Qualitative Disclosures About Market Risk                                 | 14     |
|                                                                                                                                |                                                                                        |   |
| Item 4.                                                                                                                             | Controls and  Procedures                                                                    | 14     |
|                                                                                                                                |                                                                                        |   |
| Part II.                                                                                                                            | Other Information                                                                           |   |
|                                                                                                                                |                                                                                        |
| Item 6.                                                                                                                             | Exhibits and Reports on Form 8-K                                                            | 14     |

 

----

 

**MovieGallery, Inc.**

**ConsolidatedBalance Sheets**

**(inthousands)**

 
|                                                                                                                                 |   | **January 5,  2003** |       | **October 5,  2003** |       |
|--------------------------------------------------------------------------------------------------------------------------------------|--------|---------------------------|------------|---------------------------|------------|
|                                                                                                                                 |   |                      |       | **(Unaudited)**           |       |
| **Assets**                                                                                                                           |   |                      | ** ** |                      | ** ** |
| Current  assets:                                                                                                                     |   |                      | ** ** |                      | ** ** |
| Cash  and cash equivalents                                                                                                           |   | $                         | 39,526     | ** **                | **$**      | **19,411** | ** ** |
| Merchandise  inventory                                                                                                               |   | 18,646                    | ** ** | **17,620**                | ** ** |
| Prepaid  expenses                                                                                                                    |   | 1,533                     | ** ** | **2,107**                 | ** ** |
| Store  supplies and other                                                                                                            |   | 7,585                     | ** ** | **8,978**                 | ** ** |
| Total  current assets                                                                                                                |   | 67,290                    | ** ** | **48,116**                | ** ** |
|                                                                                                                                 |   |                      | ** ** |                      | ** ** |
| Rental  inventory, net                                                                                                               |   | 82,880                    | ** ** | **95,453**                | ** ** |
| Property,  furnishings and equipment, net                                                                                            |   | 86,993                    | ** ** | **106,835**               | ** ** |
| Goodwill                                                                                                                             |   | 116,119                   | ** ** | **132,710**               | ** ** |
| Other  intangibles, net                                                                                                              |   | 6,677                     | ** ** | **8,419**                 | ** ** |
| Deposits  and other assets                                                                                                           |   | 3,615                     | ** ** | **6,983**                 | ** ** |
| Total  assets                                                                                                                        |   | $                         | 363,574    | ** **                | **$**      | **398,516** | ** ** |
|                                                                                                                                 |   |                      | ** ** |                      | ** ** |
| **Liabilities and stockholders’ equity**                                                                                        |   |                      | ** ** |                      | ** ** |
| Current  liabilities:                                                                                                                |   |                      | ** ** |                      | ** ** |
| Accounts  payable                                                                                                                    |   | $                         | 66,996     | ** **                | **$**      | **49,272** | ** ** |
| Accrued  liabilities                                                                                                                 |   | 23,524                    | ** ** | **25,004**                | ** ** |
| Deferred  revenue                                                                                                                    |   | 9,636                     | ** ** | **7,028**                 | ** ** |
| Deferred  income taxes                                                                                                               |   | 742                       | ** ** | **844**                   | ** ** |
| Total  current liabilities                                                                                                           |   | 100,898                   | ** ** | **82,148**                | ** ** |
|                                                                                                                                 |   |                      | ** ** |                      | ** ** |
| Other  accrued liabilities                                                                                                           |   | 249                       | ** ** | **190**                   | ** ** |
| Deferred  income taxes                                                                                                               |   | 3,376                     | ** ** | **15,217**                | ** ** |
|                                                                                                                                 |   |                      | ** ** |                      | ** ** |
| Stockholders’  equity:                                                                                                          |   |                      | ** ** |                      | ** ** |
| Preferred  stock, $.10 par value; 2,000,000 shares authorized, no shares issued or  outstanding                                      |   | —                    | ** ** | **—**                | ** ** |
| Common  stock, $.001 par value; 65,000,000 shares authorized, 32,061,871 and  32,647,426 shares issued and outstanding, respectively |   | 32                        | ** ** | **33**                    | ** ** |
| Additional  paid-in capital                                                                                                          |   | 216,631                   |       | **223,533**               | ** ** |
| Retained  earnings                                                                                                                   |   | 42,647                    |       | **74,623**                | ** ** |
| Accumulated  other comprehensive income (loss)                                                                                       |   | (259                      | )          | **2,772**                 | ** ** |
| Total  stockholders’ equity                                                                                                     |   | 259,051                   |       | **300,961**               | ** ** |
| Total  liabilities and stockholders’ equity                                                                                     |   | $                         | 363,574    | ** **                | **$**      | **398,516** | ** ** |

 

*Seeaccompanying notes.*

 

1

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**MovieGallery, Inc.**

**ConsolidatedStatements of Income**

**(Unaudited)**

**(inthousands, except per share data)**

 
|                                  |   | **Thirteen Weeks Ended**  |       | **Thirty-Nine Weeks Ended** |       |
|---------------------------------------|--------|---------------------------|------------|-----------------------------|------------|
|                                  |   | **October 6,  2002** |       | **October 5,  2003**   |       | **October 6,  2002** |   | **October 5,  2003** |   |
|                                  |   |                      | ** ** |                        | ** ** |   | ** ** |   | ** ** |
| Revenues:                             |   |                      | ** ** |                        | ** ** |   | ** ** |   | ** ** |
| Rentals                               |   | $                         | 122,246    | ** **                  | **$**      | **154,565** |   | $ | 354,298 | ** ** | **$** | **456,322** | ** ** |
| Product  sales                        |   | 8,189                     | ** ** | **12,674**                  |       | 21,845 | ** ** | **40,564** | ** ** |
| Total  revenues                       |   | 130,435                   | ** ** | **167,239**                 |       | 376,143 | ** ** | **496,886** | ** ** |
|                                  |   |                      | ** ** |                        | ** ** |   | ** ** |   | ** ** |
| Cost  of sales:                       |   |                      | ** ** |                        | ** ** |   | ** ** |   | ** ** |
| Cost  of rental revenues              |   | 34,551                    | ** ** | **44,559**                  |       | 99,285 | ** ** | **134,966** | ** ** |
| Cost  of product sales                |   | 5,481                     | ** ** | **10,005**                  |       | 15,403 | ** ** | **32,447** | ** ** |
| Gross  margin                         |   | 90,403                    | ** ** | **112,675**                 |       | 261,455 | ** ** | **329,473** | ** ** |
|                                  |   |                      | ** ** |                        | ** ** |   | ** ** |   | ** ** |
| Operating  costs and expenses:        |   |                      | ** ** |                        | ** ** |   | ** ** |   | ** ** |
| Store  operating expenses             |   | 65,062                    | ** ** | **84,902**                  |       | 185,737 | ** ** | **238,801** | ** ** |
| General  and administrative           |   | 9,339                     | ** ** | **11,956**                  |       | 31,476 | ** ** | **34,461** | ** ** |
| Amortization  of intangibles          |   | 416                       |       | **493**                     |       | 1,113 | ** ** | **1,389** | ** ** |
| Stock  option compensation            |   | (151                      | )          | **128**                     |       | 795 | ** ** | **1,626** | ** ** |
| Operating  income                     |   | 15,737                    |       | **15,196**                  |       | 42,334 | ** ** | **53,196** | ** ** |
|                                  |   |                      |       |                        | ** ** |   | ** ** |   | ** ** |
| Interest  expense, net                |   | (84                       | )          | **(89**                     | **)**      | (924 | ) | **(331** | **)** |
| Income  before income taxes           |   | 15,653                    | ** ** | **15,107**                  |       | 41,410 | ** ** | **52,865** | ** ** |
|                                  |   |                      | ** ** |                        | ** ** |   | ** ** |   | ** ** |
| Income  taxes                         |   | 6,261                     | ** ** | **5,892**                   |       | 16,544 | ** ** | **20,889** | ** ** |
| Net  income                           |   | $                         | 9,392      | ** **                  | **$**      | **9,215** |   | $ | 24,866 | ** ** | **$** | **31,976** | ** ** |
|                                  |   |                      | ** ** |                        | ** ** |   | ** ** |   | ** ** |
| Net  income per share:                |   |                      | ** ** |                        | ** ** |   | ** ** |   | ** ** |
| Basic                                 |   | $                         | 0.29       | ** **                  | **$**      | **0.28** |   | $ | 0.84 | ** ** | **$** | **0.99** | ** ** |
| Diluted                               |   | $                         | 0.29       | ** **                  | **$**      | **0.28** |   | $ | 0.81 | ** ** | **$** | **0.96** | ** ** |
|                                  |   |                      | ** ** |                        | ** ** |   | ** ** |   | ** ** |
| Weighted  average shares outstanding: |   |                      | ** ** |                        | ** ** |   | ** ** |   | ** ** |
| Basic                                 |   | 31,937                    | ** ** | **32,536**                  |       | 29,701 | ** ** | **32,303** | ** ** |
| Diluted                               |   | 32,902                    | ** ** | **33,499**                  |       | 30,878 | ** ** | **33,298** | ** ** |

 

*Seeaccompanying notes.*

 

2

----

 

**MovieGallery, Inc.**

**ConsolidatedStatements of Cash Flows**

**(Unaudited)**

**(inthousands)**

 
|                                                                               |   | **Thirty-Nine Weeks Ended** |       |
|------------------------------------------------------------------------------------|--------|-----------------------------|------------|
|                                                                               |   | **October 6,  2002**   |       | **October 5,  2003** |   |
|                                                                               |   |                        |       |   |   |
| **Operating activities:**                                                          |   |                        |       |   |   |
| Net  income                                                                        |   | $                           | 24,866     | ** ** | **$** | **31,976** | ** ** |
| Adjustments  to reconcile net income to net cash provided by operating activities: |   |                        | ** ** |   | ** ** |
| Rental  inventory amortization and non-cash cost of rental inventory sold          |   | 71,051                      |       | **98,620** | ** ** |
| Depreciation  and intangibles amortization                                         |   | 14,545                      |       | **16,911** | ** ** |
| Stock  option compensation                                                         |   | 795                         |       | **1,626** | ** ** |
| Tax  benefit of stock options exercised                                            |   | 4,006                       |       | **2,793** | ** ** |
| Deferred  income taxes                                                             |   | 9,388                       |       | **11,943** | ** ** |
| Changes  in operating assets and liabilities:                                      |   |                        |       |   | ** ** |
| Merchandise  inventory                                                             |   | (3,880                      | )          | **1,376** | ** ** |
| Other  current assets                                                              |   | 179                         |       | **(1,891** | **)** |
| Deposits  and other assets                                                         |   | (678                        | )          | **(3,315** | **)** |
| Accounts  payable                                                                  |   | 2,911                       |       | **(17,724** | **)** |
| Accrued  liabilities and deferred revenue                                          |   | (3,459                      | )          | **(2,097** | **)** |
| Net  cash provided by operating activities                                         |   | 119,724                     |       | **140,218** | ** ** |
|                                                                               |   |                        |       |   | ** ** |
| **Investing activities:**                                                          |   |                        |       |   | ** ** |
| Business  acquisitions                                                             |   | (47,508                     | )          | **(25,447** | **)** |
| Purchases  of rental inventory                                                     |   | (81,674                     | )          | **(106,492** | **)** |
| Purchases  of property, furnishings and equipment                                  |   | (21,011                     | )          | **(33,909** | **)** |
| Net  cash used in investing activities                                             |   | (150,193                    | )          | **(165,848** | **)** |
|                                                                               |   |                        |       |   | ** ** |
| **Financing activities:**                                                          |   |                        |       |   | ** ** |
| Proceeds  from issuance of common stock                                            |   | 66,775                      |       | **—** | ** ** |
| Proceeds  from exercise of stock options                                           |   | 2,459                       |       | **2,484** | ** ** |
| Net  payments on long-term debt                                                    |   | (26,000                     | )          | **—** | ** ** |
| Net  cash provided by financing activities                                         |   | 43,234                      |       | **2,484** | ** ** |
|                                                                               |   |                        |       |   | ** ** |
| Effect  of exchange rate changes on cash and cash equivalents                      |   | (14                         | )          | **3,031** | ** ** |
| Increase  (decrease) in cash and cash equivalents                                  |   | 12,751                      |       | **(20,115** | **)** |
| Cash  and cash equivalents at beginning of period                                  |   | 16,349                      |       | **39,526** | ** ** |
| Cash  and cash equivalents at end of period                                        |   | $                           | 29,100     |   | **$** | **19,411** | ** ** |

 

*Seeaccompanying notes.*

 

3

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**MovieGallery, Inc.**

 

**Notes toConsolidated Financial Statements (Unaudited)**

 

**October 5, 2003**

 

**1. Basis of Presentation**

 

The accompanyingunaudited consolidated financial statements have been prepared in accordancewith generally accepted accounting principles for interim financial informationand with the instructions to Form 10-Q and Article 10 of Regulation S-X.  Accordingly, the unaudited consolidatedfinancial statements do not include all of the information and footnotesrequired by generally accepted accounting principles for complete consolidatedfinancial statements.  In the opinion ofmanagement, all adjustments (consisting of normal recurring accruals)considered necessary for a fair presentation have been included.  Operating results for the thirty-nine weekperiod ended October 5, 2003 are not necessarily indicative of the resultsthat may be expected for the fiscal year ending January 4, 2004.  For further information, refer to theconsolidated financial statements and footnotes thereto included in our AnnualReport on Form 10-K for the fiscal year ended January 5, 2003.

 

*Stock Option Plan*

 

We account forstock-based employee compensation under the recognition and measurementprinciples of APB Opinion No. 25, *Accounting for Stock Issued to Employees*,and related Interpretations.  Stockoption compensation is reflected in net income for variable options outstandingunder the plan.  No stock optioncompensation is reflected in net income for fixed options outstanding under theplan where the exercise price was equal to the market value of the underlyingcommon stock on the date of grant.  Thefollowing table illustrates the effect on net income and earnings per share ifwe had applied the fair value recognition provision of FASB Statement No. 123, *Accountingfor Stock-Based Compensation*, as amended, to stock-based employeecompensation.

 
|                                                                                                          |   | **Thirteen Weeks Ended**                  |   | **Thirty-Nine Weeks Ended** |   |
|---------------------------------------------------------------------------------------------------------------|--------|-------------------------------------------|--------|-----------------------------|--------|
|                                                                                                          |   | **October 6,  2002**                 |   | **October 5,  2003**   |   | **October 6,  2002** |   | **October 5,  2003** |   |
|                                                                                                          |   | **(in thousands, except per share data)** |   |
|                                                                                                          |   |                                      |   |                        |   |   |   |   |   |
| Net  income, as reported                                                                                      |   | $                                         | 9,392  |                        | $      | 9,215 |   | $ | 24,866 |   | $ | 31,976 |   |
| Add:  Stock option compensation included in  reported net income, net of tax                             |   | (91                                       | )      | 78                          |   | 477 |   | 981 |   |
| Deduct:  Stock option compensation determined under  fair value based methods for all awards, net of tax |   | (343                                      | )      | (540                        | )      | (903 | ) | (812 | ) |
|                                                                                                          |   |                                      |   |                        |   |   |   |   |   |
| Pro  forma net income                                                                                         |   | $                                         | 8,958  |                        | $      | 8,753 |   | $ | 24,440 |   | $ | 32,145 |   |
|                                                                                                          |   |                                      |   |                        |   |   |   |   |   |
| Net  income per share:                                                                                        |   |                                      |   |                        |   |   |   |   |   |
| Basic                                                                                                         |   | $                                         | 0.29   |                        | $      | 0.28 |   | $ | 0.84 |   | $ | 0.99 |   |
| Diluted                                                                                                       |   | $                                         | 0.29   |                        | $      | 0.28 |   | $ | 0.81 |   | $ | 0.96 |   |
|                                                                                                          |   |                                      |   |                        |   |   |   |   |   |
| Pro  forma net income per share:                                                                              |   |                                      |   |                        |   |   |   |   |   |
| Basic                                                                                                         |   | $                                         | 0.28   |                        | $      | 0.27 |   | $ | 0.82 |   | $ | 1.00 |   |
| Diluted                                                                                                       |   | $                                         | 0.27   |                        | $      | 0.26 |   | $ | 0.78 |   | $ | 0.96 |   |

 

4

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*Recently Issued Accounting Pronouncements*

 

InNovember 2002, the Emerging Issues Task Force (“EITF”) reached a concensuson Issue No. 02-16, *Accounting by a Customer (Including a Reseller) forCertain Consideration Received from a Vendor,* effective for fiscalyears beginning after December 15, 2002. EITF 02-16 generally requires that cash consideration received from avendor be considered as a reduction of the prices of the vendor’s products,reflected as a reduction of cost of sales in the customer’s incomestatement.  The presumption can beovercome if the vendor receives an identifiable benefit in exchange for theconsideration, in which case the consideration should be recorded as revenue,or if the consideration represents a reimbursement of a specific identifiableincremental cost incurred by the customer in selling the vendor’s productswhere the consideration should be characterized as a reduction of thatcost.  Our adoption of this standard asof January 6, 2003 did not have a material impact on our financialposition or results of operations.

 

In January 2003, theFinancial Accounting Standards Board issued Interpretation No. 46, *Consolidationof Variable Interest Entities, an Interpretation of Accounting ResearchBulletin No. 51*(“the Interpretation”).  The Interpretation requires the consolidation of entities inwhich an enterprise absorbs a majority of the entity’s expected losses,receives a majority of the entity’s expected residual returns, or both, as aresult of ownership, contractual or other financial interests in theentity.  Currently, entities aregenerally consolidated by an enterprise when it has a controlling financialinterest through ownership of a majority voting interest in the entity.  The Interpretation is effective as ofDecember 31, 2003 for all qualifying interests in existence as ofJanuary 31, 2003 and as of February 1, 2003 for all qualifyinginterests obtained after January 31, 2003.  We had no qualifying interests as of January 31, 2003.  We have subsequently made equity investmentsin other entities during 2003.  Theseinvestments are immaterial and consolidation is not currently required underthe Interpretation.

 

In May 2003, theFinancial Accounting Standards Board issued Statement No. 150, *Accounting for Certain Financial Instruments withCharacteristics of both Liabilities and Equity. *Statement 150 clarifies the classification andmeasurement of certain financial instruments with characteristics of bothliabilities and equity, and is effective for financial instruments entered intoor modified after May 31, 2003, or otherwise for the first interim periodbeginning after June 15, 2003.  Theadoption of Statement 150 had no material impact on our net earnings, cashflows or financial position.

 

**2.  Rental Inventory**

 

In the fourth quarter of2002, we made a strategic decision to make a portion of our base stock, orcatalog, VHS rental inventory available for sale during the holiday period aspreviously viewed inventory.  The saleof base stock VHS rental inventory was designed to make room on our storeshelves for a significant investment in base stock DVD rental inventory which arrivedin stores in the first quarter of 2003. Our decision to make this investment in base stock DVD was primarilydriven by the continued growth in consumer acceptance of the DVD platform inour core markets throughout the last year. DVD rental revenue represented approximately 50% of our movie rentalrevenue as of the end of fiscal 2002 versus approximately 20% as of the end offiscal 2001.  As a result of thesignificant shift from VHS to DVD that occurred in our rental inventory base,we changed the estimates used to amortize rental inventory in the fourthquarter of fiscal 2002 as discussed below. The revised estimates reflect a reduction in the estimated useful livesof the rental inventory and a reduced salvage value for both VHS and gameinventory.  We believe the revisedestimated useful lives and salvage values are better matched to our currentrental business and are consistent with industry trends.

 

Rental inventory is stated at cost and amortized overits economic useful life. The up-front fees and minimum costs of rental productpurchased under revenue-sharing arrangements are capitalized and amortized inaccordance with our rental inventory amortization policy.  Revenue-sharing payments are expensed asincurred and are included in cost of rental revenues.  Effective as of the beginning of the fourth quarter of 2002, thecost of base stock movie inventory is amortized on an accelerated basis overthe first twelve months and then on a straight-line basis over the next twelvemonths to its salvage value, $4 for DVD and $2 for VHS.  The cost of non-base stock, or new release,movie inventory is amortized to

 

5

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its salvage value on an accelerated basis over six months.  Video games are amortized on a straight-linebasis to a $5 salvage value over twelve months.

 

The changes in our estimates for rental inventoryamortization were applied to all inventory held at the beginning of the fourthquarter of fiscal 2002.  The changeswere accounted for as a change in accounting estimate during the fourth quarterended January 5, 2003. The change in estimate decreased rental inventoryand increased depreciation expense for the thirteen weeks and thirty-nine weeksended October 5, 2003 by approximately $1.0 million and $5.1 million,respectively; and reduced net income by $0.02 and $0.09 per diluted share,respectively.

 

Prior to the fourth quarter of 2002, the cost of basestock movie inventory was amortized on an accelerated basis to a net book valueof $8 over six months and to a $4 salvage value over the next thirtymonths.  The cost of non-base stockmovie inventory was amortized on an accelerated basis over six months to a netbook value of $4, which was then amortized on a straight-line basis over thenext 30 months or until the movie was sold, at which time the unamortized bookvalue was charged to cost of rental revenues. Video games were amortized on a straight-line basis to a $10 salvagevalue over eighteen months or until the game was sold, at which time theunamortized book value was charged to cost of rental revenues.

 

**3. Goodwill and Other Intangible Assets**

 

The components ofamortized other intangible assets are as follows (in thousands):

 
|                          |   |                                      |       | **January 5, 2003**   |       | **October 5, 2003**      |       |
|-------------------------------|--------|-------------------------------------------|------------|----------------------------|------------|-------------------------------|------------|
|                          |   | **Weighted-Average  Amortization Period** |       | **Gross Carrying  Amount** |       | **Accumulated  Amortization** |       | **Gross Carrying  Amount** |   | **Accumulated  Amortization** |   |
|                          |   |                                      | ** ** |                       | ** ** |                          | ** ** |   | ** ** |   | ** ** |
| Non-compete agreements        |   | 9 years                                   |       | $                          | 9,492      |                          | $          | (6,493 | ) | $ | 10,672 |   | $ | (7,361 | ) |
| Customer lists                |   | 7 years                                   |       | 3,996                      |       | (318                          | )          | 5,950 |   | (842 | ) |
| Total other intangible assets |   |                                      |       | $                          | 13,488     |                          | $          | (6,811 | ) | $ | 16,622 |   | $ | (8,203 | ) |

 

Estimatedamortization expense for other intangible assets for the remainder of 2003 andthe five succeeding fiscal years is as follows (in thousands):

 

| **2003 (remainder)** |   | **$** | **542** |   |
|----------------------|--------|-------|---------|--------|
| 2004                 |   | 2,101 |    |
| 2005                 |   | 1,628 |    |
| 2006                 |   | 1,301 |    |
| 2007                 |   | 1,160 |    |
| 2008                 |   | 932   |    |

 

The changes in thecarrying amounts of goodwill for the thirty-nine weeks ended October 5,2003, are as follows (in thousands):

 

| Balance as of January 5, 2003     |   | $      | 116,119     |       |
|----------------------------------------|--------|--------|-------------|------------|
| Goodwill acquired                      |   | 16,591 | ** **  |
| **Balance as of October 5, 2003** |   | **$**  | **132,710** | ** ** |

** **

**During the thirty-nine weeks ended October 5, 2003, we purchased134 stores in 29 separate transactions for approximately $24.3 million andrecorded approximately $16.6 million in goodwill, $1.9 million for customerlists and $1.2 million for non-compete agreements related to thesetransactions.**

 

6

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**4. Financing Obligations**

 

On June 27,2001, we entered into a credit agreement with a syndicate of banks, led bySouthTrust Bank, with respect to a revolving credit facility.  Our credit facility is unsecured and, asamended, provides for borrowings of up to $65 million through final maturity onJuly 4, 2005.  The interest rate onour credit facility is based on LIBOR plus an applicable margin percentage,which depends on cash flow generation and borrowings outstanding.  As of October 5, 2003, there were nooutstanding borrowings under our credit facility.  The amount available for borrowing, which was reduced by standbyletters of credit outstanding of $1.2 million, was $63.8 million.

 

**5. Earnings Per Share**

 

Basic earnings pershare is computed based on the weighted average number of shares of commonstock outstanding during the periods presented.  Diluted earnings per share is computed based on the weightedaverage number of shares of common stock outstanding during the periodspresented, increased solely by the effects of shares to be issued from theexercise of dilutive common stock options (965,000 and 963,000 for the thirteenweeks ended October 6, 2002 and October 5, 2003, respectively;1,177,000 and 995,000 for the thirty-nine weeks ended October 6, 2002 andOctober 5, 2003, respectively).  Noadjustments were made to net income in the computation of basic or diluted earningsper share.

 

**6. Comprehensive Income**

 

Comprehensiveincome was as follows (in thousands):

 
|                                    |   | **Thirteen Weeks Ended**  |   | **Thirty-Nine Weeks Ended** |   |
|-----------------------------------------|--------|---------------------------|--------|-----------------------------|--------|
|                                    |   | **October 6,  2002** |   | **October 5,  2003**   |   | **October 6,  2002** |   | **October 5,  2003** |   |
|                                    |   |                      |   |                        |   |   |   |   |   |
| Net income                              |   | $                         | 9,392  |                        | $      | 9,215 |   | $ | 24,866 |   | $ | 31,976 |   |
| Foreign currency translation adjustment |   | (221                      | )      | 2                           |   | (14 | ) | 3,031 |   |
| Comprehensive income                    |   | $                         | 9,171  |                        | $      | 9,217 |   | $ | 24,852 |   | $ | 35,007 |   |

 

7

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**MovieGallery, Inc.**

 

**Management’s Discussion****and Analysis of Financial Conditionand Results of Operations**

 

**Resultsof Operations**

 

The following table sets forth, for theperiods indicated, statements of income data and Adjusted EBITDA (see“Liquidity and Capital Resources” below for our calculation of Adjusted EBITDA)expressed as a percentage of total revenue, and the store count for eachperiod.

 
|                          |   | **Thirteen Weeks Ended**  |   | **Thirty-Nine Weeks Ended** |   |
|-------------------------------|--------|---------------------------|--------|-----------------------------|--------|
|                          |   | **October 6,  2002** |   | **October 5,  2003**   |   | **Increase  (Decrease)** |   | **October 6,  2002** |   | **October 5,  2003** |   | **Increase  (Decrease)** |   |
| Revenues:                     |   |                      |   |                        |   |   |   |   |   |   |   |   |   |
| Rentals                       |   | 93.7                      | %      | 92.4                        | %      | (1.3 | )% | 94.2 | % | 91.8 | % | (2.4 | )% |
| Product sales                 |   | 6.3                       |   | 7.6                         |   | 1.3 |   | 5.8 |   | 8.2 |   | 2.4 |   |
| Total revenues                |   | 100.0                     |   | 100.0                       |   | — |   | 100.0 |   | 100.0 |   | — |   |
| Cost of sales:                |   |                      |   |                        |   |   |   |   |   |   |   |   |   |
| Cost of rental revenues       |   | 26.5                      |   | 26.6                        |   | 0.1 |   | 26.4 |   | 27.2 |   | 0.8 |   |
| Cost of product sales         |   | 4.2                       |   | 6.0                         |   | 1.8 |   | 4.1 |   | 6.5 |   | 2.4 |   |
| Gross margin                  |   | 69.3                      |   | 67.4                        |   | (1.9 | ) | 69.5 |   | 66.3 |   | (3.2 | ) |
| Operating costs and expenses: |   |                      |   |                        |   |   |   |   |   |   |   |   |   |
| Store operating expenses      |   | 49.9                      |   | 50.8                        |   | 0.9 |   | 49.4 |   | 48.1 |   | (1.3 | ) |
| General and administrative    |   | 7.1                       |   | 7.1                         |   | — |   | 8.4 |   | 6.9 |   | (1.5 | ) |
| Amortization of intangibles   |   | 0.3                       |   | 0.3                         |   | — |   | 0.3 |   | 0.3 |   | — |   |
| Stock option compensation     |   | (0.1                      | )      | 0.1                         |   | 0.2 |   | 0.2 |   | 0.3 |   | 0.1 |   |
| Operating income              |   | 12.1                      |   | 9.1                         |   | (3.0 | ) | 11.2 |   | 10.7 |   | (0.5 | ) |
|                          |   |                      |   |                        |   |   |   |   |   |   |   |   |   |
| Interest expense, net         |   | (0.1                      | )      | (0.1                        | )      | — |   | (0.2 | ) | (0.1 | ) | 0.1 |   |
| Income before income taxes    |   | 12.0                      |   | 9.0                         |   | (3.0 | ) | 11.0 |   | 10.6 |   | (0.4 | ) |
| Income taxes                  |   | 4.8                       |   | 3.5                         |   | (1.3 | ) | 4.4 |   | 4.2 |   | (0.2 | ) |
| Net income                    |   | 7.2                       | %      | 5.5                         | %      | (1.7 | )% | 6.6 | % | 6.4 | % | (0.2 | )% |
|                          |   |                      |   |                        |   |   |   |   |   |   |   |   |   |
| Adjusted EBITDA               |   | 14.7                      | %      | 12.0                        | %      | (2.7 | )% | 15.2 | % | 15.4 | % | 0.2 | % |
|                          |   |                      |   |                        |   |   |   |   |   |   |   |   |   |
| Store count:                  |   |                      |   |                        |   |   |   |   |   |   |   |   |   |
| Beginning of period           |   | 1,560                     |   | 1,936                       |   | 376 |   | 1,415 |   | 1,784 |   | 369 |   |
| New store builds              |   | 42                        |   | 79                          |   | 37 |   | 87 |   | 163 |   | 76 |   |
| Stores acquired               |   | 73                        |   | 42                          |   | (31 | ) | 192 |   | 134 |   | (58 | ) |
| Stores closed                 |   | (13                       | )      | (7                          | )      | 6 |   | (32 | ) | (31 | ) | 1 |   |
| End of period                 |   | 1,662                     |   | 2,050                       |   | 388 |   | 1,662 |   | 2,050 |   | 388 |   |

 

*Revenue.*  For the thirteen weeks and thirty-nine weeksended October 5, 2003, total revenues were $167.2 million and $496.9million, respectively, increases of 28.2% and 32.1% over the comparable periodsin 2002.  The increases were primarilydue to the expansion of our store base to 2,050 stores at the end of the thirdquarter of 2003, representing a 23.8% increase in the average number of storesopen during the quarter and a 24.8% increase during the year-to-date period of2003.  Increases in same-store revenuesof 5.0% and 8.0% for the third quarter and year-to-date period of 2003,respectively, also contributed to the overall increase in total revenues.  The increase in same-store revenues was theresult of: (i) continued growth of DVD rental and sales revenue; (ii) increasesin the sales of previously viewed movies and previously played games; (iii)higher video game rental revenues driven by our increased commitment to ourgame library over the last year; (iv) increased revenue from product sales as aresult of a significant expansion of new movie inventory available in thestores beginning during the latter half of 2002; and (v) continued revenuegrowth in the Video Update stores we acquired in December 2001 and otheracquisitions and new stores built over the last two years.  The revenue 

 

8

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increases were partially offset by the continued decline in rentalrevenue from VHS product due to the consumer transition to DVD.

 

*Cost of Sales.*  The gross margin on rental revenue for thethird quarter and year-to-date period of 2003 was 71.2% and 70.4%,respectively, versus 71.7% and 72.0% for the comparable quarter andyear-to-date period of 2002.  The costof rental revenues includes the amortization of rental inventory, revenuesharing expenses incurred and the cost of previously viewed rental inventorysold during the period.  The decrease inthe gross margin on rental revenue was primarily due to: (i) a change inestimate related to our amortization policy for rental inventory during thefourth quarter of fiscal 2002 (see Note 2 to our consolidated financialstatements); and (ii) amortization of the investment in DVD catalog inventorythat took place in the first quarter of 2003 in order to satisfy increasingconsumer demand for movies on the DVD format. The change in estimate decreased rental inventory and increaseddepreciation expense for the thirteen weeks and thirty-nine weeks endedOctober 5, 2003 by approximately $1.0 million and $5.1 million,respectively; and reduced net income by $0.02 and $0.09 per diluted share, respectively.

 

Cost of product sales includes thecosts of new DVD, VHS, concessions and other goods sold.  The gross margin on product sales decreasedto 21.1% for the third quarter of 2003 from 33.1% in the third quarter of 2002,and decreased to 20.0% for the year-to-date period of 2003 versus 29.5% in thecomparable period of 2002.  The decreasein the gross margin reflects an expected trend as a result of our increased mixof new movie sales compared to last year. The increase in new movie sales is a result of our increased inventorycommitment, beginning in the latter half of 2002, to accommodate an increasedconsumer demand for retail movies and to complement our rental business.  New movie sales generate lower margins thanother product offerings, such as concessions.

 

*OperatingCosts and Expenses.* Store operating expenses, which include store-level expenses such aslease payments and in-store payroll, increased to 50.8% of total revenue forthe third quarter of 2003 from 49.9% in the third quarter of 2002.  Store operating expenses decreased to 48.1%of total revenue for the year-to-date period of 2003 from 49.4% for thecomparable period of 2002.  The slightincrease for the third quarter of 2003 was due to the large number of immaturestores in our store base that are absorbing the start-up expenses associatedwith a new store while the revenue levels are still ramping up.  We opened a record number of new stores inthe third quarter of 2003 (see store count table provided above).  The decrease for the year-to-date period instore operating expenses as a percentage of total revenue was due to: (i) theleveraging of expenses, particularly in the Video Update stores acquired latein 2001, against an increase in same-store revenues of 5.0% and 8.0% in thethird quarter and year-to-date period of 2003, respectively; (ii) continuedinitiatives to reduce operating costs; and (iii) continued closure ofunder-performing units.

 

General and administrative expenses as a percentage ofrevenue were flat for the third quarter of 2003 at 7.1% despite additionalspending incurred this year to support new initiatives and our future growthplans.  Year-to-date general andadministrative expenses declined as a percentage of revenue to 6.9% in 2003from 8.4% in 2002. The year-to-date decrease was attributable to a legalsettlement charge of $4.0 million incurred in the second quarter of 2002regarding our extended viewing fee policy, as well as costs and expensesassociated with the conversion of the Video Update stores’ point of sale systemthat were incurred in the first quarter of 2002.  This decline was offset slightly by overhead increases in 2003 tosupport new initiatives and our future growth plans, which include expansioninto new geographic areas where our market penetration is lower.

 

Stock option compensation represents the non-cashcharge associated with certain stock options that were repriced during thefirst quarter of 2001 and are subsequently accounted for as variable stockoptions under FASB Interpretation No. 44,*Accounting for Certain Transactions involving StockCompensation, an interpretation of APB Opinion No. 25*. We expect torecord adjustments to income from stock option compensation in future periodsuntil all variable options are vested and exercised or cancelled.

 

9

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Interest expense includes fees for the unusedborrowings available under our credit facility and amortization of theassociated debt issue costs, as well as the costs of any borrowings under ourcredit facility, net of interest income. Interest expense as a percentage of total revenue decreased to 0.1% forthe year-to-date period ended October 5, 2003 compared to 0.2% in thecomparable period of 2002.  The decreasewas primarily due to the repayment of all outstanding debt inMay 2002.  Interest expense for thethird quarter of 2003 was consistent with the prior year at 0.1% of revenue.

 

As a result of the impact of the above factors onrevenues and expenses, operating income was essentially flat for the thirdquarter of 2003 at $15.2 million versus $15.7 million in the prior yearquarter.  Operating income for theyear-to-date period of 2003 increased by 25.7% to $53.2 million from $42.3million in the comparable period of 2002. Operating income includes stock option compensation and in 2002, wasreduced by the $4 million legal settlement charge previously discussed.

 

**Liquidity and Capital Resources**

 

Our primary capital needs are for opening andacquiring new stores and for purchasing inventory. Other capital needs includerefurbishing, remodeling and relocating existing stores and refreshing,rebranding, and supplying new computer hardware for acquired stores.  We fund inventory purchases, remodeling,rebranding and relocation programs, new store opening costs and acquisitionsprimarily from cash flow from operations, and, if necessary, loans underrevolving credit facilities.  AtOctober 5, 2003, we had cash and cash equivalents of $19.4 million, nolong-term debt and $63.8 million in available borrowings under our creditfacility.

 

We fund short-term working capital needs, includingthe purchase of rental inventory, primarily through cash flow from operations.Net cash provided by operating activities was $140.2 million for thethirty-nine weeks ended October 5, 2003 compared to $119.7 million for thethirty-nine weeks ended October 6, 2002. The increase was primarily attributable to revenue growth and continuedefforts to maximize economies of scale within our expense structure, offset partiallyby significant accounts payable reductions in 2003 versus 2002.  Net cash provided by operating activitiescontinues to be sufficient to cover substantially all of our rental inventoryreplenishment and capital resource needs.

 

Net cash used in investing activities was $165.8million for the year-to-date period of 2003 versus $150.2 million for thecomparable period in 2002.  The increasewas primarily due to increased rental inventory purchases in 2003 to support alarger store base, the DVD catalog investment in the first quarter of 2003 andsignificantly more new store builds in 2003 versus 2002.  The increase was partially offset by areduction in business acquisitions in 2003 versus 2002.

 

Net cash provided by financing activities was $2.5million for the year-to-date period of 2003, versus $43.2 million for thecomparable period in 2002.  Net cashprovided by financing activities in 2002 includes the net proceeds from ourstock offering in May 2002, partially offset by the repayment of amounts outstandingunder our credit facility.  Financingactivities in 2003 relate solely to cash received from the exercise of stockoptions.

 

During the thirty-nine weeks ended October 5,2003, we generated $76.7 million in Adjusted EBITDA, a 34.2% increase over$57.2 million for the comparable period in the prior year.  This increase was primarily driven by therevenue growth as discussed above and continued efforts to maximize economiesof scale within our expense structure. Adjusted EBITDA is defined as earnings before interest, taxes,depreciation and amortization, non-cash stock option compensation andnon-recurring items, less our purchases of rental inventory which excludesrental inventory purchases specifically for new store openings.  Adjusted EBITDA is presented not as analternative measure of operating results or cash flow from operations (asdetermined in accordance with accounting principles generally accepted in theUnited States), but because, in the home video retail industry, it is a widelyaccepted financial indicator of a company’s ability to finance its operationsand meet its growth plans, in that it treats rental inventory as being expensedupon purchase instead of being capitalized and amortized.  This measure is also used by us internally tomake new store and acquisition

 

10

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investment decisions and to calculate awards under incentive basedcompensation programs.  Our calculationof Adjusted EBITDA is not necessarily comparable to reported EBITDA and/orAdjusted EBITDA of other companies due to the lack of uniform definitions ofEBITDA and Adjusted EBITDA.  Ourcalculation of Adjusted EBITDA is as follows (in thousands):

 
|                                                                      |   | **Thirteen Weeks Ended**  |       | **Thirty-Nine Weeks Ended** |       |
|---------------------------------------------------------------------------|--------|---------------------------|------------|-----------------------------|------------|
|                                                                      |   | **October 6,  2002** |       | **October 5,  2003**   |       | **October 6,  2002** |   | **October 5,  2003** |   |
|                                                                      |   |                      | ** ** |                        | ** ** |   | ** ** |   | ** ** |
| Operating  income                                                         |   | $                         | 15,737     | ** **                  | **$**      | **15,196** |   | $ | 42,334 | ** ** | **$** | **53,196** | ** ** |
| Rental  inventory amortization and non-cash cost of rental inventory sold |   | 24,705                    |       | **32,666**                  |       | 71,051 | ** ** | **98,620** | ** ** |
| Depreciation  and intangibles amortization                                |   | 4,978                     |       | **5,930**                   | ** ** | 14,545 | ** ** | **16,911** | ** ** |
| Stock  option compensation                                                |   | (151                      | )          | **128**                     | ** ** | 795 | ** ** | **1,626** | ** ** |
| Legal  settlement                                                         |   | —                    |       | **—**                  | ** ** | 4,000 |   | **—** | ** ** |
| Purchases  of rental inventory                                            |   | (29,107                   | )          | **(37,101**                 | **)**      | (81,674 | ) | **(106,492** | **)** |
| DVD  catalog investment                                                   |   | —                    |       | **—**                  | ** ** | — |   | **5,421** | ** ** |
| New  store rental inventory purchases                                     |   | 3,033                     | ** ** | **3,219**                   |       | 6,132 | ** ** | **7,448** | ** ** |
| Adjusted  EBITDA                                                          |   | $                         | 19,195     | ** **                  | **$**      | **20,038** |   | $ | 57,183 | ** ** | **$** | **76,730** | ** ** |

 

We grow our store base throughinternally developed and acquired stores. We opened 163 internally developedstores, acquired 134 stores and closed 31 stores during the first nine monthsof 2003.  We expect to open a total of200 to 225 new stores in 2003. To the extent available, new stores and futureacquisitions may be completed using funds available under our credit facility,financing provided by sellers or alternative financing arrangements such asfunds raised in public or private debt or equity offerings.   However, we cannot assure you thatfinancing will be available to us on terms which will be acceptable, if at all.

 

At October 5, 2003, we had a working capitaldeficit of $34.0 million, due to the accounting treatment of rentalinventory.  Rental inventory is treatedas a noncurrent asset under accounting principles generally accepted in theUnited States because it is a depreciable asset and a portion of this asset isnot reasonably expected to be completely realized in cash or sold in the normalbusiness cycle. Although the rental of this inventory generates the majorportion of our revenue, the classification of this asset as noncurrent resultsin its exclusion from working capital. The aggregate amount payable for this inventory, however, is reported asa current liability until paid and, accordingly, is reflected as a reduction inworking capital. Consequently, we believe that working capital is not anappropriate measure of our liquidity and we anticipate that we will continue tooperate with a working capital deficit.

 

The following table discloses ourcontractual obligations and commercial commitments as of October 5, 2003:

 
|                                   |   | **Payments Due by Period  (in thousands)** |    |
|----------------------------------------|--------|--------------------------------------------|---------|
| **Contractual  Obligations**           |   | **Total**                                  |    | **< 1 Year** |   | **1-3   Years** |   | **4-5  Years** |   | **>5 Years** |   |
| Credit facility –  outstanding(1) |   | $                                          | —  |   | $ | — |   | $ | — |   | $ | — |   | $ | — |   |
| Operating leases                       |   | 248,988                                    |    | 8,108 |   | 188,353 |   | 37,366 |   | 15,161 |   |
| Unconditional  purchase obligations    |   | 11,838                                     |    | 4,000 |   | 7,838 |   | — |   | — |   |
| Total contractual  cash obligations    |   | $                                          | 260,826 |   | $ | 12,108 |   | $ | 196,191 |   | $ | 37,366 |   | $ | 15,161 |   |

 

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(1)  The total commercial commitmentunder our credit facility is $65 million, which expires on July 4,2005.  As of October 5, 2003, therewere standby letters of credit outstanding under our credit facility of$1,172,000, of which $322,000 expires in 2003 and $850,000 expires in 2004.

 

11

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We believe our projected cash flow from operations,cash on hand, borrowing capacity under our credit facility and trade creditwill provide the necessary capital to fund our current plan of operations,including our anticipated new store openings and acquisition program, throughfiscal 2004.  However, to fund a majoracquisition, or to provide funds in the event that our need for funds isgreater than expected, or if the financing sources identified above are notavailable to the extent anticipated or if we increase our growth plan, we mayneed to seek additional or alternative sources of financing.  This financing may not be available onsatisfactory terms.  Failure to obtainfinancing to fund our expansion plans or for other purposes could have amaterial adverse effect on our operating results.

 

Our ability to fund ourcurrent plan of operations and our growth plans will depend upon our futureperformance, which is subject to general economic, financial, competitive andother factors that are beyond our control. We cannot assure you that our business will continue to generatesufficient cash flow from operations to fund capital resource needs, cover theongoing costs of operating our business and service any debt incurred in thefuture.  If we are unable to satisfythese requirements with cash flow from operations and cash on hand, we may berequired to sell assets or to obtain additional financing. We cannot assure youthat any such sales of assets or additional financing could be obtained.

 

**Recently Issued Accounting Pronouncements**

 

In November 2002, the Emerging Issues Task Force(“EITF”) reached a concensus on Issue No. 02-16, *Accounting by a Customer (Including aReseller) for Certain Consideration Received from a Vendor,*effective for fiscal years beginning after December 15, 2002.  EITF 02-16 generally requires that cashconsideration received from a vendor be considered as a reduction of the pricesof the vendor’s products, reflected as a reduction of cost of sales in thecustomer’s income statement.  Thepresumption can be overcome if the vendor receives an identifiable benefit inexchange for the consideration, in which case the consideration should berecorded as revenue, or if the consideration represents a reimbursement of a specificidentifiable incremental cost incurred by the customer in selling the vendor’sproducts where the consideration should be characterized as a reduction of thatcost.  Our adoption of this standard asof January 6, 2003 did not have a material impact on our financialposition or results of operations.

 

In January 2003, theFinancial Accounting Standards Board issued Interpretation No. 46, *Consolidationof Variable Interest Entities, an Interpretation of Accounting ResearchBulletin No. 51*(“the Interpretation”).  The Interpretation requires the consolidation of entities inwhich an enterprise absorbs a majority of the entity’s expected losses,receives a majority of the entity’s expected residual returns, or both, as aresult of ownership, contractual or other financial interests in theentity.  Currently, entities aregenerally consolidated by an enterprise when it has a controlling financialinterest through ownership of a majority voting interest in the entity.  The Interpretation is effective as ofDecember 31, 2003 for all qualifying interests in existence as ofJanuary 31, 2003 and as of February 1, 2003 for all qualifyinginterests obtained after January 31, 2003.  We had no qualifying interests as of January 31, 2003.  We have subsequently made equity investmentsin other entities during 2003.  Theseinvestments are immaterial and consolidation is not currently required underthe Interpretation.

 

In May 2003, theFinancial Accounting Standards Board issued Statement No. 150, *Accounting for Certain Financial Instruments withCharacteristics of both Liabilities and Equity. *Statement 150 clarifies the classification andmeasurement of certain financial instruments with characteristics of bothliabilities and equity, and is effective for financial instruments entered intoor modified after May 31, 2003, or otherwise for the first interim periodbeginning after June 15, 2003.  Theadoption of Statement 150 had no material impact on our net earnings, cashflows or financial position.

 

**Critical Accounting Policies**

 

Our significant accounting policies are described inNote 1 to our consolidated financial statements as filed in our Annual Reporton Form 10-K for the fiscal year ended January 5, 2003.  Our discussion and analysis of financial 

 

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condition and results of operations are based upon our consolidatedfinancial statements, which have been prepared in accordance with accountingprinciples generally accepted in the United States. The preparation of thefinancial statements requires us to make estimates and judgments that affectthe reported amounts of assets, liabilities, revenues, expenses, and relateddisclosure of contingent assets and liabilities.  On an on-going basis, we evaluate the estimates that we havemade. These estimates have been based upon historical experience and on variousother assumptions that we believe to be reasonable under the circumstances.Actual results may differ from these estimates under different conditions orusing different assumptions. We believe our most critical accounting policiesinclude our policies with respect to rental inventory amortization, therecognition of extended viewing fee revenue, impairment of long-lived assets,purchase price allocation of acquired businesses and deferred incometaxes.  These policies are discussed inItem 7 of our Annual Report on Form 10-K for the fiscal year endedJanuary 5, 2003.

 

##### **Forward Looking Statements**

 

This quarterlyreport on Form 10-Q contains forward-looking statements within the meaning ofSection 27A of the Securities Act of 1933, as amended, andSection 21E of the Securities Exchange Act of 1934, as amended, whichrepresent our expectations or beliefs about future events and financialperformance.  Forward-looking statementsare identifiable by the fact that they do not relate strictly to historicalinformation and may include words such as “believe,” “anticipate,” “expect,”“intend,” “plan,” “will,” “may,” “estimate” or other similar expressions andvariations thereof.  In addition, anystatements that refer to expectations, projections or other characterizationsof future events or circumstances are forward-looking statements.  Our forward-looking statements are based onmanagement’s current intent, belief, expectations, estimates and projectionsregarding our company and our industry. Forward-looking statements are subject to known and unknown risks anduncertainties, including those described in our Annual Report on Form 10-K forthe fiscal year ended January 5, 2003. In light of these risks, uncertainties and assumptions, theforward-looking events discussed in this Form 10-Q might not occur.  In addition, actual results could differ materiallyfrom those suggested by the forward-looking statements, and therefore youshould not place undue reliance on the forward-looking statements.  We undertake no obligation to publiclyupdate or revise any forward-looking statements, whether as a result of newinformation, future events or otherwise. We desire to take advantage of the “safe harbor” provisions of thePrivate Securities Litigation Reform Act of 1995 and in that regard we cautionthe readers of this Form 10-Q that the important factors described in ourAnnual Report on Form 10-K for the fiscal year ended January 5, 2003,among others, could affect our actual results of operations and may causechanges in our strategy with the result that our operations and results maydiffer materially from those expressed in any forward-looking statements madeby us, or on our behalf.

 

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Item 3.  Quantitative and Qualitative Disclosures About Market Risk

 

There have been nomaterial changes in our inherent market risk since the disclosures made as ofJanuary 5, 2003 in our Annual Report on Form 10-K.

 

Item 4.  Controls and Procedures

#### ** **

Pursuant to Rule13a-15(b) under the Securities Exchange Act of 1934 (the “Exchange Act”), ourmanagement, with the participation of the Chief Executive Officer and ChiefFinancial Officer, evaluated the effectiveness of our disclosure controls andprocedures as of the end of the period covered by this report.  Based on that evaluation, the ChiefExecutive Officer and Chief Financial Officer concluded that our disclosurecontrols and procedures are effective in ensuring that information required tobe disclosed in reports that we file or submit under the Exchange Act isrecorded, processed, summarized and reported within the time periods specifiedin the SEC’s rules and forms.  No changein our internal controls over financial reporting occurred during the mostrecent fiscal quarter that materially affected, or is reasonably likely tomaterially affect, our internal controls over financial reporting.

#### ** **

#### **Part II** - Other Information

 
| Item 6.   Exhibits and Reports on Form 8-K |
|-------------------------------------------------|
|                                            |   |   |   |
|                                            | a) |   | Exhibits |
|                                            |   |   | 31.1 | Certification of  Chief Executive Officer Pursuant to 15 U.S.C. §7241, as adopted Pursuant to  Section 302 of the Sarbanes-Oxley Act of 2002. |
|                                            |   |   |   |   |
|                                            |   |   | 31.2 | Certification of  Chief Financial Officer Pursuant to 15 U.S.C. §7241, as adopted Pursuant to  Section 302 of the Sarbanes-Oxley Act of 2002. |
|                                            |   |   |   |   |
|                                            |   |   | 32.1 | Certification of Chief  Executive Officer Pursuant to 18 U.S.C §1350, as adopted Pursuant to  Section 906 of the Sarbanes-Oxley Act of 2002 |
|                                            |   |   |   |   |
|                                            |   |   | 32.2 | Certification of Chief  Financial Officer Pursuant to 18 U.S.C. §1350, as adopted Pursuant to  Section 906 of the Sarbanes-Oxley Act of 2002 |
|                                            |   |   |   |
|                                            | b) |   | Reports on Form 8-K |
|                                            |   |   |   |
|                                            |   |   | We filed a Form 8-K  reporting on Items 7 and 12 dated July 9, 2003. |
|                                            |   |   |   |
|                                            |   |   | We filed a Form 8-K  reporting on Items 7 and 12 dated August 5, 2003. |

** **

**Signatures**

 

Pursuant to the requirements of the SecuritiesExchange Act of 1934, the registrant has duly caused this report to be signedon its behalf by the undersigned thereunto duly authorized.

 

 
|                               |   | Movie Gallery,  Inc.                                                  |   |
|------------------------------------|--------|-----------------------------------------------------------------------|--------|
|                               |   | (Registrant)                                                          |   |
|                               |   |                                                                  |
|                               |   |                                                                  |
| Date:  November 19, 2003 |   | /s/ J. Steven Roy                                                     |   |
|                               |   | J. Steven Roy,  Executive Vice President and  Chief Financial Officer |

 

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