SECURITIES AND EXCHANGE COMMISSION
                             Washington, D.C. 20549

                                      ----

                                    FORM 10-Q
     Quarterly Report Pursuant to Section 13 or 15(d) of Securities Exchange
                                   Act of 1934

                      For Quarter Ended September 30, 1996
                                        ------------------

                          Commission File Number 1-4373
                                                 ------

                            THREE-FIVE SYSTEMS, INC.
             ------------------------------------------------------
             (Exact name of registrant as specified in its charter)


          Delaware                                               86-0654102
-------------------------------                            ---------------------
(State or other jurisdiction of                               I.R.S. Employer
 incorporation or organization)                            Identification Number

1600 North Desert Drive, Tempe, Arizona                                  85281
---------------------------------------                                ---------
(Address of principal executive offices)                              (Zip Code)

                                  (602)389-8600
              ----------------------------------------------------
              (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, at the latest practical date.

CLASS                                       OUTSTANDING AS OF September 30, 1996
-----                                       ------------------------------------

Common                                                    7,779,829
Par value $.01 per share
<PAGE>
                            THREE-FIVE SYSTEMS, INC.
                          QUARTERLY REPORT ON FORM 10-Q
                    FOR THE QUARTER ENDED SEPTEMBER 30, 1996
                                TABLE OF CONTENTS


<TABLE>
<CAPTION>
                                     PART I - FINANCIAL INFORMATION
                                                                                                Page
                                                                                                ----
<S>               <C>                                                                           <C>
ITEM 1.           FINANCIAL STATEMENTS:                                                     

                  Consolidated Balance Sheets-
                           September 30, 1996 and December 31, 1995..........................     1

                  Consolidated Statements of Income (Loss)-
                           Three Months and Nine Months Ended September 30, 1996 and 1995....     2

                  Consolidated Statements of Cash Flows-
                           Nine Months Ended September 30, 1996 and 1995.....................     3

                  Notes to Consolidated Financial Statements.................................     4

ITEM 2.           MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS
                  OF OPERATIONS AND FINANCIAL CONDITION......................................     5


                                     PART II - OTHER INFORMATION


ITEM 6.           EXHIBITS AND REPORTS ON FORM 8-K..........................................     10

SIGNATURES..................................................................................     11
</TABLE>
<PAGE>
                            THREE-FIVE SYSTEMS, INC.
                           CONSOLIDATED BALANCE SHEETS
                                 (in thousands)
<TABLE>
<CAPTION>
                                                                      SEPTEMBER 30,  DECEMBER 31,
                                                                          1996           1995   
                                                                      -------------  ------------
                                                                        (Unaudited)             
                                     ASSETS                                                     
                                     ------                                                     
<S>                                                                      <C>           <C>      
CURRENT ASSETS:                                                                                 
  Cash and cash equivalents                                              $ 9,878       $ 4,551  
  Accounts receivable, net                                                 4,686         9,346  
  Inventories, net                                                         6,215        13,703  
  Deferred tax asset                                                       6,376         1,826  
  Other current assets                                                     2,696           491  
                                                                         -------       -------  
                                                                                                
       Total current assets                                               29,851        29,917  
                                                                                                
PROPERTY, PLANT AND EQUIPMENT, net                                        31,334        33,493  
                                                                                                
COST IN EXCESS OF NET ASSETS ACQUIRED, net                                   140           170  
                                                                                                
OTHER ASSETS                                                                 197           200  
                                                                         -------       -------  
                                                                                                
                                                                                                
                                                                         $61,522       $63,780  
                                                                         =======       =======  
                                                                                                
                         LIABILITIES AND STOCKHOLDERS' EQUITY                         
                         ------------------------------------                         
                                                                                                
CURRENT LIABILITIES:                                                                            
  Accounts payable                                                       $ 3,658       $ 3,199  
  Accrued liabilities                                                      4,685         1,318  
  Current maturities of long-term debt                                      --           3,000  
  Current taxes payable                                                     --            --    
                                                                         -------       -------  
                                                                                                
       Total current liabilities                                           8,343         7,517  
                                                                         -------       -------  
                                                                                                
 LONG-TERM DEBT, net of current maturities                                  --            --    
                                                                         -------       -------  
                                                                                                
                                                                                                
DEFERRED TAX LIABILITY                                                     2,528         1,039  
                                                                         -------       -------  
                                                                                                
                                                                                                
COMMITMENTS AND CONTINGENCIES                                                                   
                                                                                                
STOCKHOLDERS' EQUITY:                                                                           
  Preferred stock                                                           --            --    
  Common stock                                                                78            77  
  Additional paid-in capital                                              32,298        32,286  
  Retained earnings                                                       18,261        22,847  
  Cumulative translation adjustment                                           14            14  
                                                                         -------       -------  
                                                                                                
       Total stockholders' equity                                         50,651        55,224  
                                                                         -------       -------  
                                                                                                
                                                                         $61,522       $63,780  
                                                                         =======       =======  
</TABLE>                                                              

The  accompanying  notes  are an  integral  part of these  consolidated  balance
sheets. 
                                       1
<PAGE>
                            THREE-FIVE SYSTEMS, INC.
                    CONSOLIDATED STATEMENTS OF INCOME (LOSS)
                                   (UNAUDITED)
                      (in thousands, except share amounts)
<TABLE>
<CAPTION>
                                                                          THREE MONTHS                    NINE MONTHS
                                                                       ENDED SEPTEMBER 30,            ENDED SEPTEMBER 30,
                                                                  ---------------------------     ---------------------------

                                                                      1996            1995            1996            1995
                                                                  -----------     -----------     -----------     -----------
<S>                                                               <C>             <C>             <C>             <C>        
NET SALES                                                         $    13,118     $    24,217     $    45,657     $    70,805
                                                                  -----------     -----------     -----------     -----------

COSTS AND EXPENSES:
     Cost of sales                                                     19,798          19,790          46,143          53,510
     Selling, general and administrative                                1,316           1,419           4,246           3,904
     Research and development                                           1,074             770           2,904           1,576
                                                                  -----------     -----------     -----------     -----------
                                                                       22,188          21,979          53,293          58,990
                                                                  -----------     -----------     -----------     -----------

         Operating income (loss)                                       (9,070)          2,238          (7,636)         11,815


OTHER INCOME (EXPENSE):
  Interest, net                                                            90             120             242             741
  Other, net                                                              (17)            (14)           (116)            (29)
                                                                  -----------     -----------     -----------     -----------

INCOME (LOSS) BEFORE PROVISION FOR (BENEFIT FROM) INCOME TAXES         (8,997)          2,344          (7,510)         12,527
         Provision for (benefit from) income taxes                     (3,519)            961          (2,924)          5,011
                                                                  -----------     -----------     -----------     -----------


NET INCOME (LOSS)                                                 $    (5,478)    $     1,383     $    (4,586)    $     7,516
                                                                  ===========     ===========     ===========     ===========

EARNINGS (LOSS) PER COMMON SHARE AND COMMON
SHARE EQUIVALENT                                                  $     (0.70)    $      0.17     $     (0.59)    $      0.93
                                                                  ===========     ===========     ===========     ===========

WEIGHTED AVERAGE NUMBER OF COMMON
SHARES AND COMMON SHARE EQUIVALENTS
OUTSTANDING                                                         7,779,492       8,088,318       7,763,687       8,086,454
                                                                  ===========     ===========     ===========     ===========
</TABLE>
The accompanying notes are an integral part of these consolidated statements.
                                       2
<PAGE>
                            THREE-FIVE SYSTEMS, INC.
                      CONSOLIDATED STATEMENTS OF CASH FLOWS
                                   (UNAUDITED)
                                 (in thousands)
<TABLE>
<CAPTION>
                                                                             NINE MONTHS ENDED
                                                                               SEPTEMBER 30,
                                                                           ---------------------

                                                                             1996         1995
                                                                           --------     --------
<S>                                                                        <C>          <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
  Net income (loss)                                                        $ (4,586)    $  7,516
  Adjustments to reconcile net income (loss) to net cash
    provided by operating activities:
        Depreciation and amortization                                         2,626        1,553
        Provision (reduction) of accounts receivable valuation reserves          46          (61)
        Provision of inventory valuation reserves                             6,203        1,076
        (Gain) loss on disposal of assets                                        15          (38)
  Change in assets and liabilities:
        (Increase) decrease in accounts receivable                            4,614       (3,499)
        (Increase) decrease in inventories                                    1,285       (6,968)
        Increase in other assets                                               (671)        (550)
        Increase in accounts payable and accrued liabilities                  3,826        3,206
        Decrease in taxes payable, net                                       (4,592)      (1,246)
                                                                           --------     --------

             Net cash provided by operating activities                        8,766          989
                                                                           --------     --------


CASH FLOWS FROM INVESTING ACTIVITIES:
  Purchase of property, plant and equipment                                    (453)     (26,119)
  Proceeds from sale of furniture and equipment                                   1          278
                                                                           --------     --------

             Net cash used for investing activities                            (452)     (25,841)
                                                                           --------     --------


CASH FLOWS FROM FINANCING ACTIVITIES:

  Net payments on notes payable to banks                                     (3,000)        --
  Principal payments on and retirement of long-term debt                       --           (182)
  Stock options exercised                                                        13           29
                                                                           --------     --------

             Net cash used for financing activities                          (2,987)        (153)
                                                                           --------     --------

Effect of exchange rate changes on cash and cash equivalents                      0           (2)
                                                                           --------     --------

NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS                          5,327      (25,007)
CASH AND CASH EQUIVALENTS, beginning of period                                4,551       27,136
                                                                           --------     --------

CASH AND CASH EQUIVALENTS, end of period                                   $  9,878     $  2,129
                                                                           ========     ========
</TABLE>
The accompanying notes are an integral part of these consolidated statements.
                                       3
<PAGE>
ITEM 1. (continued)


              Three-Five  Systems,  Inc. and Subsidiaries  Notes to Consolidated
              ------------------------------------------------------------------
              Financial Statements
              --------------------


Note A        The accompanying   unaudited   Consolidated   Financial Statements
              have  been  prepared  in  accordance   with   generally   accepted
              accounting  principles for interim  financial  information and the
              instructions  to Form 10-Q.  Accordingly,  they do not include all
              the  information  and  footnotes  required by  generally  accepted
              accounting  principles for complete financial  statements.  In the
              opinion of management,  all adjustments (which include only normal
              recurring  adjustments)  necessary to present fairly the financial
              position,  results of  operations,  and cash flows for all periods
              presented have been made. The results of operations for the three-
              and   nine-month   periods  ended   September  30,  1996  are  not
              necessarily  indicative  of  the  operating  results  that  may be
              expected  for the entire  year ending  December  31,  1996.  These
              financial  statements  should  be read  in  conjunction  with  the
              Company's December 31, 1995 financial  statements and accompanying
              notes thereto.

Note B        Earnings  (loss) per share is  computed  by dividing  net earnings
              (loss) by the weighted  average number of common shares and common
              share  equivalents  assumed  outstanding  during  the  three-  and
              nine-month periods.  For the three and nine months ended September
              30,  1996,  no common share  equivalents  were  considered  in the
              calculation  of  earnings  (loss)  per  share  as the  effect  was
              antidilutive.   For  all  other  periods  presented  common  share
              equivalents  have been  included  in the  calculation  of earnings
              (loss)  per  share.  Fully  diluted  earnings  (loss) per share is
              considered  equal to  primary  earnings  (loss)  per  share in all
              periods presented.

Note C        Inventories consist of the following at:

                                          September 30, 1996  December 31, 1995
                                          ------------------  -----------------
                                            (Unaudited)
                                                     (in thousands)
              Raw Materials                  $  2,871              $  9,257
              Work-In-Process                   1,829                 2,002
              Finished Goods                    1,515                 2,444
                                             --------              --------
                                             $  6,215              $ 13,703
                                             ========              ========



Note D        Property, plant, and equipment consist of the following at:


                                          September 30, 1996  December 31, 1995
                                          ------------------  -----------------
                                           (Unaudited)
                                                     (in thousands)
              Building and
              improvements                   $10,427                 $10,375

              Furniture and
              equipment                       28,304                  27,971
                                             -------                 -------
                                              38,731                  38,346
              Less-accumulated
              depreciation                    (7,397)                 (4,853)
                                             -------                 -------
                                             $31,334                 $33,493
                                             =======                 =======
                                       4
<PAGE>
ITEM 2.           MANAGEMENT'S DISCUSSION AND ANALYSIS
------------------------------------------------------
Three Months Ended September 30, 1996 Compared with Three Months Ended September
--------------------------------------------------------------------------------
30, 1995.
---------

         Net sales were  $13,118,000 for the quarter ended September 30, 1996, a
decrease of 45.8 percent  compared with net sales of $24,217,000 for the quarter
ended  September 30, 1995.  The Company's net sales have not been subject to any
significant  seasonal  fluctuations  or  variations.   The  sales  decrease  was
primarily  a result of lower order  rates from a major  wireless  communications
customer for  existing  product  programs.  That  customer  informed the Company
during the first quarter that it had decided to phase out the Company's  highest
volume,  longest  running  programs more quickly than  originally  planned.  The
unexpected  reduction  of those  programs was the  greatest  contributor  to the
reduced revenue in the third quarter.  The long product  development time in the
custom  business  prevented  the Company from quickly  replacing  the phased out
programs. In the third quarter, the Company's largest customer accounted for net
sales of $8,905,000  compared with net sales of $19,300,000 to that customer for
the quarter ended  September 30, 1995,  for an overall  decrease in net sales to
the Company's  largest  customer of 53.9 percent.  The Company's  major customer
accounted for  approximately  67.9 percent of the net sales in the third quarter
1996  compared with  approximately  79.7 percent for the  comparable  quarter in
1995. All other customers  accounted for net sales of $4,213,000 for the quarter
ended  September  30, 1996  compared  with the net sales of  $4,917,000  for the
quarter ended September 30, 1995, for an overall decrease of 14.3%.

         Cost of sales, as a percentage of net sales, increased to 150.9 percent
for the quarter  ended  September 30, 1996 as compared with 81.7 percent for the
quarter ended September 30, 1995. The corresponding  decline in the gross margin
in the third quarter was the result of a number of factors,  including increased
provisions for excess and obsolete inventory,  manufacturing variances occurring
as a result of decreased manufacturing volume and material purchases,  and sales
of low margin  rework  products.  Without the  provision for excess and obsolete
inventory, the cost of sales, as a percentage of net sales, would have been 97.3
percent for the third quarter.

         Selling,  general,  and administrative  expense decreased to $1,316,000
for the quarter ended  September 30, 1996 from  $1,419,000 for the quarter ended
September 30, 1995.  The 7.3 percent  decrease was due to lower bad debt expense
and lower directors and officers insurance premiums offset by increased salaries
and  benefits.  Selling,  general,  and  administrative  expense  increased as a
percentage of net sales to 10.0 percent for the quarter ended September 30, 1996
from 5.9 percent for the quarter ended September 30, 1995, primarily as a result
of decreased sales.

         Research and development expense totaled $1,074,000,  or 8.2 percent of
net sales,  for the quarter ended  September 30, 1996 as compared with $770,000,
or 3.2 percent of net sales, for the quarter ended September 30, 1995.  Research
and  development  expenses  consist  principally  of  salaries  and  benefits to
scientists and other personnel,  related  facilities costs, and various expenses
for projects.  Research and development expense has increased as the Company has
invested in new technologies and manufacturing  processes and has continued with
its  in-house   process   development   efforts   related  to  the   high-volume
manufacturing  LCD line located in Tempe,  Arizona.  The Company  believes  that
continued  investments  in research and  development  relating to  manufacturing
processes and new display  technology are necessary to remain competitive in its
marketplace  as  well  as  providing  opportunities  for  growth.  Further,  the
development  of the  high-volume  manufacturing  LCD line will help  reduce  its
dependence on foreign suppliers.  Accordingly, the Company expects that research
and development  expenses will continue to increase in absolute  dollars for the
remainder of 1996 and on into 1997.

         Interest  income  (net) for the quarter  ended  September  30, 1996 was
$90,000,  down from  $120,000 for the quarter  ended  September  30,  1995.  The
decrease in  interest  income was the result of  investing  lower  average  cash
balances  during the quarter.  Other  expenses (net) was $17,000 for the quarter
ended  September  30,  1996 as  compared  with  $14,000  for the  quarter  ended
September 30, 1995. The difference was due to increased  foreign  exchange loss,
decreased closed facilities  expenses,  a loss on sale of assets for the quarter
ended September 30, 1996 as compared to a gain on sale of assets for the quarter
ended  September  30,  1996  and  miscellaneous  income  for the  quarter  ended
September 30, 1996.
                                       5
<PAGE>
         There was a benefit  from income  taxes of  $3,519,000  for the quarter
ended September 30, 1996 as compared to a provision for income taxes of $961,000
for the quarter ended September 30, 1995. This resulted primarily from a loss in
the quarter ended September 30, 1996, as compared with income in the same period
in 1995.

         Net loss was  $5,478,000,  or $0.70 per share,  for the  quarter  ended
September 30, 1996 as compared to net income of $1,383,000,  or $0.17 per share,
for the quarter ended  September 30, 1995.  Without the provision for excess and
obsolete  inventory,  the net  loss  for  the  third  quarter  would  have  been
$1,179,000 or $0.15 per share.

Nine Months Ended  September 30, 1996 Compared with Nine Months Ended  September
--------------------------------------------------------------------------------
30, 1995.
---------

         Net sales were  $45,657,000  for the nine months  ended  September  30,
1996, a decrease of 35.5 percent  compared with net sales of $70,805,000 for the
nine months ended  September  30, 1995.  The  Company's  net sales have not been
subject  to any  significant  seasonal  fluctuations  or  variations.  The sales
decrease  was  primarily  a result of lower  order  rates from a major  wireless
communications   customer  for  existing  product  programs.  The  long  product
development  time in the custom  business  prevented  the Company  from  quickly
replacing the phased out programs.  In the nine-month period ended September 30,
1996,  the Company's  largest  customer  accounted for net sales of  $31,523,000
compared  with net sales of  $57,035,000  to that  customer  for the nine months
ended September 30, 1995 for an overall decrease of 44.7 percent.  The Company's
major customer accounted for approximately 69.0 percent of the net sales for the
nine months ended  September 30, 1996 compared with  approximately  80.6 percent
for the comparable  period in 1995. All other customers  accounted for net sales
of  $14,134,000  for the nine months ended  September 30, 1996 compared with net
sales of $13,770,000 for the nine months ended September 30, 1995.

         Cost of sales, as a percentage of net sales, increased to 101.1 percent
for the nine months ended  September  30, 1996 as compared with 75.6 percent for
the nine months ended September 30, 1995. The corresponding decline in the gross
margin was the result of a number of factors, including increased provisions for
excess and obsolete inventory,  manufacturing variances occurring as a result of
decreased  manufacturing volume and material purchases,  and sales of low margin
rework products.  Without the provision for excess and obsolete  inventory taken
in the third  quarter,  the cost of sales,  as a percentage of net sales,  would
have been 85.7 percent for the nine month period.

         Selling,  general,  and administrative  expense increased to $4,246,000
for the nine months ended September 30, 1996 from $3,904,000 for the nine months
ended  September 30, 1995.  The 8.8 percent  increase  resulted  primarily  from
wages,  legal,  accounting and consulting expenses offset by lower directors and
officers  insurance  premiums  and  bad  debt  expense.  Selling,  general,  and
administrative expense increased as a percentage of net sales to 9.3 percent for
the nine months  ended  September  30, 1996 from 5.5 percent for the nine months
ended September 30, 1995, primarily as a result of decreased sales. Research and
development  expense totaled  $2,904,000,  or 6.4 percent of net sales,  for the
nine months ended September 30, 1996 as compared with $1,576,000, or 2.2 percent
of net sales,  for the nine  months  ended  September  30,  1995.  Research  and
development  expenses consist principally of salaries and benefits to scientists
and  other  personnel,  related  facilities  costs,  and  various  expenses  for
projects.  Research  and  development  expense has  increased as the Company has
invested in new technologies and manufacturing  processes and has continued with
its  in-house   process   development   efforts   related  to  the   high-volume
manufacturing LCD line located in Tempe, Arizona

         Interest  income (net) for the nine months ended September 30, 1996 was
$242,000,  down from $741,000 for the nine months ended  September 30, 1995. The
decrease in  interest  income was the result of  investing  lower  average  cash
balances during the nine months.  Other expenses (net) increased to $116,000 for
the nine months ended  September 30, 1996 from $29,000 for the nine months ended
September  30,  1995.  The  increase  was  due  primarily  to  increased  closed
facilities  expenses,  increased  foreign  exchange  loss  and a loss on sale of
assets for the nine  months  ended  September  30, 1996 as compared to a gain on
sale of assets for the nine months ended September 30, 1995.

         There was a benefit from income taxes of $2,924,000 for the nine months
ended  September  30,  1996 as  compared  to a  provision  for  income  taxes of
$5,011,000 for the nine months ended September 30, 1995. This
                                       6
<PAGE>
resulted  primarily  from a loss in the nine months ended  September 30, 1996 as
compared with income in the same period in 1995.

         Net loss was $4,586,000,  or $0.59 per share, for the nine months ended
September 30, 1996 as compared to net income of $7,516,000,  or $0.93 per share,
for the nine months ended  September 30, 1995.  Without the provision for excess
and obsolete  inventory  taken in the third quarter,  the net loss for the first
nine months in 1996 would have been $287,000 or $0.04 per share.

Liquidity and Capital Resources

         During the nine months ended September 30, 1996, the Company  generated
$8,766,000 in cash flow from  operations  as compared  with $989,000  during the
same  period  in  1995.  The  increase  in  cash  flow  from   operations   with
substantially  lower earnings was primarily due to the  significant  increase in
the Company's non-cash  depreciation  expense and inventory reserve provision as
well as the substantial reduction of its accounts receivable and inventory.  The
Company's  working  capital  decreased to $21,508,000 at September 30, 1996 from
$22,400,000  at December  31, 1995,  primarily as a result of increased  accrued
liabilities.  The Company's  current ratio at September 30, 1996 was 3.6-to-1 as
compared with a current ratio of 4.0-to-1 at December 31, 1995.

         During the nine months ended September 30, 1996, the Company's  primary
financing  activity was to repay with cash flow from  operations  $3,000,000  of
debt that was  outstanding  under the  revolving  line of credit at December 31,
1995. In August 1996, the Company modified its $15.0 million unsecured revolving
line of credit, which matures May 31, 1997, with its primary lender, Wells Fargo
Bank (formerly,  First Interstate Bank of Arizona). The unsecured revolving line
of credit  modified the $5.0 million  revolving  line of credit  entered into in
September 1995. At September 30, 1996, no borrowings were outstanding under this
credit  facility.  Advances  under the revolving  line may be made as Prime Rate
Advances,  which accrue interest  payable  monthly,  at the bank's prime lending
rate,  or as LIBOR Rate  Advances  which bear  interest  at 150 basis  points in
excess of the LIBOR Base Rate.  The  Company's  subsidiary,  Three-Five  Systems
Limited,  has  established an annually  renewable  credit facility with a United
Kingdom  bank,  Barclays  Bank  PLC,  in  order  to  fund  its  working  capital
requirements.  The facility provides  $350,000 of borrowing  capacity secured by
accounts  receivable  of  Three-Five  Systems  Limited.  Advances  are  based on
accounts  receivable,  as defined.  Advances  under the credit  facility  accrue
interest,  which is payable  quarterly,  at the bank's  base rate plus 200 basis
points.  The United Kingdom credit  facility  matures June 20, 1997.  Three-Five
Systems  Limited  had no  borrowings  outstanding  under  this line of credit at
September 30, 1996.

         On August 19, 1996,  the Board of Directors  authorized  the repurchase
from time to time of up to one million  shares of the Company's  common stock on
the open market or in negotiated  transactions,  depending on market  conditions
and other  factors.  The  closing  price of the  Company's  common  stock on the
previous  trading day was $8.75.  In  September  1996,  the  Company  received a
commitment  from Wells  Fargo Bank for a new $5  million  non-revolving  line of
credit/term loan to provide financing for the acquisition of any treasury shares
(the "Treasury Stock Loan"). It is expected that the Treasury Stock Loan will be
available for advances for one year followed by a three year amortization period
in which  principal will be payable  quarterly in equal  installments.  Advances
under the Treasury Stock Loan will be made as either Prime Rate Advances,  which
accrue interest payable  monthly,  at the bank's prime lending rate, or as LIBOR
Rate  Advances  which bear  interest at 225 basis  points in excess of the LIBOR
Base Rate. At maturity of the draw period,  the Company may chose either a fixed
rate at 250 basis  points in excess of the Treasury  Rate or a variable  rate of
either the Prime Rate or LIBOR Rate.  The Treasury Stock Loan will be secured by
all equipment located in the State of Arizona and a non-filed negative pledge on
the  Company's  real estate  located at 1600 N. Desert  Drive.  The Company must
apply  all  proceeds  from the  sale of any  treasury  stock to the  outstanding
principal  balance of the  Treasury  Stock Loan.  As of September  30, 1996,  no
treasury shares had been purchased by the Company.

         Capital  expenditures  during the nine months ended  September 30, 1996
were approximately $453,000, as compared with $26,119,000 during the same period
in 1995.  Capital  expenditures  for the nine months  ended  September  30, 1996
consisted primarily of manufacturing  equipment for its operations in Manila and
Arizona.  Expenditures  for the nine months ended  September 30, 1995  consisted
primarily  of  payments  to  complete  and  equip  its  new   manufacturing  and
headquarters  facility in Tempe,  Arizona as well as acquire  equipment  for its
                                       7
<PAGE>
operations in Manila and Arizona. The Company expects to expend approximately $1
million in the remainder of 1996 on capital  equipment and expenditures  related
to advanced  manufacturing  processes,  the  high-volume  LCD line and necessary
manufacturing equipment.

         The  Company  believes  that  its  capital,   together  with  the  loan
commitments  described above and  anticipated  cash flow from  operations,  will
provide  adequate  sources  to fund  operations  in the near term.  The  Company
anticipates that any additional cash requirements as the result of operations or
capital  expenditures  will be financed  through  cash flow from  operations  or
borrowings from the Company's primary lender.

Effects of Inflation and Foreign Currency Exchange Fluctuations

         The results of operations of the Company for the periods discussed have
not been significantly  affected by inflation or foreign currency  fluctuations.
The Company  generally  sells its products and services and negotiates  purchase
orders with its foreign  suppliers in United States dollars.  Such  transactions
expose the Company to  exchange  rate  fluctuations  for the period of time from
inception of the transaction until it is settled.  An exception is the Company's
sub-assembly agreement in the Philippines,  which is based on a fixed conversion
rate,  exposing the Company to exchange rate  fluctuations  with the  Philippine
peso.  Although  the Company has not incurred  any  material  exchange  gains or
losses to date,  there can be no  assurance  that  fluctuations  in the currency
exchange  rates in the future will not have an adverse  effect on the  Company's
operations. The Company from time to time may enter into hedging transactions in
order to minimize its exposure to currency rate fluctuations.

Business Outlook and Risk Factors

         The  principal  challenge  facing the Company in the near future is the
ongoing  development  of new  programs to replace  those  older  programs of the
Company's  major  customer that are being phased out more quickly than expected.
Due to the long product life cycle inherent in the custom business, however, the
Company  will  continue to be  adversely  impacted in the fourth  quarter by the
unexpected  phase out of those  programs by the Company's  major  customer.  The
adverse impact will occur through reduced revenue and margins,  with the margins
expected  to  suffer  principally  from  decreased  absorption  (as a result  of
manufacturing  inefficiencies from reduced sales).  Although the Company expects
that revenue in the fourth  quarter will improve over the third  quarter,  it is
possible that the Company may have a loss for the fourth quarter.  However,  the
Company  has  several  new  significant  programs  which are  expected  to begin
production  late in the fourth  quarter and in the first  quarter of 1997.  As a
result,  it is the  business  plan of the  Company  for the  revenues in 1997 to
return to 1995 levels or better.  Further,  the Company  expects that  increased
production and inventory turns in 1997 will allow the Company's gross margins to
gradually return to the low- or mid-twenties as a percent of revenue.

         In the past several  years,  a majority of the  Company's  business has
been in the communications  industry and has been with one customer. The Company
continues,  however, to establish new customer  relationships with major OEMs in
an effort to  diversify  its  customer  and market  base.  Of the 24 programs in
design engineering,  only three are with the Company's major customer,  although
each of those  three  programs  are  significant  in size.  Fifteen  of those 24
programs are in industries other than communications. In 1997, the business plan
of the Company calls for its current major customer to account for approximately
40 percent of its  revenue  and for  communication  products to account for less
than 50 percent of its revenue.

         The  Company's  future  operating  results  may be  affected by various
trends,  developments and factors that the Company must  successfully  manage in
order to achieve favorable  operating  results.  In addition,  there are trends,
developments,  and  factors  beyond the  Company's  control  that may affect its
operations.  In  accordance  with  the  provisions  of  the  Private  Securities
Litigation  Reform Act of 1995, the  cautionary  statements and risk factors set
forth below and in the Company's  other filings with the Securities and Exchange
Commission,  including its Form 10-K,  identify important trends,  factors,  and
currently  known   developments  that  could  cause  actual  results  to  differ
materially from those in any forward-looking statements contained in this report
and in any written or oral statements of the Company. Forward-looking statements
in this report include revenue,  margin,  expense, and earnings analysis for the
remainder  of 1996 and 1997 as well as the  Company's  expectations  relating to
future design and  production  orders.  Risk factors  include the risk of having
just a few customers supplying the majority of its business,  the ability of the
Company to complete  satisfactory  design services and secure future  production
orders,  
                                       8
<PAGE>
the ability of the Company to penetrate  new markets and  diversify its customer
base,  the  impact of  competitive  products  and  pricing,  product  demand and
acceptance   for  the  products  of  the  Company's   customers,   manufacturing
inefficiencies,   inventory  risks,  technological  difficulties  including  the
ability of the Company to implement new manufacturing processes and ramp the LCD
line  into  full  production,  the  availability  of  parts  and  supplies  from
third-party suppliers on a timely basis and at reasonable prices,  including the
availability of glass from its Asian suppliers and its own LCD line, and general
economic conditions.

         As noted  previously,  one  customer  is  currently  responsible  for a
majority  of the  Company's  business.  Although  that  customer  is expected to
account for only 40 percent of the  Company's  revenue in 1997,  the majority of
the Company's business in 1997 will still likely come from a core customer base.
Thus, any material delay, cancellation,  or reduction of orders from one or more
of those core  customers  could have a material  adverse effect on the Company's
operations.

         Although  the trend of the Company is to enter into more  manufacturing
contracts with its  customers,  the principal  benefit of these  contracts is to
clarify order lead times, inventory risk allocation, and similar matters and not
to provide firm, long-term volume purchase commitments.  The Company has no firm
long-term  volume  purchase  commitments  from  its  customers.  Thus,  customer
commitments can be canceled and expected volume levels can change or be delayed.
The timely replacement of canceled,  delayed,  or reduced  commitments cannot be
assured and, among other things,  could result in the Company holding excess and
obsolete  inventory.  These  risks are  exacerbated  because a  majority  of the
Company's expected sales will be to customers in the electronics industry, which
is subject  to severe  competitive  pressures,  rapid  technological  change and
obsolescence.

         Another  risk,  which  is  inherent  in  custom  manufacturing,  is the
satisfactory  completion  of design  services  and the  securing  of  production
orders.  Completion of the design is dependent on the customer's  changing needs
and not every design is  successful in meeting  those needs.  In addition,  some
designs test new theories or applications  and may not meet the desired results.
Failure of a design order to achieve the customer's desired results could result
in a material  effect on the  Company's  operations  if the expected  production
order  for  that  product  was  significant.  It is  expected  that  as  much as
two-thirds of the Company's anticipated revenue for 1997 will come from programs
currently in the design or pilot production stage.

         The Company  designs and  manufactures  products  based on firm quotes.
Thus,  the Company  bears the risk of  component  price  increases,  which could
adversely affect the Company's gross margins.  In addition,  the Company depends
on certain suppliers and the unavailability or shortage of materials could cause
delays or lost orders,  either of which could have a material  adverse effect on
the Company.

         Finally,  the Company's success,  especially in penetrating new markets
and increasing its OEM customer base, depends to a large extent upon the efforts
and abilities of key managerial and technical employees. The loss of services of
certain key personnel could have a material  adverse effect on the Company.  The
Company's  business  also  depends  upon its  ability to continue to attract and
retain senior managers and skilled  employees.  Failure to do so could adversely
effect the Company's operations.

         As a result of the noted  factors,  the  Company's  stock  price may be
subject to  significant  volatility,  particularly  on a  quarterly  basis.  Any
shortfall in revenues or earnings from levels  expected by investors and brokers
could have an immediate and  significant  adverse effect on the trading price of
the Company's  common stock in any given period.  Additionally,  the Company may
not learn of such shortfalls until late in a fiscal quarter,  which could result
in an even  more  immediate  and  adverse  effect  on the  trading  price of the
Company's common stock. Finally, other factors which generally affect the market
for stocks of high  technology  companies could cause the price of the Company's
stock to fluctuate substantially over short periods.
                                       9
<PAGE>
                           PART II. OTHER INFORMATION

ITEM 6.  Exhibits and Reports on Form 8-K
         --------------------------------

              (a) EXHIBIT 11: Statement Re:  Computation of Per Share Earnings.

              (b) EXHIBIT 27: Financial Data Schedule

              (c) Reports on Form 8-K: None

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<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.


                            THREE-FIVE SYSTEMS, INC.
                            ------------------------
                                  (Registrant)



Dated:_______________               By ______________________
                                        Jeffrey D. Buchanan

                                    Its: Vice President Finance, Administration 
                                         and Legal; Chief Financial Officer

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