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

FORM 10-Q

(Mark One)

Commission file number 0-24548

Movie Gallery, Inc.
(Exact name of registrant as specified in its charter)

(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.

Movie Gallery, Inc.
Index

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

See accompanying notes.

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

See accompanying notes.

2

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

See accompanying notes.

3

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.

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

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

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

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.

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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):

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.

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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.

        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

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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:

        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-

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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 stoc