---

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UNITED STATES
SECURITIES AND EXCHANGE COMMISSIONWashington, D.C. 20549

FORM 10-Q

(Mark One)

|ý | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934  
|- | -----------------------------------------------------------------------------------------
|  | For the quarterly period ended October 6, 2002                                           
|  | OR                                                                                       
|o | 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(State or other jurisdiction of
incorporation or organization)        |  | 63-1120122(I.R.S. Employer
Identification No.)
|----------------------------------------------------------------------------- |  | ----------------------------------------------
|900 West Main Street, Dothan, Alabama(Address of principal executive offices) |  | 36301(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 o    NO ý

The
number of shares outstanding of the registrant's common stock as of November 13, 2002 was 31,958,284.

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Movie Gallery, Inc.  Index

|Part I. Financial Information                                                                                       |  |   
|------------------------------------------------------------------------------------------------------------------- |  | --
|Item 1. Consolidated Financial Statements (Unaudited)                                                               |  |   
|Consolidated Balance SheetsJanuary 6, 2002 and
October 6, 2002                                                     |  | 1 
|Consolidated Statements of IncomeThirteen weeks and thirty-nine weeks ended September 30, 2001 and October 6, 2002 |  | 2 
|Consolidated Statements of Cash FlowsThirty-nine weeks ended September 30, 2001 and October 6, 2002                |  | 3 
|Notes to Consolidated Financial StatementsOctober 6, 2002                                                          |  | 4 
|Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations                       |  | 7 
|Item 3. Quantitative and Qualitative Disclosures About Market Risks                                                 |  | 14
|Item 4. Controls and Procedures                                                                                     |  | 14
|Part II. Other Information                                                                                          |  |   
|Item 6. Exhibits and Reports on Form 8-K                                                                            |  | 15

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

|                                           |                                                                                                                                    | January 6,
2002 |         | October 6,
2002 |  
|------------------------------------------ | ---------------------------------------------------------------------------------------------------------------------------------- | --------------- | ------- | --------------- | -
|
|Assets                                     |                                                                                                                                    |                 |         |                 |  
|Current assets:                            |                                                                                                                                    |                 |         |                 |  
|                                           | Cash and cash equivalents                                                                                                          |                 | $       | 16,349          |  
|                                           | Merchandise inventory                                                                                                              |                 |         | 6,739           |  
|                                           | Prepaid expenses                                                                                                                   |                 |         | 2,085           |  
|                                           | Store supplies and other                                                                                                           |                 |         | 5,582           |  
|                                           | Deferred income taxes                                                                                                              |                 |         | 1,159           |  
|                                           |                                                                                                                                    |                 |         |                 |  
|Total current assets                       |                                                                                                                                    |                 | 31,914  |                 |  
|Rental inventory, net                      |                                                                                                                                    |                 | 88,424  |                 |  
|Property, furnishings and equipment, net   |                                                                                                                                    |                 | 71,739  |                 |  
|Goodwill, net                              |                                                                                                                                    |                 | 71,682  |                 |  
|Other intangibles, net                     |                                                                                                                                    |                 | 4,156   |                 |  
|Deposits and other assets                  |                                                                                                                                    |                 | 2,217   |                 |  
|                                           |                                                                                                                                    |                 |         |                 |  
|Total assets                               |                                                                                                                                    | $               | 270,132 |                 | $
|                                           |                                                                                                                                    |                 |         |                 |  
|Liabilities and stockholders' equity       |                                                                                                                                    |                 |         |                 |  
|Current liabilities:                       |                                                                                                                                    |                 |         |                 |  
|                                           | Accounts payable                                                                                                                   |                 | $       | 51,785          |  
|                                           | Accrued liabilities                                                                                                                |                 |         | 28,935          |  
|                                           |                                                                                                                                    |                 |         |                 |  
|Total current liabilities                  |                                                                                                                                    |                 | 80,720  |                 |  
|Long-term debt                             |                                                                                                                                    |                 | 26,000  |                 |  
|Other accrued liabilities                  |                                                                                                                                    |                 | 606     |                 |  
|Deferred income taxes                      |                                                                                                                                    |                 | 624     |                 |  
|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, 27,214,936 and 31,948,919 shares issued and outstanding, respectively |                 |         | 27              |  
|                                           | Additional paid-in capital                                                                                                         |                 |         | 140,475         |  
|                                           | Retained earnings                                                                                                                  |                 |         | 21,713          |  
|                                           | Accumulated other comprehensive loss                                                                                               |                 |         | (33             | )
|                                           |                                                                                                                                    |                 |         |                 |  
|Total stockholders' equity                 |                                                                                                                                    |                 | 162,182 |                 |  
|                                           |                                                                                                                                    |                 |         |                 |  
|Total liabilities and stockholders' equity |                                                                                                                                    | $               | 270,132 |                 | $
|                                           |                                                                                                                                    |                 |         |                 |  

See accompanying notes.

1

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

|                                     |                             | Thirteen Weeks Ended |        | Thirty-Nine Weeks Ended |  
|------------------------------------ | --------------------------- | -------------------- | ------ | ----------------------- | -
|
|Revenues:                            |                             |                      |        |                         |  
|                                     | Rentals                     |                      | $      | 82,109                  |  
|                                     | Product sales               |                      |        | 4,358                   |  
|                                     |                             |                      |        |                         |  
|Total revenues                       |                             |                      | 86,467 |                         |  
|Cost of sales:                       |                             |                      |        |                         |  
|                                     | Cost of rental revenues     |                      |        | 25,829                  |  
|                                     | Cost of product sales       |                      |        | 3,536                   |  
|                                     |                             |                      |        |                         |  
|Gross margin                         |                             |                      | 57,102 |                         |  
|Operating costs and expenses:        |                             |                      |        |                         |  
|                                     | Store operating expenses    |                      |        | 42,810                  |  
|                                     | General and administrative  |                      |        | 7,531                   |  
|                                     | Amortization of intangibles |                      |        | 1,568                   |  
|                                     | Stock option compensation   |                      |        | 2,443                   |  
|                                     |                             |                      |        |                         |  
|Operating income                     |                             |                      | 2,750  |                         |  
|Interest expense, net                |                             |                      | (666   | )                       |  
|                                     |                             |                      |        |                         |  
|Income before income taxes           |                             |                      | 2,084  |                         |  
|Income taxes                         |                             |                      | 813    |                         |  
|                                     |                             |                      |        |                         |  
|Net income                           |                             | $                    | 1,271  |                         | $
|                                     |                             |                      |        |                         |  
|Earnings per share:                  |                             |                      |        |                         |  
|                                     | Basic                       |                      | $      | 0.05                    |  
|                                     |                             |                      |        |                         |  
|                                     | Diluted                     |                      | $      | 0.05                    |  
|                                     |                             |                      |        |                         |  
|Weighted average shares outstanding: |                             |                      |        |                         |  
|                                     | Basic                       |                      |        | 26,072                  |  
|                                     | Diluted                     |                      |        | 27,920                  |  

See accompanying notes.

2

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

|                                                                                  |                                                                          | Thirty-Nine Weeks Ended |        
|--------------------------------------------------------------------------------- | ------------------------------------------------------------------------ | ----------------------- | -------
|
|Operating activities:                                                             |                                                                          |                         |        
|Net income                                                                        |                                                                          | $                       | 6,217  
|Adjustments to reconcile net income to net cash provided by operating activities: |                                                                          |                         |        
|                                                                                  | Rental inventory amortization and non-cash cost of rental inventory sold |                         |        
|                                                                                  | Depreciation and intangibles amortization                                |                         |        
|                                                                                  | Stock option compensation                                                |                         |        
|                                                                                  | Tax benefit of stock options exercised                                   |                         |        
|                                                                                  | Deferred income taxes                                                    |                         |        
|Changes in operating assets and liabilities:                                      |                                                                          |                         |        
|                                                                                  | Merchandise inventory                                                    |                         |        
|                                                                                  | Notes receivable                                                         |                         |        
|                                                                                  | Other current assets                                                     |                         |        
|                                                                                  | Deposits and other assets                                                |                         |        
|                                                                                  | Accounts payable                                                         |                         |        
|                                                                                  | Accrued liabilities                                                      |                         |        
|                                                                                  |                                                                          |                         |        
|Net cash provided by operating activities                                         |                                                                          |                         | 74,248 
|Investing activities:                                                             |                                                                          |                         |        
|Business acquisitions                                                             |                                                                          |                         | (5,718 
|Purchases of rental inventory                                                     |                                                                          |                         | (60,944
|Purchases of property, furnishings and equipment                                  |                                                                          |                         | (15,375
|                                                                                  |                                                                          |                         |        
|Net cash used in investing activities                                             |                                                                          |                         | (82,037
|Financing activities:                                                             |                                                                          |                         |        
|Net proceeds from issuance of common stock                                        |                                                                          |                         |       
|Proceeds from exercise of stock options                                           |                                                                          |                         | 3,589  
|Net proceeds from (payments on) long-term debt                                    |                                                                          |                         | 3,780  
|                                                                                  |                                                                          |                         |        
|Net cash provided by financing activities                                         |                                                                          |                         | 7,369  
|Effect of exchange rate changes on cash and cash equivalents                      |                                                                          |                         |       
|                                                                                  |                                                                          |                         |        
|Increase (decrease) in cash and cash equivalents                                  |                                                                          |                         | (420   
|Cash and cash equivalents at beginning of period                                  |                                                                          |                         | 7,029  
|                                                                                  |                                                                          |                         |        
|Cash and cash equivalents at end of period                                        |                                                                          | $                       | 6,609  
|                                                                                  |                                                                          |                         |        

See accompanying notes.

3

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Movie Gallery, Inc.
Notes to Consolidated Financial Statements (Unaudited)
October 6, 2002

1. Basis of Presentation

The accompanying unaudited 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 6, 2002 are not necessarily indicative of
the results that may be expected for the fiscal year ending January 5, 2003. For further information, refer to the consolidated financial statements and footnotes thereto included in our annual
report on Form 10-K for the fiscal year ended January 6, 2002.

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

The
extraordinary loss on early extinguishment of debt reported in the third quarter of 2001 ($177,000, net of taxes of $113,000) has been reclassified to interest expense and income
taxes. The item is not
material to our operating results and the reclassification had no impact on net income as previously reported.

2. Business Combinations, Goodwill and Other Intangible Assets

In June 2001, the FASB issued Statement No. 141,Business Combinations, and Statement
No. 142,Goodwill and Other Intangible Assets. Statement 141 requires that all business combinations be accounted for by the purchase method, and
requires all intangible assets acquired in a business combination to be recognized as assets apart from goodwill if they meet certain contractual-legal criterion or separability criterion. The
provisions of Statement 141 apply to all business combinations with an acquisition date subsequent to June 30, 2001. The application of Statement 141 did not affect any of the previously
reported amounts included in goodwill or other intangible assets. Under Statement 142, goodwill and indefinite lived intangible assets are no longer amortized but are reviewed for impairment annually,
or more frequently if impairment indicators arise. Separable intangible assets that are not deemed to have an indefinite life will continue to be amortized over their useful lives. We adopted
Statement 142 as of January 7, 2002. The adoption of Statement 142 did not have any impact on the classification of intangible assets. Application of the nonamortization provisions of Statement
142 as of January 1, 2001 would have increased net income by approximately $862,000, or $0.03 per diluted share, and $2,577,000, or $0.09 per diluted share, for the thirteen weeks and
thirty-nine weeks ended September 30, 2001, respectively. We completed the transitional impairment test and determined that none of the goodwill recorded was impaired as of
January 7, 2002.

4

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

January 6, 2002

October 6, 2002Gross Carrying
Amount

Accumulated
Amortization

Gross Carrying
Amount

Accumulated
AmortizationNon-compete agreements

$
8,688

$
(5,662
)
$
9,291

$
(6,241
)Customer lists


1,130





5,957


(383
)Total

$
9,818

$
(5,662
)
$
15,248

$
(6,624
)


Estimated
amortization expense for other intangible assets for the remainder of 2002 and the five succeeding fiscal years follows (in thousands):

2002 (remainder)

$
4592003


1,8412004


1,7862005


1,3132006


1,0512007


949


The
changes in the carrying amounts of goodwill for the thirty-nine weeks ended October 6, 2002, are as follows (in thousands):

Balance as of January 6, 2002

$
71,682Goodwill acquired


32,512Balance as of October 6, 2002

$
104,194


3. Financing Obligations

On June 27, 2001, we entered into a credit agreement with a syndicate of banks, led by SouthTrust Bank, with respect to a revolving credit facility. Our
credit facility is unsecured and, as amended, provides for borrowings of up to $65 million through final maturity on July 4, 2004. The interest rate on our credit facility is based on
LIBOR plus an applicable margin percentage, which depends on cash flow generation and borrowings outstanding. In December 2001, as required by the credit facility, we entered into an interest
rate swap agreement in order to hedge exposure to interest rate fluctuations on $10 million of outstanding debt at a fixed rate of 3.5% plus an applicable margin percentage. In May 2002,
we repaid all amounts outstanding under our credit facility with the proceeds from our stock offering (see note 5) and terminated the interest rate swap agreement.

4. Exit Costs

In connection with the purchase price allocation for Video Update, Inc. (acquired in December 2001), we recorded accrued expenses of approximately
$1.3 million to terminate the operations of the Video Update corporate office and to transition those functions to our corporate offices. The accrual consists primarily of payroll costs, rent
and utilities during the transition period. The accrual is subject to change if the transition period extends beyond that originally anticipated. Adjustments to the accrual, if any, will be recorded
as an adjustment to the purchase price allocation. We paid approximately $89,000 and $1,125,000 against the accrual during the thirteen weeks and thirty-nine weeks ended October 6,
2002, respectively.

5

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5. Stockholders' Equity

Common Stock

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

Earnings Per Share

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 (1,848,000 and 965,000 for the thirteen weeks ended September 30, 2001 and October 6, 2002, respectively; 1,200,000 and 1,177,000 for the
thirty-nine weeks ended September 30, 2001 and October 6, 2002, respectively). No adjustments were made to net income in the computation of basic or diluted earnings per
share.

Stock Offering

On April 11, 2002, we filed a registration statement with the SEC for an offering of our common stock. The offering was priced at $18.25 and closed on
May 21, 2002. We sold 3,900,000 shares and received the proceeds from 350,000 stock options exercised in conjunction with the offering for total proceeds, net of expenses of the offering, of
approximately $67.6 million. A portion of the proceeds from the offering were used to repay outstanding borrowings under the credit facility. We are currently using the balance of the proceeds
from the offering for new store openings, selective acquisitions, working capital and other general corporate purposes.

6. Comprehensive Income

Comprehensive income was as follows (in thousands):

Thirteen Weeks Ended

Thirty-Nine Weeks EndedSeptember 30,
2001

October 6,
2002

September 30,
2001

October 6,
2002Net income

$
1,271

$
9,392

$
6,217

$
24,866Foreign currency translation adjustment





(221
)




(14
)Comprehensive income

$
1,271

$
9,171

$
6,217

$
24,852


7. Legal Settlement

On April 19, 2002, we obtained preliminary court approval of a settlement agreement to resolve class action lawsuits regarding extended viewing fees
charged to our customers. The terms of the settlement would provide coupons to eligible customers with values ranging from $9 to $16 to be used toward movie or game rentals or non-food
purchases at Movie Gallery and affiliated stores nationwide. The agreement is subject to a fairness hearing currently scheduled for November 22, 2002. If final approval is received, the coupons
will be issued and will be redeemable between January 30 and June 30, 2003. As a result of the agreement, we have recorded a one-time charge in the second quarter of 2002 of
approximately $4 million, including attorneys' fees for the class of $850,000.

6

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Movie Gallery Inc.  Management's Discussion and Analysis of Financial Condition  and Results of Operations

Results of Operations

The following table sets forth, for the periods indicated, statements of income data and Adjusted EBITDA expressed as a percentage of total revenue, and the
number of stores open at the end of each period.

|                                       |                             | Thirteen Weeks Ended |      | Thirty-Nine Weeks Ended |     
|-------------------------------------- | --------------------------- | -------------------- | ---- | ----------------------- | ----
|
|Revenues:                              |                             |                      |      |                         |     
|                                       | Rentals                     |                      | 95.0 | %                       | 93.7
|                                       | Product sales               |                      | 5.0  |                         | 6.3 
|                                       |                             |                      |      |                         |     
|Total revenues                         |                             | 100.0                |      | 100.0                   |     
|Cost of sales:                         |                             |                      |      |                         |     
|                                       | Cost of rental revenues     |                      | 29.9 |                         | 26.5
|                                       | Cost of product sales       |                      | 4.1  |                         | 4.2 
|                                       |                             |                      |      |                         |     
|Gross margin                           |                             | 66.0                 |      | 69.3                    |     
|Operating costs and expenses:          |                             |                      |      |                         |     
|                                       | Store operating expenses    |                      | 49.5 |                         | 49.9
|                                       | General and administrative  |                      |      |                         |     
|                                       |                             | Recurring expenses   |      | 8.7                     |     
|                                       |                             | Non-recurring items  |      |                        |     
|                                       | Amortization of intangibles |                      | 1.8  |                         | 0.3 
|                                       | Stock option compensation   |                      | 2.8  |                         | (0.1
|                                       |                             |                      |      |                         |     
|Operating income                       |                             | 3.2                  |      | 12.1                    |     
|Interest expense, net                  |                             | (0.8                 | )    | (0.1                    | )   
|                                       |                             |                      |      |                         |     
|Income before income taxes             |                             | 2.4                  |      | 12.0                    |     
|Income taxes                           |                             | 0.9                  |      | 4.8                     |     
|                                       |                             |                      |      |                         |     
|Net income                             |                             | 1.5                  | %    | 7.2                     | %   
|                                       |                             |                      |      |                         |     
|Adjusted EBITDA                        |                             | 11.1                 | %    | 14.7                    | %   
|Number of stores open at end of period |                             | 1,082                |      | 1,662                   |     

Revenue.For the thirteen weeks and thirty-nine weeks ended October 6, 2002, total revenues were
$130.4 million and $376.1 million, respectively, increases of 50.8% and 44.1% over the comparable periods in 2001. The increase for the year was due primarily to the expansion of our
store base to 1,662 stores at the end of the third quarter of 2002 from 1,082 at the end of the third quarter last year, representing a 45.3% increase in the average number of stores open during the
year-to-date period of 2002. The incremental stores in 2002 are primarily attributable to our acquisition of 520 stores over the last year, which includes the acquisition of
324 Video Update stores in December 2001. Increases in same store revenues of 4.7% and 2.0% for the third quarter and year-to-date period of 2002, respectively, also
contributed to the overall increase in total revenues. The increase in same store revenues was the result of: (i) continued growth of DVD rental and sales revenue; (ii) increases in the
sales of previously viewed movies and previously played games; (iii) higher video game rental revenues driven by growth in the video game industry and consumer acceptance of new platforms
released late

7

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in 2001; and, (iv) a favorable slate of new release titles in the third quarter of 2002 versus the third quarter of 2001. The revenue increases were partially offset by: (i) a
significant decline in rental revenue from VHS product due to the continued consumer transition to DVD; (ii) unfavorable weather during the first half of 2002 as compared to the first half of
2001; and, (iii) the broadcast of the Winter Olympics during the first quarter of 2002.

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

2001

2002First Quarter

$
4,165

$
5,741Second Quarter


3,813


7,276Third Quarter


3,739


6,917Fourth Quarter


5,348


Cost of Sales.The gross margin on rental revenue for the third quarter and year-to-date period of
2002 was 71.7% and 72.0%, respectively, versus 68.5% and 68.1% for the comparable quarter and year-to-date period of 2001. The cost of rental revenues includes the amortization
of rental inventory, revenue sharing expenses incurred and the cost of previously viewed rental inventory sold during the period. The improvement in the gross margin on rental revenue is a result of
(i) the increasing shift of movie rentals from videocassettes to DVD, which currently has a lower cost structure than videocassettes and (ii) the purchase price allocation of Video
Update that produced lower than normal rental inventory amortization in the first half of 2002. The improvement in rental margins was partially offset by the initial investment in our game expansion
program that is taking place in order to provide significant copy depth of all game platforms in our stores.

Cost
of product sales includes the costs of new VHS, DVD, concessions and other goods sold. The gross margin on product sales increased to 33.1% for the third quarter of 2002 from 18.9%
in the third quarter of 2001, and increased to 29.5% for the year-to-date period of 2002 versus 19.9% in the comparable period of 2001. The increase in the
year-to-date gross margin was due to the decreased level of lower margin, new movies available for sale in the first half of 2002 versus 2001, coupled with deep discounts of
certain new sales merchandise in the first quarter of 2001 to diminish levels of slow moving inventory.

Operating Costs and Expenses.Store operating expenses, which include store-level expenses such as lease payments and
in-store payroll, increased to 49.9% and 49.4% of total revenue for the third quarter and year-to-date period of 2002, respectively. This reflects an increase from
49.5% and 47.8% in the comparable periods of 2001, respectively. The increase in store operating expenses as a percentage of total revenue was primarily due to a higher cost structure associated with
the 324 Video Update stores acquired in December 2001. The increase was offset partially by: (i) continued initiatives to reduce operating costs; (ii) strong performance of new
stores; (iii) continued closure of under-

8

---

performing units; and, (iv) the same store revenues increase of 4.7% and 2.0% in the third quarter and year-to-date period of 2002, respectively.

General
and administrative expenses as a percentage of revenue decreased to 7.1% and 8.4% for the third quarter and year-to-date period of 2002 from 8.7% and 8.5%
in the comparable periods of 2001. General and administrative expenses include a legal settlement charge of $4.0 million in the second quarter of 2002 regarding our extended viewing fee policy
and a non-recurring charge of $1.6 million related to an amendment of our supply agreement with Rentrak Corporation in the first quarter of 2001. Excluding these two items, general
and administrative expenses as a percentage of revenue decreased to 7.3% for the year-to-date period of 2002 from 7.9% for the comparable period in 2001. The decreases were
attributable to increased revenues while leveraging general and administrative expenses associated with an increased store base.

Amortization
of intangibles as a percentage of total revenue for the thirteen weeks and thirty-nine weeks ended October 6, 2002 was 0.3%, decreases from 1.8% and 1.9%
for the comparable periods of 2001, respectively. This decrease is due to the adoption of Financial Accounting Standards Board Statement No. 142. (See Business Combinations, Goodwill and Other
Intangible Assets below).

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

Interest
expense includes fees for the unused borrowings available under our credit facility and amortization of the associated debt issue costs, as well as the costs of any outstanding
borrowings under our credit facility, net of interest income. Interest expense as a percentage of total revenue decreased to 0.1% and 0.2% for the thirteen weeks and thirty-nine weeks
ended October 6, 2002, from 0.8% and 0.9% in the comparable periods of 2001, respectively. The decrease is primarily due to the repayment of all outstanding debt in May 2002.

As
a result of the impact of the above factors on revenues and expenses, operating income increased by 472.3% and 231.7% for the third quarter and year-to-date
period of 2002 to $15.7 million and $42.3 million, respectively. Excluding the legal settlement charge, the non-recurring charge to amend a supply contract and
non-cash stock option compensation expense, operating income increased by 200.1% and 133.9% for the third quarter and year-to-date period of 2002 to
$15.6 million and $47.1 million, respectively.

Business Combinations, Goodwill and Other Intangible Assets

In June 2001, the FASB issued Statement No. 141,Business Combinations, and Statement
No. 142,Goodwill and Other Intangible Assets. Statement 141 requires that all business combinations be accounted for by the purchase method, and
requires all intangible assets acquired in a business combination to be recognized as assets apart from goodwill if they meet certain contractual-legal criterion or separability criterion. The
provisions of Statement 141 apply to all business combinations with an acquisition date subsequent to June 30, 2001. The application of Statement 141 did not affect any of the previously
reported amounts included in goodwill or other intangible assets. Under Statement 142, goodwill and indefinite lived intangible assets are no longer amortized but are reviewed for impairment annually,
or more frequently if impairment indicators arise. Separable intangible assets that are not deemed to have an indefinite life will continue to be amortized over their useful lives. We adopted
Statement 142 as of January 7, 2002. Our adoption of Statement 142 did not have any impact on the classification of intangible assets. Application of the nonamortization provisions of Statement
142 as of January 1, 2001 would have increased net income by approximately $862,000, or $0.03 per diluted share, for the third quarter of 2001 and by approximately $2,577,000, or $0.09 per
diluted share,

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for the thirty-nine weeks ended September 30, 2001. We completed the transitional impairment test and determined that none of the goodwill recorded was impaired as of
January 7, 2002.

General Economic Trends, Quarterly Results of Operations and Seasonality

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



Liquidity and Capital Resources

Our primary capital needs are for opening and acquiring new stores and for purchasing inventory. Other capital needs include refurbishing, remodeling and
relocating existing stores and refreshing, rebranding, and supplying new computer hardware for acquired stores. We fund inventory purchases, remodeling, rebranding and relocation programs, new store
opening costs and acquisitions primarily from cash flow from operations, proceeds from our common stock offering and, if necessary, loans under revolving credit facilities.

During
the thirty-nine weeks ended October 6, 2002 we generated $57.2 million in Adjusted EBITDA, a 48.8% increase over $38.4 million for the comparable
period in the prior year. This increase was primarily driven by the revenue growth and gross margin increases as discussed above. Adjusted EBITDA is defined as earnings before interest, taxes,
depreciation and amortization, non-cash cost of rental inventory sold, non-cash stock option compensation and non-recurring items, less our purchases of rental
inventory which excludes rental inventory purchases specifically for new store openings. Adjusted EBITDA is presented not as an alternative measure of operating results or cash flow from operations
(as determined in accordance with accounting principles generally accepted in the United States), but because, in the home video specialty retail industry, it is a widely accepted financial indicator
of a company's ability to incur and service debt. Our calculation of Adjusted EBITDA is not necessarily comparable to reported EBITDA and/or Adjusted EBITDA of other companies due to the lack of
uniform definitions of EBITDA and Adjusted EBITDA.

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Our
calculation of Adjusted EBITDA is as follows:

|                                                                         |  | Thirteen Weeks Ended |         | Thirty-Nine Weeks Ended |  
|------------------------------------------------------------------------ |  | -------------------- | ------- | ----------------------- | -
|
|Operating income                                                         |  | $                    | 2,750   |                         | $
|Rental inventory amortization and non-cash cost of rental inventory sold |  |                      | 18,076  |                         |  
|Depreciation and intangibles amortization                                |  |                      | 5,364   |                         |  
|Stock option compensation(a)                                             |  |                      | 2,443   |                         |  
|Non-recurring items(b)                                                   |  |                      |        |                         |  
|Purchases of rental inventory                                            |  |                      | (19,942 | )                       |  
|New store rental inventory purchases(c)                                  |  |                      | 881     |                         |  
|                                                                         |  |                      |         |                         |  
|Adjusted EBITDA                                                          |  | $                    | 9,572   |                         | $
|                                                                         |  |                      |         |                         |  

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We
fund short-term working capital needs, including the purchase of rental inventory, primarily through cash flow from operations. Net cash provided by operating activities
was $119.7 million for the thirty-nine weeks ended October 6, 2002 compared to $74.2 million for the thirty-nine weeks ended September 30, 2001. The
increase is primarily attributable to the increases in operating income. Net cash provided by operating activities continues to be sufficient to cover our rental inventory and capital asset
replenishment needs.

Net
cash used in investing activities was $150.2 million for the year-to-date period of 2002 versus $82.0 million for the comparable period in 2001.
The increase is primarily due to more significant acquisition activity in 2002 versus 2001 and increased rental inventory purchases in 2002 to support a larger store base.

Net
cash provided by financing activities was $43.2 million for the year-to-date period of 2002, versus $7.4 million for the comparable period in
2001. The increase is primarily due to the net result of the proceeds from our stock offering and the subsequent repayment of amounts outstanding under our credit facility.

On
April 11, 2002, we filed a registration statement with the SEC for an offering of our common stock. The offering was priced at $18.25 and closed on May 21, 2002. We sold
3,900,000 shares and received the proceeds from 350,000 stock options exercised in conjunction with the offering for total proceeds, net of expenses of the offering, of approximately
$67.6 million. We used a portion of the proceeds to repay outstanding borrowings under our credit facility. We are currently using the balance of the proceeds from the offering for new store
openings, selective acquisitions, working capital and other general corporate purposes.

On
June 27, 2001, we entered into a credit agreement with a syndicate of banks, led by SouthTrust Bank, with respect to a revolving credit facility. Our credit facility is
unsecured and, as amended, provides for borrowings of up to $65 million through July 4, 2004. The interest rate on our credit facility is based on LIBOR plus an applicable margin
percentage, which depends on cash flow generation and
borrowings outstanding. In December 2001, as required by the credit facility, we entered into an interest rate swap agreement in order to hedge exposure to interest rate fluctuations on

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$10 million of outstanding debt at a fixed rate of 3.5% plus an applicable margin percentage. In May 2002, we repaid all amounts outstanding under our credit facility with the proceeds
from our stock offering and terminated the interest rate swap agreement.

We
grow our store base through internally developed and acquired stores. We opened 87 internally developed stores, acquired 192 stores and closed 32 stores during the first nine months
of 2002. We expect to open 140 new stores in 2002. To the extent available, new stores and future acquisitions will be completed using proceeds from our recent stock offering, funds available under
our credit facility, financing provided by sellers, and alternative financing arrangements such as funds raised in public or private debt or equity offerings or shares of our stock issued to sellers.
However, we cannot assure you that financing will be available to us on terms which will be acceptable, if at all.

At
October 6, 2002, we had a working capital deficit of $31.8 million, due to the accounting treatment of rental inventory. Rental inventory is treated as a noncurrent
asset under accounting principles generally accepted in the United States because it is a depreciable asset and a portion of this asset is not reasonably expected to be completely realized in cash or
sold in the normal business cycle. Although the rental of this inventory generates the major portion of our revenue, the classification of this asset as noncurrent results in its exclusion from
working capital. The aggregate amount payable for this inventory, however, is reported as a current liability until paid and, accordingly, is included in working capital. Consequently, we believe that
working capital is not an appropriate measure of our liquidity and we anticipate that we will continue to operate with a working capital deficit.

The
following table discloses our contractual obligations and commercial commitments as of October 6, 2002:

|                                   |  | Payments Due by Period
(in thousands)
|---------------------------------- |  | -------------------------------------
|
|Credit facilityoutstanding(1)     |  | $                                    
|Operating leases                   |  |                                      
|Unconditional purchase obligations |  |                                      
|                                   |  |                                      
|Total contractual cash obligations |  | $                                    
|                                   |  |                                      

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

Our
ability to fund our current plan of operations and our growth plans will depend upon our future performance, which is subject to general economic, financial, competitive and other
factors that are beyond our control. We cannot assure you that our business will continue to generate sufficient cash flow from operations in the future to fund capital resource needs, cover the
ongoing costs of operating our business and service any debt incurred in the future. If we are unable to satisfy these

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requirements with cash flow from operations and cash on hand, we may be required to sell assets or to obtain additional financing. We cannot assure you that any such sales of assets or additional
financing could be obtained.

Critical Accounting Policies

Our significant accounting policies are described in note 1 to our consolidated financial statements as filed in our annual report on
Form 10-K for the fiscal year ended January 6, 2002. Our discussion and analysis of financial condition and results of operations are based upon our consolidated financial
statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of the financial statements requires us to make estimates and
judgments that affect the reported amounts of assets, liabilities, revenues, expenses, and related disclosure of contingent assets and liabilities. On an on-going basis, we evaluate the
estimates that we have made. These estimates have been based upon historical experience and on various other assumptions that we believe to be reasonable under the circumstances. Actual results may
differ from these estimates under different conditions or using different assumptions. We believe our most critical accounting policies include our policies with respect to rental inventory
amortization, the recognition of extended viewing fee revenue, impairment of long-lived assets, purchase price allocation of acquired businesses and deferred income taxes. These policies
are discussed in Item 7 of our annual report on Form 10-K for the fiscal year ended January 6, 2002.

With
respect to rental inventory, a major component of our cost structure is based upon the method by which we amortize our rental inventory. This method (described in note 1 to
our consolidated financial statements as filed in our annual report on Form 10-K for the fiscal year ended January 6, 2002) is dependent upon the net realizable value of our
inventory and the demand patterns of the rental products we provide. The two largest chains in our industry tend to operate in more urban areas with higher levels of DVD penetration. As a result of
the transition of consumer preferences from renting videocassettes to DVDs, these two companies have changed their estimates used to amortize rental inventory by reducing the residual values of the
videocassette product and by accelerating the write-off period, resulting in significant non-cash charges to the reported earnings of these chains. We periodically evaluate the
necessity of accelerating our amortization method based on consumer demand for our products. With the steady growth of DVD as a percentage of our rental revenue, which is expected to reach nearly 50%
by the end of the fiscal year, we recently began analyzing whether to adjust our merchandise mix between DVD and videocassette catalog inventory. We plan to complete our evaluation of our merchandise
mix during the fourth quarter of this year. If such a change to our
merchandise mix were to be made, we would likely need to change our amortization method for rental inventory. Such a change would result in significant non-cash charges to our earnings.

Forward Looking Statements

To take advantage of the "safe harbor" provisions of the Private Securities Litigation Reform Act of 1995, you are hereby cautioned that this report contains
forward-looking statements that are based upon current expectations and involve a number of risks and uncertainties. These risks and uncertainties include, but are not limited to, the risk factors
that are discussed from time to time in our SEC reports, including, but not limited to, the report on Form 10-K for the fiscal year ended January 6, 2002, and the Prospectus
filed pursuant to rule 424(b)(1), filed with the SEC on May 17, 2002. We undertake no obligation to update any forward-looking statements, whether as a result of new information, future
events, or otherwise.

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Item 3. Quantitative and Qualitative Disclosures About Market Risks

In May 2002, we repaid all outstanding debt and terminated our interest rate swap agreement. There have been no other material changes in our inherent
market risks since the disclosures made as of January 6, 2002 in our annual report on Form 10-K.

Item 4. Controls and Procedures

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

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Part IIOther Information

Item 6. Exhibits and Reports on Form 8-K

a) Exhibits



b)
Reports on Form 8-K



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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.(Registrant)                                                    
|----------------------- |  | -----------------------------------------------------------------------------------
|Date: November 20, 2002 |  | /s/J. STEVEN ROYJ. Steven Roy, Executive Vice President and Chief Financial Officer

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MOVIE GALLERY, INC.

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

CERTIFICATION

I, J. T. Malugen, certify that:

1.    I
have reviewed this quarterly report on Form 10-Q of Movie Gallery, Inc.;

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

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

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



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



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

Date:
November 20, 2002

|/s/J. T. MALUGENName: J. T. Malugen
Its: Chief Executive Officer |  | 
|---------------------------------------------------------------- |  | 

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CERTIFICATION

I, J. Steven Roy, certify that:

1.    I
have reviewed this quarterly report on Form 10-Q of Movie Gallery, Inc.;

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

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

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



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



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

Date:
November 20, 2002

|/s/J. STEVEN ROYName: J. Steven Roy
Its: Chief Financial Officer |  | 
|---------------------------------------------------------------- |  | 

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