THREE FIVE SYSTEMS INC
DEF 14A, 1999-03-19
SEMICONDUCTORS & RELATED DEVICES
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                            SCHEDULE 14A INFORMATION

           Proxy Statement Pursuant to Section 14(a) of the Securities
                      Exchange Act of 1934 (Amendment No. )

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

Check the appropriate box:

[ ] Preliminary Proxy Statement      [ ] Confidential, for Use of the Commission
[X] Definitive Proxy Statement           Only (as permitted by Rule 14a-6(e)(2))
[ ] Definitive Additional Materials
[ ] Soliciting Material pursuant to Rule 14a-11(c) or Rule 14a-12

                            THREE-FIVE SYSTEMS, INC.
                -------------------------------------------------
                (Name of Registrant as Specified In Its Charter)


                -------------------------------------------------
                   (Name of Person(s) Filing Proxy Statement)

Payment of Filing Fee (Check the appropriate box):

[X]  No fee required.
[ ]  Fee computed on table below per Exchange Act Rules 14a-6(i)(4) and 0-11.
     1)   Title of each class of securities to which transaction applies:

     ---------------------------------------------------------------------------
     2)   Aggregate number of securities to which transaction applies:

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

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     4)   Proposed maximum aggregate value of transaction:

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     5)   Total fee paid:

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[ ]  Fee paid previously with preliminary materials.

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

     1)   Amount Previously Paid:

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     2)   Form, Schedule or Registration Statement No.:

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     3)   Filing Party:

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     4)   Date Filed:

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<PAGE>
                         THREE-FIVE SYSTEMS, INC. LOGO

- --------------------------------------------------------------------------------
                    NOTICE OF ANNUAL MEETING OF STOCKHOLDERS
                                 APRIL 22, 1999
- --------------------------------------------------------------------------------

         The Annual  Meeting of  Stockholders  of  Three-Five  Systems,  Inc., a
Delaware  corporation (the  "Company"),  will be held at 9:00 a.m., on Thursday,
April 22, 1999, at the  Company's  corporate  headquarters  at 1600 North Desert
Drive, Tempe, Arizona, for the following purposes:

         1. To  elect  directors  to serve  until  the next  annual  meeting  of
stockholders and until their successors are elected and qualified.

         2. To approve an amendment to the  Company's  1998 Stock Option Plan to
increase the number of shares of Common Stock that may be issued pursuant to the
1998 Stock Option Plan from 300,000 shares to 550,000 shares.

         3. To ratify the  appointment of Arthur Andersen LLP as the independent
auditors of the Company for the fiscal year ending December 31, 1999.

         4. To  transact  such other  business as may  properly  come before the
meeting or any adjournment thereof.

         The foregoing  items of business are more fully  described in the Proxy
Statement accompanying this Notice.

         Only  stockholders of record at the close of business on March 12, 1999
are entitled to notice of and to vote at the meeting.

         All stockholders are cordially invited to attend the meeting in person.
To assure your  representation at the meeting,  however,  you are urged to mark,
sign,  date,  and return the  enclosed  proxy as  promptly  as  possible  in the
postage-prepaid  envelope  enclosed for that purpose.  Any stockholder of record
attending  the  meeting  may vote in  person  even if he or she  previously  has
returned a proxy.

                                             Sincerely,

                                             /s/ Jeffrey D. Buchanan

Tempe, Arizona                               Jeffrey D. Buchanan
March 19, 1999                               Secretary
<PAGE>
                         THREE-FIVE SYSTEMS, INC. LOGO
                             1600 NORTH DESERT DRIVE
                              TEMPE, ARIZONA 85281

- --------------------------------------------------------------------------------
                                 PROXY STATEMENT
- --------------------------------------------------------------------------------

                            VOTING AND OTHER MATTERS

GENERAL

         The enclosed proxy is solicited on behalf of Three-Five Systems,  Inc.,
a Delaware corporation (the "Company"), by the Company's board of directors (the
"Board of Directors")  for use at the Annual Meeting of  Stockholders to be held
Thursday,  April 22, 1999 at 9:00 a.m. (the  "Meeting"),  or at any  adjournment
thereof,  for  the  purposes  set  forth  in  this  Proxy  Statement  and in the
accompanying Notice of Annual Meeting of Stockholders.  The Meeting will be held
at the  Company's  corporate  headquarters,  1600  North  Desert  Drive,  Tempe,
Arizona.

         These proxy solicitation  materials were first mailed on or about March
19, 1999 to all stockholders entitled to vote at the Meeting.

VOTING SECURITIES AND VOTING RIGHTS

         Stockholders  of record at the close of business on March 12, 1999 (the
"Record  Date") are  entitled  to notice of and to vote at the  Meeting.  On the
Record Date, there were issued and outstanding 7,012,107 shares of the Company's
Common Stock, $0.01 par value per share (the "Common Stock").

         The  presence,  in person or by proxy,  of the holders of a majority of
the total number of shares of Common Stock outstanding  constitutes a quorum for
the  transaction  of business at the  Meeting.  Each  stockholder  voting at the
Meeting,  either in  person  or by proxy,  may cast one vote per share of Common
Stock held on all matters to be voted on at the Meeting.  Assuming that a quorum
is present,  the affirmative vote of a majority of the shares of Common Stock of
the  Company  present  in  person or  represented  by proxy at the  Meeting  and
entitled to vote is required  (i) for the  election of  directors,  (ii) for the
approval of the amendment to the Company's 1998 Stock Option Plan, and (iii) for
the  ratification  of the  appointment of Arthur Andersen LLP as the independent
auditors of the Company for the year ending December 31, 1999.

         Votes cast by proxy or in person at the Meeting  will be  tabulated  by
the election  inspectors  appointed for the Meeting and will determine whether a
quorum is present. The election inspectors will treat abstentions as shares that
are present and entitled to vote for purposes of  determining  the presence of a
quorum but as unvoted for  purposes of  determining  the  approval of any matter
submitted to the  stockholders  for a vote.  If a broker  indicates on the proxy
that it does not have discretionary  authority as to certain shares to vote on a
particular  matter,  those shares will not be considered as present and entitled
to vote with respect to that matter.

VOTING OF PROXIES

         When  a  proxy  is  properly  executed  and  returned,  the  shares  it
represents  will be voted at the Meeting as  directed.  If no  specification  is
indicated,  the shares will be voted (i) "for" the  election of the nominees set
forth in this Proxy  Statement,  (ii) "for" the approval of the amendment to the
Company's  1998 Stock  Option  Plan,  and (iii)  "for" the  ratification  of the
appointment of Arthur  Andersen LLP as the  independent  auditors of the Company
for the year ending December 31, 1999.
<PAGE>
REVOCABILITY OF PROXIES

         Any person  giving a proxy may revoke the proxy at any time  before its
use by delivering to the Company written notice of revocation,  or by delivering
to the Company a duly  executed  proxy bearing a later date, or by attending the
Meeting and voting in person.

SOLICITATION

         The  cost of  this  solicitation  will  be  borne  by the  Company.  In
addition,   the  Company  may  reimburse   brokerage  firms  and  other  persons
representing  beneficial  owners of shares for expenses  incurred in  forwarding
solicitation  materials to such beneficial owners. Proxies also may be solicited
by certain of the Company's  directors and officers,  personally or by telephone
or telegram, without additional compensation.

ANNUAL REPORT AND OTHER MATTERS

         The Company's 1998 Annual Report to  Stockholders,  which was mailed to
stockholders  with or preceding  this Proxy  Statement,  contains  financial and
other  information  about the  Company but is not  incorporated  into this Proxy
Statement and is not to be considered a part of these proxy soliciting materials
or subject to Regulations  14A or 14C or to the liabilities of Section 18 of the
Securities   Exchange  Act  of  1934,  as  amended  (the  "Exchange  Act").  The
information  contained  in  the  "Compensation  Committee  Report  on  Executive
Compensation"  below and  "Performance  Graph" below shall not be deemed "filed"
with  the  Securities  and  Exchange   Commission  (the  "SEC")  or  subject  to
Regulations 14A or 14C or to the liabilities of Section 18 of the Exchange Act.

         THE COMPANY WILL PROVIDE UPON WRITTEN  REQUEST,  WITHOUT CHARGE TO EACH
STOCKHOLDER  OF RECORD AS OF THE RECORD  DATE,  A COPY OF THE  COMPANY'S  ANNUAL
REPORT ON FORM 10-K FOR THE YEAR ENDED  DECEMBER 31, 1998 AS FILED WITH THE SEC.
ANY EXHIBITS  LISTED IN THE FORM 10-K REPORT ALSO WILL BE FURNISHED UPON REQUEST
AT THE ACTUAL EXPENSE  INCURRED BY THE COMPANY IN FURNISHING  SUCH EXHIBIT.  ANY
SUCH  REQUESTS  SHOULD BE DIRECTED TO THE  COMPANY'S  SECRETARY AT THE COMPANY'S
EXECUTIVE OFFICES SET FORTH IN THIS PROXY STATEMENT.

                              ELECTION OF DIRECTORS

NOMINEES

         The  Company's  bylaws  provide that the number of  directors  shall be
fixed from time to time by resolution of the Board of Directors or stockholders.
All directors are elected at each annual  meeting of the Company's  stockholders
for a term of one year and hold office  until their  successors  are elected and
qualified.

         A board of five  directors  is to be  elected  at the  Meeting.  Unless
otherwise  instructed,  the proxy holders will vote the proxies received by them
for  each  of the  nominees  named  below.  All of the  nominees  currently  are
directors  of the  Company.  In the  event  that any such  nominee  is unable or
declines to serve as a director at the time of the Meeting,  the proxies will be
voted for any nominee  designated  by the current Board of Directors to fill the
vacancy.  It is not expected  that any nominee will be unable or will decline to
serve as a  director.  The term of office of each  person  elected as a director
will continue until the next annual meeting of stockholders or until a successor
has been elected and qualified.

                                       2
<PAGE>
         The  following  table  sets forth  certain  information  regarding  the
nominees for directors of the Company:

        NAME            AGE           POSITION HELD
        ----            ---           -------------
  David C. Malmberg     56   Director
  Kenneth M. Julien     44   Director
  Gary R. Long          66   Director
  Jeffrey D. Buchanan   43   Executive Vice President - Finance, Administration,
                              and Legal; Chief Financial Officer; Secretary;
                              Treasurer; and Director
  Thomas H. Werner      38   Director

         DAVID C.  MALMBERG has been a director of the Company since April 1993.
Mr. Malmberg is a private investor and management  consultant.  Before resigning
in May 1994, Mr. Malmberg spent 22 years at National Computer Systems, including
13 years as its President and Chief  Operating  Officer.  Mr. Malmberg serves as
the Chairman of the Board of National City Bank of  Minneapolis  and is a member
of the boards of directors of National City  Bancorporation,  PPT/Vision,  Inc.,
Fieldworks,  Inc.,  Concerted  Technology,  Inc.,  and the Board of Trustees for
Mankato State University.

         KENNETH M.  JULIEN has been a director  of the  Company  since  October
1996.  Mr.  Julien has served as  President  and a director of Julien  Aerospace
Systems, Inc., an aerospace parts supplier,  since November 1996 and as Managing
Director  of Julien  Investments  LLC, a real  estate  development  and  lending
company,  since August 1994.  Mr. Julien served as Executive  Vice President and
Chief  Operating  Officer of the Company from August 1992 to April 1993; as Vice
President,  Chief Financial Officer,  and Secretary of the Company or one of its
predecessors  from May 1988 to August 1992;  and as a director of the Company or
one of its predecessors  from July 1987 to May 1990. Mr. Julien served as a Vice
President and Chief Financial Officer of CerProbe  Corporation  ("CerProbe"),  a
publicly held company engaged in the business of designing,  manufacturing,  and
marketing  semiconductor  test  equipment,  from October  1983 to May 1988.  Mr.
Julien also served as a director of CerProbe from February 1988 to June 1988.

         GARY R. LONG has been a director of the Company since October 1996. Mr.
Long served as President and Chief Executive Officer of CalComp Technology, Inc.
("CalComp"),  a  computer  peripherals  company,  from  January  1994  until his
retirement  in February  1997.  Mr. Long  served as Senior  Vice  President  and
General Manager of CalComp's Digitizer Products Division in Scottsdale, Arizona,
from 1980 to January 1994.  Prior to 1980,  Mr. Long served as Vice President of
Operations for Talos Systems, which designed and manufactured digitizers for the
computer graphics industry.

         JEFFREY  D.  BUCHANAN  has  served as a  director  and  Executive  Vice
President - Finance,  Administration,  and Legal of the Company since July 1998;
as Chief Financial  Officer and Treasurer of the Company since June 1996; and as
Secretary of the Company since May 1996. Mr. Buchanan served as Vice President -
Finance, Administration, and Legal of the Company from June 1996 until July 1998
and as Vice  President - Legal and  Administration  of the Company from May 1996
until June 1996. Mr. Buchanan served as a Senior Partner of O'Connor,  Cavanagh,
Anderson,  Killingsworth  &  Beshears  from June 1986  until May 1996,  where he
practiced  as a business  lawyer with an  emphasis on mergers and  acquisitions,
joint ventures, and taxation. Mr. Buchanan was associated with the international
law firm of Davis Wright  Tremaine from 1984 to 1986,  and he was a senior staff
person at Deloitte & Touche from 1982 to 1984.  Mr.  Buchanan is a member of the
Arizona and  Washington  state bars and passed the certified  public  accounting
examination in 1983. Mr.  Buchanan is the son of David R. Buchanan,  the current
Chairman of the Board, President, and Chief Executive Officer of the Company.

         THOMAS H. WERNER has been a director  of the Company  since March 1999.
Mr.  Werner  has  served  as Vice  President  and  General  Manager  for the LAN
Connectivity Division of 3Com Corporation since October 1998. Prior to that, Mr.
Werner was Vice President of the Manufacturing  Personal  Communication Division
of U.S.  Robotics,  which 3Com  Corporation  acquired in June 1997, from January
1996 until  September  1998. Mr. Werner also served in various  positions at Oak
Frequency  Control,  a  manufacturer  of  telecommunications   components,  most
recently as President of the Networks  Group from  February  1994 until  January
1996,  and earlier as President of the McCoy  International  Unit from July 1993
until February 1994.
                                       3
<PAGE>
         Directors hold office until the next annual meeting of  stockholders or
until their  successors  have been elected and qualified.  Officers serve at the
pleasure of the Board of Directors.  Messrs.  Julien, Long, Malmberg, and Burton
E.  McGillivray,  who is not  standing  for  re-election  as a  director  at the
Meeting,  serve as the members of the Audit Committee of the Board of Directors,
with Mr. Julien serving as the Chair of the Audit Committee.  Messrs.  Malmberg,
Julien,  Long, and McGillivray serve as the Compensation  Committee of the Board
of  Directors,  with Mr.  Malmberg  serving  as the  Chair  of the  Compensation
Committee.

MEETINGS AND COMMITTEES OF THE BOARD OF DIRECTORS

         The Company's  bylaws authorize the Board of Directors to appoint among
its members one or more committees composed of one or more directors.  The Board
of Directors has appointed an Audit Committee and a Compensation Committee.  The
Audit  Committee  reviews  the  annual  financial  statements,  the  significant
accounting  issues,  and the scope of the audit with the  Company's  independent
auditors and is  available to discuss with the auditors any other audit  related
matters that may arise during the year. The Compensation  Committee  reviews and
acts on  matters  relating  to  compensation  levels and  benefit  plans for key
executives of the Company.

         The Board of  Directors  of the Company  held a total of five  meetings
during the fiscal year ended  December 31, 1998. The Company's  Audit  Committee
met separately at two formal  meetings during the fiscal year ended December 31,
1998.  The  Company's  Compensation  Committee  held one formal  meeting and met
informally  several  times during the fiscal year ended  December  31, 1998.  No
director  attended  fewer than 75% of the  aggregate  of (i) the total number of
meetings of the Board of Directors during the period in which such person served
as a director,  and (ii) the total number of meetings held by all  Committees of
the Board of Directors on which such director was a member and during the period
in which such person served on such committee.

DIRECTOR COMPENSATION AND OTHER INFORMATION

         The Company pays each  non-employee  director an annual retainer fee in
the amount of $15,000,  plus $1,250 for each board meeting attended and $500 for
each committee meeting held on a day other than the same day as a board meeting.
Beginning in 1998, each non-employee  director is required to receive two-thirds
of his or her  annual  retainer  fee in shares  of the  Company's  Common  Stock
pursuant to the Company's  Directors' Stock Plan. See "Executive  Compensation -
Stock Option Plans and Directors'  Stock Plan." The Company also reimburses each
non-employee  director for travel and related  expenses  incurred in  connection
with attendance at board and committee  meetings.  Employees of the Company that
also serve as directors receive no additional compensation for their services as
a director.  The terms of the 1994 Automatic Stock Option Plan for  Non-Employee
Directors (the "1994 Plan") provide that each non-employee director will receive
an automatic  grant of options to acquire 1,000 shares of the  Company's  Common
Stock on the date of his or her first  appointment  or  election to the Board of
Directors.  The 1994 Plan also  provides for the  automatic  grant of options to
purchase 500 shares of the Company's  Common Stock to non-employee  directors at
the time of the meeting of the Board of  Directors  held  immediately  following
each annual meeting of stockholders.  Pursuant to the 1994 Plan, each of Messrs.
Malmberg, Julien, Long, and Werner will receive an automatic grant of options to
purchase  500  shares  of  Common  Stock at the time of the  Board of  Directors
meeting immediately  following the Meeting. See "Executive  Compensation - Stock
Option Plans and Directors' Stock Plan."

                                       4
<PAGE>
                             EXECUTIVE COMPENSATION

SUMMARY OF CASH AND OTHER COMPENSATION

              The following table sets forth the total compensation  received by
each person who served as the Company's  Chief  Executive  Officer during fiscal
1998, as well as its other executive  officers whose aggregate cash compensation
exceeded  $100,000  for  services  in all  capacities  to the  Company  and  its
subsidiaries for the fiscal year ended December 31, 1998 (the "Named Officers").

                           SUMMARY COMPENSATION TABLE
<TABLE>
<CAPTION>
                                                                   LONG TERM
                                                                 COMPENSATION
                                                                 ------------
                                                                    AWARDS
                                                                 ------------
                                        ANNUAL COMPENSATION       SECURITIES      ALL OTHER
                                   ----------------------------   UNDERLYING    COMPENSATION
NAME AND PRINCIPAL POSITION        YEAR  SALARY($)(1)  BONUS($)  OPTIONS(#)(2)     ($)(3)
- ---------------------------        ----  ------------  --------  -------------  ------------
<S>                                <C>     <C>          <C>         <C>           <C>
David R. Buchanan                  1998    $346,037          --          --       $12,224
 Chairman of the Board, President, 1997     398,846     221,500      50,000         7,658
 and Chief Executive Officer(4)    1996     257,448          --          --         7,308

Vincent C. Hren                    1998    $188,609          --      30,000       $ 5,503
 President, Chief Executive        1997     170,769      97,350      35,000         5,154
 Officer, and Director(5)          1996     129,308      20,000      70,000(6)     63,445

Dan J. Schott                      1998    $126,604    $ 22,000      10,000       $ 5,761
 Vice President - Research and     1997     120,769      41,000          --         4,301
 Development                       1996     111,903          --          --         3,911

Jeffrey D. Buchanan                1998    $162,864    $ 52,500      25,000       $ 5,245
 Vice President - Finance,         1997     155,385      89,650          --         4,917
 Administration, and Legal; Chief  1996      90,541      30,000      60,000           123
 Financial Officer; Secretary;     
 Treasurer; and Director(7)        
</TABLE>
- ----------
(1)  Messrs.  David Buchanan,  Hren,  Schott, and Jeffrey Buchanan also received
     certain perquisites,  the value of which did not exceed 10% of their annual
     salary and bonus.
(2)  The  exercise  price of all stock  options  granted  were equal to the fair
     market value of the Company's Common Stock on the date of grant.
(3)  Amounts  shown for fiscal 1998  include (i) matching  contributions  to the
     Company's  401(k) Plan earned in fiscal 1998 but not paid until fiscal 1999
     in the amount of $5,000, on behalf of each of Messrs. David Buchanan, Hren,
     Schott,  and Jeffrey  Buchanan;  and (ii) term life  insurance  premiums of
     $3,024, $418, $761, and $245 paid by the Company on behalf of Messrs. David
     Buchanan, Hren, Schott, and Jeffrey Buchanan, respectively.
(4)  Mr. Buchanan served as the Company's  President and Chief Executive Officer
     from  February  1990  until July 1998 and  re-assumed  those  positions  in
     January 1999. Mr. Buchanan is not standing for re-election as a director at
     the Meeting.
(5)  Mr. Hren served as  President  and Chief  Executive  Officer of the Company
     from July 1998 until January 1999.  Mr. Hren served as a Vice  President of
     the Company from January 1996 until July 1998.
(6)  The amount shown includes  options to acquire 35,000 shares of Common Stock
     that were cancelled during 1996.
(7)  Mr. Buchanan became an officer of the Company in May 1996.

                                       5
<PAGE>
OPTION GRANTS

         The  following  table sets forth  certain  information  with respect to
stock  options  granted  to the Named  Officers  during  the  fiscal  year ended
December 31, 1998.

                        OPTION GRANTS IN LAST FISCAL YEAR
<TABLE>
<CAPTION>

                                      INDIVIDUAL GRANTS                   POTENTIAL REALIZABLE
                       ------------------------------------------------  VALUE AT ASSUMED ANNUAL
                        NUMBER OF   % OF TOTAL                            RATES OF STOCK PRICE
                       SECURITIES     OPTIONS                                 APPRECIATION
                       UNDERLYING    GRANTED TO   EXERCISE                  FOR OPTION TERM(2)
                        OPTIONS     EMPLOYEES IN    PRICE    EXPIRATION  ----------------------
NAME                   GRANTED (#)   FISCAL YEAR  ($/SH)(1)     DATE         5%          10%
- ----                   -----------   -----------  ---------  ----------   --------    --------
<S>                      <C>            <C>         <C>       <C>         <C>         <C>
David R. Buchanan......      --          --             --         --           --          --
Vincent C. Hren(3).....  30,000         9.0%        $17.88     7/1/08(3)  $337,245    $854,644
Dan J. Schott..........  10,000         3.0%        $10.00    11/9/08(4)  $ 62,889    $159,374
Jeffrey D. Buchanan....  25,000         7.5%        $17.88     7/1/08(4)  $281,037    $712,204
</TABLE>
- ----------
(1)  The options were granted at the fair value of the Company's Common Stock on
     the date of grant and have a ten-year term.
(2)  Potential gains are net of the exercise price,  but before taxes associated
     with the  exercise.  Amounts  represent  hypothetical  gains  that could be
     achieved for the  respective  options if exercised at the end of the option
     term. The assumed 5% and 10% rates of stock price appreciation are provided
     in accordance with the rules of the Securities and Exchange  Commission and
     do not represent  the Company's  estimate or projection of the future price
     of the  Company's  Common  Stock.  Actual  gains,  if any, on stock  option
     exercises will depend upon the future market prices of the Company's Common
     Stock.
(3)  Mr.  Hren  resigned  as an officer of the  Company  in January  1999.  Such
     options were not vested and were automatically canceled at that time.
(4)  Such  options vest and become  exercisable  at the rate of 20% on the first
     anniversary of the date of grant, 30% on the second anniversary of the date
     of grant, and 50% on the third anniversary of the date of grant.

OPTION EXERCISES AND OPTION HOLDINGS

              The following table contains  certain  information with respect to
options held by the Named  Officers as of December  31, 1998.  None of the Named
Officers exercised options during fiscal 1998.

                             YEAR-END OPTION VALUES

                                                        VALUE OF UNEXERCISED    
                         NUMBER OF UNEXERCISED          IN-THE MONEY OPTIONS
                      OPTIONS AT FISCAL YEAR-END(#)    AT FISCAL YEAR-END($)(1)
                     ----------------------------   ----------------------------
NAME                 EXERCISABLE UNEXERCISABLE(2)   EXERCISABLE UNEXERCISABLE(2)
- ----                 ----------- ----------------   ----------- ----------------
David R. Buchanan....  50,000            --            $46,875             --
Vincent C. Hren(3)...   7,000        93,000            $31,063       $124,250
                                                    
Dan J. Schott........  24,000        26,000                 --       $ 36,875
Jeffrey D. Buchanan..  22,500        62,500            $34,956       $ 34,956
- ----------                                         
(1)  Calculated  based upon the  December  31,  1998,  New York  Stock  Exchange
     closing price of $13.69 per share,  multiplied by the applicable  number of
     shares in-the-money, less the aggregate exercise price for such shares. The
     exercise  price of certain  options  held by the Named  Officers is greater
     than $13.69 per share.
(2)  Not vested as of December 31, 1998.
(3)  Mr. Hren resigned as an officer of the Company in January 1999.

                                       6
<PAGE>
EMPLOYMENT AGREEMENTS

         The  Company has no written  employment  contracts  with its  executive
officers or  directors.  The Company does have  employment  agreements or signed
terms-and-conditions  agreements with certain employees.  The Company offers its
employees  medical,   dental,  life,  and  disability  insurance  benefits.  The
executive  officers  and other key  personnel  of the  Company  are  eligible to
receive  incentive  bonuses and are eligible to receive  stock options under the
Company's stock option plans.

401(K) PROFIT SHARING PLAN

         On  September  1,  1990,  the  Company  adopted a profit  sharing  plan
pursuant to Section 401(k) (the "401(k)  Plan") of the Internal  Revenue Code of
1986, as amended (the "Internal Revenue Code"). Pursuant to the 401(k) Plan, all
eligible  employees may contribute  through payroll deductions up to the maximum
allowable under Section 402(g) of the Internal  Revenue Code,  which was $10,000
for calendar  1998.  In addition,  the 401(k) Plan provides that the Company may
make  matching  and  discretionary  contributions  in  such  amount  as  may  be
determined  by the Board of Directors.  The Company made matching  contributions
pursuant  to the  401(k)  Plan to the Named  Officers  for 1998 in the amount of
$20,000.

STOCK OPTION PLANS AND DIRECTORS' STOCK PLAN

         The Company  currently has five stock options plans: the 1990 Incentive
Stock  Option  Plan (the "1990  Plan");  the 1993 Stock  Option  Plan (the "1993
Plan");  the 1994 Automatic  Stock Option Plan for  Non-Employee  Directors (the
"1994 Plan");  the 1997 Stock Option Plan (the "1997 Plan");  and the 1998 Stock
Option Plan (the "1998 Plan").  The eligible persons under the 1990 Plan are key
employees  of the  Company.  Eligible  persons  under the 1993 Plan  include key
personnel  (including  directors  and  executive  officers),   consultants,  and
independent  contractors  who perform  valuable  services for the Company or its
subsidiaries.  Persons who are employees of or consultants to the Company or its
subsidiaries,  other than directors,  executive officers, and persons who own 10
percent or more of the Company's  Common Stock,  are eligible to receive options
granted  under the 1997  Plan.  Eligible  persons  under  the 1998 Plan  include
employees of the Company  (including  officers and  directors)  and  independent
contractors.  Directors who are not employees  receive automatic grants of stock
options under the 1994 Plan, are eligible to receive options under the 1993 Plan
and the 1998 Plan, but are not eligible under the 1990 Plan or the 1997 Plan.

         In conjunction  with  stockholder  approval of the 1993 Plan, the Board
terminated the 1990 Plan with respect to 85,454 options that were unissued as of
the date that the 1993 Plan was adopted.  There were 164,850  options issued but
unexercised  under the 1990 Plan as of March 12, 1999. If any option  terminates
or expires  without having been  exercised in full,  stock not issued under such
stock option will become available for reissuance under the 1990 Plan.

         Under the 1993 Plan, an aggregate of 385,454  shares of Common Stock of
the Company may be issued  pursuant to the granting of options to acquire Common
Stock of the Company,  the direct  granting of Common Stock,  or the granting of
stock  appreciation  rights.  If any option terminates or expires without having
been exercised in full, stock not issued under such option will become available
for reissuance under the 1993 Plan. As of March 12, 1999, an aggregate of 15,650
shares of Common Stock had been issued upon  exercise of options  granted  under
the 1993 Plan, and there were  outstanding  options to acquire 293,900 shares of
the Company's Common Stock.

         Under the 1994 Plan,  50,000  shares of Common Stock of the Company may
be issued upon exercise of stock options  automatically  granted to non-employee
directors of the Company  pursuant to the terms  described in the section  above
entitled "Elections of Directors - Director Compensation and Other Information."
Persons  other than  non-employee  directors  of the Company are not eligible to
receive  options  granted  pursuant  to the 1994 Plan.  There  were  outstanding
options to acquire  12,000 shares of the  Company's  Common Stock under the 1994
Plan as of March 12, 1999.

                                       7
<PAGE>
         An  aggregate  of  100,000  shares of Common  Stock may be issued  upon
exercise of options granted pursuant to the 1997 Plan. If any option  terminates
or expires  without having been  exercised in full,  stock not issued under such
option will become  available  for  reissuance  under the 1997 Plan.  There were
outstanding options to acquire 44,800 shares of the Company's Common Stock under
the 1997 Plan as of March 12, 1999.

         The Board of Directors  adopted the 1998 Plan on January 29, 1998,  and
the Company's  stockholders  approved the 1998 Plan on April 23, 1998. A maximum
of 300,000  shares of Common Stock of the Company  currently may be issued under
the 1998 Plan.  The Board of Directors has amended the 1998 Plan to increase the
number of shares  authorized  for issuance from 300,000 to 550,000  shares.  See
"Proposal  to Amend  the  Company's  1998  Stock  Option  Plan."  If any  option
terminates or expires  without having been  exercised in full,  stock not issued
under such option  will again be  available  for the  purposes of the 1998 Plan.
There were  outstanding  options to acquire  92,500 shares of Common Stock under
the 1998 Plan as of March 12, 1999.

         On January 29,  1998,  the  Company's  Board of  Directors  adopted the
Directors'  Stock Plan (the  "Directors'  Plan").  Stockholder  approval  of the
Directors'  Plan was not required.  Under the Directors'  Plan, the Company will
issue to the  non-employee  members of the Board of  Directors  shares of Common
Stock  equal in value  to  two-thirds  of the  annual  retainer  fee paid to the
non-employee directors in lieu of an equivalent amount of cash. The value of the
shares of Common  Stock issued  under the  Directors'  Plan will be based on the
closing  price of the Company's  Common Stock on the New York Stock  Exchange on
the last trading day prior to the Company's annual meeting of stockholders.  The
shares will be issued to the non-employee directors on the date of the Company's
annual  meeting  of  stockholders  to be held in each year,  beginning  in 1998.
Participation in the Directors Plan by non-employee  directors is mandatory.  An
aggregate  of 20,000  treasury  shares of Common  Stock may be issued  under the
Directors' Plan.

         If any change in the Common Stock of the Company occurs through merger,
consolidation,   reorganization,   capitalization,   stock  dividend,  split-up,
combination of shares,  exchange of shares,  change in corporate  structure,  or
otherwise,  adjustments  will be made as to the maximum number of shares subject
to the 1990 Plan, 1993 Plan, 1994 Plan, 1997 Plan, 1998 Plan, and the Directors'
Plan,  and the number of shares and exercise price per share of stock subject to
outstanding options.

COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION

         During  the  fiscal  year  ended   December  31,  1998,  the  Company's
Compensation Committee consisted of Messrs.  Malmberg,  Julien, Long, and Burton
E. McGillivray, who is not standing for re-election at the Meeting. None of such
individuals had any contractual or other  relationships  with the Company during
such fiscal year except as directors.

             COMPENSATION COMMITTEE REPORT ON EXECUTIVE COMPENSATION

INTRODUCTION

         The Compensation  Committee of the Board of Directors (the "Committee")
of Three-Five Systems,  Inc. consists  exclusively of independent,  non-employee
directors.  The Committee is  responsible  for reviewing  and  recommending  for
approval  by the  Board  of  Directors  the  Company's  compensation  practices,
executive salary levels, and variable compensation programs, both cash-based and
equity-based.  The Committee  generally reviews base salary levels for executive
officers of the Company in April or May each  fiscal  year and  approves  actual
bonuses  at the end of each  fiscal  year  based  upon  Company  and  individual
performance.

         David C.  Malmberg is the Chairman of the  Committee  and Gary R. Long,
Kenneth  M.  Julien,  and  Burton  E.  McGillivray,  who  is  not  standing  for
re-election as a director at the Meeting, are the current Committee members.

PHILOSOPHY

         The  executive  compensation  program  seeks  to  provide  a  level  of
compensation  that is  competitive  with  companies  similar  in both  size  and
industry.   The  Committee   obtains  the   comparative   data  used  to  assess
competitiveness  from a variety of resources.  Actual total compensation  levels
may differ from competitive  levels in surveyed  companies as a result of annual
and  long-term  Company  performance,  as well as  individual  performance.

                                       8
<PAGE>
The Committee  uses its  discretion to set executive  compensation  when, in its
judgment, external, internal, or an individual's circumstances warrant.

COMPENSATION PROGRAM

         The  primary  components  of  executive  compensation  consist  of base
salary, annual incentive bonuses, and stock option grants.

BASE SALARY

         The  Committee  reviews  salaries  recommended  by the Chief  Executive
Officer  for  executive  officers  other than the Chief  Executive  Officer.  In
formulating  these  recommendations,  the Chief Executive  Officer considers the
overall  performance  of the Company and  conducts  an  informal  evaluation  of
individual officer  performance.  Final decisions on any adjustments to the base
salary for executives,  other than the Chief Executive Officer,  are made by the
Committee in  conjunction  with the Chief  Executive  Officer.  The  Committee's
evaluation of the  recommendations  by the Chief Executive Officer considers the
same factors outlined above and is subjective with no particular weight assigned
to any one  factor.  Base  salaries  for  fiscal  1998  were  determined  by the
Committee in April 1998.  Base  salaries  were raised in 1998 for the  executive
officers  so  that  their  respective  compensation  remained  competitive  with
companies similar in both size and industry.

ANNUAL INCENTIVE BONUSES

         Annual incentive bonuses are intended to provide incentive compensation
to key officers and employees who contribute substantially to the success of the
Company.  The bonuses are calculated  and paid out of the  Management  Incentive
Compensation  Plan  ("MICP"),  which was  approved by the Board of  Directors in
April 1997. The MICP is intended to enhance and reinforce the Company's goals of
profitable  growth and a sound overall  financial  condition by making incentive
compensation awards available to senior level management and key employees.

         The  granting of such awards is based upon the  achievement  of Company
performance  objectives  and  predefined  individual   performance   objectives.
Individual  performance  objectives are developed for every senior level manager
and key employee early in each fiscal year.  Upon the close of each fiscal year,
executive  management  and the  Committee  conduct an  assessment  of individual
performance achieved versus individual performance  objectives.  This assessment
may include but not be limited to individual  responsibility,  performance,  and
compensation  level.  Simultaneously,  the Board  conducts an  assessment of the
Company's  overall  performance to date, which may include but not be limited to
the  achievement  of sales,  net income,  and other  performance  criteria.  The
combination of these factors determines any incentive bonuses to be paid.

         For fiscal 1998, the Committee  awarded bonuses to certain officers and
employees  with the  amount of the award  based  upon the  achievement  of their
individual  performance  objectives and the Board's  assessment of the Company's
overall performance in 1998.

STOCK OPTION GRANTS

         The Company grants stock options periodically to executive officers and
other  key  employees  to  provide  additional  incentive  to work  to  maximize
long-term  total  return  to  stockholders.  Although  the  Board  is  the  Plan
Administrator  of the stock option  plans,  it has  delegated its authority to a
Senior  Committee  and an Employee  Committee.  The members of the  Compensation
Committee serve as members of the Senior Committee,  which is the Committee that
grants options to officers of the Company.  As of July 1998, the Chief Executive
Officer  and  Chief  Financial  Officer  serve as the  members  of the  Employee
Committee,  which grants options to employees  other than officers.  In general,
stock options are granted to managers and key  technical  employees at the onset
of employment.  If, in the opinion of the Plan  Administrator,  the  outstanding
service of an  existing  employee  merits an  increase  in the number of options
held,  however,  the Plan  Administrator  may  elect to issue  additional  stock
options to that  employee.  The vesting period on grants is generally four years
for new  employees  and three years for employees who have been employed for two
years or longer. The vesting schedule is generally  backloaded (with 50% vesting
in the last year) in order to encourage  optionholders to continue in the employ
of the  Company.  The Plan  Administrators  retain the right to  accelerate  the
vesting of options granted by the Company. Certain officers may

                                       9
<PAGE>
also have  longer  vesting  schedules.  In 1998,  the Senior  Committee  and the
Employee Committee authorized the issuance of stock options to certain executive
officers and other key employees.

BENEFITS

         The Company provides various employee benefit programs to its executive
officers,  including medical,  dental and life insurance  benefits,  an employee
401(k) retirement savings plan, and short- and long-term  disability  insurance.
These programs are generally available to all employees of the Company.

CHIEF EXECUTIVE OFFICER COMPENSATION

         The  Committee  considers  the same  factors  outlined  above for other
executive  officers in evaluating the base salary and other  compensation of the
Company's Chief Executive Officer ("CEO"). The Committee's evaluation of the CEO
is  subjective,  with no  particular  weight  assigned to any one  factor.  From
January to July,  the  Company's  CEO was David R.  Buchanan and his annual base
salary remained at $400,000,  which was the same amount that it was for 1997. In
July 1998, David R. Buchanan resigned,  and Vincent C. Hren was appointed CEO of
the  Company.  David  Buchanan  remained  as  Executive  Chairman.  Based on his
experience and comparable data, the Committee established Mr. Hren's annual base
salary at $220,000.  In early January 1999,  Mr. Hren resigned and Mr.  Buchanan
resumed  his former  position as CEO until a  replacement  for Mr. Hren could be
found.  The Committee  determined  that Mr. Hren's  individual  performance  for
fiscal year 1998 merited the payment of no bonus in accordance with the terms of
the  MICP  and  based  upon  the  Board's  assessment  of  the  overall  Company
performance. Mr. Buchanan declined to be considered for a bonus for 1998.

         The Senior  Committee  authorized an additional  30,000 options for Mr.
Hren upon his  appointment  as CEO in July 1998, but those options were canceled
upon his resignation in January.

COMPLIANCE WITH INTERNAL REVENUE CODE SECTION 162(M)

         Section 162(m) of the Internal  Revenue Code generally  disallows a tax
deduction to public  companies for  compensation in excess of $1 million paid to
each of any publicly held  corporation's  chief executive officer and four other
most  highly  compensated  executive  officers.   Qualifying   performance-based
compensation is not subject to the deduction limit if certain  requirements  are
met. The Company currently intends to structure the performance-based portion of
the  compensation  of its  executive  officers  in a manner that  complies  with
Section 162(m).

         This  report has been  furnished  by the  members  of the  Compensation
Committee to the Board of Directors of the Company.

                  David C. Malmberg, Chairman
                  Burton E. McGillivray
                  Gary R. Long
                  Kenneth M. Julien

             SECTION 16(A) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE

         Section  16(a) of the Exchange Act  requires the  Company's  directors,
officers,  and persons who own more than 10 percent of a registered class of the
Company's  equity  securities  to file  reports  of  ownership  and  changes  in
ownership  with  the SEC.  Officers,  directors,  and  greater  than 10  percent
stockholders  are required by SEC regulations to furnish the Company with copies
of all Section 16(a) forms they file.

              Except as noted below,  based solely upon the Company's  review of
the copies of such forms  received by it during the fiscal  year ended  December
31, 1998, and written  representations that no other reports were required,  the
Company  believes that each person who, at any time during such fiscal year, was
a  director,  officer,  or  beneficial  owner  of more  than 10  percent  of the
Company's  Common Stock  complied  with all Section  16(a)  filing  requirements
during such fiscal year, except that (i) Robert T. Berube filed a late report on
Form 3 with respect to his ownership of the Company's  securities as of the date
he became an executive  officer of the Company,  and (ii) Gary R. Long filed one
late Form 5 covering one transaction.

                                       10
<PAGE>
                            COMPANY PERFORMANCE GRAPH

         The following line graph compares  cumulative total stockholder returns
for the five years ended  December 31, 1998 for (i) the Company's  Common Stock;
(ii) the Standard and Poor's SmallCap 600 Index (the "SmallCap  600"); and (iii)
the Standard and Poor's  Electrical  Equipment Index (the "Electrical  Equipment
Index").  The graph  assumes an  investment  of $100 on December 31,  1993.  The
calculations  of  cumulative  stockholder  return  on the  SmallCap  600 and the
Electrical   Equipment  Index  include   reinvestment  of  dividends,   but  the
calculation of cumulative  stockholder return on the Company's Common Stock does
not include  reinvestment of dividends because the Company did not pay dividends
during  the  measurement  period.  The  performance  shown  is  not  necessarily
indicative of future performance.

                                          CUMULATIVE TOTAL RETURN
                             --------------------------------------------------
                             12/93    12/94    12/95    12/96    12/97    12/98
                             -----    -----    -----    -----    -----    -----
Three-Five Systems, Inc.      100      206       96       73       94       78
S & P Smallcap 600            100       95      124      150      189      194
S & P Electrical Equipment    100      101      142      192      271      363



                                       11
<PAGE>
                  SECURITY OWNERSHIP OF PRINCIPAL STOCKHOLDERS,
                             DIRECTORS, AND OFFICERS

         The  following  table  sets forth  certain  information  regarding  the
beneficial ownership of the Company's Common Stock on March 12, 1999 by (i) each
director and each executive  officer of the Company,  and (ii) all directors and
officers of the Company as a group. The Company is not aware of any other person
that owns more than five percent of the Company's Common Stock.

                                                          SHARES BENEFICIALLY
                                                                OWNED
                                                        -----------------------
NAME OF BENEFICIAL OWNER                                NUMBER(1)    PERCENT(2)
- ------------------------                                ---------    ----------
DIRECTORS AND EXECUTIVE OFFICERS:
David R. Buchanan(3)..................................   877,198        12.4%
Dan J. Schott(4)......................................    36,000           *
Lawrence E. Kagemann, Jr.(5)..........................     3,000           *
Jeffrey D. Buchanan(6)................................    55,590           *
Radu G. Andrei(7) ....................................        --          --
Robert T. Berube (8)..................................     3,750           *
Burton E. McGillivray(9)..............................    70,501           1%
David C. Malmberg(10).................................    27,001           *
Kenneth M. Julien(11).................................     3,867           *
Gary R. Long(12)......................................     6,167           *
Thomas H. Werner......................................        --          --
All directors and executive officers as a group
  (eleven persons).................................... 1,083,074        15.2%
- ----------
* Less than 1% of the outstanding shares of Common Stock

(1)  Includes,  when  applicable,  shares owned of record by such person's minor
     children and spouse and by other  related  individuals  and  entities  over
     whose shares of Common Stock such person has custody,  voting  control,  or
     power of  disposition.  Also  includes  shares  of  Common  Stock  that the
     identified person had the right to acquire within 60 days of March 12, 1999
     by the exercise of vested stock options.
(2)  The  percentages  shown include the shares of Common Stock which the person
     will  have the  right to  acquire  within  60 days of March  12,  1999.  In
     calculating  the percentage of ownership,  all shares of Common Stock which
     the  identified  person  will have the right to  acquire  within 60 days of
     March 12, 1998 upon the exercise of vested  stock  options are deemed to be
     outstanding for the purpose of computing the percentage of shares of Common
     Stock owned by such person,  but are not deemed to be  outstanding  for the
     purpose of computing the  percentage of the shares of Common Stock owned by
     any other person.
(3)  Includes  50,000  shares of Common Stock  issuable  upon exercise of vested
     stock options.  Mr.  Buchanan is not standing for re-election as a director
     at the Meeting.
(4)  Includes  32,000  shares of Common Stock  issuable  upon exercise of vested
     stock options.
(5)  Mr. Kagemann serves as the Company's Vice President - Operations.
(6)  Includes  27,500  shares of Common Stock  issuable  upon exercise of vested
     stock options.
(7)  Mr. Andrei serves as the Company's Vice President - Sales and Marketing.
(8)  Includes  1,750 shares of Common  Stock  issuable  upon  exercise of vested
     stock  options.  Mr. Berube serves as the  Company's  Principal  Accounting
     Officer and Corporate Controller.
(9)  Includes  4,000 shares of Common  Stock  issuable  upon  exercise of vested
     stock  options.  Mr.  McGillivray  is not  standing  for  re-election  as a
     director at the Meeting.
(10) Includes  4,000 shares of Common  Stock  issuable  upon  exercise of vested
     stock options.
(11) Includes  1,666 shares of Common  Stock  issuable  upon  exercise of vested
     stock options.
(12) Represents  700 shares of Common Stock held by Mr.  Julien as custodian for
     his minor  children and 1,666 shares of Common Stock issuable upon exercise
     of vested stock options.

                                       12
<PAGE>
                         PROPOSAL TO AMEND THE COMPANY'S
                             1998 STOCK OPTION PLAN

         On January  28,  1999,  the Board of  Directors  approved a proposal to
amend the  Company's  1998  Stock  Option  Plan (the  "1998  Plan"),  subject to
approval by the  Company's  stockholders,  to  increase  the number of shares of
Common Stock that may be issued pursuant to the 1998 Plan from 300,000 shares to
550,000  shares.  The full text of the 1998 Stock  Option Plan as proposed to be
amended  is  included  as  "Appendix  A" to this Proxy  Statement.  The Board of
Directors recommends a vote "for" the proposed amendment to the 1998 Plan.

         The  purpose  of the 1998  Plan is to  attract,  retain,  and  motivate
employees,  independent  contractors,  and non-employee  members of the Board of
Directors  by  providing  them with the  opportunity  to  acquire a  proprietary
interest in the Company and to link their interests and efforts to the long-term
interests of the Company's  stockholders.  By January 28, 1999,  the Company had
granted  options to purchase an  aggregate  of 122,500 of the 300,000  shares of
Common Stock then reserved for issuance  under the 1998 Plan. At that time,  the
Board of Directors  considered the likelihood  that the Company will be required
to grant a  significant  number of stock  options in the near future in order to
attract additional senior management  personnel,  particularly a Chief Technical
Officer and a  permanent  Chief  Executive  Officer.  Accordingly,  the Board of
Directors  approved  a proposal  to  increase  the number of shares  that may be
issued  pursuant  to the 1998 Plan to 550,000 in order to enable the  Company to
make grants to new  executive  officers as well as to continue to grant  options
and/or  issue  shares of Common  Stock  under the 1998 Plan to other  employees,
independent contractors, and non-employee directors.

DESCRIPTION OF THE 1998 STOCK OPTION PLAN

SHARES SUBJECT TO THE PLAN

         A maximum of 300,000  shares of Common  Stock of the Company  currently
may be issued under the 1998 Plan. If any option  terminates or expires  without
having been exercised in full,  stock not issued under such option will again be
available  for the purposes of the 1998 Plan. If any change is made in the stock
subject to the 1998 Plan or subject  to any option  granted  under the 1998 Plan
(through  merger,   consolidation,   reorganization,   recapitalization,   stock
dividend,  split-up,  combination  of  shares,  exchange  of  shares,  change in
corporate  structure,  or  otherwise),  the 1998 Plan provides that  appropriate
adjustments  will be made as to the maximum number of shares subject to the 1998
Plan and the number of shares and exercise  price per share of stock  subject to
outstanding  options.  As of March 12, 1999, no shares of the  Company's  Common
Stock had been issued  upon  exercise  of options  granted  pursuant to the 1998
Plan,  and there  were  outstanding  options  to  acquire  92,500  shares of the
Company's Common Stock.

ELIGIBILITY AND ADMINISTRATION

         Options  may be  granted  pursuant  to the 1998  Plan  only to  persons
("Eligible  Persons")  who at  the  time  of  grant  are  either  (i)  employees
(including  officers and  directors)  of the Company or its  subsidiaries,  (ii)
independent  contractors,   or  (iii)  non-employee  members  of  the  Board  of
Directors.  Options  granted  pursuant to the 1998 Plan may be  incentive  stock
options or non-qualified stock options. Options that are incentive stock options
may be granted  only to  employees  of the  Company.  To the extent that granted
options are incentive  stock options,  the terms and conditions of those options
must be consistent with the qualification requirements set forth in the Internal
Revenue Code.

         The Board of Directors administers the 1998 Plan, except that the Board
of Directors  may delegate its  authority  and duties under the 1998 Plan (other
than the  power to amend the Plan) to one or more  committees  appointed  by the
Board of  Directors.  The Board of  Directors  and any  committee  that has been
delegated  authority to administer the 1998 Plan are each referred to as a "Plan
Administrator."  Each Plan  Administrator  determines  (i) which of the Eligible
Persons in its group will be granted options;  (ii) the type of options granted;
(iii)  the  amount  and  timing  of the  grant  of such  options;  (iv)  vesting
conditions,  provided that no vesting  period may be less than one year; and (v)
such other  terms and  conditions  as may be  imposed by the Plan  Administrator
consistent with the 1998 Plan.

                                       13
<PAGE>
TERMS AND CONDITIONS OF OPTIONS; EXERCISE PRICES; EXERCISE OF OPTIONS

         Each Plan Administrator  determines the expiration date, maximum number
of shares  purchasable,  and the other  provisions of the options at the time of
grant.  The 1998 Plan  currently  provides  that no Eligible  Person may receive
options for more than 150,000  shares of Common Stock  pursuant to the 1998 Plan
in any  one-year  period.  No option may be  granted  for a term in excess of 10
years.  Options  vest  and  become  exercisable  in  whole  or in  one  or  more
installments  at such time as may be determined by the Plan  Administrator  upon
the grant of the options,  except that options  granted  under the 1998 Plan may
not have a vesting  period of less  than one year  after the date of grant.  All
outstanding options under the 1998 Plan automatically  terminate upon completion
of a  merger  or  consolidation  in  which  the  Company  is not  the  surviving
corporation.

         Although  each Plan  Administrator  determines  the exercise  prices of
options at the time of grant,  the exercise  price all of options  granted under
the 1998 Plan may not be less than 100 percent of the fair  market  value of the
Common Stock at the time of the grant.  On March 12, 1999,  the closing price of
the Company's Common Stock on the New York Stock Exchange was $11.19 per share.

         To exercise an option,  the  optionholder is required to deliver to the
Company full payment of the exercise price for the shares as to which the option
is being  exercised.  Generally,  options can be  exercised by delivery of cash,
check, or shares of Common Stock of the Company.

NO AFFILIATE REPRICINGS WITHOUT STOCKHOLDER APPROVAL

         The Company may not cancel any options granted to officers,  directors,
or 10%  shareholders  under the 1998 Plan and issue,  in place of the  cancelled
options,  new options with a lower  exercise  price (a  "repricing")  unless the
repricing is approved by the Company's stockholders within 12 months of the date
of repricing.

REASONS FOR AND EFFECT OF THE PROPOSED AMENDMENT

         It is proposed to increase  the number of shares  reserved for issuance
under the 1998 Plan from 300,000 to 550,000  shares.  The proposed  amendment to
the 1998 Plan also would increase the aggregate number of shares of Common Stock
that may be  subject to options  granted to any one  individual  in any one year
from  150,000  shares to 275,000  shares.  The Company  currently is seeking new
executive  officers,  particularly a new Chief Technical Officer and a permanent
Chief Executive Officer. The Company believes that it will be necessary to grant
a significant  number of stock options to attract and retain these officers.  In
addition, the Company believes that the proposed amendment to the 1998 Plan will
provide a sufficient  reserve of additional shares available for grant under the
1998 Plan to enable the Company to attract and retain other directors, officers,
and key  employees  from time to time in the future and to motivate such persons
to exert their best efforts on behalf of the Company.

         In addition to approving  the proposed  amendment to the 1998 Plan,  on
January  28,  1999 the Board of  Directors  also  reduced  the  number of shares
authorized for issuance under the 1994 Automatic  Stock Option Plan from 100,000
to  50,000  shares.  This  action  by the  Board of  Directors  did not  require
stockholder approval. The Board of Directors recognized that, because of the low
number of options granted under the 1994 Plan each year, the number of shares of
Common Stock authorized for issuance under the 1994 Plan was unnecessarily high.
Accordingly,  and in light of the  proposed  increase  in the  number  of shares
authorized  under the 1998 Plan,  the Board of  Directors  reduced the number of
shares  authorized  for issuance under the 1994 Plan with the intent to minimize
the total number of shares  authorized  under all of the  Company's  stock-based
plans.  In the event that the  stockholders  of the Company approve the proposed
amendment to the 1998 Plan,  the combined  effect of the actions of the Board of
Directors will be a net increase of 200,000 shares  authorized  under all of the
Company's stock-based plans.

                                       14
<PAGE>
FEDERAL INCOME TAX CONSEQUENCES

         Certain options granted under the 1998 Plan will be intended to qualify
as incentive  stock  options  under  Section 422 of the Internal  Revenue  Code.
Accordingly,  there will be no taxable  income to an employee  when an incentive
stock  option is granted  to him or her or when that  option is  exercised.  The
amount  by which the fair  market  value of the  shares at the time of  exercise
exceeds the exercise  price,  however,  generally  will be treated as an item of
preference   in  computing  the  alternate   minimum   taxable   income  of  the
optionholder.  If an  optionholder  exercises an incentive stock option and does
not dispose of the shares within either two years after the date of the grant of
the  option  or  one  year  of the  date  the  shares  were  transferred  to the
optionholder,  any  gain  realized  upon  disposition  will  be  taxable  to the
optionholder  as a  capital  gain.  If the  optionholder  does not  satisfy  the
applicable holding periods,  however,  the difference between the exercise price
and the fair  market  value of the shares on the date of  exercise of the option
will be taxed as ordinary  income,  and the balance of the gain, if any, will be
taxed as capital  gain.  If the shares are disposed of before the  expiration of
the one-year and two-year  periods and the amount realized is less than the fair
market  value of the shares at the date of  exercise,  the  employee's  ordinary
income is limited to the amount  realized  less the  exercise  price  paid.  The
Company will be entitled to a tax deduction only to the extent the  optionholder
has ordinary  income upon the sale or other  disposition of the shares  received
when the option was exercised.

         Certain other options  issued under the 1998 Plan may be  non-qualified
options.  The income tax consequences of non-qualified  options will be governed
by Section 83 of the Internal  Revenue Code. Under Section 83, the excess of the
fair market value of the shares of the Company's Common Stock acquired  pursuant
to the exercise of any non-qualified  option over the amount paid for such stock
(hereinafter referred to as "Excess Value") must be included in the gross income
of the holder in the first  taxable year in which the Common  Stock  acquired by
the holder is not subject to a substantial  risk of  forfeiture.  In calculating
Excess  Value,  fair  market  value  will be  determined  on the  date  that the
substantial risk of forfeiture expires,  unless a Section 83(b) election is made
to include the Excess  Value in income  immediately  after the  acquisition,  in
which case fair market value will be determined on the date of the  acquisition.
Generally, the Company will be entitled to a federal income tax deduction in the
same taxable year that holders recognize income. The Company will be required to
withhold income taxes with respect to income  reportable  pursuant to Section 83
by a holder.  The basis of the shares acquired by an optionholder  will be equal
to the  exercise  price of those shares plus any income  recognized  pursuant to
Section 83. Subsequent sales of the acquired shares will produce capital gain or
loss. Such capital gain or loss will be long term if the stock has been held for
more than 12 months from the date the substantial risk of forfeiture  lapsed or,
if a Section  83(b)  election  is made,  more  than 12 months  from the date the
shares were acquired.  The maximum  federal  capital gains tax rate currently is
20% for property held more than 12 months.

RATIFICATION BY STOCKHOLDERS OF THE AMENDMENT TO THE 1998 PLAN

         Upon  approval  of the  amendment  to the  Company's  1998  Plan by the
stockholders of the Company, the effective date of the amendment will be January
29,  1999.  In the event that the  amendment to the  Company's  1998 Plan is not
approved by the stockholders,  the 1998 Plan will remain in effect as previously
adopted. Any options outstanding under the 1998 Plan prior to the amendment will
remain valid and unchanged,  except that if the  stockholders do not approve the
proposed  amendment,  any  options  granted  in  excess  of the  300,000  shares
originally  authorized  for issuance under the 1998 Plan will  automatically  be
terminated  and of no further  force and  effect,  as though they had never been
granted.

               RATIFICATION OF APPOINTMENT OF INDEPENDENT AUDITORS

         The Board of Directors has appointed  Arthur Andersen LLP,  independent
public  accountants,  to audit  the  consolidated  financial  statements  of the
Company  for the fiscal  year  ending  December  31,  1999 and  recommends  that
stockholders vote in favor of the ratification of such appointment. In the event
of a negative vote on such ratification,  the Board of Directors will reconsider
its selection. The Board of Directors anticipates that representatives of Arthur
Andersen LLP will be present at the Meeting, will have the opportunity to make a
statement  if they  desire,  and will be  available  to respond  to  appropriate
questions.
                                       15
<PAGE>
                 DEADLINE FOR RECEIPT OF STOCKHOLDERS PROPOSALS

         In  order  to be  included  in the  proxy  statement  and form of proxy
relating to the annual meeting of  stockholders of the Company to be held during
calendar  2000,  stockholder  proposals  that are  intended to be  presented  by
stockholders  must  be  received  at  the  principal  executive  offices  of the
Corporation (i) not less than 60 days in advance of such meeting if such meeting
is to be held on a day which is within 30 days preceding the  anniversary of the
previous  year's annual  meeting,  or 90 days in advance of such meeting if such
meeting is to be held on or after the  anniversary of the previous year's annual
meeting,  and (ii) with respect to any other annual meeting of stockholders,  on
or before the close of the business on the  fifteenth day following the date (or
the first date,  if there be more than one) of public  disclosure of the date of
such meeting such meeting.

         Pursuant to Rule 14a-4 under the Exchange  Act, the Company  intends to
retain  discretionary  authority to vote  proxies  with  respect to  shareholder
proposals for which the proponent does not seek to have the Company  include the
proposed  matter in the proxy statement for the annual meeting to be held during
calendar 2000, except in circumstances  where (i) the Company receives notice of
the proposed matter within the time periods described in the paragraph above and
(ii) the proponent complies with the other requirements set forth in Rule 14a-4.

                                  OTHER MATTERS

         The Company  knows of no other  matters to be submitted to the Meeting.
If any other matters  properly  come before the Meeting,  it is the intention of
the persons named in the enclosed  proxy card to vote the shares they  represent
as the Board of Directors may recommend.

                                                           Dated: March 19, 1999

                                       16
<PAGE>
                                   APPENDIX A

                              AMENDED AND RESTATED
                 THREE-FIVE SYSTEMS, INC. 1998 STOCK OPTION PLAN
                        (AMENDED AS OF JANUARY 28, 1999)

         1. ADOPTION.  On January 29, 1997, the Board of Directors (the "Board")
of Three-Five Systems, Inc., a Delaware corporation (the Company"),  adopted the
1998 Stock Option Plan (the "Original  Plan").  The  stockholders of the Company
approved the Original  Plan on April 23,  1998.  On January 28, 1999,  the Board
amended the Original  Plan in order to increase  the number of available  shares
for issuance under the Plan by 250,000  shares.  This amended and restated plan,
fully  incorporating  the  revisions  made on January 28,  1999,  is referred to
herein  as the  "Revised  Plan."  The  Revised  Plan  must  be  approved  by the
stockholders  of the Company  within one year of the date of its adoption by the
Board. If the Revised Plan is not timely approved by the Company's stockholders,
the Original  Plan, as previously  amended and except as otherwise  specifically
provided herein, shall continue in effect and any Options or Awards issued after
the date of the adoption of the Revised Plan shall remain valid and unchanged to
the extent that such Options or Awards  contain  terms such that they could have
been issued under the Original Plan. Any Options or Awards  outstanding prior to
the adoption by the Board of the Revised Plan shall remain valid and  unchanged.
The Revised  Plan shall be known as the  Three-Five  Systems,  Inc.  Amended and
Restated 1998 Stock Option Plan (the "Plan").  When applicable,  the term "Plan"
shall include the Original Plan, as previously amended, and/or the Revised Plan.
Capitalized terms used in this Plan are defined in SECTION 13 hereof.

         2. PURPOSE.  The purpose of this 1998 Stock Option Plan (the "Plan") is
to  attract,   retain  and  motivate  employees,   independent  contractors  and
non-employee  board members by providing them with the  opportunity to acquire a
proprietary  interest in the Company and to link their  interests and efforts to
the long-term interests of the Company's stockholders.

         3. PLAN ADMINISTRATION

            3.1 IN  GENERAL.  The Plan shall be  administered  by the  Company's
Board of  Directors  (the  "Board").  Except  for the power to amend the Plan as
provided in SECTION 12, the Board,  in its sole  discretion,  may  delegate  its
authority and duties under the Plan to one or more  committees  appointed by the
Board,  under such conditions and limitations as the Board may from time to time
establish.  The Board and/or any committee that has been delegated the authority
to administer the Plan shall be referred to as the "Plan Administrator".  Except
as otherwise explicitly set forth in the Plan, the Plan Administrator shall have
the authority,  in its discretion,  to determine all matters relating to options
granted under the Plan,  including  selection of the  individuals  to be granted
options,  the type of options  granted,  the  number of shares of the  Company's
Common Stock ("Common Stock") subject to an option, vesting conditions,  and any
and all other terms,  conditions,  restrictions and  limitations,  if any, of an
option.  Notwithstanding the foregoing,  no options granted under the Plan shall
have a  vesting  period  of less  than one year  from  the  date of  grant.  All
decisions made by the Plan Administrator pursuant to the Plan and related orders
and resolutions shall be final and conclusive.

            3.2  RULE  16B-3  AND  CODE  SECTION  162(M).   Notwithstanding  any
provision of this Plan to the contrary,  only the Board or a committee  composed
of two or more or  Non-Employee  Directors  may  make  determinations  regarding
grants of options to officers,  directors  and 10%  stockholders  of the Company
("Affiliates").  (The term "Non-Employee Directors shall satisfy the meaning set
forth in Rule 16b-3  promulgated  under the Securities  Exchange Act of 1934, as
amended).  The Plan  Administrator  shall have the authority  and  discretion to
determine the extent to which option grants will conform to the  requirements of
Section 162(m)  Internal  Revenue Code of 1986, as amended (the "Code"),  and to
take such action, establish such procedures, and impose such restrictions as the
Plan Administrator  determines to be necessary or appropriate to conform to such
requirements.

         4. ELIGIBILITY.  Any employee of the Company (the term "employee" shall
include a person who has signed an  agreement  to become an  employee)  shall be
eligible to receive  Incentive Stock Options and/or

                                      A-1
<PAGE>
Nonqualified  Stock  Options  (as such terms are  defined in  SECTION  6.1).  An
independent contractor or non-employee board member shall be eligible to receive
only  Nonqualified  Stock  Options.  For purposes of this  SECTION 4,  "Company"
includes  any parent or  subsidiary  of the Company as defined in Section 424 of
the Code.

         5. SHARES SUBJECT TO THE PLAN

            5.1 NUMBER AND  SOURCE.  The stock  offered  under the Plan shall be
shares  of  Common  Stock  and may be  unissued  shares  or  shares  now held or
subsequently   acquired  by  the  Company  as  treasury  shares,   as  the  Plan
Administrator  may from time to time determine.  Any shares subject to an option
granted under the Plan that is forfeited,  terminated or canceled shall again be
available for the granting of options  under the Plan.  Subject to adjustment as
provided in SECTION 5.2, the aggregate number of shares of Common Stock that may
be issued  under the Plan  shall not exceed  550,000.  The  aggregate  number of
shares of  Common  Stock  that may be  covered  by  options  granted  to any one
individual in any year shall not exceed 275,000.

            5.2 CAPITAL  ADJUSTMENTS.  The aggregate  numbers and type of shares
available for options under the Plan, the maximum number and type of shares that
may be subject to options to any individual  under the Plan, the number and kind
of shares covered by each outstanding  option,  and the exercise price per share
(but not the total price) for stock options outstanding under the Plan shall all
be proportionately adjusted for any increase or decrease in the number of issued
shares of Common Stock  resulting from any split-up,  combination or exchange of
shares,  consolidation,  spin-off  or  recapitalization  of  shares  or any like
capital adjustment or the payment of any stock dividend.

            5.3 MERGERS, ETC. If the Company is the surviving corporation in any
merger or consolidation,  any option granted under the Plan shall pertain to and
apply to the  securities  to which a holder  of the  number  of shares of Common
Stock  subject to the option  would  have been  entitled  prior to the merger or
consolidation.  A dissolution  or  liquidation  of the Company shall cause every
option  outstanding  under this Plan to terminate.  A merger or consolidation in
which the Company is not the surviving corporation shall also cause every option
outstanding under this Plan to terminate,  but each optionholder  shall have the
right, immediately prior to such merger or consolidation in which the Company is
not a surviving  corporation,  to exercise  vested  options in whole or in part,
subject  to the  other  provisions  of  this  Plan  and  the  applicable  option
agreement.

         6. STOCK OPTIONS

            6.1  GRANT.  The  Plan   Administrator   may  grant  stock  options,
designated as either  "Incentive Stock Options" which comply with the provisions
of  Section  422  of  the  Code  or  any  successor  statutory   provision,   or
"Nonqualified  Stock  Options" The price at which  shares may be purchased  upon
exercise of a particular  option shall be determined by the Plan  Administrator;
however,  the exercise  price of any stock option shall not be less than 100% of
the Fair Market Value of such shares on the date such option is granted (110% if
options  are  intended  to be  Incentive  Stock  Options  and are  granted  to a
stockholder who at the time the option is granted owns or is deemed to own stock
possessing  more than 10% of the total  combined  voting power of all classes of
stock of the  Company).  For purposes of the Plan,  "Fair Market  Value" as to a
particular  day equals the  closing  price for the Common  Stock on the New York
Stock Exchange as reported in the Wall Street Journal or in such other source as
the Plan  Administrator  deems reliable.  If there is no reported sale of Common
Stock on the New York Stock  Exchange on the date in question,  then Fair Market
Value shall be the closing  selling price on the New York Stock  Exchange on the
last  preceding  date  for  which  an  actual  reported  sale  exists.  The Plan
Administrator shall set the term of each stock option, but no stock option shall
be exercisable  more than 10 years after the date such option is granted and, to
the extent the aggregate Fair Market Value (determined as of the date the option
is  granted)  of Common  Stock with  respect to which  Incentive  Stock  Options
granted to a particular  individual become exercisable for the first time during
any  calendar  year  (under  the Plan and all other  stock  option  Plans of the
Company)  exceeds  $100,000 (or such  corresponding  amount as may be set by the
Code)  such  options  shall  be  treated  as  Nonqualified  Stock  Options.   An
optionholder  and the Plan  Administrator  can agree at any time to  convert  an
Incentive Stock Option to a Nonqualified Stock Option.

            6.2 NO REPRICING  WITHOUT  STOCKHOLDER  APPROVAL.  No Stock  Options
granted to Affiliates may be repriced  without the approval of the  stockholders
of the Company  ("Repricing")  within 12 months of such  repricing.  Stockholder
approval  shall be  evidenced  by the  affirmative  vote of the  holders  of the
majority of the

                                      A-2
<PAGE>
shares of the  Company's  Common Stock present and person by proxy and voting at
the  meeting.  For  purposes  of this  Agreement,  "Repricing"  shall  mean that
situation  in which  new  options  are  issued  to an  optionholder  in place of
cancelled  options and which would be reportable  in the repricing  table of the
annual proxy.

            6.3 INDIVIDUAL  STOCK OPTION  AGREEMENTS.  Options granted under the
Plan shall be  evidenced  by option  agreements  in such form and content as the
Plan  Administrator   from  time  to  time  approves,   which  agreements  shall
substantially  comply  with and be subject to the terms of the Plan.  The option
agreements may contain other provisions or conditions as the Plan  Administrator
deems  necessary or  appropriate to effectuate the sense and purpose of the Plan
and may be amended from time to time in accordance with the terms thereof.

         7. OPTION EXERCISE

            7.1  PRECONDITION  TO STOCK  ISSUANCE.  No shares shall be delivered
pursuant  to the  exercise  of any  stock  option,  in whole  or in part,  until
qualified for delivery  under such  securities  laws and  regulations  as may be
deemed by the Plan Administrator to be applicable thereto and until, in the case
of the exercise of an option,  payment in full of the option  price  thereof (in
cash or stock as provided in SECTION 7.2) is received by the Company.  No holder
of an option, or any legal representative, legatee or distributee shall be or be
deemed to be a holder of any shares  subject to such option or right  unless and
until  such  shares are  issued.  No option  may at any time be  exercised  with
respect to a fractional share.

            7.2 FORM OF  PAYMENT An  optionholder  may  exercise a stock  option
using as the form of payment (a) cash or cash  equivalent,  (b)  stock-for-stock
payment (as described below) (c) any combination of the above, or (d) such other
means as the Plan  Administrator  may approve.  Any optionholder who owns Common
Stock may use such shares,  the value of which shall be as the Fair Market Value
on the date the stock  option is  exercised,  as a form of payment  to  exercise
stock options under the Plan. The Plan  Administrator,  in its  discretion,  may
restrict or rescind the right to use stock-for-stock payment. A stock option may
be exercised in such manner only by tendering  (actually or by  attestation)  to
the Company  whole shares of Common Stock having a Fair Market Value equal to or
less than the aggregate  exercise price.  The Plan  Administrator  may permit an
optionholder to elect to pay the exercise price of a stock option by authorizing
a third party to sell  shares of Common  Stock (or a  sufficient  portion of the
shares)  acquired  upon  exercise of the stock option and remit to the Company a
sufficient  portion of the sale proceeds to pay the entire  exercise  price plus
any tax withholding  resulting from such exercise.  If an option is exercised by
surrender of stock having a Fair Market Value less than the  aggregate  exercise
price, the optionholder must pay the difference in cash.

         8.  TRANSFERABILITY.  Any Incentive Stock Option granted under the Plan
shall,  during the recipient's  lifetime,  be exercisable only by such recipient
and shall not be assignable or transferable by such recipient other than by will
or the laws of descent and distribution.  Except as specifically  allowed by the
Plan Administrator, a Nonqualified Stock Option granted under the Plan or any of
the  rights  and  privileges  conferred  thereby  shall  not  be  assignable  or
transferable by the  optionholder  other than by will or the laws of descent and
distribution  and such option  shall be  exercisable  during the  optionholder's
lifetime only by the optionholder.

         9.  WITHHOLDING  TAXES;  OTHER  DEDUCTIONS.  The Company shall have the
right to  deduct  from any  settlement  of an  option  granted  under  the Plan,
including the delivery or vesting of shares,  (a) an amount  sufficient to cover
withholding  as required by law for any federal,  state or local taxes,  and (b)
any  amounts  due from the  recipient  of such  option to the  Company or to any
subsidiary  of the Company or to take such other  action as may be  necessary to
satisfy any such withholding or other  obligations,  including  withholding from
any other cash  amounts due or to become due from the Company to such  recipient
an amount equal to such taxes or obligations.

         10.  TERMINATION OF SERVICES.  The terms and conditions  under which an
option may be exercised following termination of an optionholder's employment or
independent contractor  relationship with the company shall be determined by the
Plan Administrator; provided, however, that Incentive Stock Options shall not be
exercisable  at any time after the earliest of the date that is (a) three months
after  termination of employment,  unless due to death or Disability (as defined
in Section 22(e)(3) of the Code);  (b) one year after  termination of employment
due to death or Disability.

                                      A-3
<PAGE>
         11. TERM OF THE PLAN. The Plan shall become effective as of January 29,
1998, and shall remain in full force and effect through January 28, 2008, unless
sooner terminated by the Board. After the Plan is terminated,  no future options
may be granted,  but options  previously  granted  shall remain  outstanding  in
accordance with their  applicable  terms and conditions and the Plan's terms and
conditions.

         12. PLAN AMENDMENT.  The Board may amend, suspend or terminate the Plan
at any time;  provided that no such amendment shall be made without the approval
of the Company's  stockholders  if such approval is: (a) required to comply with
Section 422 of the Code with respect to Incentive  Stock  options;  (b) required
for purposes of Section 162(m) of the Code; (c) required to comply with New York
Stock Exchange rules and  regulations;  (d) required to comply with SEC or state
rules and  regulations;  (e) to  increase  the  number of shares  available  for
issuance under the Plan;  (f) to reduce the minimum  exercise price of an option
below Fair Market Value on the date of grant; or (g) to allow Repricings without
stockholder approval.  The Original Plan was unanimously adopted by the Board on
January  29,  1997.  The  Amended  and  Restated  1998  Stock  Option  Plan  was
unanimously adopted by the Board on January 28, 1999.

         13.  APPROVAL  BY  STOCKHOLDERS.  The Plan  shall be  submitted  to the
stockholders  of the Company for their approval at a regular  meeting to be held
within  12 months  after  the  adoption  of the Plan by the  Board.  Stockholder
approval shall be evidenced by the affirmative  vote of the holder of a majority
of the shares of the  Company's  Common Stock  present in person or by proxy and
voting in the meeting.

                                            THREE-FIVE SYSTEMS, INC.

                                            By:      /s/ Jeffrey D. Buchanan
                                                     ---------------------------
                                            Name:    Jeffrey D. Buchanan
                                                     ---------------------------
                                            Its:     Secretary

                                      A-4
<PAGE>
                            THREE-FIVE SYSTEMS, INC.
                       1999 ANNUAL MEETING OF STOCKHOLDERS

           THIS PROXY IS SOLICITED ON BEHALF OF THE BOARD OF DIRECTORS

         The  undersigned  stockholder of THREE-FIVE  SYSTEMS,  INC., a Delaware
corporation (the "Company"), hereby acknowledges receipt of the Notice of Annual
Meeting of Stockholders and Proxy Statement of the Company, each dated March 19,
1999, and hereby appoints  Jeffrey D. Buchanan and Elizabeth A. Sharp,  and each
of them, proxies and attorneys-in-fact, with full power to each of substitution,
on behalf and in the name of the  undersigned,  to represent the  undersigned at
the 1999 Annual Meeting of Stockholders of the Company,  to be held on Thursday,
April  22,  1999,  at  9:00  a.m.,  local  time,  at  the  Company's   corporate
headquarters at 1600 North Desert Drive, Tempe,  Arizona, and at any adjournment
or adjournments  thereof,  and to vote all shares of the Company's  Common Stock
that the  undersigned  would be  entitled  to vote if then and there  personally
present, on the matters set forth on the reverse side.

         THIS PROXY WILL BE VOTED AS DIRECTED  OR, IF NO CONTRARY  DIRECTION  IS
INDICATED,  WILL BE VOTED FOR THE  ELECTION OF  DIRECTORS;  FOR  APPROVAL OF THE
PROPOSED AMENDMENT TO THE COMPANY'S 1998 STOCK OPTION PLAN; FOR THE RATIFICATION
OF THE  APPOINTMENT OF ARTHUR  ANDERSEN LLP AS THE  INDEPENDENT  AUDITORS OF THE
COMPANY;  AND AS SAID PROXIES DEEM  ADVISABLE ON SUCH OTHER  MATTERS AS MAY COME
BEFORE THE MEETING.

         A majority of such proxies or substitutes as shall be present and shall
act at said meeting or any adjournment or  adjournments  thereof (or if only one
shall be present and act,  then that one) shall have and may exercise all of the
powers of said proxies hereunder.

            (CONTINUED AND TO BE SIGNED AND DATED ON THE OTHER SIDE.)

                                            THREE-FIVE SYSTEMS, INC.
                                            P.O. BOX 11227
                                            NEW YORK, NY  10203-0227
1. ELECTION OF DIRECTORS:
     FOR all nominees [ ]    WITHHOLD AUTHORITY to vote [ ]     *EXCEPTIONS [ ]
     listed below.           for all nominees listed below.

Nominees: Jeffrey D. Buchanan, David C. Malmberg, Kenneth M. Julien,
          Gary R. Long, Thomas H. Werner

(INSTRUCTIONS:  To withhold authority to vote for any individual  nominee,  mark
the "Exceptions" box and write that nominee's name in the space provided below.)

*Exceptions
            --------------------------------------------------------------------
2. Proposal to amend the Company's 1998 Stock Option Plan.
   [ ] FOR                 [ ] AGAINST              [ ] ABSTAIN

3. Proposal to ratify the  appointment of Arthur Andersen LLP as the independent
auditors of the Company.
   [ ] FOR                 [ ] AGAINST              [ ] ABSTAIN

and upon  such  matters  which may  properly  come  before  the  meeting  or any
adjournment or adjournments thereof.

                               Change of Address and/ or Comments Mark Here  [ ]

                               (This  Proxy  should  be  dated,  signed  by  the
                               stockholder(s) exactly as his or her name appears
                               hereon,  and  returned  promptly in the  enclosed
                               envelope.  Persons  signing a fiduciary  capacity
                               should so  indicate.  If shares are held by joint
                               tenants   or   as   community   property,    both
                               stockholders should sign.)

                               Dated:                                     , 1999
                                     -------------------------------------

                               -------------------------------------------------
                                                   Signature
                               -------------------------------------------------
                                            Signature if held jointly

  SIGN, DATE, AND RETURN THE PROXY CARD PROMPTLY USING THE ENCLOSED ENVELOPE.
                Votes must be indicated (x) in Black or Blue ink.


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