FORM 10-Q

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

       QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
                              EXCHANGE ACT OF 1934

                  FOR THE QUARTERLY PERIOD ENDED JUNE 27, 1997

                         Commission file number 0-28352

                         TECHNOLOGY SERVICE GROUP, INC.
             (Exact name of Registrant as specified in its charter)

               Delaware                                    59-1637426
   (State or other jurisdiction of                      (I.R.S. Employer
    Incorporation or Organization)                   Identification Number)

20 Mansell Court East - Suite 200
         Roswell, Georgia                                     30076
(Address of  principal executive offices)                  (Zip Code)

                                 (770) 587-0208
                         (Registrant's Telephone Number,
                              including area code)

Indicate by check mark whether  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 ___

At July 31, 1997, there were 4,708,476  shares of common stock,  $.01 par value,
outstanding.


<PAGE>
                                     INDEX
                                                                           Page
                                                                          Number

PART I.   FINANCIAL INFORMATION

   Item 1.  Financial Statements

             Consolidated Balance Sheets at June 27, 1997
               (unaudited) and March 28, 1997                                3

             Consolidated Statements of Operations for the
               three months ended June 27, 1997 (unaudited) and
               June 28, 1996 (unaudited)                                     4

             Consolidated Statements of Cash Flows for the
               three months ended June 27, 1997 (unaudited) and
               June 28, 1996 (unaudited)                                     5

             Consolidated Statement of Changes in Stockholders'
               Equity for the three months ended June 27, 1997
               (unaudited)                                                   6

             Notes to Consolidated Financial Statements                      7

   Item 2.  Management's Discussion and Analysis of
            Financial Condition and Results of Operations                   10

PART II.   OTHER INFORMATION

   Item 6.  Exhibits and Reports on Form 8-K                                18


                                       2

<PAGE>

                         PART I - FINANCIAL INFORMATION

Item 1.  Financial Statements

                         TECHNOLOGY SERVICE GROUP, INC.
                           CONSOLIDATED BALANCE SHEETS

                                                  June 27,            March 28,
                                                    1997                1997
                                              ---------------       ------------
                                                 (Unaudited)
ASSETS
Current assets:
    Cash                                        $     99,924       $     67,880
    Accounts receivable, less 
        allowance for doubtful
        accounts of $147,000                       3,162,195          3,234,777
    Inventories                                    9,781,012         10,879,180
    Refundable income taxes                          301,146               --
    Deferred tax asset                               350,174            542,654
    Prepaid expenses and other 
        current assets                               112,549            140,981
                                                ------------       ------------
          Total current assets                    13,807,000         14,865,472
Property and equipment, net                          723,758            847,443
Other assets                                       4,037,175          4,059,467
                                                ------------       ------------
                                                $ 18,567,933       $ 19,772,382
                                                ============       ============

LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
    Bank overdraft                            $      324,194       $    242,652
    Borrowings under revolving 
       credit agreement                            2,399,705          3,810,961
    Accounts payable                               1,938,012          1,047,206
    Income taxes payable                                --              126,007
    Deferred revenue                                    --              375,000
    Accrued liabilities                              742,455          1,015,032
    Accrued restructuring charges                       --               27,794
                                             ---------------      -------------
          Total current liabilities                5,404,366          6,644,652
Long-term liabilities                                   --                 --
                                             ---------------      -------------
          Total liabilities                        5,404,366          6,644,652
                                             ---------------      -------------
Commitments and contingencies                           --                 --
Stockholders' equity:                                        
    Preferred stock, $100 par value,                         
        100,000 authorized,                                  
        none issued or outstanding                      --                 --
    Common stock, $.01 par value,                            
        10,000,000 shares authorized,                        
        4,701,760 shares issued and                          
        outstanding                                  47,018              47,018
    Capital in excess of par value               11,962,856          11,962,856
    Retained earnings                             1,159,579           1,122,449
    Cumulative translation adjustment                (5,886)             (4,593)
                                             --------------      --------------
          Total stockholders' equity             13,163,567          13,127,730
                                             --------------      --------------
                                             $   18,567,933      $   19,772,382
                                             ==============      ==============
                                                          

              The accompanying notes are an integral part of these
                       consolidated financial statements.

                                       3

<PAGE>

                         TECHNOLOGY SERVICE GROUP, INC.
                      CONSOLIDATED STATEMENTS OF OPERATIONS
                                   (Unaudited)

                                                     Three Months Ended
                                           ----------------------------------
                                              June 27,          June 28,
                                                1997              1996
                                           ---------------  -----------------


Net sales                                    $  6,216,558       $ 12,078,496
                                           ---------------  -----------------

Costs and expenses:
    Cost of goods sold                          5,122,640          9,840,449
    General and administrative
        expenses                                  554,065            644,985
    Marketing and selling 
        expenses                                  164,555            361,478
    Engineering, research and
        development expenses                      292,028            409,095
    Litigation settlement                           --              (105,146)
    Interest expense                               72,150            141,540
    Other income                                  (14,089)           (16,187)
                                           ---------------  -----------------
                                                6,191,349         11,276,214
                                           ---------------  -----------------
Income before income tax (expense)
    benefit                                        25,209            802,282
Income tax (expense) benefit                       11,921           (217,202)
                                           ---------------  -----------------
Net income                                      $  37,130          $  585,080
                                           ===============  =================

Income per common and common
    equivalent share:
      Primary                                     $ 0.02             $  0.13
                                           ===============  =================
      Assuming full dilution                     $  0.02             $  0.13
                                           ===============  =================

Weighted average number of 
    common and common equivalent
    shares outstanding:
      Primary                                   5,025,208          4,501,732
                                           ===============  =================
      Assuming full dilution                    5,025,208          4,501,732
                                           ===============  =================

              The accompanying notes are an integral part of these
                       consolidated financial statements.


                                       4
<PAGE>

                         TECHNOLOGY SERVICE GROUP, INC.
                      CONSOLIDATED STATEMENTS OF CASH FLOWS
                                   (Unaudited)
<TABLE>
<CAPTION>


                                                                       Three Months Ended
                                                               -----------------------------------
                                                                   June 27,           June 28,
                                                                     1997               1996
                                                               ---------------    ----------------
<S>                                                            <C>                <C>          
Cash flows from operating activities
    Net income                                                 $     37,130       $     585,080
    Adjustments to reconcile net income to net cash
      provided by (used for) operating activities
        Depreciation and amortization                               227,146             287,973
        Gain on disposition of assets                                  (633)              --
        Provisions for inventory losses and
          warranty expense                                           61,170             172,942
        Provision for uncollectible accounts receivable               --                 30,882
        Deferred tax expense (benefit)                              274,832            ( 45,390)
        Changes in operating assets and
          liabilities
          (Increase) decrease in accounts                            72,582          (2,795,058)
             receivable
          (Increase) decrease in inventories                      1,070,364          (1,203,069)
          (Increase) in refundable income taxes                    (301,146)              --
          Decrease in prepaid expenses and
            other current assets                                     28,432              75,517
          (Increase) in other assets                               (127,410)                (12)
          Increase in accounts payable                              890,806             515,291
          Increase (decrease) in income taxes payable              (126,007)            113,549
          (Decrease) in accrued liabilities                        (305,943)           (340,655)
          (Decrease) in accrued restructuring charges               (27,794)              --
          (Decrease) in deferred revenue                           (375,000)           (485,512)
          Other                                                          88                (633)
                                                               ------------       -------------
            Net cash provided by (used for)
               operating activities                               1,398,617          (3,089,095)
                                                               ------------       -------------
Cash flows from investing activities
    Proceeds from disposition of assets                                 696               --
    Capital expenditures                                            (37,555)            (58,981)
                                                               ------------       -------------
            Net cash used for investing  activities                 (36,859)            (58,981)
                                                               ------------       -------------
Cash flows from financing activities
    Net payments under revolving credit
      agreement                                                  (1,411,256)           (901,025)
    Proceeds from initial public offering, net
      of issuance expenses                                            --              8,648,215
    Proceeds from exercise of common stock
      options and warrants                                            --                160,000
    Repayment of notes payable to stockholders                        --             (2,800,000)
    Principal payments on long-term debt and
      capital lease obligations                                       --             (2,578,410)
    Increase in bank overdraft                                       81,542             760,228
                                                               ------------       -------------
            Net cash provided by (used for)
              financing activities                               (1,329,714)          3,289,008
                                                               ------------       -------------
Increase in cash                                                     32,044             140,932
Cash, beginning of period                                            67,880              19,787
                                                               ============       =============
Cash, end of period                                            $     99,924       $     160,719
                                                               ============       =============
</TABLE>

              The accompanying notes are an integral part of these
                       consolidated financial statements.

                                       5
<PAGE>

                         TECHNOLOGY SERVICE GROUP, INC.
                  STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY
                    FOR THE THREE MONTHS ENDED JUNE 27, 1997
                                   (Unaudited)

<TABLE>
<CAPTION>


                                                     Capital in                         Cummulative
                                    Common           Excess of        Retained          Translation
                                     Stock           Par Value        Earnings           Adjustment         Total
                                    -------       -------------     -------------       -----------     -------------
<S>                                 <C>           <C>               <C>                  <C>            <C>          
Balance at March 29, 1996           $47,018       $  11,962,856     $   1,122,449        $ (4,593)      $  13,127,730  
Net income for the period             --                 --                37,130           --                 37,130
Foreign currency translation
  adjustment                          --                 --                --               (1,293)            (1,293)
                                    -------       -------------     -------------         --------      -------------
Balance at June 27, 1997            $47,018       $  11,962,856     $   1,159,579         $ (5,886)     $  13,163,567
                                    =======       =============     =============         ========      =============
</TABLE>
                                
              The accompanying notes are an integral part of these
                       consolidated financial statements.


                                       6
<PAGE>

                         TECHNOLOGY SERVICE GROUP, INC.

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

1. GENERAL

         The accompanying  unaudited  consolidated  balance sheet as of June 27,
1997, unaudited consolidated statements of operations for the three months ended
June 27, 1997 and June 28, 1996, unaudited consolidated statements of cash flows
for the three  months  ended  June 27,  1997 and June 28,  1996,  and  unaudited
consolidated  statement of changes in stockholders'  equity for the three months
ended June 27, 1997 have been prepared in accordance  with  instructions to Form
10-Q.  Accordingly,  the  financial  information  does  not  include  all of the
information and footnotes required by generally accepted  accounting  principles
for  complete  financial   statements.   In  the  opinion  of  management,   all
adjustments,  consisting  only of normal  recurring  accruals  and  adjustments,
necessary for a fair  presentation  of the financial  position of the Company at
June 27, 1997 and its  operations  and its cash flows for the three months ended
June 27, 1997 and June 28, 1996 have been made. For further  information,  refer
to the audited  financial  statements  and  footnotes  included in the Company's
annual report on Form 10-K for the fiscal year ended March 28, 1997.

         The results of operations  for the three months ended June 27, 1997 are
not  necessarily  indicative  of the results  for the entire  fiscal year ending
April 3, 1998.

2. INVENTORIES

         Inventories  at June 27,  1997 and  March  28,  1997  consisted  of the
following:

                                                 June 27,            March 28,
                                                  1997                1997
                                            --------------       -------------
                                                              
     Raw materials                          $    6,229,106       $   6,153,808
     Work-in-process                             1,826,929           2,117,668
     Finished goods                              2,840,375           4,036,191
                                            --------------       -------------
                                                10,896,410          12,307,667
     Reserve for potential losses               (1,115,398)         (1,428,487)
                                            --------------       -------------
                                            $    9,781,012       $  10,879,180
                                            ==============       =============
                                                              
3. BORROWINGS UNDER REVOLVING CREDIT AGREEMENT

         At June 27, 1997 and March 28,  1997,  the Company is able to borrow up
to a maximum of $9 million under a revolving  credit  agreement  pursuant to the
terms of a Loan and  Security  Agreement  (the  "Loan  Agreement")  between  the
Company  and its bank.  At June 27,  1997 and March 28,  1997,  the  Company had
outstanding debt of $2,399,705 and $3,810,961, respectively, under the revolving
credit agreement.  Indebtedness  outstanding under the Loan Agreement is secured
by  substantially  all  assets of the  Company  including  accounts  receivable,
inventories and property and equipment.  The borrowing limit under the revolving
credit  agreement is based upon  specified  percentages  applied to the value of
collateral, consisting of eligible accounts receivable and inventories. Interest
is payable  monthly at a variable rate per annum equal to 1.5% above a base rate
quoted by Citibank, N.A. (8.5% at June 27, 1997 and March 28, 1997).


                                       7
<PAGE>

4. INCOME PER COMMON AND COMMON EQUIVALENT SHARE

         Income  per common and  common  equivalent  share for the three  months
ended June 27, 1997 and June 28,  1996 is computed on the basis of the  weighted
average  number of common  shares  outstanding  and dilutive  common  equivalent
shares  outstanding  during  the  period,   except  as  required  by  Accounting
Principles Board Opinion No. 15, Earnings per Share, all outstanding options and
warrants have been included in the  calculation in accordance  with the modified
treasury  stock  method  and  except as  required  by  Securities  and  Exchange
Commission  Staff  Accounting  Bulletin  ("SECSAB")  Topic 4:D, shares of common
stock underlying  warrants issued and options granted during the 12 months prior
to the Company's May 10, 1996 initial public offering at prices below the public
offering  price have been  included in the  calculation  of weighted  average of
common and common equivalent  shares  outstanding as if they were outstanding as
of the beginning of the periods.

5. INCOME TAXES

          Income taxes charged  (credited)  to  operations  for the three months
ended June 27, 1997 and June 28, 1996 consisted of the following:

                                                      Three Months Ended
                                                 ------------------------------
                                                    June 27,         June 28,
                                                      1997              1996
                                                 ------------      -----------
          Current tax expense (benefit)
            Federal                               $  (257,308)     $   218,953
            State                                     (29,445)          43,640
                                                 ------------      -----------
                                                     (286,753)         262,593
                                                 ------------      -----------
          Deferred tax expense (benefit)                           
            Federal                                   248,486          (34,742)
            State                                      26,346          (10,649)
                                                 ------------      -----------
                                                      274,832          (45,391)
                                                 ------------      -----------
                                                 $    (11,921)     $   217,202
                                                 ============      ===========
                                                            
         A reconciliation  of income tax expense  (benefit) for the three months
ended June 27, 1997 and June 28, 1996 to income tax expense (benefit) determined
by applying the  applicable  U.S.  statutory  federal  income tax rate to income
before income taxes is as follows:

                                                      Three Months Ended
                                                 -------------------------------
                                                   June 27,           June 28,
                                                     1997              1996
                                                 -------------    --------------
          Statutory U.S. tax rates               $      8,361      $   272,776 
          State taxes, net of federal 
            benefit                                   (19,433)          26,276
          Non-deductible expenses                      13,564           14,932
          Utilization of loss carryforwards           (71,995)         (71,995)
          Other                                        57,582          (24,787)
                                                 ------------      -----------
          Effective tax rates                    $   (11,921)      $   217,202
                                                 ============      ===========


                                       8
<PAGE>

6. SUPPLEMENTAL CASH FLOW INFORMATION

          Supplemental cash flow information for the three months ended June 27,
1997 and June 28, 1996 consists of the following:

                                                          Three Months Ended
                                                     ---------------------------
                                                      June 27,         June 28,
                                                        1997             1996
                                                     ---------       -----------
          Interest paid                                $81,632      $   284,035
          Income taxes paid                            140,400          149,044
          Deferred offering expenses charged
            against proceeds of initial
            public offering                               --            338,372
          Tax benefits applied to goodwill              82,352          159,663

8. COMMITMENTS AND CONTINGENT LIABILITIES

         In June 1997, the Company  entered into an agreement with  Southwestern
Bell Telephone  Company  ("SWBT") that supersedes and terminates a December 1994
agreement.  Under  the new  agreement,  the  Company  agreed  to  reduce  SWBT's
remaining purchase  commitment to approximately $3 million from approximately $8
million  under the former  agreement.  In  addition,  the  Company  provided  an
upgraded  electronic  key product  and,  among other  things,  agreed to provide
equipment and software to upgrade SWBT's payphone management system. SWBT made a
$250,000 cash payment to the Company, terminated the Company's obligation to pay
royalties  on sales  of a  certain  product  to other  customers,  terminated  a
contingent  obligation of the Company to repay revenue of $375,000 from the sale
of product  software under the former  agreement,  and agreed to make additional
cash payments to the Company of $250,000 on July 2, 1997,  $100,000 on September
1, 1997, $150,000 on December 31, 1997 and $250,000 on March 31, 1998 subject to
the Company's compliance with its obligations, including conditions with respect
to performance,  service and repair.  SWBT has the right to cancel the agreement
upon default by the Company.  Therefore,  there is no assurance that the Company
will receive the additional payments or that it will ship the products set forth
in the agreement.

         At June 27, 1997,  the Company is  committed to purchase  approximately
$5.5 million of product assemblies under the terms of a manufacturing  agreement
entered  into in  October  1994.  Upon a  termination  of the  agreement  by the
Company,   the  Company  is  obligated  to  purchase  inventories  held  by  the
manufacturer  and  pay  vendor  cancellation  and  restocking  charges,   and  a
reasonable  profit  thereon.  In  addition,  the Company is  obligated  to pay a
cancellation  penalty of up to $500,000 if it cancels its purchase obligation or
a substantial portion thereof.  The amount of the cancellation  penalty, if any,
will vary depending upon quantities purchased by the Company.


                                       9
<PAGE>

Item 2.  Management's Discussion and Analysis of Financial Condition and 
         Results of Operations

Forward Looking Statements

         This report contains certain forward looking statements  concerning the
Company's  operations,   economic  performance  and  financial  condition.  Such
statements are subject to various risks and uncertainties.  Actual results could
differ  materially from those currently  anticipated due to a number of factors,
including those identified herein.

Results of Operations

         The  following   table  shows  certain  line  items  in  the  Company's
consolidated  statements of operations  for the three months ended June 27, 1997
and June 28, 1996 that are discussed below together with amounts  expressed as a
percentage of sales and with the change expressed as a percentage.

<TABLE>
<CAPTION>
                                               Three Months               Three Months
                                                  Ended       Percent        Ended        Percent   Percentage
                                                June 27,         of         June 28,         of      Increase
                                                  1997         Sales          1996         Sales    (Decrease)
                                             ---------------- --------- ----------------- --------- ------------
<S>                                          <C>                  <C>    <C>                <C>        <C>  
 Sales                                       $  6,216,558         100%   $ 12,078,496       100%       (49%)
 Cost of goods sold                             5,122,640          82%      9,840,449        81%       (48%)   
 General and administrative expenses              554,065           9%        644,985        5%        (14%)   
 Marketing and selling expenses                   164,555           3%        361,478        3%        (54%)   
 Engineering, research and development                                                            
   expenses                                       292,028           5%        409,095        3%        (29%)   
 Litigation settlement                               --            --        (105,146)      (1%)      (100%)   
 Interest expense                                  72,150           1%        141,540        1%        (49%)   
 Income tax expense (benefit)                     (11,921)          0%        217,202        2%       (105%)
                                                                                                  
</TABLE>
                       
         Sales.  The  decrease in sales for the three months ended June 27, 1997
as compared to the three months ended June 28, 1996 is primarily attributable to
(i) a decrease in sales volume of smart payphone systems and processors and (ii)
a 25% reduction in the sales price of GeminiTM  processors  under the terms of a
sales agreement between the Company and Telesector Resources Group, Inc. and its
affiliates  ("NYNEX")  entered into during the year ended March 28, 1997, offset
by (i) an  increase  in  exported  wireless  payphone  systems of  approximately
$600,000  and (ii)  sales  revenue  of  $625,000  under the terms of a new sales
agreement  between the Company and Southwestern  Bell Telephone Company ("SWBT")
entered  into in June  1997.  Sales  of smart  payphone  products  decreased  by
approximately  $6.7 million and accounted for  approximately 25% of sales during
the three  months  ended June 27, 1997 as  compared  to 69% of sales  during the
three months ended June 28, 1996.  Refurbishment and repair services and related
product   sales  for  the  three  months  ended  June  27,  1997   decreased  by
approximately  10% as compared to the same period last year,  and  accounted for
55% of sales as compared to 31% last year.  No export sales were made during the
three months ended June 28, 1996.


         The Company believes that the uncertainty in the marketplace  caused by
the   implementation  of  the   Telecommunications   Reform  Act  of  1996  (the
"Telecommunications  Act")  and the  merger  activity  within  the  industry  is
adversely affecting its sales. In addition,  following a high level of demand at
the start of the program last year,  NYNEX has  stabilized its deployment of the
Company's smart payphone  systems and processors  under the five-year  agreement
entered into last year.

         In June 1997,  the Company  entered  into an  agreement  with SWBT that
supersedes  and terminates a December 1994  agreement.  Under the new agreement,
the Company agreed to reduce SWBT's remaining  


                                       10
<PAGE>

purchase commitment of GemStarTM processor kits to approximately $3 million from
approximately $8 million under the former  agreement.  In addition,  the Company
provided an upgraded  electronic key product and, among other things,  agreed to
provide  equipment and software to upgrade SWBT's  payphone  management  system.
SWBT made a $250,000  cash  payment to the  Company,  terminated  the  Company's
obligation to pay royalties on sales of GemStar  processors to other  customers,
terminated a contingent  obligation  of the Company to repay revenue of $375,000
from the sale of product software under the former agreement, and agreed to make
additional cash payments to the Company of $250,000 on July 2, 1997, $100,000 on
September 1, 1997,  $150,000 on December 31, 1997 and $250,000 on March 31, 1998
subject to the Company's  compliance with its obligations,  including conditions
with respect to performance, service and repair.

         Cost of  Goods  Sold.  Cost of  goods  sold as a  percentage  of  sales
increased to 82% for the three months ended June 27, 1997 as compared to 81% for
the three months ended June 28, 1996. This increase  resulted  principally  from
the decrease in sales volume and sales prices  referred to above and an increase
in manufacturing  costs of printed circuit board assemblies  shifted to contract
manufacturers,  offset by the impact of the initial  sales  revenues  recognized
under the terms of the new agreement between the Company and SWBT.

         General  and  Administrative  Expenses.  The  decline  in  general  and
administrative  expenses is primarily  attributable to the closure of one of the
Company's  manufacturing  facilities  during the year ended  March 28,  1997,  a
decrease  in accrued  performance  based  compensation  and a  reduction  in the
provision for doubtful accounts receivable.

         Marketing and Selling  Expenses.  The decrease in marketing and selling
expenses  during the three  months  ended June 27,  1997 as compared to the same
period  last  year is  primarily  attributable  to the  expiration  of a royalty
agreement and the resulting decrease in royalty expense associated with sales of
smart payphone products.

         Engineering,  Research and Development  Expenses.  The Company began to
expand its engineering  resources during the three months ended June 28, 1996 in
order to facilitate the  development  of a new smart payphone  processor and the
implementation  of  lower-cost  manufacturing  methodologies.  During  the three
months ended June 27, 1997, the  requirement for contract  engineering  services
diminished  and the related  expense  decreased  accordingly.  Also, the Company
capitalized  approximately  $130,000 of software development costs in connection
with the development of its new smart payphone processor during the three months
ended June 27, 1997.  Software  development  costs during the three months ended
June 28, 1996 were not significant.

         Litigation Settlement.  Pursuant to the terms of a settlement agreement
and mutual  release  dated July 3, 1996,  a suit filed  against the Company by a
former  supplier to collect  approximately  $400,000 of unpaid  obligations  was
dismissed with prejudice.  As a result of the settlement agreement,  the Company
realized  a  gain  of  $105,146   representing  the  difference  between  unpaid
obligations recorded in the Company's accounts and aggregate settlement payments
set forth in the settlement agreement.

         Interest  Expense.  The decrease in interest  expense  during the three
months ended June 27, 1997 as compared to the same period last year is primarily
due to the repayment of outstanding bank and stockholder debt obligations during
May 1996 from proceeds of the Company's initial public offering.  See "Liquidity
and Capital Resources - Cash Flows From Financing Activities," below.

         Income Taxes.  During the three months ended June 27, 1997, the Company
recorded  an income tax  benefit  of  $11,921  on  pre-tax  income of $25,209 as
compared to an income tax  provision  of $217,202 on pre-tax  income of $802,282
for the three  months  ended June 28,  1996.  Current tax benefits for the three
months  ended June 27,  1997  amounted  to  $286,753  as compared to current tax
expense of $262,593  for the three  months  ended 


                                       11
<PAGE>

June 28,  1996.  Deferred  tax expense for the three  months ended June 27, 1997
amounted to $274,832  as  compared to deferred  tax  benefits of $45,391 for the
three months ended June 28, 1996.

Liquidity and Capital Resources

The Loan Agreement

         At June 27, 1997 and March 28,  1997,  the Company is able to borrow up
to a maximum of $9 million under a revolving credit agreement under the terms of
a Loan and Security Agreement (the "Loan Agreement") between the Company and its
bank. At June 27, 1997 and March 28, 1997, the Company had  outstanding  debt of
$2,399,705 and $3,810,961,  respectively,  under the revolving credit agreement.
Indebtedness  outstanding  under the Loan Agreement is secured by  substantially
all  assets  of the  Company  including  accounts  receivable,  inventories  and
property and equipment. The borrowing limit under the revolving credit agreement
is  based  upon  specified  percentages  applied  to the  value  of  collateral,
consisting of eligible accounts receivable and inventories.  Interest is payable
monthly at a variable  rate per annum  equal to 1.5% above a base rate quoted by
Citibank,  N.A.  (8.5% at June 27, 1997 and March 28, 1997).  The Loan Agreement
expires on November 30, 1997,  and is  renewable  annually for one-year  periods
unless  terminated  by the bank upon an  occurrence of an event of default or by
the Company upon at least 90 days notice.

         The Loan  Agreement  contains  conditions and covenants that prevent or
restrict the Company from engaging in certain  transactions  without the consent
of the  bank,  including  merging  or  consolidating,  payment  of  subordinated
stockholder  debt  obligations,   declaration  or  payment  of  dividends,   and
disposition of assets, among others.  Additionally,  the Loan Agreement requires
the Company to comply with specific  financial  covenants,  including  covenants
with respect to cash flow, working capital and net worth. Noncompliance with any
of these  conditions and covenants or the occurrence of an event of default,  if
not  waived  or  corrected,   could  accelerate  the  maturity  of  indebtedness
outstanding  under the Loan  Agreement.  Although the Company was in  compliance
with the covenants set forth in the Loan Agreement at June 27, 1997, there is no
assurance  that the  Company  will be able to  remain  in  compliance  with such
covenants in the future.

         The Company uses the financing  available  under the Loan  Agreement to
finance  its  working  capital  requirements.  If an event of default  under the
existing revolving credit facility were to occur, however, the Company's ability
in this  regard  could be  curtailed.  In such  event,  the  Company  would seek
alternative  financing  sources,  but  there is no  assurance  that  alternative
financing  sources would be available on  commercially  reasonable  terms, or at
all.  Further,  the Loan  Agreement  expires on  November  30, 1997 unless it is
renewed in  accordance  with its terms.  The  Company  is  presently  discussing
renewal  options  with its bank.  Although  the  Company  believes  that it will
negotiate  an  acceptable  renewal  agreement,  there is no  assurance  that its
efforts will be  successful.  The Company's  liquidity  would be materially  and
adversely  affected  if it is unable to renew or  refinance  is  present  credit
facility.

         The Company borrows funds to finance  increases in accounts  receivable
and inventories and decreases in bank  overdrafts,  accounts payable and accrued
liability  obligations to the extent that such requirements exceed cash provided
by operations,  if any. The Company also uses the financing  available under the
revolving credit agreement to fund operations, investing activities and payments
on long-term debt when  necessary.  The Company repays borrowed funds with cash,
if any,  provided by operating  activities.  The Company  measures its liquidity
based upon the amount of funds that the Company is able to borrow under the Loan
Agreement,  which  varies  based  upon  operating  performance  and the value of
current assets and liabilities. At June 27, 1997, the Company was able to borrow
approximately $5.4 million under its revolving credit facility.

Cash Flows From Financing Activities

         During May 1996, the Company  completed an initial  public  offering of
1,150,000  Units,  each  Unit  consisting  of one  share of  common  stock and a
redeemable  warrant,  at a price  of  $9.00  per  Unit  for  gross  


                                       12
<PAGE>

proceeds of  $10,350,000.  In connection  with the offering,  the Company issued
warrants to the  underwriter  to purchase  100,000  shares of common  stock (the
"Underwriter  Warrants") for gross proceeds of $10. Net proceeds received by the
Company as of June 28,  1996,  after  underwriting  discounts  and  expenses  of
$1,231,897 and other expenses of $808,269,  aggregated $8,309,444.  At March 29,
1996,  the Company had  incurred  and  deferred  offering  expenses of $338,372.
Accordingly,  net proceeds from the Company's initial public offering during the
three months ended June 28, 1996 aggregated $8,648,215.

         The  proceeds  of the  offering,  net  of  underwriting  discounts  and
expenses,  were initially used to repay 10% interest bearing  subordinated notes
payable to stockholders of $2.8 million and outstanding  indebtedness  under the
Loan Agreement of $6,318,113.  Indebtedness outstanding under the Loan Agreement
repaid with the net proceeds  consisted of a $2.2 million term note due November
30, 1997, $309,524  outstanding under a $650,000 term note due November 30, 1997
and indebtedness under the revolving credit line of $3,808,589.  Total principal
payments on long-term debt and capital lease obligations during the three months
ended June 28, 1996 aggregated $2,578,410.

         Net payments under the Company's revolving credit line during the three
months ended June 27, 1997 amounted to $1,411,256 as compared to $901,025 during
the three  months  ended June 28,  1996.  Exclusive  of  payments  made with the
proceeds of the offering,  the net proceeds under the revolving credit agreement
during the three months ended June 28, 1996 aggregated $2,907,564.

         The Company has also  established  a cash  management  program with its
bank  pursuant  to which  the  Company  funds  drafts  as they  clear  the bank.
Accordingly,  the Company  maintains bank  overdrafts  representing  outstanding
drafts and utilizes  the cash  management  account as a source of funding.  Bank
overdrafts vary according to many factors, including the volume of business, and
the timing of purchases  and  disbursements.  During the three months ended June
27, 1997, the Company's bank  overdrafts  increased by $81,542 as compared to an
increase of $760,228 during the three months ended June 28, 1996.

         In June 1996,  the Company  issued  40,000  shares of common  stock for
aggregate  proceeds of $160,000  upon the exercise of  outstanding  common stock
purchase warrants issued in May 1995.

Cash Flows From Operating Activities

         Three Months Ended June 27, 1997. Cash provided by operating activities
during the three months ended June 27, 1997 amounted to  $1,398,617.  During the
three months ended June 27, 1997, the Company's operations generated $599,645 in
cash,  after  adjustments  related to non-cash  charges and credits of $562,515.
Changes in operating assets and liabilities provided $798,972 of cash during the
three months ended June 27, 1997.  Inventories decreased by $1,070,364 primarily
as a result of shipments of smart payphone products manufactured during the year
ended March 28, 1997.  Accounts  payable  increased  by $890,806  primarily as a
result  of  fluctuations  in  inventory  purchases.   The  decrease  in  accrued
liabilities   of  $305,943  and  deferred   revenue  of  $375,000  is  primarily
attributable  to  satisfaction  of  obligations  under the new  sales  agreement
between the Company and SWBT, and the payment of performance based  compensation
accrued at March 28, 1997. The increase in other assets is  attributable  to the
capitalization  of software  development  costs of approximately  $130,000.  The
increase in  refundable  income taxes of $301,146 is primarily  attributable  to
current tax benefits  recognized  the three  months ended June 27, 1997.  Income
taxes payable  declined by $126,007 due to payments made during the three months
ended June 27, 1997.

         Three  Months  Ended  June  28,  1996.  Cash  used  to  fund  operating
activities  during the three months ended June 28, 1996 amounted to  $3,089,095.
During the three months ended June 28, 1996, the Company's  operations generated
$1,031,487 in cash, after adjustments related to non-cash charges and credits of
$446,407.  Changes in operating  assets and liabilities  used $4,120,582 of cash
during the three months ended June 28, 1996.  Accounts  receivable  increased by
$2,795,058  as a result of an  increase  in the  volume of  business  during 


                                       13
<PAGE>

the period.  The  increase in inventory of  $1,203,069  and accounts  payable of
$515,291,  although partially related to the increase in the volume of business,
was primarily  attributable  to an excess of inventory  purchases under purchase
commitments  over  sales  requirements  as a result of a change in the  delivery
requirements  of one of the Company's  customers.  During the three months ended
June 28, 1996, the Company  satisfied the majority of its delivery  requirements
with respect to  prepayments  from customers and deferred  revenue  decreased by
$485,512.  The  decrease  in  accrued  liabilities  of  $340,655  was  primarily
attributable  to  the  payment  of  interest  accrued  under  the  terms  of the
subordinated  notes payable to stockholders that were retired during the period,
and the payment of performance  based  compensation  accrued at the beginning of
the period.  Current tax expense for the period exceeded  estimated tax payments
and income taxes payable increased by $113,549.

Cash Flows From Investing Activities

         Cash used to fund  investing  activities  during the three months ended
June 27, 1997  amounted to $36,859 as compared to $58,981  during  three  months
ended June 28, 1996.  The Company's  capital  expenditures  during these periods
consisted  primarily of investments in  manufacturing  tooling and equipment and
automated test equipment. The Company expects that its capital expenditures over
the next several  quarters will  increase as the Company  continues to invest in
manufacturing and test equipment  required to improve its in-house prototype and
manufacturing   capabilities   and  moves   forward  to  select  and  begin  the
implementation of new management  information systems (see "Capital  Commitments
and Liquidity," below).

Capital Commitments and Liquidity

         The Company has not entered into any  significant  commitments  for the
purchase of capital assets. However, the Company intends to purchase and install
information  systems and capital  equipment,  including  printed  circuit  board
assembly equipment and other manufacturing  equipment,  to advance its prototype
manufacturing  and  product  testing  capabilities  during  the  next  year.  In
addition,  the Company intends to expand its manufacturing  capabilities through
the purchase of capital equipment in the future as required to meet the needs of
its business.  However, there can be no assurance that capital expenditures will
be made as planned or that additional capital expenditures will not be required.
The Company believes, based on its current plans and assumptions relating to its
operations,  that its sources of capital,  including capital available under the
revolving  credit line and cash flow from operations will be adequate to satisfy
its anticipated cash needs,  including anticipated capital expenditures,  for at
least the next year. However, in the event that the Company's plans or the basis
for its assumptions  change or prove to be inaccurate,  or cash flow and sources
of  capital  prove  to  be  insufficient  to  provide  for  the  Company's  cash
requirements  (due  to  unanticipated   expenses,  loss  of  sales  revenues,  a
significant increase in inventories,  operating difficulties or otherwise),  the
Company would be required to seek additional financing.  In such an event, there
can be no assurance that additional  financing would be available to the Company
on commercially reasonable terms, or at all.

         Extension of credit to customers and inventory  purchases represent the
principal working capital requirements of the Company, and significant increases
in accounts  receivable  and inventory  balances could have an adverse effect on
the Company's liquidity. The Company's accounts receivable,  less allowances for
doubtful  accounts,  at June 27, 1997 and March 28, 1997  amounted to $3,162,195
and $3,234,777, respectively. Accounts receivable at June 27, 1997 and March 28,
1997  consists  primarily  of  amounts  due from  the  Regional  Bell  Operating
Companies.  The Company's inventories,  less allowances for potential losses due
to obsolescence and excess quantities, amounted to $9,781,012 and $10,879,180 at
June 27,  1997  and  March  28,  1997,  respectively.  The  level  of  inventory
maintained  by the  Company  is  dependent  on a number  of  factors,  including
delivery requirements of customers, availability and lead-time of components and
the ability of the Company to estimate and plan the volume of its business.  The
Company  markets a wide range of services and products and the  requirements  of
its customers vary significantly from period to period.  Accordingly,  inventory
balances may vary significantly.


                                       14
<PAGE>

         At June 27, 1997,  the Company is  committed to purchase  approximately
$5.5 million of smart  payphone  assemblies  under the terms of a  manufacturing
agreement  entered into in October 1994.  Upon a termination of the agreement by
the  Company,  the  Company is  obligated  to purchase  inventories  held by the
manufacturer  and  pay  vendor  cancellation  and  restocking  charges,   and  a
reasonable  profit  thereon.  In  addition,  the Company is  obligated  to pay a
cancellation  penalty of up to $500,000 if it cancels its purchase obligation or
a substantial portion thereof.  The amount of the cancellation  penalty, if any,
will vary depending upon quantities purchased by the Company.

Operating Trends and Uncertainties

         Dependence on Customers and Contractual Relationships.  During the past
three years,  four of the RBOCs have accounted for the majority of the Company's
sales.  The  Company  anticipates  that it will  continue  to derive most of its
revenues from such customers,  and other regional telephone  companies,  for the
foreseeable future.  Significant  reductions and/or fluctuations in sales volume
from  these  customers  can  have  material  adverse  effects  on the  Company's
business. In addition,  the loss of a significant customer could have a material
adverse effect on the Company's business.

         The  Company's  prospects  for  continued   profitability  are  largely
dependent  upon the RBOCs  upgrading  the  technological  capabilities  of their
installed base of payphones,  and utilizing the Company's  products and services
for such upgrade  conversion  programs.  Also,  the Company's  prospects and the
ability  of the  Company  to  maintain  a  profitable  level of  operations  are
dependent upon its ability to continue to secure contract awards from the RBOCs.
In addition,  the Company's  prospects for growth are dependent  upon the market
acceptance and success of its smart payphone products, as well as development of
smart products containing additional advanced features. If the Company is unable
to attract the  interest  of the RBOCs to deploy the  Company's  smart  payphone
products, the Company's sales revenues,  business and prospects for growth would
be  adversely  affected.  Further,  the  Company's  ability to  maintain  and/or
increase  its sales is  dependent  upon its ability to compete for and  maintain
satisfactory  relationships  with the RBOCs,  particularly  those RBOCs that are
presently significant customers of the Company.

         Sales Prices. The Company's agreements with its contract  manufacturers
generally provide that the Company will bear certain cost increases  incurred by
the manufacturer.  Accordingly,  the Company's manufacturing costs may fluctuate
based on costs  incurred by its  contract  manufacturers  and such  fluctuations
could have a material  and  adverse  impact on  earnings.  The  Company's  sales
agreements with customers generally have fixed product prices with limited price
escalation provisions. Consequently, there is a risk that the Company may not be
able to increase  sales prices when  product  costs  increase.  In the event the
Company's costs increase  without a  corresponding  price increase or orders are
lost due to price  increases,  the  Company's  profitability  would be adversely
affected. The Company encounters  substantial  competition with respect to smart
payphone  contract  awards from the RBOCs.  Pending the release of the Company's
new smart  payphone  processor  later this year,  market  pressures  have eroded
margins on the  product  version  currently  being  shipped.  Until the  Company
releases its new smart payphone processor, the Company will realize little to no
gross  profit  with  respect to smart  product  sales to NYNEX.  Any other price
reductions  in  response to  competition  will  result in reduced  gross  profit
margins unless the Company is able to achieve reductions in product costs.

         Seasonality.  The Company's sales are generally stronger during periods
when  weather  does not  interfere  with the  maintenance  and  installation  of
payphone  equipment by the Company's  customers,  and may be adversely  impacted
near the end of the  calendar  year by the  budget  short  falls  of  customers.
However,  the Company may also receive large year-end  orders from its customers
for shipment in December depending upon their budget positions. In the event the
Company  does not  receive  any  significant  end of year  orders  for its smart
payphone products, its third quarter sales may decline significantly in relation
to other quarters.


                                       15
<PAGE>

         Sources of Supply and Dependence on Contract Manufacturers. The Company
generally  assembles its smart  payphone  products from  assemblies  produced by
certain  manufacturers under contractual  arrangements.  To the extent that such
manufacturers  encounter  difficulties in their production  processes that delay
shipment  to the  Company or that  affect the  quality of items  supplied to the
Company,  the Company's  ability to perform its sales agreements or otherwise to
meet supply schedules with its customers can be adversely affected. In the event
that contract manufacturers delay shipments or supply defective materials to the
Company,  and such  delays or  defects  are  material,  the  Company's  customer
relations  could  deteriorate  and its  sales  and  operating  results  could be
materially and adversely affected.

         As a percentage  of revenues,  the majority of the  Company's  products
contain  components or assemblies  that are purchased from single  sources.  The
Company  believes that there are  alternative  sources of supply for most of the
components and assemblies  currently  purchased from those sources.  Most of the
components  and  assemblies  used  by  the  Company  for  which  there  are  not
immediately  available alternative sources of supply are provided to the Company
under  standard  purchase  arrangements.   In  addition,  suppliers  of  certain
electronic  parts and  components to the Company and its contract  manufacturers
occasionally  place their customers on allocation for those parts. If a shortage
or termination of the supply of any one or more of such components or assemblies
were to  occur,  the  Company's  business  could  be  materially  and  adversely
affected.  In such event,  the Company would have to incur the costs  associated
with redesigning its products to include  available  components or assemblies or
otherwise obtain adequate substitutes,  and those costs could be material. Also,
any delays in  redesigning  products or obtaining  substitute  components  could
adversely affect the Company's business.

         Telecommunication  Act. On February 8, 1996, the President  signed into
law the Telecommunications  Reform Act of 1996 (the  "Telecommunications  Act"),
the most  comprehensive  reform of communications law since the enactment of the
Communications Act of 1934. As a result of the Telecommunications Act, the RBOCs
will be permitted to manufacture and provide telecommunications equipment and to
manufacture customer premises equipment when certain competitive conditions have
been met.  It is  possible  that one or more  RBOCs will  decide to  manufacture
payphone products, which would increase the competition faced by the Company and
could decrease demand for the Company's products by such RBOCs. Notwithstanding,
the Company  believes  that  deregulation  generally  will  benefit the Company.
However,  there  can  be  no  assurance  that  the  Company  will  benefit  from
deregulation or that it will not be adversely affected by deregulation.

         Net Operating Loss Carryforwards.  As of June 27, 1997, the Company had
net operating loss  carryforwards  for income tax purposes of approximately  $11
million to offset  future  taxable  income.  Under  Section 382 of the  Internal
Revenue  Code of  1986,  as  amended,  the  utilization  of net  operating  loss
carryforwards is limited after an ownership  change,  as defined in such Section
382,  to an  annual  amount  equal  to  the  value  of  the  loss  corporation's
outstanding stock immediately before the date of the ownership change multiplied
by the  federal  long-term  tax-exempt  rate in  effect  during  the  month  the
ownership change occurred. Such an ownership change occurred on October 31, 1994
and could occur in the future.  As a result,  the Company  will be subject to an
annual  limitation  on the  use of its net  operating  losses  of  approximately
$210,000.  This limitation only affects net operating  losses incurred up to the
ownership  change and does not reduce the total amount of net  operating  losses
which may be taken,  but  limits the  amount  which may be used in a  particular
year. Therefore, in the event the Company maintains profitable operations,  such
limitation  would have the effect of increasing  the Company's tax liability and
reducing net income and available  cash resources if the taxable income during a
year  exceeded the  allowable  loss carried  forward to that year.  In addition,
because of such  limitations,  the Company  will be unable to use a  significant
portion of its net operating loss carryforwards.

New Accounting Pronouncements

         In February  1997,  the  Financial  Accounting  Standards  Board issued
Statement of Financial  Accounting  Standards No. 128, Earnings Per Share ("SFAS
128"). SFAS 128 requires  disclosure of basic earnings per 


                                       16
<PAGE>

share based on income available to common  stockholders and the weighted average
number of common shares  outstanding during the period, and diluted earnings per
share based on income available to common  stockholders and the weighted average
number of common and dilutive  potential  common shares  outstanding  during the
period.  The  adoption of SFAS 128 is required  for fiscal  years  ending  after
December 15, 1997, and earlier  adoption is not permitted.  The adoption of SFAS
128 is not  expected  to have a  material  effect on the  Company's  results  of
operations or financial position.

         Also, in February 1997, the Financial Accounting Standards Board issued
Statement of Financial  Accounting  Standards No. 129, Disclosure of Information
about Capital Structure ("SFAS 129"). SFAS 129 requires a Company to explain the
privileges  and  rights of its  various  outstanding  securities,  the number of
shares issued upon conversion,  exercise or satisfaction of required  conditions
during  the  most  recent  annual  fiscal  period,  liquidation  preferences  of
preferred stock and other matters with respect to preferred stock.  Although the
statement is effective for periods ending after December 15, 1997, the Company's
financial statement disclosures are in compliance with SFAS 129.

         In June 1997, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards No. 130, Reporting Comprehensive Income ("SFAS
130"). SFAS 130 establishes standards for reporting and display of comprehensive
income and its components in a full set of general-purpose financial statements.
Comprehensive  income is defined as the change in equity of a business  during a
period from  transactions and events and circumstances  from non-owner  sources,
and includes all changes in equity during a period except those  resulting  from
investments  by owners and  distributions  to owners.  SFAS 130 is effective for
fiscal years  beginning after December 15, 1997. The adoption of SFAS 130 is not
expected to have a material  effect on the  Company's  results of  operations or
financial position.

         Also, in June 1997,  the Financial  Accounting  Standards  Board issued
Statement of Financial  Accounting Standards No. 131, Disclosures about Segments
of an Enterprise and Related  Information ("SFAS 131"). SFAS 131 requires public
entities to report certain information about operating segments,  their products
and  services,  the  geographic  areas in which they  operate,  and their  major
customers,  in complete financial  statements and in condensed interim financial
statements  issued to  stockholders.  SFAS 131 is  effective  for  fiscal  years
beginning  after  December 15, 1997. The adoption of SFAS 131 is not expected to
have a material  effect on the  Company's  results of  operations  or  financial
position.


                                       17
<PAGE>

PART II - OTHER INFORMATION

Item 6 - Exhibits and Reports on Form 8-K

(a)      Exhibits

         The following exhibits are filed herewith as a part of this Report.

        Exhibit
          No.                  Description of Exhibit
          ---                  ----------------------
          11.      Statement re computation of per share earnings

          27.      Financial Data Schedule (EDGAR Filing only)

(b)      Reports on Form 8-K

         No  reports on Form 8-K were filed  during the  quarter  for which this
report is filed.


                                       18
<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.


                                   TECHNOLOGY SERVICE GROUP, INC.
                                           (Registrant)


Date:    August 6, 1997            By:  /s/  Vincent C. Bisceglia
                                        -----------------------------------
                                        Vincent C. Bisceglia
                                        President & Chief Executive Officer

                                   By:  /s/  William H. Thompson
                                        ----------------------------------
                                        William H. Thompson
                                        Vice President of Finance
                                          & Chief Financial Officer



                                       19
<PAGE>

                                  EXHIBIT INDEX

                 
         Exhibit
          No.                      Description of Exhibit               At Page
          ---                      ----------------------               -------

          11.         Statement re computation of per share earnings       21

          27.         Financial Data Schedule (EDGAR filing only)          22