VIDEO CITY INC, DEF 14A, 1998-07-24

VIDEO CITY INC
DEF 14A, 1998-07-24
MOTION PICTURE & VIDEO TAPE DISTRIBUTION

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PROXY STATEMENT PURSUANT TO SECTION 14(a) OF THE SECURITIES
EXCHANGE ACT OF 1934 (AMENDMENT NO. )

Filed by the Registrant [X]
Filed by a Party other than the Registrant [_]

Check the appropriate box:

[_] Preliminary Proxy Statement
[X] Definitive Proxy Statement
[_] Definitive Additional Materials
[_] Soliciting Material Pursuant to (S) 240.14a-11(c) or (S) 240.14a-12

VIDEO CITY, INC.
- --------------------------------------------------------------------------------
(Name of Registrant as Specified in its Charter)

- --------------------------------------------------------------------------------
(Name of Person(s) Filing Proxy Statement if other than the Registrant)

Payment of Filing Fee (Check the appropriate box):

[X] No fee required.
[_] $125 per Exchange Act Rules 0-11(c)(l)(ii), 14a-6(i)(l), or 14a-6(j)(2) or
Item 22(a)(2) of Schedule 14A.
[_] Fee computed on table below per Exchange Act Rules 14a-6(i)(4) and 0-11.

1) Title of each class of securities to which transaction applies:

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2) Aggregate number of securities to which transaction applies:

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3) Per unit price or other underlying value of transaction computed
pursuant to Exchange Act Rule 0-11:
(Set forth the amount on which the filing fee is calculated and state
how it was determined.)

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4) Proposed maximum aggregate value of transaction:

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5) Total fee paid:

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[_] Fee paid previously by written preliminary materials.
[_] Check box if any part of the fee is offset as provided by Exchange Act Rule
0-11(a)(2) and identify the filing for which the offsetting fee was paid
previously. Identify the previous filing by registration statement number,
or the Form or Schedule and the date of its filing.

1) Amount Previously Paid:_______________________________________________

2) Form, Schedule or Registration Statement No.:_________________________

3) Filing Party:_________________________________________________________

4) Date Filed:___________________________________________________________
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VIDEO CITY, INC.
6840 DISTRICT BOULEVARD
BAKERSFIELD, CALIFORNIA 93313

NOTICE OF ANNUAL MEETING OF STOCKHOLDERS

TO BE HELD ON WEDNESDAY, AUGUST 19, 1998

NOTICE IS HEREBY GIVEN that the Annual Meeting of Stockholders of Video
City, Inc. (the "Company") will be held at the Los Angeles Airport Hilton &
Towers, Los Angeles Ballroom, located at 5711 West Century Boulevard, Los
Angeles, California, on Wednesday, August 19, 1998 at 10:00 A.M., Pacific
Daylight Time, for the following purposes, as more fully described in the
attached Proxy Statement:

(1) To elect nine directors of the Company to serve until the next
annual meeting of stockholders or until their successors are duly elected
and qualified;

(2) To ratify the adoption of the Company's 1998 Stock Option Plan;
and

(3) To transact such other business as may properly be brought before
the Annual Meeting or any and all adjournments thereof.

The Board of Directors has fixed the close of business on July 1, 1998 as
the record date for the determination of stockholders entitled to notice of and
to vote at the Annual Meeting. Only stockholders at the close of business on
the record date are entitled to vote at the Annual Meeting.

Accompanying this Notice are a Proxy and Proxy Statement. IF YOU WILL NOT
BE ABLE TO ATTEND THE ANNUAL MEETING TO VOTE IN PERSON, PLEASE COMPLETE, SIGN
AND DATE THE ACCOMPANYING PROXY AND RETURN IT PROMPTLY IN THE ENCLOSED POSTAGE
PAID ENVELOPE. The Proxy may be revoked at any time prior to its exercise at
the Annual Meeting. The Proxy and Proxy Statement are first being mailed to
stockholders on or about July 23, 1998.

By Order of the Board of Directors,

/s/ Robert Y. Lee

Robert Y. Lee
Chairman of the Board

Bakersfield, California
July 23, 1998
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VIDEO CITY, INC.
6840 DISTRICT BOULEVARD
BAKERSFIELD, CALIFORNIA 93313

ANNUAL MEETING OF STOCKHOLDERS
AUGUST 19, 1998

PROXY STATEMENT

INTRODUCTION

This Proxy Statement (the "Proxy Statement") is furnished to the
stockholders of Video City, Inc., a Delaware corporation (the "Company"), in
connection with the solicitation of proxies by and on behalf of the Board of
Directors of the Company. The proxies solicited hereby are to be voted at the
Annual Meeting of Stockholders of the Company to be held on Wednesday, August
19, 1998, and at any and all adjournments thereof (the "Annual Meeting").

PURPOSE OF ANNUAL MEETING

At the Annual Meeting, stockholders will be asked: (i) to elect nine
directors of the Company to serve until the next annual meeting of stockholders
or until their successors are duly elected and qualified; (ii) to ratify the
adoption of the 1998 Stock Option Plan; and (iii) to transact such other
business as may properly be brought before the Annual Meeting or any and all
adjournments thereof. The Board recommends a vote in favor of (i.e., "FOR") (a)
the election of the nine nominees for directors of the Company listed below and
(b) the ratification of the adoption of the 1998 Stock Option Plan.

QUORUM AND VOTING RIGHTS

The presence, in person or by proxy, of the holders of a majority of the
outstanding shares of Common Stock is necessary to constitute a quorum at the
Annual Meeting. Only stockholders of record at the close of business on July 1,
1998 (the "Record Date") will be entitled to notice of, and to vote at, the
Annual Meeting. As of the Record Date, there were 11,725,719 shares of Common
Stock outstanding and entitled to vote. Holders of Common Stock as of the
Record Date are entitled to one vote for each share held.

All shares of Common Stock represented by properly executed proxies will,
unless the proxies have previously been revoked, be voted in accordance with the
instructions indicated in the proxies. If no instructions are indicated, the
shares will be voted in favor of (i.e., "FOR") (i) the election of the nine
nominees for directors of the Company listed under Proposal 1; and (ii) the
ratification of the adoption of the 1998 Stock Option Plan. With respect to any
other item of business that may come before the Annual Meeting, the proxy
holders will vote the proxy in accordance with their best judgment.

In the election of directors, the nine candidates receiving the highest
number of votes will be elected as directors. The other matters submitted for
stockholder approval at the Annual Meeting will be decided by the affirmative
vote of the majority of the shares represented in person or by proxy and
entitled to vote on each such matter. Abstentions with respect to any matter
are treated as shares present or represented and entitled to vote on that matter
and thus have the same effect as negative votes. If a broker which is the
record holder of certain shares indicates on a proxy that it does not have
discretionary authority to vote on a particular matter as to such shares, or if
shares are not voted in other circumstances in which proxy authority is
defective or has been withheld with respect to a particular matter, these non-
voted shares will be counted for quorum purposes but are not deemed to be
present or represented for purposes of determining whether

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stockholder approval of that matter has been obtained. Any stockholder
executing a proxy has the power to revoke the proxy at any time prior to its
exercise. A proxy may be revoked prior to exercise by (a) filing with the
Company a written revocation of the proxy; (b) appearing at the Annual Meeting
and casting a vote contrary to that indicated on the proxy; or (c) submitting a
duly executed proxy bearing a later date.

Stockholders may cumulate their votes with respect to the election of
directors if one or more stockholder gives notice at the Annual Meeting, prior
to voting, of an intention to cumulate votes for a nominated director. A
stockholder may cumulate votes by casting for the election of one nominee a
number of votes equal to the number of directors to be elected multiplied by the
number of votes to which his shares are entitled or by distributing his votes on
the same principle among as many candidates as he sees fit. If a proxy is
marked "FOR" the election of directors, it may, at the discretion of the proxy
holders, be voted cumulatively in the election of directors.

The cost of preparing, printing, assembling and mailing this Proxy
Statement and other material furnished to stockholders in connection with the
solicitation of proxies will be borne by the Company. In addition to the
solicitation of proxies by use of the mails, officers, directors and regular
employees of the Company may solicit proxies by written communications, by
telephone, telegraph or personal call. These persons are to receive no special
compensation for any solicitation activities. The Company will reimburse banks,
brokers and other persons holding Common Stock in their names, or those of their
nominees, for their expenses in forwarding proxy solicitation materials to
beneficial owners of Common Stock.

This Proxy Statement and the accompanying form of proxy are first being
mailed to stockholders on or about July 23, 1998.

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PROPOSAL 1 -
ELECTION OF DIRECTORS

NOMINEES

At the Annual Meeting, nine directors, who will constitute the entire Board
of Directors, are to be elected to serve until the next Annual Meeting of
Stockholders and until their successors shall be elected and shall qualify. All
nominees have consented to being named herein and have agreed to serve if
elected. The nominees are as follows:

Robert Y. Lee
Barry L. Collier
David A. Ballstadt
James Craig Kelly
John T. Sheehy
Stephen C. Lehman
Gerald W. B. Weber
Charles E. Cooke
Michael T. Anderson

Management proxies will be voted FOR the election of all of the above named
nominees unless the stockholder indicates that the proxy shall not be voted for
all or any one of the nominees. If cumulative voting is utilized, the proxy
holders intend to distribute the votes represented by each proxy, unless such
authority is withheld, among the nine nominees named, in such proportion as they
see fit. Nominees receiving the highest number of affirmative votes cast, up to
the number of directors to be elected, will be elected as directors.
Abstentions, broker non-votes, and instructions on the accompanying proxy card
to withhold authority to vote for one or more of the nominees will result in the
respective nominees receiving fewer votes. If for any reason any nominee
should, prior to the Annual Meeting, become unavailable for election as a
Director, an event not now anticipated, the proxies will be voted for such
substitute nominee, if any, as may be recommended by management. In no event,
however, shall the proxies be voted for a greater number of persons than the
number of nominees named.

THE BOARD OF DIRECTORS RECOMMENDS A VOTE "FOR" THE ELECTION OF
THE NINE PERSONS NOMINATED FOR DIRECTOR HEREIN.

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MANAGEMENT OF THE COMPANY

The following sets forth certain information with respect to the directors
and executive officers of the Company:

<TABLE>
<CAPTION>
DIRECTOR
NAME AGE POSITIONS WITH THE COMPANY SINCE
---- --- -------------------------- --------
<S> <C> <C> <C>
Robert Y. Lee 35 Chairman of the Board and 1997(1)
Chief Executive Officer
Barry L. Collier 55 President and Director 1997(2)
David A. Ballstadt 58 Senior Vice President and Director 1998
James Craig Kelly 40 Senior Vice President, Chief 1997
Operating Officer, Secretary and Director
John T. Sheehy 55 Director 1997
Stephen C. Lehman 47 Director 1997
Gerald W. B. Weber 47 Director 1997
Charles E. Cooke 36 Director 1997
Michael T. Anderson 35 Director 1997
Timothy J. Denari 39 Chief Financial Officer --
</TABLE>
_______________

(1) Mr. Lee has served as a director of the Company's predecessor, Lee Video
City, Inc., since 1990. Lee Video City, Inc. merged with and into Prism
Entertainment Corporation in January 1997 and the surviving corporation
changed its name to Video City, Inc.
(2) Mr. Collier has served as a director of the Company's predecessor, Prism
Entertainment Corporation, since 1984. Lee Video City, Inc. merged with
and into Prism Entertainment Corporation in January 1997 and the surviving
corporation changed its name to Video City, Inc.

ROBERT Y. LEE has served as the Company's Chairman of the Board and Chief
Executive Officer since the merger of Lee Video City, Inc. ("Lee Video City")
with and into Prism Entertainment Corporation ("Prism") in January 1997. Mr.
Lee founded Lee Video City and served as its Chairman of the Board and Chief
Executive Officer since its inception in February 1990. Mr. Lee purchased his
first video store in 1983, and during the 1980s opened and acquired more than 20
video stores in Southern California.

BARRY L. COLLIER has served as the President and as a director of the
Company since the merger of Lee Video City, Inc. with and into Prism
Entertainment Corporation (the "Merger") in January 1997. Mr. Collier served as
the President, Chief Operating Officer and as a director of Prism since its
inception in 1984 until the Merger. He served as the Secretary of Prism from
1984 to 1985 and was appointed as the Chief Executive Officer of Prism from 1985
until the Merger. Mr. Collier served as the Chairman of the Board of Prism from
1990 until 1994. Prism filed a voluntary petition under Chapter 11 of the
Bankruptcy Code in December 1995 and emerged from Chapter 11 upon the
consummation of the Merger.

DAVID A. BALLSTADT has served as the Senior Vice President and as a
director of the Company since the acquisition by the Company of its
subsidiaries, Adventures in Video, Inc. and KDDJ Investments, Inc., in March
1998. Mr. Ballstadt founded and served as the President and Chief Executive
Officer of Adventures in Video, Inc. and KDDJ Investments, Inc. until their sale
to the Company.

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JAMES CRAIG KELLY has served as the Chief Operating Officer and Senior Vice
President and as a director of the Company since the Merger in January 1997, and
as its Secretary from January 1997 to April 16, 1997 and from November 20, 1997
to date. Mr. Kelly served as the Chief Operating Officer of Lee Video City from
1992 until the Merger. For fifteen years, Mr. Kelly held various positions with
Wherehouse Entertainment, a $500 million revenue retailer of music and video
products, including Director of Loss Prevention from 1982 to 1984, and Vice
President and Regional Manager from 1984 to 1991.

JOHN T. SHEEHY has served as a director of the Company since November 1997.
Mr. Sheehy has been the Managing Director of The Value Group, LLC, an investment
banking firm, since April 1996. Mr. Sheehy currently serves as a director of
The First Australia Fund, Inc., The First Australia Prime Income Fund, Inc., The
First Commonwealth Fund, Inc. and The First Australia Prime Income Investment
Company Limited, all of which are publicly-held companies.

STEPHEN C. LEHMAN has served as a director of the Company since the Merger
in January 1997. Mr. Lehman served as the President, Chief Executive Officer
and Chairman of the Board of Premiere Radio Networks, Inc., a producer of radio
programming, since its inception in January 1987. Prior to this, he was the
President of Stephen Lehman Productions, a syndicated radio program company
while also serving as on-air personality at KIIS AM and FM/Los Angeles. From
1982 to 1984, Mr. Lehman specialized in building radio networks for independent
radio syndication.

GERALD W. B. WEBER has served as a director of the Company since the Merger
in January 1997. Mr. Weber was the Senior Vice President of Retail Operations
of AutoNation USA, where he was responsible for all AutoNation USA retail
operations, including sales, training, planning, hiring and loss prevention.
Prior to joining AutoNation USA, Mr. Weber held various management positions
with Blockbuster Entertainment, including Zone Vice President of the East and
Southeast Regions, Vice President of Operations, and Senior Vice President of
Domestic Retail for the video retail division and President of Blockbuster
Music.

CHARLES E. COOKE has served as a director of the Company since the Merger
in January 1997. Mr. Cooke is a principal of Cooke & Grace Properties which
owns, manages, sells and leases commercial real property. From 1985 to 1994, Mr.
Cooke was affiliated with Dobson & Johnson, Inc. as a commercial real estate
broker. Mr. Cooke currently serves as a director of Nashville Bank of Commerce,
a publicly-held company.

MICHAEL T. ANDERSON has served as a director of the Company since the
Merger in January 1997. Mr. Anderson is a principal in the law firm of Troop
Meisinger Steuber & Pasich, LLP, in Los Angeles, California, where he
specializes in commercial litigation. Prior to joining this firm, Mr. Anderson
was associated with the law firm of DeCastro, West, Chodorow & Burns, and was
also an associate at the Boston Consulting Group, a management consulting firm.

TIMOTHY J. DENARI has served as the Chief Financial Officer of the Company
since October 1997. Prior to joining the Company, he was the corporate
controller for Fleet Card Fuels, a $100 million fuel sales corporation. Between
1993 and 1995, he was the Chief Financial Officer and Controller of the
Company's predecessor, Lee Video City. Between 1990 and 1993, Mr. Denari was an
Account Executive for Merrill Lynch and Shearson Lehman, managing over $30
million in private client assets. Between 1985 and 1990, he was Vice President
of the Bank of Stockdale. In November 1997, Mr. Denari filed a voluntary
petition under Chapter 7 of the Bankruptcy Code as a result of his personal
guarantee of certain indebtedness and contingent liabilities of a corporation
that operated two video stores.

The Company, Robert Y. Lee, Barry L. Collier and Ingram Entertainment Inc.
("Ingram") have entered into a Stockholders Agreement, dated as of January 8,
1997 (the "Stockholders Agreement"), which provides that the Company's Board of
Directors shall consist of eight members and that Ingram, Mr. Lee and Mr.
Collier shall collectively vote their shares in favor of two designees of
Ingram, four designees of Mr. Lee and

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two designees of Mr. Collier. Of the present Board of Directors, Charles E.
Cooke and Michael T. Anderson are the designees of Ingram; Mr. Lee, James Craig
Kelly, John T. Sheehy and Stephen C. Lehman are the designees of Mr.Lee; and
Barry L. Collier and Gerald W. B. Weber are the designees of Mr. Collier.
Effective March 25, 1998, the Board was increased to nine members and David A.
Ballstadt was elected to fill that vacancy. The same parties also entered into
an Override Agreement, dated November 19, 1996 (the "Override Agreement"), which
provides, subject to certain exceptions, that without the written consent of
Ingram, the Company shall not enter into a merger or a sale or transfer of all
or substantially all of its assets, or make any material change in the nature of
its business as now conducted, or change the form of organization of its
business; and that without unanimous approval of the Board of Directors, the
Company shall not enter into any line of business other than the sale and rental
of video product and related goods, the completion of one film that the
Company's predecessor, Prism Entertainment Corporation, had under way, and the
exploitation of Prism's film library; these provisions will remain in force
until the later of the payment in full of the Company's $1,500,000 debt to
Ingram (which was paid in full on March 25, 1998), or such time as Ingram's
beneficial ownership interest in the Company's common stock, on a fully diluted
basis, is 4 percent or less.

The Agreements of Merger and Plan of Reorganization entered into by the
Company in connection with the acquisition by the Company of Adventures in
Video, Inc. and KDDJ Investments, Inc. from David A. Ballstadt and members of
his immediate family provide that Mr. Ballstadt shall be elected as a director
of the Company, effective upon the closing of such acquisitions. Concurrent
with the completion of the acquisitions on March 25, 1998, the Board of
Directors of the Company was expanded from eight to nine members and Mr.
Ballstadt was elected to fill this vacancy. Mr. Ballstadt has served as a
director of the Company since the consummation of the acquisitions.

Directors serve until the next annual meeting of the Company's stockholders
or until their successors are elected or appointed. Officers are elected by and
serve at the discretion of the Board of Directors. See "Compensation of
Directors and Executive Officers--Employment Agreements." There are no family
relationships among the officers or directors of the Company.

MEETINGS; ATTENDANCE; COMMITTEES

During the fiscal year ended January 31, 1998, the Board of Directors of
the Company met twice and the audit committee met once. No incumbent member who
was a director during the past fiscal year attended fewer than 75% of the
aggregate of all meetings of the Board of Directors and all meetings of the
committees of the Board of Directors on which he served.

SECTION 16(A) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE

Section 16(a) of the Securities Exchange Act of 1934 (the "Exchange Act")
requires the Company's directors and executive officers, and persons who own
more than 10 percent of a registered class of the Company's equity securities,
to file reports of ownership and changes in ownership with the Securities and
Exchange Commission (the "Commission"). Directors, executive officers and
greater than 10 percent stockholders are required by the Commission's
regulations to furnish the Company with copies of all Section 16(a) forms they
file. Based solely on a review of the copies of the forms furnished to the
Company and the

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representations made by the reporting persons to the Company, the Company
believes that during the fiscal year ended January 31, 1998, its directors,
executive officers and 10 percent stockholders complied with all filing
requirements under Section 16(a) of the Exchange Act, with the exception of the
following: Timothy J. Denari filed a late Form 3 upon being appointed as an
executive officer of the Company; and John T. Sheehy filed a late Form 3 upon
being appointed as a director of the Company.

COMPENSATION OF DIRECTORS AND EXECUTIVE OFFICERS

EXECUTIVE COMPENSATION

The following table sets forth the compensation for the fiscal years ended
January 31, 1998, December 31, 1996 and December 31, 1995 paid by the Company to
its Chief Executive Officer and the other executive officers of the Company who
earned in excess of $100,000 (collectively, the "Named Executive Officers")
based on salary and bonus for the fiscal year ended January 31, 1998:

NAME AND LONG-TERM
PRINCIPAL POSITION ANNUAL COMPENSATION(1) COMPENSATION
------------------ ---------------------------------------- ------------
Securities
Period Underlying
Ended(2) Salary($) Bonus Options (#)
---------------- --------- ----- -----------
<S> <C> <C> <C> <C>

Robert Y. Lee (3) January 31, 1998 $178,000 $ -- --
Chief Executive Officer December 31, 1996 172,701 -- --
December 31, 1995 203,958 -- --

Barry L. Collier(4) January 31, 1998 178,000 -- --
President December 31, 1996 291,168 -- 175,000
December 31, 1995 436,645 -- --

James Craig Kelly(5) January 31, 1998 120,000 -- --
Chief Operating Officer December 31, 1996 101,282 -- 761,600
December 31, 1995 100,000 -- --
</TABLE>
___________

(1) The compensation described in this table does not include medical
insurance, retirement benefits and other benefits received by the foregoing
executive officers which are available generally to all employees of the
Company and certain perquisites and other personal benefits received by the
foregoing executive officers of the Company, the value of which did not
exceed the lesser of $50,000 or 10% of the executive officer's cash
compensation in the table.
(2) Upon the consummation of the merger of Lee Video City, Inc. with and into
Prism Entertainment Corporation on January 8, 1997, the Company changed its
fiscal year end from December 31 to January 31.
(3) Mr. Lee served as the Chief Executive Officer of the Company's predecessor,
Lee Video City, before the Merger. Mr. Lee's compensation during the
fiscal years ended December 31, 1996 and December 31, 1995 reflect
compensation paid to Mr. Lee by Lee Video City.
(4) Mr. Collier served as the Chief Executive Officer of the Company's
predecessor, Prism, before the Merger. Mr. Collier's compensation during
the fiscal years ended December 31, 1996 and December 31, 1995 reflect
compensation paid to Mr. Collier by Prism.

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(5) Mr. Kelly served as the Chief Operating Officer of the Company's
predecessor, Lee Video City, before the Merger. Mr. Kelly's compensation
during the fiscal years ended December 31, 1996 and December 31, 1995
reflect compensation paid to Mr. Kelly by Lee Video City.

OPTION GRANTS

The Company did not grant any stock options to the Named Executive Officers
during the fiscal year ended January 31, 1998.

OPTION EXERCISES AND FISCAL YEAR-END OPTION VALUES

No stock options were exercised by any of the Named Executive Officers
during the fiscal year ended January 31, 1998. The following table sets forth
certain information regarding stock options held by the Named Executive Officers
as of January 31, 1998:

FISCAL YEAR-END OPTIONS
<TABLE>
<CAPTION>

NUMBER OF SECURITIES
UNDERLYING UNEXERCISED VALUE OF UNEXERCISED
OPTIONS AT FISCAL IN-THE-MONEY OPTIONS AT
NAME YEAR-END (#) FISCAL YEAR END ($)(1)
- -------------------- --------------------------- ---------------------------
EXERCISABLE UNEXERCISABLE EXERCISABLE UNEXERCISABLE
----------- ------------- ----------- -------------
<S> <C> <C> <C> <C>
Robert Y. Lee....... 0 0 0 0
Barry L. Collier.... 175,000 0 $113,750 0
James Craig Kelly... 761,600 0 $182,784 0
</TABLE>
___________________
(1) Amounts are shown as the positive spread between the exercise price and an
estimated fair market price of $0.75 per share as of January 31, 1998. The
Company's Common Stock was not traded on an established public trading
market during the fiscal year ended January 31, 1998.

DIRECTOR COMPENSATION

Directors, other than directors who are employees of the Company, receive
cash compensation in the amount of $5,000 per year for serving on the Board of
Directors and are also entitled to participate in the Company's stock option
plans and from time to time to receive grants of options thereunder to purchase
shares of the Company's Common Stock. During the fiscal year ended January 31,
1998, Stephen C. Lehman, Gerald W. B. Weber, Charles E. Cooke and Michael T.
Anderson each received options to purchase 5,000 shares of the Company's Common
Stock at $2.00 per share pursuant to the Company's 1996 Stock Option Plan. In
February and June 1998, Messrs. Lehman, Weber, Cooke, Anderson and Sheehy each
received options to purchase 5,000 and 15,000 shares, respectively, of the
Company's Common Stock at $2.00 per share. Messrs. Lehman and Weber received
additional compensation as consultants pursuant to consulting agreements entered
into with the Company. See "Certain Relationships and Related Transactions."

EMPLOYMENT AGREEMENTS

The Company entered into an employment agreement (the "Lee Employment
Agreement") with Robert Y. Lee pursuant to which Mr. Lee serves as the Chairman
of the Board and Chief Executive Officer of the Company for a term of three
years commencing January 1997. The Lee Employment Agreement provides for a base
salary of $178,000 per year and an annual bonus of 3 percent of any pre-tax
profit in excess of $1,100,000 with respect to the fiscal year commencing
February 1997; 3 percent of any pre-tax profit in excess of $1,200,000 with
respect to the fiscal year commencing February 1998; and 3 percent of any pre-
tax profit in excess of $1,300,000 with respect to the fiscal year commencing
February 1999. The Lee Employment Agreement also provides that Mr. Lee shall be
entitled to certain fringe benefits including payments of up to $500 per month
for the use of an automobile.

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The Company entered into an employment agreement (the "Collier Employment
Agreement") with Barry L. Collier pursuant to which Mr. Collier serves as the
President of the Company for a term of two years commencing January 1997. The
Collier Employment Agreement and a related noncompetition agreement provide for
compensation of $178,000 per year and provide that Mr. Collier shall be entitled
to certain fringe benefits including payments of up to $500 per month for the
use of an automobile.

The Company entered into an employment agreement (the "Kelly Employment
Agreement") with James Craig Kelly pursuant to which Mr. Kelly serves as the
Senior Vice President and Chief Operating Officer of the Company for a term of
three years commencing January 1997. The Kelly Employment Agreement provides
for a base salary of $120,000 per year and an annual bonus of 3 percent of any
pre-tax profit in excess of $1,100,000 with respect to the fiscal year
commencing February 1997; 3 percent of any pre-tax profit in excess of
$1,200,000 with respect to the fiscal year commencing February 1998; and 3
percent of any pre-tax profit in excess of $1,300,000 with respect to the fiscal
year commencing February 1999. The Kelly Employment Agreement also provides
that Mr. Kelly shall be entitled to certain fringe benefits including payments
of up to $500 per month for the use of an automobile.

In the event that the employment of Messrs. Lee, Collier or Kelly is
terminated for any reason other than "material breach" or "cause" as defined in
his employment agreement, the Company shall pay the remainder of the base salary
to such individual for the remaining term of such employment agreement.

STOCK OPTION PLANS

1996 Stock Option Plan. In November 1996, the Board of Directors and
shareholders of the Company's predecessor, Lee Video City, Inc., adopted its
1996 Stock Option Plan. The 1996 Stock Option Plan, which was assumed by the
Company, provides for the grant of options to directors, officers, other
employees and consultants of the Company to purchase up to an aggregate of
1,000,000 shares of Common Stock. The purpose of the 1996 Stock Option Plan is
to provide participants with incentives which will encourage them to acquire a
proprietary interest in, and continue to provide services to, the Company. The
1996 Stock Option Plan is administered by the Board of Directors, or a committee
of the Board, which has discretion to select optionees and to establish the
terms and conditions of each option, subject to the provisions of the 1996 Stock
Option Plan. Options granted under the 1996 Stock Option Plan may be "incentive
stock options" as defined in Section 422 of the Internal Revenue Code of 1986,
as amended (the "Code"), or nonqualified options.

The exercise price of incentive stock options may not be less than the fair
market value of Common Stock as of the date of grant (110% of the fair market
value if the grant is to an employee who owns more than 10 percent of the total
combined voting power of all classes of capital stock of the Company). The Code
currently limits to $100,000 the aggregate value of Common Stock that may become
exercisable in any one year pursuant to incentive stock options under the 1996
Stock Option Plan or any other option plan adopted by the Company. Nonqualified
options may be granted under the 1996 Stock Option Plan at an exercise price of
not less than 85% of the fair market value of the Common Stock on the date of
grant. Nonqualified options may be granted without regard to any restriction on
the amount of Common Stock that may become exercisable pursuant to such options
in any one year. Options may not be exercised more than ten years after the
date of grant (five years after the date of grant if the grant is an incentive
stock option to an employee who owns more than 10 percent of the total combined
voting power of all classes of capital stock of the Company), or such lesser
period of time as is set forth in the applicable stock option agreement.
Options granted under the 1996 Stock Option Plan generally are nontransferable
except by will or by the laws of descent and distribution. Shares subject to
options that expire unexercised under the 1996 Stock Option Plan are available
for future grant under the 1996 Stock Option Plan. The number of options
outstanding and the exercise price thereof are subject to adjustment in the case
of certain transactions such as recapitalizations, stock splits or stock
dividends. The 1996 Stock Option Plan is effective for ten years, unless sooner
terminated or suspended.

9
<PAGE>

In general, upon termination of employment of an optionee, all options
granted to such person which were not exercisable on the date of such
termination will immediately terminate, and any options that are exercisable
will terminate not less than three months (six months in the case of termination
by reason of death or disability) following termination of employment, or such
other period of not less than 30 days after the date of termination as is
specified in the applicable stock option agreement.

As of July 1, 1998, no shares remained available for grant under the 1996
Stock Option Plan. All of the stock options granted under the 1996 Stock Option
Plan were granted at an exercise price of $2.00 per share.

1998 Stock Option Plan. For a description of the Company's 1998 Stock
Option Plan, see "Proposal 2 - Proposal to Ratify the Approval of the Company's
1998 Stock Option Plan."

COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION

The Company's compensation committee was formed to determine and make
recommendations to the Board concerning salaries and incentive compensation for
officers and employees of the Company, including the grant of stock options to
the Company's executive officers under the Company's stock option plans. The
compensation committee consisted of Stephen C. Lehman and Charles E. Cooke
during the fiscal year ended January 31, 1998. Mr. Lehman provided finance,
acquisitions and corporate development consulting services to the Company
pursuant to a consulting agreement entered into between the Company and Mr.
Lehman. The consulting agreement, as amended, provides for compensation in the
form of options to purchase 90,000 shares of the Company's Common Stock at $2.00
per share and warrants to purchase 100,000 shares of the Company's Common Stock
at $2.00 per share. See "Certain Relationships and Related Transactions."

REPORT OF THE COMPENSATION COMMITTEE
OF THE BOARD OF DIRECTORS ON EXECUTIVE COMPENSATION

The Compensation Committee of the Board of Directors determines and makes
recommendations to the Board concerning salaries and incentive compensation for
the executive officers of the Company. The compensation committee consisted of
Stephen C. Lehman and Charles E. Cooke during the fiscal year ended January 31,
1998. In June 1998, Michael T. Anderson replaced Mr. Lehman as a member of the
Compensation Committee.

The Company's current compensation program for its executive officers
consists of two elements: (i) cash compensation consisting of an annual base
salary and possible bonuses based on the financial performance of the Company,
and (2) long-term compensation consisting of stock options to purchase shares of
the Company's Common Stock. Except as otherwise fixed by the agreements with
Messrs. Lee, Collier and Kelly described above under "Compensation of Directors
and Executive Officers -- Employment Agreements," the amount of annual base
salary is established by the Compensation Committee for each executive officer
based on the officer's job description and a general assessment of his
performance and experience. The amount of cash bonus, if any, is awarded based
on the Company achieving targeted pre-tax profits for each fiscal year. The
long-term component of the compensation program consists of the grant of stock
options, which the Compensation Committee believes provides the executive
officer with the incentive to implement the Company's annual objectives and
strategy and aligns his interest with that of the stockholders of the Company.
The Compensation Committee intends to regularly review publicly available
information regarding compensation programs and philosophies of the Company's
competitors and other entities of a comparable size with the Company, with the
objective of ensuring that the Company's compensation philosophy and programs
remain competitive and appropriate.

10
<PAGE>

During the fiscal year ended January 31, 1998, the Company paid Robert Y.
Lee, the Company's Chief Executive Officer, and the other executive officers,
annual cash salaries established under their respective employment agreements.
See "Compensation of Directors and Executive Officers--Employment Agreements."
Mr. Lee's employment agreement provides for a base salary of $178,000 per year
and an annual bonus of 3 percent of any pre-tax profit in excess of $1,100,000
with respect to the fiscal year commencing February 1997; 3 percent of any pre-
tax profit in excess of $1,200,000 with respect to the fiscal year commencing
February 1998; and 3 percent of any pre-tax profit in excess of $1,300,000 with
respect to the fiscal year commencing February 1999. No cash bonuses were paid
and no stock options were granted to the executive officers of the Company
during the fiscal year ended January 31, 1998.

Current Compensation Committee:
Charles E. Cooke and Michael T. Anderson

SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

The following table sets forth certain information regarding the beneficial
ownership of the Company's Common Stock as of July 1, 1998, by (i) each person
who is known by the Company to own beneficially more than 5% of the Company's
outstanding Common Stock, (ii) each of the directors of the Company, (iii) each
of the Named Executive Officers, and (iv) all officers and directors of the
Company as a group.
<TABLE>
<CAPTION>

Number of Shares Percentage of
Name and Address(1) Beneficially Owned(2) Outstanding
------------------ ----------------------- --------------
<S> <C> <C>
Robert Y. Lee............................... 3,319,024(3) 28.3%

Barry L. Collier............................ 960,434(4) 8.1%

David A. Ballstadt.......................... 335,500 2.9%

James Craig Kelly........................... 761,600(4) 6.1%

John T. Sheehy.............................. 42,031(4) *

Stephen C. Lehman........................... 435,000(4)(5) 3.6%

Gerald W. B. Weber.......................... 275,000(4)(6) 2.3%

Charles E. Cooke............................ 30,000(4) *

Michael T. Anderson......................... 50,000(4)(7) *

Ingram Entertainment Inc.(8)................ 2,757,153(8) 21.9%

Mortco, Inc.(9)............................. 1,329,666(9) 11.1%

All Directors and Executive Officers as a
group (10 persons)......................... 5,598,589(10) 41.6%
</TABLE>

_____________
* Less than one percent.
(1) Except as otherwise indicated, the address of each principal stockholder of
the Company is c/o Video City, Inc. at 6840 District Boulevard,
Bakersfield, California 93313.
(2) Beneficial ownership is determined in accordance with the rules of the
Securities and Exchange Commission and generally includes voting or
investment power with respect to the securities. Shares of Common Stock
subject to options or warrants that are currently exercisable or are
exercisable within

11
<PAGE>

60 days of July 1, 1998, are deemed outstanding for computing the
percentage of the person holding such options or warrants but are not
deemed outstanding for computing the percentage of any other person. Except
as indicated by footnote and subject to community property laws where
applicable, the persons named in the table have sole voting and investment
power with respect to all shares of Common Stock shown as beneficially
owned by them.
(3) Includes a proxy to vote 610,000 shares owned by Mr. Collier.
(4) Includes the following currently exercisable stock options to purchase
shares from the Company: Mr. Collier, 175,000 shares; Mr. Kelly, 761,600
shares; Mr. Sheehy, 20,000 shares; Mr. Lehman, 85,000 shares; Mr. Weber,
75,000 shares; Mr. Cooke, 25,000 shares; and Mr. Anderson, 25,000 shares.
(5) Includes 125,000 shares of Common Stock issuable upon conversion of
currently outstanding shares of the Company's Series A Convertible
Redeemable Preferred Stock ("Series A Preferred Stock") and 225,000 shares
of Common Stock issuable upon exercise of warrants.
(6) Includes 100,000 shares of Common Stock issuable upon conversion of
currently outstanding shares of Series A Preferred Stock and 100,000 shares
of Common Stock issuable upon exercise of warrants.
(7) Includes 12,500 shares of Common Stock issuable upon conversion of
currently outstanding shares of Series A Preferred Stock and 12,500 shares
of Common Stock issuable upon exercise of warrants.
(8) Consists of 1,500,000 shares owned outright; a warrant to purchase 404,403
shares from Robert Y. Lee; and a warrant to purchase 852,750 shares from
the Company. Ingram Entertainment Inc.'s address is Two Ingram Boulevard,
La Vergne, Tennessee 37089.
(9) Consists of 1,133,106 shares owned outright; and warrants to purchase
196,560 shares from the Company. Mortco, Inc.'s address is One Airport
Center, 7700 N.E. Ambassador Place, Portland, Oregon 97220. Mortco, Inc.
is a wholly-owned subsidiary of Rentrak Corporation.
(10) Includes shares of Common Stock issuable upon conversion of currently
outstanding shares of Series A Preferred Stock and upon exercise of
currently outstanding options and warrants. See Notes (4), (5), (6) and
(7).

The Company does not know of any arrangements that may at a subsequent date
result in a change of control of the Company.

CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

Ingram Entertainment Inc. has been the principal supplier of videocassettes
and related equipment to the Company for a number of years, and has been a
secured creditor of the Company since August 1991. As of December 31, 1995, the
Company owed Ingram $7.3 million. This amount was paid down to $4.5 million in
June 1996 with proceeds derived from the Company's sale of eleven stores. On
January 8, 1997, concurrent with the merger of Lee Video City, Inc. into Prism
Entertainment Corporation, Ingram accepted 1,500,000 shares of common stock of
the Company in cancellation of $3,000,000 of the Company's indebtedness to
Ingram, reducing the Company's remaining long-term indebtedness to Ingram to
$1,500,000. At the same time, Ingram also received warrants to purchase 852,750
shares of common stock from the Company and 404,403 shares of common stock from
Robert Y. Lee. In March 1998, the Company used funds in the amount of
$1,500,000 from the credit facility with FINOVA Capital Corporation to pay off
the term loan owing to Ingram.

In addition, the Company entered into a new long-term supply agreement with
Ingram for videocassettes and related products; Ingram released Mr. Lee from his
personal guarantee of the Company's indebtedness; and the parties entered into
the Stockholders Agreement and the Override Agreement, which among other things
prohibit certain corporate actions without the approval of Ingram or Ingram's
designees on the Board of Directors. All of these transactions and arrangements
were entered into either simultaneously with or prior to Ingram's receipt of
stock of the Company.

12
<PAGE>

On March 25, 1998, the Company acquired Adventures in Video, Inc.
("Adventures in Video") and KDDJ Investments, Inc. ("KDDJ") from David A.
Ballstadt and members of his immediate family pursuant to two Agreements of
Merger and Plan of Reorganization (each a "Merger Agreement"). Adventures in
Video owns and operates 13 stores in the greater Minneapolis metropolitan area
and KDDJ owns and operates three stores in San Francisco, California. The
purchase price for Adventures in Video was 440,000 shares of the Company's
Common Stock, plus an additional 426,000 shares that will become issuable if
either (a) the gross revenues of such stores during the three months of April
through June 1998 exceed their gross revenues during the corresponding three
months of 1997, or (b) if the Company fails to make certain specified upgrades
of the stores. The purchase price for KDDJ was 110,000 shares of the Company's
Common Stock plus an additional 106,500 shares that will become issuable if
those three stores meet targets substantially the same as the contingent share
targets described above for Adventures in Video. The two Merger Agreements
provide for an adjustment in the number of the Company's shares if and to the
extent that the aggregate liabilities of the two companies as of the closing is
greater or less than $1,200,000. Pursuant to the Adventures in Video Merger
Agreement, the Company paid off existing indebtedness of approximately $449,000
that Adventures in Video owed to Marquette Bank, N.A. Concurrently with these
two acquisitions, the Board of Directors of the Company was expanded from eight
to nine members and David A. Ballstadt was elected to fill this vacancy. Mr.
Ballstadt has served as a director of the Company since the consummation of the
two acquisitions. The Company also entered into a two-year employment agreement
with Mr. Ballstadt at a salary of $100,000 per year plus a possible bonus of up
to $100,000 per year based on increases, if any, in certain dealer allowances,
and certain additional benefits.

On March 25, 1998, the Company sold the rights to its library of 47 feature
films and other properties and related accounts receivable to an entity owned
and controlled by Stephen C. Lehman, a member of the Company's board of
directors, for $1,350,000 in cash. The film library is stated at the net
realizable value at January 31, 1998. The library was the principal asset of
Prism prior to the merger in January 1997 of Lee Video City with and into Prism.
Under the agreement by which the Company sold its film rights, the Company has a
right to buy back the film library at any time through February 4, 1999 at
escalating prices ranging from $1,650,000 to $1,850,000, less amounts actually
received and collected by the buyer on account of the accounts receivable or
other exploitation of the film library; the Company would not exercise this
right unless it expects to be able to resell the film library at a profit, since
management no longer intends to remain in the film production or distribution
business.

On March 25, 1998, the Company also entered into a restructured debt
agreement with Rentrak Corporation ("Rentrak"), a major lessor of videocassettes
under a revenue sharing arrangement. Prior to the acquisition of the five
companies on March 25, 1998, the Company and Sulpizio One, Inc. (one of the
acquired companies) were parties to such arrangements with Rentrak. With the
expanded group of stores as a result of the acquisitions, management expects to
increase its leasing of videocassettes from Rentrak. As part of the
restructuring, Rentrak agreed to accept 194,950 shares of the Company's Common
Stock in settlement of a lawsuit Rentrak had previously filed against Adventures
in Video, Inc. (one of the acquired companies), and 470,162 shares of the
Company's Common Stock in satisfaction of indebtedness owed to Rentrak by
Sulpizio One, Inc. As part of the restructured debt agreement, Rentrak also
agreed to a deferral of certain amounts owed to it by Sulpizio One, Inc. and the
Company, and obtained a security interest in the assets of the Company to secure
such amounts. Rentrak also released Robert Y. Lee, the Company's Chairman of
the Board and Chief Executive Officer, from personal guaranties of the Company's
indebtedness that Mr. Lee had previously given. Rentrak's wholly-owned
subsidiary, Mortco, Inc., is a principal stockholder of the Company.

On April 16, 1997, the Company entered into three year consulting
agreements with Gerald W. B. Weber and Stephen C. Lehman pursuant to which
Messrs. Weber and Lehman shall provide finance, acquisitions and corporate
development consulting services to the Company. The consulting agreements of
Messrs. Weber and Lehman provide for compensation in the form of options to
purchase an aggregate of 75,000 and 90,000 shares, respectively, of the
Company's Common Stock at $2.00 per share. Options to

13
<PAGE>

purchase one-third of such shares of Common Stock vest each year commencing on
April, 16, 1997 and any unexercised portions terminate on April 15, 2002. Each
consulting agreement also provides that the Company shall reimburse the
consultant for reasonable out-of-pocket expenses incurred in performing his
consulting services, that the Company shall indemnify the consultant with
respect to any claims made against the consultant arising in connection with the
consulting service, and that either party may terminate the consulting agreement
by providing 30 days notice to the other party. On March 24, 1998, Mr. Lehman's
consulting agreement was amended to provide Mr. Lehman additional compensation
in the form of warrants to purchase 100,000 shares of the Company's Common Stock
at $2.00 per share. Messrs. Weber and Lehman are directors of the Company.

In April 1997, the Company entered into an engagement agreement with Sphere
Capital Partners ("Sphere Capital") pursuant to which Sphere Capital shall act
as the exclusive financial advisor to the Company providing financial
management, acquisition and financing advisory services for a period of one year
commencing April 1997 and for such additional one year terms as may be mutually
agreed to by Sphere Capital and the Company. The agreement provided that during
the term of the engagement, Sphere Capital shall limit its financial advisory
services within the video retail industry solely to the Company. The engagement
agreement provided for a base fee of $5,000 per month which shall be credited
against any transaction fees to which Sphere Capital may be entitled upon
consummation of any acquisition or financing transaction. The engagement
agreement also provided that the Company would reimburse Sphere Capital for
reasonable out-of-pocket expenses incurred in performing its financial advisory
services and that either party may terminate the engagement by providing 45 days
notice to the other party. In May 1997, Sphere Capital assigned the agreement
to The Value Group, LLC. During the fiscal year ended January 31, 1998, the
Company paid Sphere Capital fees in the amount of approximately $28,000.
Effective April 1998, a new engagement agreement was entered into by the Company
and The Value Group, LLC, the successor entity to Sphere Capital, which provides
for a base fee of $2,500 per month which shall be credited against any
transaction fees to which The Value Group, LLC, may be entitled upon
consummation of any acquisition or financing transaction. John T. Sheehy serves
as a director of the Company and is a Managing Director of The Value Group, LLC
and its predecessor, Sphere Capital.

In May 1998, the Company commenced a private placement financing of the
Company's securities in which Ridgewood Capital Funding, Inc. ("Ridgewood") has
agreed to serve as the placement agent. John T. Sheehy, a member of the Board
of Directors of the Company, assisted Ridgewood in conducting the offering,
acting as a registered broker under Ridgewood's broker-dealership. In addition,
certain directors of the Company and The Value Group, LLC participated in the
private placement financing by investing in the Company's securities. See
"Security Ownership of Certain Beneficial Owners and Management."

The Company is currently negotiating with Game City, Inc. ("Game City") for
the acquisition of substantially all of the assets of Game City. Game City owns
and operates one video store located in Bakersfield, California, which is
currently managed by the Company under a management agreement. Game City is
owned by Young C. and Kay L. Lee, who are the parents of Robert Y. Lee, the
Company's Chief Executive Officer. The Company believes that this pending
acquisition represents an arm's length transaction on terms and valuation
comparable to other completed and pending acquisitions for the year ending
January 31, 1999.

PROPOSAL 2 -
PROPOSAL TO RATIFY THE APPROVAL OF
THE COMPANY'S 1998 STOCK OPTION PLAN

In June 1998, the Company's Board of Directors unanimously approved the
Company's 1998 Stock Option Plan, subject to stockholder approval. The purpose
of the 1998 Stock Option Plan is to enable the Company to attract and retain
top-quality employees, officers, directors and consultants and to provide them

14
<PAGE>

with an incentive to enhance stockholder return. The full text of the 1998
Stock Option Plan appears as Exhibit A to this Proxy Statement and the
description of the 1998 Stock Option Plan herein is qualified by reference to
the text of the plan.

DESCRIPTION OF THE 1998 STOCK OPTION PLAN

The key terms of the 1998 Stock Option Plan are outlined below.

The 1998 Stock Option Plan provides for the grant of options to officers,
directors, other employees and consultants of the Company to purchase up to an
aggregate of 1,200,000 shares of Common Stock. The 1998 Stock Option Plan is
administered by the Board of Directors or a committee of the Board, and is
currently administered by the Compensation Committee of the Board of Directors,
which has complete discretion to select the optionees and to establish the terms
and conditions of each option, subject to the provisions of the 1998 Stock
Option Plan. Options granted under the 1998 Stock Option Plan may be "incentive
stock options" as defined in Section 422 of the Code, or nonqualified options,
and will be designated as such.

The exercise price of incentive stock options may not be less than the fair
market value of the Company's Common Stock as of the date of grant (110% of the
fair market value if the grant is to an employee who owns more than 10% of the
total combined voting power of all classes of capital stock of the Company).
The Code currently limits to $100,000 the aggregate value of Common Stock that
may become exercisable for the first time in any one year pursuant to incentive
stock options under the 1998 Stock Option Plan or any other option plan adopted
by the Company. Nonqualified options may be granted under the 1998 Stock Option
Plan at an exercise price less than the fair market value of the Common Stock on
the date of grant. Nonqualified options also may be granted without regard to
any restriction on the amount of Common Stock that may become exercisable
pursuant to such options in any one year.

In general, upon termination of employment of an optionee, all options
granted to such person which were not exercisable on the date of such
termination would immediately terminate, and any options that are exercisable
would terminate 90 days (six months in the case of termination by reason of
death or disability) following termination of employment.

Options may not be exercised more than ten years after the grant (five
years after the grant if the grant is an incentive stock option to an employee
who owns more than 10% of the total combined voting power of all classes of
capital stock of the Company). Options granted under the 1998 Stock Option Plan
are not transferable and may be exercised only by the respective grantees during
their lifetime or by their heirs, executors or administrators in the event of
death. Under the 1998 Stock Option Plan, shares subject to cancelled or
terminated options are available for subsequently granted options. The number
of options outstanding and the exercise price thereof are subject to adjustment
in the case of certain transactions such as recapitalizations, stock splits or
stock dividends. The 1998 Stock Option Plan is effective for ten years, unless
sooner terminated or suspended. The 1998 Stock Option Plan provides that
options covering no more than 600,000 shares of Common Stock may be granted to
any one employee in any twelve month period.

CERTAIN FEDERAL INCOME TAX CONSEQUENCES

Incentive stock options under the 1998 Stock Option Plan are afforded
favorable federal income tax treatment under the Code. If an option is treated
as an incentive stock option, the optionee will recognize no income upon grant
or exercise of the option unless the alternative minimum tax rules apply. The
excess of the fair market value over the exercise price at the time an incentive
stock option is exercised is added to the tax base of the alternative minimum
tax. Upon an optionee's sale of the shares (assuming that the sale occurs more
than two years after grant of the option and more than one year after exercise
of the option), any gain will be taxed to the optionee as long-term capital
gain. If the optionee disposes of the shares prior to the

15
<PAGE>

expiration of the above holding periods, then the optionee will recognize
ordinary income in an amount generally measured as the difference between the
exercise price and the lower of the fair market value of the shares at the
exercise date or the sale price of the shares. Any gain or loss recognized on
such a premature sale of the shares in excess of the amount treated as ordinary
income will be characterized as capital gain or loss.

All other options granted under the 1998 Stock Option Plan are nonqualified
stock options. Although an optionee will not recognize any taxable income at
the time he or she is granted a nonqualified stock option, the optionee will
recognize ordinary income for federal income tax purposes upon exercise of the
nonqualified stock option in an amount equal to the excess of the then fair
market value of each share over its exercise price. Upon an optionee's resale
of such shares, any difference between the sale price and the fair market value
of such shares on the date of exercise will be treated as capital gain or loss.

Subject to the limits on deductibility of employee remuneration under
Section 162(m) of the Code, the Company will generally be entitled to a tax
deduction in the amount that an optionee recognizes as ordinary income with
respect to an option. Options granted to executive officers under the 1998
Stock Option Plan are intended to qualify as performance-based compensation for
purposes of Section 162(m) of the Code, and the Company will generally be
entitled to a tax deduction in the amount recognized by such officers upon
exercise of the options. No tax authority or court has ruled on the
applicability of Section 162(m) to the 1998 Stock Option Plan and any final
determination of the deductibility of amounts realized upon exercise of an
option granted under the 1998 Stock Option Plan could ultimately be made by the
Internal Revenue Service or a court having final jurisdiction with respect to
the matter. The Company retains the right to grant options under the 1998 Stock
Option Plan in accordance with the terms of the 1998 Stock Option Plan
regardless of any final determination as to the applicability of Section 162(m)
of the Code to these grants.

The foregoing does not purport to be a complete summary of the federal
income tax considerations that may be relevant to holders of options or to the
Company. It also does not reflect provisions of the income tax laws of any
municipality, state or foreign country in which an optionee may reside, nor does
it reflect the tax consequences of an optionee's death.

PARTICIPATION IN THE 1998 STOCK OPTION PLAN

In June 1998, options to purchase 872,637 shares of Common Stock were
granted under the 1998 Stock Option Plan, subject to stockholder approval of the
1998 Stock Option Plan. Grants under the 1998 Stock Option Plan are made at the
discretion of the administrator of the 1998 Stock Option Plan and future grants
under the 1998 Stock Option Plan have not yet been determined.

THE BOARD OF DIRECTORS RECOMMENDS A VOTE "FOR" THE PROPOSAL TO RATIFY THE
ADOPTION OF THE COMPANY'S 1998 STOCK OPTION PLAN.

CHANGES IN ACCOUNTANTS

Upon the consummation of the merger of Lee Video City with and into Prism
on January 8, 1997, the surviving corporation changed its name to "Video City,
Inc." BDO Seidman, LLP was selected as the independent certified public
accountants for Lee Video City for its fiscal year ended December 31, 1996 and
for Video City, Inc. for the fiscal year ended January 31, 1997. BDO Seidman,
LLP had served as Prism's independent certified public accountants prior to the
merger. KPMG Peat Marwick, LLP had served as Lee Video City's independent
certified public accountants for its fiscal years ended December 31, 1995 and
1994.

There were no disagreements between KPMG Peat Marwick, LLP and Lee Video
City within the meaning of Item 304 of Regulation S-K on any matter of
accounting principles or practices, financial statement

16
<PAGE>

disclosure, or auditing scope or procedure in connection with the audit of Lee
Video City's financial statements for the fiscal years ended December 31, 1995
and 1994, or for the subsequent interim period through January 1997, which
disagreements if not resolved to their satisfaction would have caused KPMG Peat
Marwick, LLP to issue an adverse opinion or disclaimer of opinion, or was
modified as to uncertainty, audit scope or accounting principles.

During the two fiscal years prior to the merger, there have been no
reportable events (as defined in Item 304 or Regulation S-K) with KPMG Peat
Marwick, LLP. Lee Video City has not consulted with BDO Seidman, LLP regarding
the application of accounting principles to a specified transaction or the type
of audit opinion that might be rendered on the financial statements during the
two fiscal years through the date of the merger.

A letter of KPMG Peat Marwick, LLP addressed to the Securities and Exchange
Commission was included as Exhibit 11.0 to the Company's Current Report on Form
8-K. The change in auditors was approved by the Board of Directors of the
Company in January 1997.

INDEPENDENT AUDITORS

The Company's independent auditors for the fiscal year ended January 31,
1998 were BDO Seidman, LLP, and the Board of Directors has selected BDO Seidman,
LLP as the Company's independent auditors for the fiscal year ending January 31,
1999. A representative of BDO Seidman, LLP will be available at the Annual
Meeting to respond to appropriate questions or make any other statements that
such representative deems appropriate.

AVAILABILITY OF ANNUAL REPORT ON FORM 10-K

The Company will furnish without charge a copy of the Company's Annual
Report on Form 10-K for the fiscal year ended January 31, 1998 as filed with the
Securities and Exchange Commission to any stockholder desiring a copy.
Stockholders may request a copy by writing to the Company at:

Timothy J. Denari
Chief Financial Officer
Video City, Inc.
6840 District Boulevard
Bakersfield, California 93313

SUBMISSION OF STOCKHOLDER PROPOSALS

Stockholders are advised that any stockholder proposal, including
nominations to the Board of Directors, intended for consideration at the 1999
Annual Stockholders Meeting must be received by the Company no later than March
15, 1999 to be included in the proxy material for the 1999 Annual Meeting. It
is recommended that stockholders submitting proposals direct them to Timothy J.
Denari, Chief Financial Officer of the Company, and utilize certified mail,
return receipt requested in order to ensure timely delivery.

OTHER MATTERS

The Board of Directors knows of no matter to come before the Annual Meeting
other than as specified herein. If other business should, however, be properly
brought before the Annual Meeting, the persons voting the proxies will vote them
in accordance with their best judgment.

17
<PAGE>

THE STOCKHOLDERS ARE URGED TO COMPLETE, SIGN, AND RETURN PROMPTLY THE
ACCOMPANYING PROXY IN THE ENCLOSED ENVELOPE.

By Order of the Board of Directors,

/s/ Robert Y. Lee

Robert Y. Lee
Chairman of the Board

Bakersfield, California
July 23, 1998

18
<PAGE>

1998 STOCK OPTION PLAN EXHIBIT A
OF
VIDEO CITY, INC.

1. PURPOSES OF THE PLAN
--------------------

The purposes of the 1998 Stock Option Plan ("Plan") of Video City, Inc., a
Delaware corporation (the "Company"), are to:

(a) Encourage selected employees, directors and consultants to
improve operations and increase profits of the Company;

(b) Encourage selected employees, directors and consultants to
accept or continue employment or association with the Company or its Affiliates;
and

(c) Increase the interest of selected employees, directors and
consultants in the Company's welfare through participation in the growth in
value of the common stock of the Company (the "Common Stock").

Options granted under this Plan ("Options") may be "incentive stock
options" ("ISOs") intended to satisfy the requirements of Section 422 of the
Internal Revenue Code of 1986, as amended, and the regulations thereunder (the
"Code"), or "nonqualified options" ("NQOs").

2. ELIGIBLE PERSONS
----------------

Every person who at the date of grant of an Option is an employee of the
Company or of any Affiliate (as defined below) of the Company is eligible to
receive NQOs or ISOs under this Plan. Every person who at the date of grant is
a consultant to, or non-employee director of, the Company or any Affiliate (as
defined below) of the Company is eligible to receive NQOs under this Plan. The
term "Affiliate" as used in this Plan means a parent or subsidiary corporation
as defined in the applicable provisions (currently Sections 424(e) and (f),
respectively) of the Code. The term "employee" includes an officer or director
who is an employee of the Company. The term "consultant" includes persons
employed by, or otherwise affiliated with, a consultant.

3. STOCK SUBJECT TO THIS PLAN; MAXIMUM NUMBER OF GRANTS
----------------------------------------------------

Subject to the provisions of Section 6.1.1 of this Plan, the total number
of shares of stock which may be issued under Options granted pursuant to this
Plan shall not exceed 1,200,000 shares of Common Stock. The shares covered by
the portion of any grant under this Plan which expires, terminates or is
cancelled unexercised shall become available again for grants under this Plan.
Where the exercise price of an Option is paid by means of the optionee's
surrender of previously owned shares of Common
<PAGE>

Stock or the Company's withholding of shares otherwise issuable upon exercise of
the Option as permitted herein, only the net number of shares issued and which
remain outstanding in connection with such exercise shall be deemed "issued"
and no longer available for issuance under this Plan. No eligible person shall
be granted Options during any twelve-month period covering more than 600,000
shares.

4. ADMINISTRATION
--------------

(a) This Plan shall be administered by the Board of Directors of
the Company (the "Board") or by a committee (the "Committee") to which
administration of this Plan, or of part of this Plan, is delegated by the Board
(in either case, the "Administrator"). The Board shall appoint and remove
members of the Committee in its discretion in accordance with applicable laws.
If necessary in order to comply with Rule 16b-3 under the Securities Exchange
Act of 1934, as amended (the "Exchange Act"), and Section 162(m) of the Code,
the Committee shall, in the Board's discretion, be comprised solely of "non-
employee directors" within the meaning of said Rule 16b-3 and "outside
directors" within the meaning of Section 162(m) of the Code. The foregoing
notwithstanding, the Administrator may delegate nondiscretionary administrative
duties to such employees of the Company as it deems proper and the Board, in its
absolute discretion, may at any time and from time to time exercise any and all
rights and duties of the Administrator under this Plan.

(b) Subject to the other provisions of this Plan, the
Administrator shall have the authority, in its discretion: (i) to grant Options;
(ii) to determine the fair market value of the Common Stock subject to Options;
(iii) to determine the exercise price of Options granted; (iv) to determine the
persons to whom, and the time or times at which, Options shall be granted, and
the number of shares subject to each Option; (v) to construe and interpret the
terms and provisions of this Plan and of any option agreement and all Options
granted under this Plan; (vi) to prescribe, amend, and rescind rules and
regulations relating to this Plan; (vii) to determine the terms and provisions
of each Option granted (which need not be identical), including but not limited
to, the time or times at which Options shall be exercisable; (viii) with the
consent of the optionee, to modify or amend any Option; (ix) to reduce the
exercise price of any Option; (x) to accelerate or defer (with the consent of
the optionee) the exercise date of any Option; (xi) to authorize any person to
execute on behalf of the Company any instrument evidencing the grant of an
Option; and (xii) to make all other determinations deemed necessary or advisable
for the administration of this Plan or any option agreement or Option. The
Administrator may delegate nondiscretionary administrative duties to such
employees of the Company as it deems proper.

2
<PAGE>

(c) All questions of interpretation, implementation, and
application of this Plan or any option agreement or Option shall be determined
by the Administrator, which determination shall be final and binding on all
persons.

5. GRANTING OF OPTIONS; OPTION AGREEMENT
-------------------------------------

(a) No Options shall be granted under this Plan after 10 years
from the date of adoption of this Plan by the Board.

(b) Each Option shall be evidenced by a written stock option
agreement, in form satisfactory to the Administrator, executed by the Company
and the person to whom such Option is granted. In the event of a conflict
between the terms or conditions of an option agreement and the terms and
conditions of this Plan, the terms and conditions of this Plan shall govern.

(c) The stock option agreement shall specify whether each Option
it evidences is an NQO or an ISO, provided, however, all Options granted under
this Plan to non-employee directors and consultants of the Company are intended
to be NQOs.

(d) Subject to Section 6.3.3 with respect to ISOs, the
Administrator may approve the grant of Options under this Plan to persons who
are expected to become employees, directors or consultants of the Company, but
are not employees, directors or consultants at the date of approval, and the
date of approval shall be deemed to be the date of grant unless otherwise
specified by the Administrator.

6. TERMS AND CONDITIONS OF OPTIONS
-------------------------------

Each Option granted under this Plan shall be subject to the terms and
conditions set forth in Section 6.1. NQOs shall be also subject to the terms
and conditions set forth in Section 6.2, but not those set forth in Section 6.3.
ISOs shall also be subject to the terms and conditions set forth in Section 6.3,
but not those set forth in Section 6.2.

6.1 Terms and Conditions to Which All Options Are Subject. All Options
-----------------------------------------------------
granted under this Plan shall be subject to the following terms and conditions:

6.1.1 Changes in Capital Structure. Subject to Section 6.1.2, if
----------------------------
the stock of the Company is changed by reason of a stock split, reverse stock
split, stock dividend, recapitalization, combination or reclassification, or if
the Company effects a spin-off of the Company's subsidiary, appropriate
adjustments shall be made by the Board, in its sole discretion, in (a) the
number and class of shares of stock

3
<PAGE>

subject to this Plan and each Option outstanding under this Plan, and (b) the
exercise price of each outstanding Option; provided, however, that the Company
shall not be required to issue fractional shares as a result of any such
adjustments.

6.1.2 Corporate Transactions. In the event of a Corporate
----------------------
Transaction (as defined below), the Administrator shall notify each optionee at
least 30 days prior thereto or as soon as may be practicable. To the extent not
previously exercised, all Options shall terminate immediately prior to the
consummation of such Corporate Transaction unless the Administrator determines
otherwise in its sole discretion; provided, however, that the Administrator, in
its sole discretion, may permit exercise of any Options prior to their
termination, even if such Options would not otherwise have been exercisable.
The Administrator may, in its sole discretion, provide that all outstanding
Options shall be assumed or an equivalent option substituted by an applicable
successor corporation or any Affiliate of the successor corporation in the event
of a Corporate Transaction. A "Corporate Transaction" means a liquidation or
dissolution of the Company, a merger or consolidation of the Company with or
into another corporation or entity, a sale of all or substantially all of the
assets of the Company, or a purchase of more than 50 percent of the outstanding
capital stock of the Company in a single transaction or a series of related
transactions by one person or more than one person acting in concert.

6.1.3 Time of Option Exercise. Subject to Section 5 and Section
-----------------------
6.3.4, an Option granted under this Plan shall be exercisable (a) immediately as
of the effective date of the stock option agreement granting the Option, or (b)
in accordance with a schedule or performance criteria as may be set by the
Administrator and specified in the written stock option agreement relating to
such Option. In any case, no Option shall be exercisable until a written stock
option agreement in form satisfactory to the Company is executed by the Company
and the optionee.

6.1.4 Option Grant Date. The date of grant of an Option under this
-----------------
Plan shall be the effective date of the stock option agreement granting the
Option.

6.1.5 Nontransferability of Option Rights. Except with the express
-----------------------------------
written approval of the Administrator which approval the Administrator is
authorized to give only with respect to NQOs, no Option granted under this Plan
shall be assignable or otherwise transferable by the optionee except by will or
by the laws of descent and distribution. During the life of the optionee, an
Option shall be exercisable only by the optionee.

4
<PAGE>

6.1.6 Payment. Except as provided below, payment in full, in cash,
-------
shall be made for all stock purchased at the time written notice of exercise of
an Option is given to the Company, and proceeds of any payment shall constitute
general funds of the Company. The Administrator, in the exercise of its
absolute discretion after considering any tax, accounting and financial
consequences, may authorize any one or more of the following additional methods
of payment:

(a) Acceptance of the optionee's full recourse promissory note
for all or part of the Option price, payable on such terms and bearing such
interest rate as determined by the Administrator (but in no event less than the
minimum interest rate specified under the Code at which no additional interest
or original issue discount would be imputed), which promissory note may be
either secured or unsecured in such manner as the Administrator shall approve
(including, without limitation, by a security interest in the shares of the
Company);

(b) Subject to the discretion of the Administrator and the terms
of the stock option agreement granting the Option, delivery by the optionee of
shares of Common Stock already owned by the optionee for all or part of the
Option price, provided the fair market value (determined as set forth in Section
6.1.9) of such shares of Common Stock is equal on the date of exercise to the
Option price, or such portion thereof as the optionee is authorized to pay by
delivery of such stock;

(c) Subject to the discretion of the Administrator, through the
surrender of shares of Common Stock then issuable upon exercise of the Option,
provided the fair market value (determined as set forth in Section 6.1.9) of
such shares of Common Stock is equal on the date of exercise to the Option
price, or such portion thereof as the optionee is authorized to pay by surrender
of such stock; and

(d) By means of so-called cashless exercises as permitted under
applicable rules and regulations of the Securities and Exchange Commission and
the Federal Reserve Board.

6.1.7 Withholding and Employment Taxes. In the case of an employee
--------------------------------
exercising an NQO, at the time of exercise and as a condition thereto, or at
such other time as the amount of such obligation becomes determinable, the
optionee shall remit to the Company in cash all applicable federal and state
withholding and employment taxes. Such obligation to remit may be satisfied, if
authorized by the Administrator in its sole discretion, after considering any
tax, accounting and financial consequences, by the optionee's (i) delivery of a
promissory note in the required amount on such terms as the Administrator deems
appropriate, (ii) tendering to the Company previously owned shares of Common
Stock or other securities of the Company with a fair market value equal

5
<PAGE>

to the required amount, or (iii) agreeing to have shares of Common Stock (with a
fair market value equal to the required amount) which are acquired upon exercise
of the Option withheld by the Company.

6.1.8 Other Provisions. Each Option granted under this Plan may
----------------
contain such other terms, provisions, and conditions not inconsistent with this
Plan as may be determined by the Administrator, and each ISO granted under this
Plan shall include such provisions and conditions as are necessary to qualify
the Option as an "incentive stock option" within the meaning of Section 422 of
the Code.

6.1.9 Determination of Value. For purposes of this Plan, the fair
----------------------
market value of Common Stock or other securities of the Company shall be
determined as follows:

(a) If the stock of the Company is listed on a securities
exchange or is regularly quoted by a recognized securities dealer, and selling
prices are reported, its fair market value shall be the closing price of such
stock on the date the value is to be determined, but if selling prices are not
reported, its fair market value shall be the mean between the high bid and low
asked prices for such stock on the date the value is to be determined (or if
there are no quoted prices for the date of grant, then for the last preceding
business day on which there were quoted prices).

(b) In the absence of an established market for the stock, the
fair market value thereof shall be determined in good faith by the
Administrator, with reference to the Company's net worth, prospective earning
power, dividend-paying capacity, and other relevant factors, including the
goodwill of the Company, the economic outlook in the Company's industry, the
Company's position in the industry, the Company's management, and the values of
stock of other corporations in the same or a similar line of business.

6.1.10 Option Term. Subject to Section 6.3.4, no Option shall be
-----------
exercisable more than 10 years after the date of grant, or such lesser period of
time as is set forth in the stock option agreement (the end of the maximum
exercise period stated in the stock option agreement is referred to in this Plan
as the "Expiration Date").

6.2 Terms and Conditions to Which Only NQOs Are Subject. Options granted
---------------------------------------------------
under this Plan which are designated as NQOs shall be subject to the following
terms and conditions:

6.2.1 Exercise Price. (a) The exercise price of an NQO shall be
--------------
the amount determined by the Administrator as specified in the option agreement.

6
<PAGE>

(b) To the extent required by applicable laws, rules and
regulations, the exercise price of an NQO granted to any person who owns,
directly or by attribution under the Code (currently Section 424(d)), stock
possessing more than ten percent of the total combined voting power of all
classes of stock of the Company or of any Affiliate (a "Ten Percent
Stockholder") shall in no event be less than 110% of the fair market value
(determined in accordance with Section 6.1.9) of the stock covered by the Option
at the time the Option is granted.

6.2.2 Termination of Employment. Except as otherwise provided in
-------------------------
the stock option agreement, if for any reason an optionee ceases to be employed
by the Company or any of its Affiliates, Options that are NQOs held at the date
of termination (to the extent then exercisable) may be exercised in whole or in
part at any time within 90 days of the date of such termination (but in no event
after the Expiration Date). For purposes of this Section 6.2.2, "employment"
includes service as a director or as a consultant. For purposes of this Section
6.2.2, an optionee's employment shall not be deemed to terminate by reason of
sick leave, military leave or other leave of absence approved by the
Administrator, if the period of any such leave does not exceed 90 days or, if
longer, if the optionee's right to reemployment by the Company or any Affiliate
is guaranteed either contractually or by statute.

6.3 Terms and Conditions to Which Only ISOs Are Subject. Options granted
---------------------------------------------------
under this Plan which are designated as ISOs shall be subject to the following
terms and conditions:

6.3.1 Exercise Price. (a) The exercise price of an ISO shall be
--------------
not less than the fair market value (determined in accordance with Section
6.1.9) of the stock covered by the Option at the time the Option is granted.

(b) The exercise price of an ISO granted to any Ten Percent
Stockholder shall in no event be less than 110% of the fair market value
(determined in accordance with Section 6.1.9) of the stock covered by the Option
at the time the Option is granted.

6.3.2 Disqualifying Dispositions. If stock acquired by exercise of
--------------------------
an ISO granted pursuant to this Plan is disposed of in a "disqualifying
disposition" within the meaning of Section 422 of the Code (a disposition within
two years from the date of grant of the Option or within one year after the
transfer of such stock on exercise of the Option), the holder of the stock
immediately before the disposition shall promptly notify the Company in writing
of the date and terms of the disposition and shall provide such other
information regarding the Option as the Company may reasonably require.

7
<PAGE>

6.3.3 Grant Date. If an ISO is granted in anticipation of
----------
employment as provided in Section 5(d), the Option shall be deemed granted,
without further approval, on the date the grantee assumes the employment
relationship forming the basis for such grant, and, in addition, satisfies all
requirements of this Plan for Options granted on that date.

6.3.4 Term. Notwithstanding Section 6.1.10, no ISO granted to any
----
Ten Percent Stockholder shall be exercisable more than five years after the date
of grant.

6.3.5 Termination of Employment. Except as otherwise provided in
-------------------------
the stock option agreement, if for any reason an optionee ceases to be employed
by the Company or any of its Affiliates, Options that are ISOs held at the date
of termination (to the extent then exercisable) may be exercised in whole or in
part at any time within 90 days of the date of such termination (but in no event
after the Expiration Date). For purposes of this Section 6.3.5, an optionee's
employment shall not be deemed to terminate by reason of sick leave, military
leave or other leave of absence approved by the Administrator, if the period of
any such leave does not exceed 90 days or, if longer, if the optionee's right to
reemployment by the Company or any Affiliate is guaranteed either contractually
or by statute.

7. MANNER OF EXERCISE
------------------

(a) An optionee wishing to exercise an Option shall give written
notice to the Company at its principal executive office, to the attention of the
officer of the Company designated by the Administrator, accompanied by payment
of the exercise price and withholding taxes as provided in Sections 6.1.6 and
6.1.7. The date the Company receives written notice of an exercise hereunder
accompanied by payment of the exercise price will be considered as the date such
Option was exercised.

(b) Promptly after receipt of written notice of exercise of an
Option and the payments called for by Section 7(a), the Company shall, without
stock issue or transfer taxes to the optionee or other person entitled to
exercise the Option, deliver to the optionee or such other person a certificate
or certificates for the requisite number of shares of stock. An optionee or
permitted transferee of the Option shall not have any privileges as a
stockholder with respect to any shares of stock covered by the Option until the
date of issuance (as evidenced by the appropriate entry on the books of the
Company or a duly authorized transfer agent) of such shares.

8. EMPLOYMENT OR CONSULTING RELATIONSHIP
-------------------------------------

Nothing in this Plan or any Option granted hereunder shall interfere with
or limit in any way the right of the Company or of

8
<PAGE>

any of its Affiliates to terminate any optionee's employment or consulting at
any time, nor confer upon any optionee any right to continue in the employ of,
or consult with, the Company or any of its Affiliates.

9. CONDITIONS UPON ISSUANCE OF SHARES
----------------------------------

Shares of Common Stock shall not be issued pursuant to the exercise of an
Option unless the exercise of such Option and the issuance and delivery of such
shares pursuant thereto shall comply with all relevant provisions of law,
including, without limitation, the Securities Act of 1933, as amended (the
"Securities Act").

10. NONEXCLUSIVITY OF THIS PLAN
---------------------------

The adoption of this Plan shall not be construed as creating any
limitations on the power of the Company to adopt such other incentive
arrangements as it may deem desirable, including, without limitation, the
granting of stock options other than under this Plan.

11. MARKET STANDOFF
---------------

Each optionee, if so requested by the Company or any representative of the
underwriters in connection with any registration of the offering of any
securities of the Company under the Securities Act, shall not sell or otherwise
transfer any shares of Common Stock acquired upon exercise of Options during the
180-day period following the effective date of a registration statement of the
Company filed under the Securities Act; provided, however, that such restriction
shall apply only to the first registration statement of the Company to become
effective under the Securities Act after the date of adoption of this Plan which
includes securities to be sold on behalf of the Company to the public in an
underwritten public offering under the Securities Act. The Company may impose
stop-transfer instructions with respect to securities subject to the foregoing
restriction until the end of such 180-day period.

12. AMENDMENTS TO PLAN
------------------

The Board may at any time amend, alter, suspend or discontinue this Plan.
Without the consent of an optionee, no amendment, alteration, suspension or
discontinuance may adversely affect outstanding Options except to conform this
Plan and ISOs granted under this Plan to the requirements of federal or other
tax laws relating to incentive stock options. No amendment, alteration,
suspension or discontinuance shall require stockholder approval unless (a)
stockholder approval is required to preserve incentive stock option treatment
for federal income

9
<PAGE>

tax purposes or (b) the Board otherwise concludes that stockholder approval is
advisable.

13. EFFECTIVE DATE OF PLAN; TERMINATION
-----------------------------------

This Plan shall become effective upon adoption by the Board provided,
however, that no Option shall be exercisable unless and until written consent of
the stockholders of the Company, or approval of stockholders of the Company
voting at a validly called stockholders' meeting, is obtained within twelve
months after adoption by the Board. If any Options are so granted and
stockholder approval shall not have been obtained within twelve months of the
date of adoption of this Plan by the Board, such Options shall terminate
retroactively as of the date they were granted. Options may be granted and
exercised under this Plan only after there has been compliance with all
applicable federal and state securities laws. This Plan (but not Options
previously granted under this Plan) shall terminate within ten years from the
date of its adoption by the Board.

10
<PAGE>

VIDEO CITY, INC.
PROXY FOR ANNUAL MEETING OF STOCKHOLDERS, WEDNESDAY, AUGUST 19, 1998
THIS PROXY IS SOLICITED ON BEHALF OF THE BOARD OF DIRECTORS.

The undersigned hereby appoints Robert Y. Lee and Timothy J. Denari, and
each or either of them, as proxy holders with power to appoint his substitute
and hereby authorizes the proxy holders to represent and vote, as designated
below, all the shares of Video City, Inc. (the "Company") held of record by the
undersigned on July 1, 1998 at the Annual Meeting of Stockholders to be held on
Wednesday, August 19, 1998 at 10:00 A.M. or any and all adjournments thereof.

1. Election of directors:

[_] FOR all nominees listed below (except as marked to the contrary
below).

[_] WITHHOLD AUTHORITY to vote for all nominees listed below.

(INSTRUCTION: TO WITHHOLD AUTHORITY TO VOTE FOR ANY NOMINEE, DRAW A LINE
THROUGH SUCH NOMINEE'S NAME.)

Robert Y. Lee James Craig Kelly Gerald W. B. Weber
Barry L. Collier John T. Sheehy Charles E. Cooke
David A. Ballstadt Stephen C. Lehman Michael T. Anderson

2. PROPOSAL TO RATIFY THE APPROVAL OF THE COMPANY'S 1998 STOCK OPTION
PLAN:

[_] FOR [_] AGAINST [_] ABSTAIN

In their discretion, the proxy holders are authorized to vote upon such
other business as may properly be brought before the Annual Meeting or any and
all adjournments thereof.

THIS PROXY WILL BE VOTED AS SPECIFIED OR, IF NO CHOICE IS SPECIFIED, FOR THE
ELECTION OF THE NOMINEES, FOR THE RATIFICATION OF THE 1998 STOCK OPTION PLAN AND
AS SAID PROXIES DEEM ADVISABLE ON SUCH OTHER MATTERS AS MAY PROPERLY COME
BEFORE THE MEETING AND ANY AND ALL ADJOURNMENTS THEREOF. IN THE EVENT ANY OF THE
NOMINEES IS UNAVAILABLE FOR ELECTION OR UNABLE TO SERVE, THE SHARES REPRESENTED
BY THIS PROXY MAY BE VOTED FOR A SUBSTITUTE NOMINEE SELECTED BY THE BOARD OF
DIRECTORS.

Dated: ____________, 1998 ___________________________________
Signature

___________________________________
(Signature, if held jointly)

Please sign exactly as your name appears hereon. When shares are held by joint
tenants, both should sign. When signing as attorney, executor, administrator,
trustee or guardian, please give full title as such. If a corporation, please
sign in full corporate name by the President or other authorized officer. If a
partnership, please sign in partnership name by an authorized partner.

PLEASE PROMPTLY MARK, SIGN, DATE, AND
RETURN THIS PROXY USING THE ENCLOSED ENVELOPE.