<PAGE>
 
                                 UNITED STATES

                       SECURITIES AND EXCHANGE COMMISSION

                             WASHINGTON, D.C. 20549

                                   FORM 10-Q

[X]  QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
                        SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended October 31, 1997

                                       OR

[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF
                      THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from _________ to ____________

Commission file number 0-14023

                                Video City, Inc.
                                ----------------
             (Exact name of registrant as specified in its charter)

            6840 District Boulevard, Bakersfield, California  93313
            -------------------------------------------------------
          (Address of principal executive offices)          (Zip code)

                                 (805) 397-7955
                                 --------------
              (Registrant's telephone number, including area code)

     Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.

Yes  X    No
    ---     ---      

Indicate the number of shares outstanding of each of the issuer's classes of
common stock as of the latest practicable date.

Class                               Outstanding at October 31, 1997
-----                               -------------------------------
Common                                         9,773,927

<PAGE>
 
PART I.  FINANCIAL INFORMATION

ITEM 1.  FINANCIAL STATEMENTS

                                VIDEO CITY, INC.
                                 BALANCE SHEETS
<TABLE>
<CAPTION>
                                           October 31,    January 31,
                                               1997           1997
                                           ----------     -----------
                                           (unaudited)
<S>                                        <C>            <C>
Assets

Current assets:
     Cash                                   $   34,556     $ 1,246,517
 
     Accounts receivable, less
      allowance for doubtful accounts
     of $239,918 and $325,422                  870,726       2,168,052
 
     Notes receivable                          262,779         398,830
 
     Merchandise inventories                   295,436          58,976
     Other                                     115,251          96,143
                                            ----------     ----------- 
Total current assets                         1,578,748       3,968,518
 
Videocassette rental inventory, net of
     Accumulated amortization                2,372,034       2,126,789
 
Property and Equipment, net                    795,429       1,017,089
 
Film Inventory                               3,688,000       3,700,000
 
Other assets                                   204,874         267,916
                                            ----------     -----------
Total assets                                $8,639,085     $11,080,312
                                            ==========     ===========
</TABLE>

                See accompanying notes to financial statements.

                                       2
<PAGE>
 
                                VIDEO CITY, INC.
                                 BALANCE SHEETS
<TABLE>
<CAPTION>
                                           October 31,     January 31,
                                               1997           1997
                                           -----------     -----------
                                           (unaudited)
<S>                                        <C>            <C>
Liabilities and Stockholders' Equity
 
Current liabilities:
     Accounts payable                      $ 1,258,796     $ 1,761,297
     Accrued expenses                          610,895         707,485
     Current portion of long-term debt       1,592,036       2,258,850
                                           -----------     ----------- 
Total current liabilities                    3,461,727       4,727,632
 
Long-term debt                               2,174,494       3,341,313
 
Other liabilities                              745,175         774,875
                                           -----------     ----------- 
Total liabilities                            6,381,396       8,843,820
 
 
Stockholders' equity:
     Common stock, $.01 par value per
     share, authorized 20,000,000
     shares; issued and outstanding
     9,773,927 shares at October 31,
     1997 and 9,753,927 shares at
     January 31, 1997                           97,739          97,539
      
Additional paid-in capital                   7,075,735       7,035,935
Accumulated deficit                         (4,915,785)     (4,896,982)
                                           -----------     -----------  
Total stockholders' equity                   2,257,689       2,236,492
Total Liabilities and Stockholders'        
 Equity                                    $ 8,639,085     $11,080,312
                                           ===========     ===========
</TABLE>

                See accompanying notes to financial statements.

                                       3
<PAGE>
 
                                VIDEO CITY, INC.
                            STATEMENTS OF OPERATIONS
                                  (UNAUDITED)
<TABLE>
<CAPTION>
 
 
                                            For the three months ended      For the nine months ended
                                           October 31,    September 30,    October 31,   September 30,
                                               1997            1996            1997          1996
                                           ------------   --------------   ------------  ------------
<S>                                        <C>            <C>              <C>            <C>
Revenues:
     Rental revenues and product sales      $2,335,378       $2,128,115     $7,141,906    $ 8,574,592
                                                                                      
Operating Costs and Expenses:                                                         
     Store operating expenses                1,103,575        1,285,927      3,258,347      4,538,544
     Amortization of videocassette             372,017          378,000      1,236,326      1,565,200
      rental inventory                                                                
     Cost of product sales                     190,611           88,871        587,883        477,916
     Cost of leased product                     82,986           85,066        236,754        501,961
     General and administrative expenses       516,236          665,886      1,646,508      1,449,128
                                            ----------       ----------     ----------    -----------
                                                                                      
Total operating costs and expenses           2,265,425        2,503,750      6,965,818      8,532,749
                                                                                      
Income (loss) from operations                   69,953         (375,635)       176,089         41,843
                                                                                      
Other (Income) Expense:                                                               
     (Gain) Loss on disposition of                   -                -          4,669     (1,409,173)
      assets, net                                                                     
     Interest expense                          111,461          122,702        435,594        577,264
     Other                                     (80,410)         (57,157)      (245,372        (95,987)
                                            ----------       ----------     ----------    -----------
                                                                                      
Net income (loss)                               38,902         (441,180)       (18,803        969,739
                                                                                      
Net income (loss) per share                      $0.00           ($0.10)        ($0.00          $0.23
                                                                                      
Weighted average number of shares            9,773,927        4,234,024      9,773,927        4,234,024
 outstanding
</TABLE>

                See accompanying notes to financial statements.

                                       4
<PAGE>
 
                                VIDEO CITY, INC.
                            STATEMENTS OF CASH FLOWS
                                  (UNAUDITED)
<TABLE>
<CAPTION>
                                        For the nine months ended
                                       October 31,    September 30,
                                           1997           1996
                                       -----------    -------------
<S>                                    <C>            <C>
Increase (decrease) in cash

Cash flows from operating
 activities:

Net income (loss)                      $   (18,391)     $   969,739

Adjustments to reconcile net loss                     
 to net cash provided by                             
 operating activities:                               
     Amortization of film cost              12,000                -
     Depreciation and amortization       1,506,958        2,580,070
     (Gain) loss on disposal of              4,669       (1,409,173)
      assets                                          
     Noncash interest                            -                -
Changes in assets and liabilities:                    
     Decrease in accounts receivable     1,297,325          109,093
     Decrease (increase) in notes       
      receivable                           136,051           18,216              
     Decrease (increase) in               
      merchandise inventories             (225,338)         108,055            
     Decrease in other assets              (19,108)          43,391
     (Decrease) in accounts payable       (502,501)        (231,157)
     (Decrease) in accrued expenses        (96,590)         (37,910)
     Increase (decrease) in other          
      liabilities                          (29,700)         255,000
                                       -----------      -----------
Total adjustments                        2,083,767        1,435,585
                                       -----------      -----------
Net cash provided by operating           2,065,376        2,405,324
 activities                                           
                                                      
Cash flows from investing                             
 activities:                                          
     Purchases of videocassette         (1,413,851)      (2,901,343)
      rental inventory, net                           
     Net Change in film inventory          (12,000)               -
     Purchases of fixed assets             (57,854)               -
     Proceeds from sale of fixed     
      assets                                     -        3,361,300
                                       -----------      -----------
Net cash used in investing              (1,483,705)         459,957
 activities                                           
                                                      
Cash flows from financing                             
 activities:                                          
     Principal payments on            
      obligations under capital                       
      leases                              (259,924)        (332,446)                
     Repayment of long-term debt        (1,695,365)      (3,290,501)
     Proceeds from issuance of         
      long-term debt                       121,657          401,661               
     Proceeds from issuance of         
      stock for debt                        40,000                -
                                       -----------      -----------               
Net cash (used in) financing          
 activities                             (1,793,632)      (3,221,826)               
                                                      
Net decrease in cash                    (1,211,961)        (356,005)
Cash at beginning of the period          1,246,517          417,517
                                       -----------      -----------
Cash at end of the period                   34,556           61,512
                                       -----------      -----------
</TABLE>

                See accompanying notes to financial statements.

                                       5
<PAGE>
 
                                VIDEO CITY, INC.
                            STATEMENTS OF CASH FLOWS
                                  (UNAUDITED)
<TABLE>
<CAPTION>
 
                                           For the nine months ended
                                          October 31,     September 30,
                                             1997            1996
                                          -----------     ------------- 
<S>                                       <C>             <C>     
Supplementary disclosures of cash flow
 information
 
Cash paid during the period:
     Interest                                $349,132      $  472,613
     Income taxes                                 800               -
                                                           
                                                           
Noncash investing and financing                            
 activities:                                               
     Videocassette rental inventory                        
      acquired through issuance                            
         of long-term debt                   $146,334               -
     Sale of stores in exchange for          
      assignment of debt                            -       3,100,000 
</TABLE>

                 See accompanying notes to financial statements

                                       6
<PAGE>
 
                                VIDEO CITY, INC.
                         NOTES TO FINANCIAL STATEMENTS

1.  FINANCIAL STATEMENT PRESENTATION

          On January 8, 1997, Lee Video City, Inc. merged with and into Prism
Entertainment Corporation ("Prism").  Upon consummation of the merger, the name
of company was changed to Video City, Inc, (the "Company").  The Company
retained Prism's year-end of January 31.  Previously, Lee Video City, Inc.'s
year-end was December 31; the change in year-end is reflected in the different
quarter periods.

          The financial statements as of October 31, 1997 and for the nine
months and three months ended October 31, 1997 and September 30, 1996 are
unaudited and have been prepared in accordance with generally accepted
accounting principles for interim financial statements and pursuant to the rules
and regulations of the Securities and Exchange Commission.  Certain information
and disclosures normally included in financial statements prepared in accordance
with generally accepted accounting principles have been omitted pursuant to such
rules and regulations, although the Company believes that the disclosures are
adequate to make the information presented not misleading. It is recommended
that these financial statements be read in conjunction with the consolidated
financial statements and notes thereto included in the Company's annual report
on Form 10-K for the period ended January 31, 1997.

          The accompanying interim consolidated financial statements reflect all
adjustments that are, in the opinion of management, necessary to present fairly
the financial position, the results of operations and cash flows for the periods
presented.  All such adjustments are of a normal and recurring nature.  The
results of operations for the interim periods presented are not necessarily
indicative of the results to be expected for the full year.

2. NEW ACCOUNTING PRONOUNCEMENTS:

          Statements of Financial Accounting Standards No. 129 "Disclosure of
Information about Capital Structure" (SFAS No. 129) issued by the FASB is
effective for financial statements ending after December 15, 1997. The new
standard reinstates various securities disclosure requirements previously in
effect under Accounting Principles Board Opinion No. 15, which has been
superseded by SFAS No. 128. The Company does not expect adoption of SFAS No. 129
to have a material effect, if any, on its financial position or results of
operations.

          Statements of Financial Accounting  Standards No. 130 "Reporting
Comprehensive Income" (SFAS No.130) issued by the FASB is effective for
financial statements with fiscal years beginning after December 15, 1997.
Earlier application is permitted. SFAS No. 130 establishes standards for
reporting and display of comprehensive income and its components in a full set
of general-purpose financial statements. The Company has not determined the
effect on its financial position or results of operations, if any, from the
adoption of this statement.

          Statements of Financial Accounting Standards No. 131, "Disclosure
about Segments of an Enterprise and Related Information" (SFAS No. 131) issued
by the FASB is effective for financial statements beginning after December 15,
1997. The new standard requires that public business enterprises report certain
information about operating segments in complete sets of financial statements of
the enterprise and in condensed financial statements of interim periods issued
to shareholders. It also requires that public business enterprises report
certain information about their products and services, the geographic areas in
which they operate and their major customers. The Company does not expect
adoption of SFAS No. 131 to have a material effect, if any, on its Results of
Operations.

3. AMORTIZATION

          The company revised the estimate of salvage value relating to the
amortization of videocassette inventory to provide for a $6 salvage value per
tape, to reflect a more accurate salvage value as demonstrated in the industry.
The effect of the revision was $115,000 for the current quarter.

                                       7
<PAGE>
 
                             RESULTS OF OPERATIONS

ITEM 2.     MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
            RESULTS OF OPERATIONS

SPECIAL NOTE REGARDING FORWARD LOOKING STATEMENTS

          Certain statements in this Quarterly Report on Form 10-Q, particularly
under this Item 2, may constitute "forward-looking statements" within the
meaning of Private Securities Litigation Reform Act of 1995 (the "Reform Act").
Such forward-looking statements involve known and unknown risks, uncertainties,
and other factors which may cause the actual results, performance or
achievements of the company to be materially different from any future results,
performance or achievements, expressed or implied by such forward-looking
statements.

RESULTS OF OPERATIONS

Three and Nine Months ended October 31, 1997 Compared to Three and Nine Months
ended September 30, 1996

REVENUES

          Revenues for the three and nine months ended October 31, 1997 were
$2,335,000 and $7,142,000, respectively, compared to revenues of $2,128,000 and
$8,574,000 for the comparable periods in 1996.  The decrease in revenues was
primarily due to the sale of 11 stores by the Company in June 1996.  Same store
revenues for the three months ended October 31, 1997 increased by $92,000 or
4.3% compared to the comparable period in 1996.  Three store's assets were
relocated to new trade areas prior to the beginning of the third quarter, 1997.

STORE OPERATING EXPENSES

          Store operating expenses were $1,104,000 and $3,258,000 for the three
and nine months ended October 31, 1997 compared to $1,286,000 and $ 4,539,000
for the comparable periods in 1996.  The decrease for the nine month period
comparison was primarily due to the sale of 11 stores by the Company in June
1996.  Store operating expenses as a percentage of total revenue were 47.3% and
45.6% in 1997 compared to 60.4% and 52.9% in 1996.  The decrease was primarily
due to continued cost improvements achieved in the stores' controllable
operating costs and decreased fixed expense percentages attributable to the
three store relocations to new trade areas.

AMORTIZATION OF VIDEOCASSETTE RENTAL INVENTORY

          Amortization of videocassette rental inventory decreased $6,000 or
1.6% and $329,000  or 21.0% for the three and nine months ended October 31, 1997
compared to the comparable periods in 1996.  The decrease for the nine month
period was primarily due to the sale of 11 stores by the Company in June 1996
resulting in fewer videocassettes amortized in 1997 and improved and more
efficient purchasing of rental product.  The company revised the estimate of
salvage value relating to the amortization of videocassette inventory to provide
for a $6 salvage value per tape, to reflect a more accurate salvage value as
demonstrated in the industry. The effect of the revision was $115,000 for the
current quarter.

                                       8
<PAGE>
 
COST OF PRODUCT SALES

          Cost of product sales increased by $102,000, to $191,000 from $89,000
for the three months and by $110,000, to $588,000 from $478,000 for the nine
months ended October 31, 1997 compared to 1996. Cost of product sales as a
percentage of total revenue were 8.2% and 8.2% for the three and nine months
ended  October 31, 1997 compared to 4.2% and 5.6% for 1996.  The increase in the
cost of product sales percentage for the three and nine month periods ended
October 31, 1997 compared to 1996 is a result of increased  sales of sell-
through product and previously viewed cassettes.


COST OF LEASED PRODUCT

          Cost of leased product decreased by $2,000 to $83,000 from $85,000 and
by $265,000 to $237,000 from $502,000 for the three and nine months ended
October 31, 1997 compared to 1996.  The decrease for the nine month period was
primarily due to the sale of 11 stores by the Company in June 1996 resulting in
the need for substantially less leased video products in 1997. Cost of leased
product as a percentage of total revenues were 3.6% and 3.3% for 1997 compared
to 4.0% and 5.9% for 1996. These decreases were a direct result of the company
leasing a lower proportion of videocassettes versus purchasing video cassettes
during the current fiscal year.

GENERAL AND ADMINISTRATIVE

          General and administrative expenses were $516,000 and $1,647,000 for
the three and nine months ended October 31, 1997, respectively, compared to
$666,000 and $1,449,000 for the comparable periods ended in 1996. General and
administrative expenses as a percentage of revenues were 22.1% and 23.0% for
1997 compared to 31.3% and 16.9% in 1996. The increase for the nine month period
was primarily due to substantial professional and administrative expenses
incurred in the finalization of the Prism Entertainment Corporation chapter 11
bankruptcy and the merger. Also, the increase is partially due to the additional
professional and administrative expenses required of a public company.  Previous
to the merger with Prism Entertainment Corporation on January 8, 1997, Lee Video
City, Inc. was a privately owned corporation. In addition, the percentage
increase is the result of spreading these corporate expenses over significantly
lower revenues due to the sale of the 11 stores by the company in 1996.

INTEREST EXPENSE

          Interest expense decreased to $111,000 and $436,000 for the three and
nine months ended October 31, 1997 from $123,000 and $577,000 for the comparable
prior year periods. The decrease in interest expense was primarily due to the
reduction of long-term debt of the Company which was paid down from the proceeds
from the sale of 11 stores in June 1996 and the conversion of debt to equity in
conjunction with the merger in January 1997.

OTHER (INCOME) EXPENSE

          Other income increased to $80,000 and $245,000 for the three and nine
months ended October 31, 1997 compared to $57,000 and $96,000 for the comparable
prior year periods.  The increase was primarily due to management fees related
to the Company adding two new stores under management agreements in July 1996
and January 1997.

INCOME TAXES

          The Company had no income tax expense or benefit for the three and
nine months ended October 31, 1997 or for the comparable 1996 periods. The
Company's effective income tax rate varied from the statutory federal tax rate
as a result of operating losses, for which no tax has been recognized, due to
the change in the valuation allowance on the net deferred tax asset.  A full
valuation allowance has been established as it is more likely than not that the
deferred tax asset will not be realized.

                                       9
<PAGE>
 
LIQUIDITY AND CAPITAL RESOURCES

          The Company's primary long-term capital needs would be for opening and
acquiring new stores.  If and as the Company does acquire or open new stores,
the Company expects to fund such needs through future cash flows from
operations, the net proceeds from the possible sale of debt or equity
securities, bank credit facilities, trade credit, and equipment leases.

          The Company funds its short-term working capital needs, including the
acquisition of videos and other inventory, primarily through cash from
operations.  The Company expects that cash from operations will be sufficient to
fund future video and other inventory purchases and other working capital needs.
Videocassette rental inventories are accounted for as noncurrent assets under
generally accepted accounting principles because they are not assets which are
reasonably expected to be completely realized in cash or sold in the normal
business cycle.  Although the rental of this inventory generates a substantial
portion of the Company's revenue, the classification of these assets as
noncurrent excludes them from the computation of working capital.  The
acquisition cost of videocassette rental inventories, however, is reported as a
current liability until paid and , accordingly, included in the computation of
working capital.  Consequently, the Company believes working capital is not as
significant a measure of financial condition for companies in the video retail
industry as it is for companies in other industries.  Because of the accounting
treatment of  videocassette rental inventory as a noncurrent asset, the Company
anticipates that it will operate with a working capital deficit during fiscal
1998.

          On January 8, 1997, in conjunction with the Company's merger with
Prism Entertainment Corporation, the Company entered into an amended and
restated credit and security agreement (the "Agreement") with Imperial Bank. The
agreement contains various covenants including a financial performance covenant,
which states that the Company must reflect a minimum of $100,000 in profits on a
quarterly basis (pre-tax and calculated in accordance with generally accepted
accounting principles). Due to the Company's failure to achieve the minimum
profit for the first and second quarters as required by the covenant, the
Company has requested and been granted a waiver for the third quarter from
Imperial Bank.

          On July 11, 1997 the Company entered into a Fourth Addendum to the
Rentrak National Agreement. The agreement provides deferral of accounts payable
of approximately $127,000 owed by the company to Rentrak under its current "PPT
Agreement" and deferral of principal and interest payments totaling
approximately $439,000 on a "Note" dated as of February 28, 1997 between the
Company and Rentrak. Payment by the Company to Rentrak of the above shall be due
on the earlier of January 1998 or the date on which any person, corporation or
other entity acquires all or substantially all of the companies assets or merges
with, consolidates with, participates in a share exchange with, or other wise
acquires control, directly or indirectly of the company. The Company is
negotiating to renew the agreement before the maturity date of these
obligations.


CASH FLOWS

Nine Months ended October 31, 1997 Compared to Nine Months ended September 30,
1996

          Net cash provided by operating activities decreased by approximately
$340,000 primarily due to an increase in merchandise inventory purchases and a
reduction in accounts payable and accrued expenses partially offset by a
decrease in accounts receivable. Net cash used in investing activities decreased
by $1,944,000 primarily due to the sale of 11 Midwest stores occurring in 1996,
partially offset by a reduction in the purchases of videocassette rental
inventory. Net cash used in financing activities increased $1,428,000 mainly due
to the pay-down of the Ingram note occurring upon the sale of the 11 Midwest
stores in 1996, partially offset by increased principal payments on long-term
debt assumed in the merger with Prism Entertainment Corporation.

                                       10
<PAGE>
 
NEW ACCOUNTING PRONOUNCEMENTS:


          Statements of Financial Accounting Standards No. 129 "Disclosure of
Information about Capital Structure" (SFAS No. 129) issued by the FASB is
effective for financial statements ending after December 15, 1997. The new
standard reinstates various securities disclosure requirements previously in
effect under Accounting Principles Board Opinion No. 15, which has been
superseded by SFAS No. 128. The Company does not expect adoption of SFAS No. 129
to have a material effect, if any, on its financial position or results of
operations.

         Statements of Financial Accounting  Standards No. 130 "Reporting
Comprehensive Income" (SFAS No.130) issued by the FASB is effective for
financial statements with fiscal years beginning after December 15, 1997.
Earlier application is permitted. SFAS No. 130 establishes standards for
reporting and display of comprehensive income and its components in a full set
of general-purpose financial statements. The Company has not determined the
effect on its financial position or results of operations, if any, from the
adoption of this statement.

         Statements of Financial Accounting Standards No. 131, "Disclosure about
Segments of an Enterprise and Related Information" (SFAS No. 131) issued by the
FASB is effective for financial statements beginning after December 15, 1997.
The new standard requires that public business enterprises report certain
information about operating segments in complete sets of financial statements of
the enterprise and in condensed financial statements of interim periods issued
to shareholders. It also requires that public business enterprises report
certain information about their products and services, the geographic areas in
which they operate and their major customers. The Company does not expect
adoption of SFAS No. 131 to have a material effect, if any, on its Results of
Operations.


PART II.  OTHER INFORMATION


ITEM 2.  CHANGES IN SECURITIES

         (a) During the quarter the Company issued a stock certificate for
20,000 shares of its common stock to Troy & Gould in satisfaction of $40,000 of
fees for legal services rendered to Lee Video City, Inc. in the January 1997
merger with Prism Entertainment Corporation.  These shares were issued without
registration under the Securities Act of 1933, in reliance upon the exemption in
Section 4(2) thereof.

ITEM 6.  EXHIBITS AND REPORTS ON FORM 8-K

         (a) Exhibits

             Exhibit 27 - Financial data schedule

         (b) Reports on Form 8-K

             None filed during the Quarter

                                       11
<PAGE>
 
                                   SIGNATURES

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

                                VIDEO CITY, INC.

     Date:  December 12,1997    By /s/ Robert Y. Lee
                                --------------------
                                Robert Y. Lee
                                Chief Executive Officer
                                (Principal Executive Officer)
 
     Date:  December 12, 1997   By /s/ Timothy J. Denari
                                ------------------------
                                Timothy J. Denari
                                Chief Financial Officer
                                (Principal Financial Officer)

                                       12