The iPhone already downloaded the 9.3.5 update and can't download / install iOS 10 until that is dealt with. Either remove this download from the iPhone, or install the update and later update to iOS 10.
To delete the update:
Go to Settings > General > Usage > Manage Storage.
Tap Delete Update, and tap Delete Update again to confirm.
It doesn't show as an available Download but rather shows that it's already downloaded and is waiting for you to hit the Install Now button so what you'd like to do is navigate to Settings > General > Storage & iCloud Usage > Manage Storage under the STORAGE group and you could then delete the downloaded update.
You would then check again for an available update and iOS 10.0.1 should show up.