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

                                    FORM 10-Q

                                   (Mark one)

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

                  For the quarterly period ended June 30, 1998

                                       OR

     [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
                     EXCHANGE ACT OF 1934 (NO FEE REQUIRED)

              For the transition period from _________ to _________

                         Commission file number 0-21335

                                 GARGOYLES, INC.
             (Exact name of registrant as specified in its charter)

                              Washington 91-1247269
        (State of Incorporation) (I.R.S. Employer Identification Number)

                             5866 SOUTH 194TH STREET
                             KENT, WASHINGTON 98032
                                 (425) 921-3600
   (Address and telephone number of registrant's principal executive offices)

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

                                 Yes [X] No [ ]

As of June 30, 1998, there were 7,837,191 outstanding shares of the registrant's
common stock, no par value, which is the only class of common or voting stock of
the registrant.




<PAGE>

                                 GARGOYLES, INC.
                               INDEX TO FORM 10-Q


                                                                         PAGE(S)
                                                                         -------
                         PART 1 - FINANCIAL INFORMATION

Item 1:   Financial Statements (Unaudited)

          Consolidated Balance Sheets ....................................... 1

          Consolidated Statements of Operations ............................. 2

          Consolidated Statements of Cash Flows .......................... ...3

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

Item 2:   Management's  Discussion  and  Analysis  of  Financial
          Condition  and Results of Operations .............................. 7

Item 3:   Quantitative and Qualitative Disclosure about Market Risk ........  *

                           PART II - OTHER INFORMATION

Item 1:   Legal Proceedings ................................................ 11

Item 2:   Changes in Securities and Use of Proceeds ........................  *

Item 3:   Defaults upon Senior Securities ..................................  *

Item 4:   Submission of Matters to a Vote of Security Holders .............. 11

Item 5:   Other Information ................................................ 11

Item 6:   Exhibits and Reports on Form 8-K ................................. 12

* Omitted as not applicable



<PAGE>


                         PART I - FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

                                 GARGOYLES, INC.
                           CONSOLIDATED BALANCE SHEETS

<TABLE>

                                                                 JUNE 30,          DECEMBER 31,
                                                                   1998                 1997
                                                               ------------         ------------
                                                                (UNAUDITED)
<S>                                                            <C>                  <C>         
ASSETS
Current assets:
  Cash and cash equivalents                                    $    797,965         $    892,176
  Trade receivables, net                                         10,689,856            8,540,120
  Inventories, net                                               11,399,436           13,057,024
  Other current assets and prepaid expenses                       2,446,753            1,792,124
                                                               ------------         ------------
Total current assets                                             25,334,010           24,281,444
Property and equipment, net                                       2,084,552            2,441,133
Intangibles, net                                                 20,818,593           21,232,817
Other assets                                                      1,142,512              671,411
                                                               ------------         ------------
Total assets                                                   $ 49,379,668         $ 48,626,805
                                                               ============         ============
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
  Accounts payable                                             $  7,492,567         $  6,487,131
  Accrued expenses and other current liabilities                  4,163,402            6,402,287
  Current portion of long-term debt                              32,055,512               --
                                                               ------------         ------------
Total current liabilities                                        43,711,481           12,889,418

Long-term debt, net of current portion                               ---              29,160,554

Commitments and contingencies

Shareholders' equity:
  Preferred stock                                                     --                   --
  Common stock, no par value, authorized shares --
    40,000,000, issued and outstanding --
    7,837,191 and 7,437,191, respectively                        26,574,281           25,711,782
  Accumulated deficit                                           (20,876,280)         (19,121,995)
  Cumulative translation adjustment                                 (29,815)             (12,954)
                                                               ------------         ------------
Total shareholders' equity                                        5,668,187            6,576,833
                                                               ------------         ------------
Total liabilities and shareholders' equity                     $ 49,379,668         $ 48,626,805
                                                               ============         ============
</TABLE>

     See accompanying notes to the Consolidated Financial Statements



<PAGE>


<TABLE>

                                                         GARGOYLES, INC.
                                               CONSOLIDATED STATEMENTS OF OPERATIONS
                                                           (UNAUDITED)



                                                        THREE MONTHS ENDED JUNE 30,        SIX MONTHS ENDED JUNE 30,

                                                     ---------------------------------    -----------------------------
                                                         1998                 1997            1998             1997
                                                     ------------         ------------    ------------     ------------
<S>                                                  <C>                  <C>             <C>              <C>         
Net sales                                            $ 13,175,741         $ 15,866,299    $ 24,654,260     $ 24,064,565
Cost of sales                                           5,499,125            6,161,330      10,613,003        9,542,486
                                                     ------------         ------------    ------------     ------------
Gross profit                                            7,676,616            9,704,969      14,041,257       14,522,079
License income                                            190,703              221,736         190,703          331,736
                                                     ------------         ------------     -----------     ------------
                                                        7,867,319            9,926,705      14,231,960       14,853,815
                                                     ------------         ------------     -----------     ------------
Operating expenses:
    Sales and marketing                                 4,354,382            5,396,833       8,776,690        8,186,038
    General and administrative                          1,952,919            1,600,820       3,810,787        2,757,821
    Shipping and warehousing                              672,792              597,829       1,307,309          707,700
    Research and development                              218,396              398,865         416,214          764,156
                                                     ------------         ------------     -----------     ------------
Total operating expenses                                7,198,489            7,994,347      14,311,000       12,415,715
                                                     ------------         ------------     -----------     ------------
Income (loss) from operations                             668,830            1,932,358         (79,040)       2,438,100
Interest income (expense)                                (880,940)            (533,060)     (1,675,082)        (506,269)
                                                     ------------         ------------      -----------    ------------
Income (loss) before income taxes                        (212,110)           1,399,298      (1,754,122)       1,931,831
Income tax provision                                           --              286,500           ----           393,500
                                                     ------------         ------------      ----------     ------------
Net income (loss)                                    $   (212,110)        $  1,112,798    $ (1,754,122)    $  1,538,331
                                                     ============         ============    ============     ============
Basic and diluted net income (loss) per share        $      (0.03)        $       0.14    $      (0.22)    $       0.20
                                                     ============         ============    ============     ============
</TABLE>

     See accompanying notes to the Consolidated Financial Statements





<PAGE>


                                 GARGOYLES, INC.
                      CONSOLIDATED STATEMENT OF CASH FLOWS
                                   (UNAUDITED)
<TABLE>


                                                                     SIX MONTHS ENDED JUNE 30,
                                                                 ---------------------------------
                                                                     1998                 1997
                                                                 ------------         ------------
OPERATING ACTIVITIES
<S>                                                              <C>                  <C>         
Net income (loss)                                                $ (1,754,122)        $  1,538,331
  Adjustments to reconcile net income (loss) to net cash
    used in operating activities:
    Depreciation                                                      426,593              466,080
    Amortization                                                      722,393              195,158
    Deferred license income                                                --             (180,000)
    Minority interest                                                      --

    Changes in assets and liabilities net of effects from 
     business acquisitions:
        Accounts receivable                                        (2,149,736)          (6,844,140)
        Inventories                                                 1,657,588           (5,836,318)
        Other current assets and other assets                        (771,399)          (3,501,258)
        Accounts payable, accrued expenses and other
          current liabilities                                      (1,033,612)           3,770,305
                                                                 ------------         ------------
Net cash used in operating activities                              (2,902,295)         (10,394,842)
                                                                 ------------         ------------
INVESTING ACTIVITIES
Acquisition of property and equipment                                 (70,013)         ( 1,163,376)
Purchase of Sungold                                                        --         ( 11,771,497)
Purchase of Private Eyes                                                   --           (7,914,642)
                                                                 -------------         ------------
                                                                      (70,013)         (20,849,515)
FINANCING ACTIVITIES
Proceeds from stock issuance                                               --               35,135
Net proceeds from revolving of credit                                                   12,658,439
Net proceeds from issuance of long-term debt                        2,894,958           14,559,167
                                                                 ------------         ------------
Net cash provided by financing activities                           2,894,958           27,252,741
                                                                 ------------         ------------
Effect of foreign currency translation on cash                        (16,861)                  --
                                                                 ------------         ------------
Net decrease in cash                                                  (94,211)          (3,991,616)
Cash and cash equivalents, beginning of period                        892,176            4,382,048
                                                                 ------------         ------------
Cash and cash equivalents, end of period                         $    797,965         $    390,432
                                                                 ============         ============
</TABLE>

     See accompanying notes to the Consolidated Financial Statements




<PAGE>



                                 GARGOYLES, INC.
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                                  JUNE 30, 1998
                                   (UNAUDITED)

1.  INTERIM FINANCIAL STATEMENTS

     The accompanying  consolidated financial statements of Gargoyles,  Inc. and
its  subsidiaries  ("Gargoyles" or the "Company") are unaudited and include,  in
the opinion of management, all normal recurring adjustments necessary to present
fairly the  consolidated  financial  position  at June 30,  1998 and the related
consolidated  results of  operations  and cash flows for the periods  presented.
Certain  information  and  footnote  disclosure  normally  included in financial
statements prepared in accordance with generally accepted accounting  principles
have been  condensed  or omitted  pursuant to the rules and  regulations  of the
Securities  and Exchange  Commission.  These  condensed  consolidated  financial
statements should be read in conjunction with the Company's audited consolidated
financial  statements  and the related notes  thereto  included in the Company's
1997 Annual  Report on Form  10-K/A as filed with the  Securities  and  Exchange
Commission.

     The  Company's net sales are subject to seasonal  variations.  Accordingly,
the  results  of  operations  for  the  periods  ended  June  30,  1998  are not
necessarily indicative of the results that may be expected for the entire year.

2.  INVENTORIES

    Inventories consist of the following:


                                                 June 30,      December 31,
                                                   1998            1997
                                               ------------    ------------
Materials ..................................   $  6,789,159    $  7,119,328
Finished goods .............................      6,455,560       7,909,147
   Reserves for excess, slow-moving and
      obsolete inventories .................     (1,845,283)     (1,971,451)
                                               ------------    ------------
           Inventories, net ................   $ 11,399,436    $ 13,057,024
                                               ============    ============

3.  COMMITMENTS AND CONTINGENCIES

     In 1998,  the Company  negotiated  releases  from certain of its  operating
leases  decreasing  its  minimum  future  lease  payments  under   noncancelable
operating leases.  Minimum future lease payments under  noncancelable  operating
leases are as follows:

                                                     June 30,      December 31,
                                                      1998             1997
                                                   -----------     ------------
1998 .........................................     $   306,721       $1,381,397
1999 .........................................         668,923        1,304,276
2000 .........................................         445,209        1,101,755
2001 .........................................         283,277          949,370
2002 .........................................          94,571          700,000
Thereafter ...................................           7,881        3,500,000
                                                   -----------       ----------
                                                   $ 1,806,582       $8,936,798
                                                   ===========       ==========
<PAGE>

     On June 8, 1998, the Company entered into a lease agreement with respect to
a  warehouse  facility  located in Kent,  Washington.  The lease term  commences
August  1,  1998  and  terminates  July  31,  2001  and is  subject  to  earlier
termination  on July  31,  2000  at the  option  of the  Company.  Base  rent is
$13,411.54 per month.

     The Company is currently  involved in two lawsuits  involving (i) claims by
the  Company  against a third  party  related  to  alleged  infringement  of the
Company's toric curve  technology and (ii) claims by a former  employee  against
the Company alleging wrongful termination and discrimination under various laws.
In the opinion of management,  the ultimate  resolution of such  litigation will
not have a significant  adverse effect on the Company's  financial  condition or
the results of its operations.

4.  INCOME TAXES

     The Company recorded no income tax benefit relating to the net loss for the
three-month and six-month periods ended June 30, 1998, since a future benefit is
not assured.  In 1997, the difference from the federal statutory income tax rate
of 34% resulted from a decrease in the reserve against certain tax assets.

5.  DEBT RESTRUCTURING

     In January 1998, the Company restructured its credit agreement (the "Credit
Agreement") with its primary lender.  The amended Credit  Agreement  consists of
(i) a revolving loan  commitment of up to $14 million,  secured by the assets of
the Company,  (ii) a term loan of $16.47 million,  also secured by the assets of
the  Company  and  (iii)  an  equipment  loan of $3.9  million,  secured  by the
equipment  of the  Company,  resulting in  approximately  $5 million  additional
availability to the Company.  The Credit  Agreement was further amended on March
31, 1998 to reschedule principal payments and to revise financial covenants. The
Credit  Agreement  was  further  amended  on August 13,  1998 to waive  covenant
defaults  through July 30, 1998 and to revise  financial  covenants  for periods
after July 31,  1998.  The revised  Credit  Agreement  requires  $8.8 million of
principal payments due January 4, 1999, with all remaining  outstanding debt due
in April 1999. The Company  believes that it is unlikely it will be able to make
such  principal  payments  when due,  absent the  Company  obtaining  additional
financing  through  the sale of equity or debt  securities,  but there can be no
assurance that such financing will be available on a timely basis,  on favorable
terms or at all.  The  additional  funds are subject to certain  conditions  and
covenants, which include minimum tangible net worth, working capital, net sales,
and EBIDTA  requirements,  as well as ratios  relating  to debt  coverages.  The
Credit  Agreement  also  prohibits  the  Company  from paying  dividends  to its
shareholders.

     In consideration  for the amendments to the Credit  Agreement,  in January,
1998 the Company  issued  400,000  shares of the  Company's  common  stock to an
affiliate of its lender and agreed to file a registration  statement  related to
those shares with the Securities  and Exchange  Commission by November 15, 1998.
The shares were valued at the time of issuance  based on the market price of the
Company's  stock on the date of issuance less an  appropriate  discount based on
the nature of the underlying stock and its  marketability.  The common stock was
valued at  $862,500  and was  recorded  as payment of $200,000 in bank fees that
were due December 31, 1997 and $662,500 in debt issuance costs.

6.  COMPREHENSIVE INCOME (LOSS)

     In 1997,  the  Financial  Accounting  Standards  Board issued  Statement of
Financial Accounting Standards No. 130, "Reporting  Comprehensive Income," which
establishes   display   requirements  of   comprehensive   income  in  financial
statements.  The Company's total  comprehensive  income (loss) for the three and
six  month  periods  of  1998  and  1997  was  ($206,331)  and  $1,112,798,  and
$(1,770,984) and $1,538,331,respectively.
<PAGE>

7.  EARNINGS PER SHARE

     The  weighted-average  number of common  shares for the three and six month
periods ended June 30, 1998 and 1997 is 7,837,191 and  7,423,193,  and 7,806,079
and 7,421,613,respectively. The weighted-average number of common shares used in
the  calculation of earnings per share for the three and six month periods ended
June  30,  1997 is  7,689,283  and  7,686,083,  respectively.  For  purposes  of
calculating  diluted  earnings per share for the three and six months ended June
30, 1998, common stock equivalents have not been included as the effect would be
antidilutive.

8.  RECLASSIFICATIONS

    Certain  reclassifications  have been made to the  prior  years'  financial
statements to conform to the current year presentation.

9.  1997 BUSINESS ACQUISITIONS

Sungold Acquisition
-------------------

     On April 11, 1997, the Company  purchased  substantially all the assets and
assumed certain liabilities of Sungold Enterprises, LTD., a New York corporation
("Sungold")  Sungold  manufactured  two principal  lines of premium  sunglasses,
Stussy EyeGear, a young men's fashion brand licensed to Sungold by Stussy, Inc.,
a leading designer of streetwear apparel and accessories, and Anarchy Eyewear, a
cutting-edge brand popular with alternative sports enthusiasts age 15 to 25.

     The  acquisition  was accounted for using the purchase method of accounting
at the date of acquisition.  Accordingly, the allocation of the initial purchase
price of  $10,970,000  was based on the fair  value of the assets  acquired  and
liabilities  assumed.  Costs in excess of the fair value of the assets  acquired
and liabilities  assumed are reflected as  intangibles,  a component of which is
the Stussy license  agreement,  which is being amortized over the remaining term
of the license.


     Proforma  information for the six months ended June 30, 1997,  assuming the
Sungold acquisition had occurred at January 1, 1997, is as follows:

Sales                                $  28,325,752
Gross profit                            17,635,734
Net income (loss)                        1,682,694
Net income (loss) per share          $        0.22

Private Eyes Acquisition
------------------------

     On May 14, 1997,  the Company  purchased  substantially  all the assets and
assumed  certain  liabilities  of  the  Private  Eyes  Sunglass  Corporation,  a
Massachusetts  corporation  ("Private Eyes").  Private Eyes was the licensee for
Ellen Tracy eyewear which  features a collection of  high-quality,  high-fashion
women's  sunglasses,  readers,  optical  frames and  accessories in a variety of
designs ranging from traditional to fashion  forward.  Private Eyes is the North
American distributor for Emmanuelle Khanh Paris Eyewear and also distributes its
own line of prescription frames and eyewear accessories.

     The  acquisition  was accounted for using the purchase method of accounting
at the date of  acquisition.  Accordingly,  the allocation of the purchase price
was based on the fair  value of the assets  acquired  and  liabilities  assumed.
Costs in excess of the fair value of the assets acquired and liabilities assumed
are  reflected as  intangibles,  a component of which is the Ellen Tracy license
agreement, which is being amortized over the remaining term of the license.

     Proforma  information for the six months ended June 30, 1997,  assuming the
Private Eyes acquisition had occurred at January 1, 1997, is as follows:

Sales                                $32,463,817
Gross profit                          19,922,279
Net income (loss)                      1,658,962
Net income (loss) per share          $      0.22
<PAGE>

10.  LIQUIDITY

     The Company incurred  significant  operating losses in 1997 and for the six
months ended June 30, 1998.  The Company was unable to make a scheduled  payment
on its bank debt in December  1997,  and at the Company's  request,  its banking
arrangements  were  restructured  in the first quarter of 1998. The Company also
has had difficulty paying suppliers on a timely basis, and has made arrangements
with certain suppliers to provide for payment schedules for past due amounts and
to  provide  letters of credit  for a portion  of the  purchase  price of future
orders.

     The Company is exploring  various options designed to maximize  shareholder
value,  including the possible sale of equity or convertible  debt securities to
fund working capital and, in part, to finance the January 1999 loan payment, but
there can be no assurance  that such  financing or other source of funds will be
available  on a  timely  basis,  on  favorable  terms  or at all.  In  addition,
management  is seeking to reduce  expenses  to levels that can be  sustained  by
operations.  Failure  of  operations  or expense  reduction  efforts to meet the
Company's expectations, unanticipated expenses, loss of continued cooperation of
the  Company's  key  suppliers  or  the  bank,  third-party  claims  or  adverse
developments in pending  litigation could result in additional cash requirements
that could be difficult or  impossible  to satisfy and could require the Company
to further  reduce its  operating  expenditures,  to curtail  operations,  or to
dispose of operating assets to enable it to continue operations through December
31, 1998.


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

FORWARD-LOOKING STATEMENTS

     Certain   statements   within  this  report   constitute   "forward-looking
statements" within the meaning of the Private  Securities  Litigation Reform Act
of  1995.   Forward-looking   statements   involve  known  and  unknown   risks,
uncertainties  and other factors that may cause the actual results,  performance
or achievements of the Company or industry  results,  to differ  materially from
the anticipated  results,  performance or  achievements  expressed or implied by
such forward-looking  statements.  Such factors include, without limitation, the
factors  discussed in the Company's  Annual Report,  as amended,  on Form 10-K/A
under  factors  discussed in  connection  with the  forward-looking  statements.
Forward-looking statements reflect management's views, estimates and opinions at
the date on which the statements are made. The Company  undertakes no obligation
to update  forward-looking  statements to reflect  changes in  circumstances  or
changes in the views,  estimates or opinions of management  that occur after the
statements  are made.  Because of the inherent  uncertainty  of  forward-looking
statements  and because  circumstances  or  management's  views,  estimates  and
opinions may change,  investors  are  cautioned  not to place undue  reliance on
forward-looking  statements.  Certain forward-looking  statements are identified
with a cross reference to this paragraph.

GENERAL

     Gargoyles  designs,  assembles,  markets and  distributes  a broad range of
sunglasses and eyewear products.  The Company competes  primarily in the premium
sunglass markets by offering a diverse line of products  marketed under a number
of brands owned by the Company or licensed  from third  parties.  The  Company's
principal brands include Gargoyles  Performance  Eyewear,  Gargoyles  Protective
Eyewear, Hobie Polarized Sunglasses, Timberland Eyewear, Stussy EyeGear, Anarchy
Eyewear, Angel Eyewear, Ellen Tracy Eyewear, Emmanuelle Khanh Paris Eyewear, and
Private Eyes.  Under the Ellen Tracy  Eyewear,  Emmanuelle  Khanh Paris Eyewear,
Private Eyes and  Timberland  Eyewear  brands,  the Company also offers  diverse
lines of ophthalmic frames.

     The  Company   operates  both  directly  and  through  three   wholly-owned
subsidiaries and one  majority-controlled  subsidiary.  The Company's  operating
subsidiaries include:  H.S.C., Inc., a Washington corporation,  Sungold Eyewear,
Inc., a Washington corporation,  Private Eyes Sunglass Corporation, a Washington
corporation, and the kindling company, a California corporation.
<PAGE>

RESULTS OF OPERATIONS

     The following  table sets forth results of  operations,  as a percentage of
net sales, for the periods indicated:

<TABLE>

                                                     Three Months            Six Months
                                                        Ended                  Ended
                                                       June 30,               June 30,
                                                 --------------------    -----------------
                                                  1998          1997      1998       1997
                                                 ------        ------    ------     ------
<S>                                              <C>           <C>        <C>          <C>   
Net sales ...............................        100.0%        100.0%    100.0%     100.0%
Cost of sales ...........................         41.7          38.8      43.0       39.7
Gross profit ............................         58.3          61.2      57.0       60.3
License income ..........................          1.4           1.4        .8        1.4
Operating expenses:
   Sales and marketing ...................        33.0          34.0      35.6       34.0
   General and administrative ............        14.8          10.1      15.5       11.5
   Shipping and warehousing ..............         5.1           3.8       5.3        2.9
   Research and development ..............         1.7           2.5       1.7        3.2
Total operating expenses ................         54.6          50.4      58.0       51.6
Income (loss) from operations ...........          5.1          12.2      (0.3)      10.1
</TABLE>


THREE MONTHS ENDED JUNE 30, 1998 COMPARED TO THREE MONTHS ENDED JUNE 30, 1997

     Net sales.  Net sales  decreased  from $15.9  million for the quarter ended
June 30,  1997 to $13.2  million  for the  quarter  ended  June 30,  1998.  This
decrease of $2.7 million (17%) was primarily the result of decreases in sales of
the Company's  Gargoyles,  Hobie and  Timberland  products  that were  partially
offset by increases in sales of the Company's Sungold product lines. The Sungold
operation was acquired during the second quarter of 1997 so the 1997 quarter did
not reflect a full quarter's sales of Sungold  products.  See Note 9 of Notes to
Financial Statements.

     Gross  profit.  Gross  profit  decreased  from $9.7 million for the quarter
ended June 30, 1997 to $7.7 million for the quarter  ended June 30, 1998.  Gross
margin  decreased to 58.3% in the 1998  quarter from 61.2% in the 1997  quarter.
The decrease in gross margin in 1998 was  attributable  to reduced  sales levels
and liquidation of certain inventories in the 1998 quarter at discounted prices.

     License income.  License income decreased to $191,000 for the quarter ended
June 30, 1998 compared to $222,000 for the quarter ended June 30, 1997.  License
income represents  royalties  collected on product sold by others that have been
authorized to utilize the Gargoyles name or technology.

     Operating  expenses.  Operating  expenses decreased to $7.2 million for the
quarter ended June 30, 1998 from $8 million for the quarter ended June 30, 1997.
As a percentage of net sales,  operating expenses increased to 54.6% in the 1998
quarter from 50.4% in the 1997 quarter.  Sales and marketing  expenses decreased
$1.0  million  in the 1998  quarter,  as a result of cost  cutting  efforts  and
reduced sales levels. As a percentage of net sales, sales and marketing expenses
decreased to 33.0% in the 1998 quarter from 34.0% in the 1997  quarter.  General
and  administrative  expenses  increased  $352,000  in the  1998  quarter.  As a
percentage of net sales, general and administrative  expenses increased to 14.8%
in the 1998 quarter  from 10.1% in the 1997  quarter.  Shipping and  warehousing
expenses  increased  $75,000 in the 1998 quarter.  As a percentage of net sales,
shipping  and  warehousing  expenses  increased to 5.1% in the 1998 quarter from
3.8% in the 1997 quarter.  Research and development  expenses decreased $180,000
in the 1998 quarter,  primarily as a result of  management's  efforts to contain
certain costs. As a percentage of net sales,  research and development  expenses
decreased  to 1.7% in the  1998  quarter  from  2.5% in the  1997  quarter.  The
decrease in total operating expenses of $796,000 million is primarily due to the
reduction  in  operating  expenses  resulting  from the  Company's  cost-cutting
measures and reduced sales levels.

     Income (loss) from operations.  The Company realized income from operations
of  $669,000  for the  quarter  ended  June 30,  1998  compared  to income  from
operations of $1,932,000 for the quarter ended June 30, 1997.


<PAGE>

     Interest income  (expense).  Interest  expense was $881,000 for the quarter
ended June 30, 1998 compared  with interest  expense of $533,000 for the quarter
ended June 30, 1997 as a result of increased  interest-bearing  borrowings.  The
Company's outstanding borrowings were $32.1 million at June 30, 1998 compared to
$27.2 million at June 30, 1997.

     Income tax provision  (benefit).  The Company's income tax benefit was zero
for the quarter  ended June 30,  1998  compared  to an income tax  provision  of
$286,500  for the  quarter  ended June 30,  1997.  Differences  from the federal
statutory  income tax rate of 34% resulted  from changes in the reserve  against
certain tax assets.

     Net income (loss).  As a result of the items discussed above, the Company's
net loss was  $212,000  or $.03 per share for the  quarter  ended June 30,  1998
compared to a net income of $1.1 million or $.14 per share for the quarter ended
June 30, 1997.

SIX MONTHS ENDED JUNE 30, 1998 COMPARED TO SIX MONTHS ENDED JUNE 30, 1997

     Net sales.  Net sales  increased to $24.7  million for the six months ended
June 30, 1998 from $24.1  million for the six months ended June 30,  1997.  This
increase was primarily  the result of sales by Sungold,  acquired by the Company
during the 1997 second quarter,  that was partially offset by decreases in sales
of the Company's Gargoyles, Hobie, and Timberland products.

     Gross  profit.  Gross profit  decreased to $14.0 million for the six months
ended June 30, 1998 from $14.5  million for the six months  ended June 30, 1997.
Gross  margin  decreased  to 57.0% in 1998 from 60.3% in 1997.  The  decrease in
gross margin in 1998 was primarily  attributable to reduced sales levels and the
liquidation of certain inventories in 1998 at discounted prices.

     License  income.  License  income  decreased to $191,000 for the six months
ended June 30, 1998 compared to $332,000 for the six months ended June 30, 1997.
The  decrease  in license  income in 1998 was the  result of a one-time  sale of
product by a licensee in 1997.

     Operating  expenses.  Operating expenses increased to $14.3 million for the
six months ended June 30, 1998 from $12.4  million for the six months ended June
30, 1997. As a percentage of net sales, operating expenses increased to 58.0% in
1998 from 51.6% in 1997. Sales and marketing expenses increased $591,000 in 1998
as compared to the same period in 1997. As a percentage of net sales,  sales and
marketing  expenses  increased  to 35.6% in the 1998  period  from  34.0% in the
comparable  1997 period.  General and  administrative  expenses  increased  $1.1
million for the six months  ended June 30,  1998,  primarily  as a result of the
second  quarter 1997 Sungold and Private Eyes  acquisitions.  As a percentage of
net sales,  general and administrative  expenses increased to 15.5% in 1998 from
11.5% in 1997.  Shipping and warehousing  expenses increased $600,000 in 1998 as
compared to the six months  ended June 30, 1997.  As a percentage  of net sales,
shipping and warehousing  expenses  increased to 5.3% in 1998 from 2.9% in 1997.
Research and  development  expenses  decreased  $348,000 in the six months ended
June 30, 1998,  primarily as a result of management's efforts to contain certain
costs. As a percentage of net sales, research and development expenses decreased
to 1.7% in 1998 from 3.2% in 1997. The increase in total  operating  expenses of
$1.1 million is the result of the Sungold and Private Eyes  acquisitions  during
the  second  quarter  of 1997  which were  partially  offset by a  reduction  in
operating expenses resulting from the Company's cost-cutting measures.

     Income (loss) from operations.  The Company incurred a loss from operations
of  $79,000  for the six months  ended June 30,  1998  compared  to income  from
operations of $2,438,000 for the six months ended June 30, 1997.

     Interest  income  (expense).  Interest  expense was  $1,675,000 for the six
months ended June 30, 1998 compared with interest  expense of $506,  000 for the
six  months  ended  June 30,  1997 as a  result  of  increased  interest-bearing
borrowings.

     Income tax provision  (benefit).  The Company's income tax benefit was zero
for the six months  ended June 30, 1998  compared to an income tax  provision of
$393,500 for the six months ended June 30,  1997.  Differences  from the federal
statutory  income tax rate of 34% resulted  from changes in the reserve  against
certain tax assets.

     Net income (loss).  As a result of the items discussed above, the Company's
net loss was $1.7  million or $.22 per share for the six  months  ended June 30,
1998 compared to a net income of $1,538,000 or $.20 per share for the six months
ended June 30, 1997.
<PAGE>

LIQUIDITY AND CAPITAL RESOURCES

     Historically,  the Company has relied  primarily  on cash from  operations,
borrowings  and its  initial  public  offering  of common  stock to finance  its
operations. Cash used in the Company's operating activities totaled $2.9 million
and $10.4 million for the six months ended June 30, 1998 and 1997, respectively.
The  Company  reduced  the cash used in  operating  activities  in the first six
months of 1998 by $7.5  million  compared to the first six months of 1997 by (i)
reducing the buildup of accounts  receivable by $4.7 million,  (ii) reducing net
inventories  by $1.7 million in the first six months of 1998  compared to a $5.8
million  increase in inventories in the first six months of 1997, (iii) reducing
the effect of  changes in other  assets  and  liabilities,  primarily  through a
decrease in  expenditures on prepaid  advertising  costs and (iv) repaying $1.03
million  in  accounts  payable  and  accrued  expenses  in 1998 as  compared  to
incurring $3.8 million in additional  accounts  payable and accrued  expenses in
the similar period in 1997. Cash used in the Company's investing activities,  to
fund acquisitions of property and equipment,  totaled $70,000 and $1,163,000 for
the six  months  ended  June  30,  1998 and  1997,  respectively.  The  purchase
acquisitions of Sungold and Private Eyes required $19,686,139 of cash during the
six  months  ended June 30,  1997.  Cash  provided  by the  Company's  financing
activities,  primarily  proceeds from bank debt,  totaled $2.9 million and $27.2
million  for the six months  ended June 30, 1998 and 1997,  respectively.  As of
June 30, 1998,  the Company had unused  sources of  liquidity  of $2.0  million,
consisting of cash and cash  equivalents  of $798,000 and  borrowings  available
under its revolving loan of $1.2 million.

     The Company has initiated  certain cost  reduction  measures  including the
consolidation of its office and warehouse space.  During April 1998, the Company
vacated its Norwell,  Massachusetts facility and negotiated a termination of the
Norwell lease,  negotiated a termination of the lease for its warehouse facility
in Kent,  Washington  and negotiated an amendment to the lease for its Lynnwood,
Washington  facility,  thereby  decreasing  minimum  future lease payments under
noncancelable  operating  leases from $8.9  million at December 31, 1997 to $1.8
million at June 30, 1998.

     In January 1998, the Company restructured its credit agreement (the "Credit
Agreement") with its primary lender.  The amended Credit  Agreement  consists of
(i) a revolving loan  commitment of up to $14 million,  secured by the assets of
the Company,  (ii) a term loan of $16.47 million,  also secured by the assets of
the  Company  and  (iii)  an  equipment  loan of $3.9  million,  secured  by the
equipment  of the  Company,  resulting in  approximately  $5 million  additional
availability to the Company, subject to certain collateral levels and covenants,
which include minimum tangible net worth, working capital, net sales, and EBIDTA
requirements, as well as ratios relating to debt coverages. The Credit Agreement
was further  amended on March 31, 1998 to reschedule  principal  payments and to
revise financial covenants.  The Credit Agreement was further amended on August,
13,  1998 to  waive  covenant  defaults  through  July 30,  1998  and to  revise
financial  covenants  for  periods  after  July 31,  1998.  The  revised  Credit
Agreement  requires $8.8 million of principal payments due January 4, 1999, with
all remaining  outstanding  debt due April 1999. The Company believes that it is
unlikely it will be able to make such  principal  payments when due,  absent the
Company obtaining additional financing.

     The Company has had difficulty  paying suppliers on a timely basis, and has
made  arrangements  with certain  suppliers to provide for payment schedules for
past due amounts and to provide  letters of credit for a portion of the purchase
price of future orders.  Failure of operations or expense  reduction  efforts to
meet the  Company's  expectations,  unanticipated  expenses,  loss of  continued
cooperation  of the Company's key suppliers or the bank,  third-party  claims or
adverse  developments  in pending  litigation  could result in  additional  cash
requirements  that could be difficult or impossible to satisfy and could require
the Company to further reduce its operating expenditures, to curtail operations,
or to dispose  of  operating  assets to enable it to  continue  operations.  The
Company is exploring  various options  designed to maximize  shareholder  value,
including  the  possible  sale of  common  or  convertible  preferred  stock  or
convertible debt securities to fund working capital and, in part, to finance the
January  1999  loan  payment,  but  there  can be no  assurance  that  any  such
transaction  could be completed on a timely basis, on favorable terms or at all.
See "Forward-Looking Statements."


<PAGE>

SEASONALITY

     The Company's net sales generally have been higher in the period from March
to September,  the period  during which  sunglass  purchases  are highest.  As a
result,  operating income is typically lower in the first and fourth quarters as
fixed operating costs are spread over lower sales volume.  See  "Forward-Looking
Statements." The Company has experienced higher accounts receivable during March
through September as a result of higher sales during this period.  The Company's
quarterly  results of operations have fluctuated in the past and may continue to
fluctuate as a result of a number of factors,  including  seasonal  cycles,  the
timing of new  product  introductions,  the  timing  of orders by the  Company's
customers,  the mix of product  sales and the effects of weather  conditions  on
consumer purchases.

                           PART II - OTHER INFORMATION

ITEM 1.  LEGAL PROCEEDINGS

     On November  22,  1996,  the Company  filed an action in the United  States
District Court for the District of Massachusetts,  under Case No.  996-12344RCL,
against Aearo Corporation, a Delaware corporation,  alleging infringement of the
Company's  toric  curve  lens  utility  patent.   Both  the  Company  and  Aearo
Corporation  filed summary judgment motions with the Court. On May 19, the Court
ruled in favor of the  Company  and found  that  product  manufactured  by Aearo
Corporation  infringes the Company's toric curve patent. Aearo Corporation moved
for  reconsideration  of the Court's ruling on infringement,  but Aearo's motion
for  reconsideration  was denied.  Trial is expected to be  scheduled  for early
1999.  The  Company  believes  that the only  significant  issues left for trial
include whether the Company's patent was validly issued,  and, if so, the extent
of  damages  to  be  awarded  to  the  Company  resulting  from  Aearo's  patent
infringement.  Any judgment  awarded in favor of the Company would be subject to
appeal.

     There have been no material changes in other legal proceedings  reported in
the Company's 1997 Annual  Report,  as amended,  on Form 10-K/A  Amendment No. 1
filed with the Securities and Exchange Commission on April 15, 1998.

ITEM 4.  SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

     The Company held its annual meeting of shareholders on June 4, 1998. At the
annual  meeting Class 1 Directors  were up for election,  and a Class 3 Director
was up for  election  as a result  of  resignations  of Class 3  directors.  The
following summarizes all matters voted on at the meeting:

     Election of Directors                       For                  Withheld

     Class 3 Director: Elected to serve
      until the 2000 annual meeting

          Robert G. Wolfe                      6,366,608                 56,890

    Class 1 Directors:  Elected to serve until
      the 2001 annual meeting

          Walter F. Walker                    6,357,686                 65,812
          Timothy C. Potts                    6,340,819                 82,679


ITEM 5. OTHER INFORMATION

     In July,  the Company  received  notice  from Nasdaq that a Nasdaq  Listing
Qualifications  Panel had  determined to delist the Company's  common stock from
the Nasdaq National Market for failure to meet Nasdaq's listing requirement with
respect to net  tangible  assets.  Delisting  was  effective  as of the close of
business July 13, 1998. The Company's common stock has continued to be quoted on
the Nasdaq's over-the-counter bulletin board.


<PAGE>

ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K

(a) EXHIBITS

Exhibit 10.1   Lease  Agreement  dated June 8, 1998, by and between South Valley
               Associates, as Landlord, and the Company, as Tenant.

Exhibit 10.2   Eighth  Amendment to First Amended and Restated Credit  Agreement
               dated  April  30,  1998  by  and  between  U.S.   Bank   National
               Association,  successor  by  merger to U.S.  Bank of  Washington,
               National Association, and Gargoyles, Inc.

Exhibit 27.1   Financial Data Schedule

(b) REPORTS ON FORM 8-K

     Form 8-K with respect to the Company's decision to close its London office,
positive developments in the Company's litigation against Aearo Corporation, and
other matters was filed with the Securities and Exchange  Commission on April 3,
1998.


                                   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 hereunto duly authorized.

                                        Gargoyles, Inc.
                                        (Registrant)

August 14, 1998                         /s/ Leo Rosenberger
                                        -------------------
                                            Leo Rosenberger
                                        Chief Executive Officer, Chief
                                        Financial Officer and Treasurer



<PAGE>


                                  EXHIBIT INDEX

EXHIBIT
NUMBER             EXHIBIT DESCRIPTION

Exhibit 10.1      Lease  Agreement  dated June 8, 1998, by and between South
                  Valley Associates,  as Landlord, and Gargoyles,  Inc.,
                  as Tenant.

Exhibit 10.2      Eighth Amendment to First  Amended and  Restated
                  Credit Agreement dated April 30, 1998 by and between U.S.
                  Bank National Association, successor by merger to U.S. Bank
                  of Washington, National Association, and Gargoyles, Inc.

Exhibit 27.1      Financial Data Schedule
[{"type": "10-Q", "sequence": "1", "description": "QUARTERLY REPORT", "secsgml_size_bytes": 50837}]
{"company-data": {"conformed-name": "GARGOYLES INC", "cik": "0001016278", "assigned-sic": "3851", "irs-number": "911247269", "state-of-incorporation": "WA", "fiscal-year-end": "1231"}, "filing-values": {"form-type": "10-Q", "act": "34", "file-number": "000-21335", "film-number": "98689076"}, "business-address": {"street1": "5866 SOUTH 194TH STREET", "city": "KENT", "state": "WA", "zip": "98032", "phone": "4259213600"}, "mail-address": {"street1": "5866 SOUTH 194TH STREET", "city": "KENT", "state": "WA", "zip": "98032"}}
UNITED STATES
                       SECURITIES AND EXCHANGE COMMISSION
                             Washington, D.C. 20549

                                    FORM 10-Q

                                   (Mark one)

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

                  For the quarterly period ended June 30, 1998

                                       OR

     [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
                     EXCHANGE ACT OF 1934 (NO FEE REQUIRED)

              For the transition period from _________ to _________

                         Commission file number 0-21335

                                 GARGOYLES, INC.
             (Exact name of registrant as specified in its charter)

                              Washington 91-1247269
        (State of Incorporation) (I.R.S. Employer Identification Number)

                             5866 SOUTH 194TH STREET
                             KENT, WASHINGTON 98032
                                 (425) 921-3600
   (Address and telephone number of registrant's principal executive offices)

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

                                 Yes [X] No [ ]

As of June 30, 1998, there were 7,837,191 outstanding shares of the registrant's
common stock, no par value, which is the only class of common or voting stock of
the registrant.
GARGOYLES, INC.
                               INDEX TO FORM 10-Q

                                                                         PAGE(S)
                                                                         -------
                         PART 1 - FINANCIAL INFORMATION

Item 1:   Financial Statements (Unaudited)

          Consolidated Balance Sheets ....................................... 1

          Consolidated Statements of Operations ............................. 2

          Consolidated Statements of Cash Flows .......................... ...3

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

Item 2:   Management's  Discussion  and  Analysis  of  Financial
          Condition  and Results of Operations .............................. 7

Item 3:   Quantitative and Qualitative Disclosure about Market Risk ........  *

                           PART II - OTHER INFORMATION

Item 1:   Legal Proceedings ................................................ 11

Item 2:   Changes in Securities and Use of Proceeds ........................  *

Item 3:   Defaults upon Senior Securities ..................................  *

Item 4:   Submission of Matters to a Vote of Security Holders .............. 11

Item 5:   Other Information ................................................ 11

Item 6:   Exhibits and Reports on Form 8-K ................................. 12

* Omitted as not applicable
PART I - FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

                                 GARGOYLES, INC.
                           CONSOLIDATED BALANCE SHEETS

                                                                 JUNE 30,          DECEMBER 31,
                                                                   1998                 1997
                                                               ------------         ------------
                                                                (UNAUDITED)
ASSETS
Current assets:
  Cash and cash equivalents                                    $    797,965         $    892,176
  Trade receivables, net                                         10,689,856            8,540,120
  Inventories, net                                               11,399,436           13,057,024
  Other current assets and prepaid expenses                       2,446,753            1,792,124
                                                               ------------         ------------
Total current assets                                             25,334,010           24,281,444
Property and equipment, net                                       2,084,552            2,441,133
Intangibles, net                                                 20,818,593           21,232,817
Other assets                                                      1,142,512              671,411
                                                               ------------         ------------
Total assets                                                   $ 49,379,668         $ 48,626,805
                                                               ============         ============
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
  Accounts payable                                             $  7,492,567         $  6,487,131
  Accrued expenses and other current liabilities                  4,163,402            6,402,287
  Current portion of long-term debt                              32,055,512               --
                                                               ------------         ------------
Total current liabilities                                        43,711,481           12,889,418

Long-term debt, net of current portion                               ---              29,160,554

Commitments and contingencies

Shareholders' equity:
  Preferred stock                                                     --                   --
  Common stock, no par value, authorized shares --
    40,000,000, issued and outstanding --
    7,837,191 and 7,437,191, respectively                        26,574,281           25,711,782
  Accumulated deficit                                           (20,876,280)         (19,121,995)
  Cumulative translation adjustment                                 (29,815)             (12,954)
                                                               ------------         ------------
Total shareholders' equity                                        5,668,187            6,576,833
                                                               ------------         ------------
Total liabilities and shareholders' equity                     $ 49,379,668         $ 48,626,805
                                                               ============         ============
See accompanying notes to the Consolidated Financial Statements
GARGOYLES, INC.
                                               CONSOLIDATED STATEMENTS OF OPERATIONS
                                                           (UNAUDITED)

                                                        THREE MONTHS ENDED JUNE 30,        SIX MONTHS ENDED JUNE 30,

                                                     ---------------------------------    -----------------------------
                                                         1998                 1997            1998             1997
                                                     ------------         ------------    ------------     ------------
Net sales                                            $ 13,175,741         $ 15,866,299    $ 24,654,260     $ 24,064,565
Cost of sales                                           5,499,125            6,161,330      10,613,003        9,542,486
                                                     ------------         ------------    ------------     ------------
Gross profit                                            7,676,616            9,704,969      14,041,257       14,522,079
License income                                            190,703              221,736         190,703          331,736
                                                     ------------         ------------     -----------     ------------
                                                        7,867,319            9,926,705      14,231,960       14,853,815
                                                     ------------         ------------     -----------     ------------
Operating expenses:
    Sales and marketing                                 4,354,382            5,396,833       8,776,690        8,186,038
    General and administrative                          1,952,919            1,600,820       3,810,787        2,757,821
    Shipping and warehousing                              672,792              597,829       1,307,309          707,700
    Research and development                              218,396              398,865         416,214          764,156
                                                     ------------         ------------     -----------     ------------
Total operating expenses                                7,198,489            7,994,347      14,311,000       12,415,715
                                                     ------------         ------------     -----------     ------------
Income (loss) from operations                             668,830            1,932,358         (79,040)       2,438,100
Interest income (expense)                                (880,940)            (533,060)     (1,675,082)        (506,269)
                                                     ------------         ------------      -----------    ------------
Income (loss) before income taxes                        (212,110)           1,399,298      (1,754,122)       1,931,831
Income tax provision                                           --              286,500           ----           393,500
                                                     ------------         ------------      ----------     ------------
Net income (loss)                                    $   (212,110)        $  1,112,798    $ (1,754,122)    $  1,538,331
                                                     ============         ============    ============     ============
Basic and diluted net income (loss) per share        $      (0.03)        $       0.14    $      (0.22)    $       0.20
                                                     ============         ============    ============     ============
See accompanying notes to the Consolidated Financial Statements
GARGOYLES, INC.
                      CONSOLIDATED STATEMENT OF CASH FLOWS
                                   (UNAUDITED)

                                                                     SIX MONTHS ENDED JUNE 30,
                                                                 ---------------------------------
                                                                     1998                 1997
                                                                 ------------         ------------
OPERATING ACTIVITIES
Net income (loss)                                                $ (1,754,122)        $  1,538,331
  Adjustments to reconcile net income (loss) to net cash
    used in operating activities:
    Depreciation                                                      426,593              466,080
    Amortization                                                      722,393              195,158
    Deferred license income                                                --             (180,000)
    Minority interest                                                      --

    Changes in assets and liabilities net of effects from 
     business acquisitions:
        Accounts receivable                                        (2,149,736)          (6,844,140)
        Inventories                                                 1,657,588           (5,836,318)
        Other current assets and other assets                        (771,399)          (3,501,258)
        Accounts payable, accrued expenses and other
          current liabilities                                      (1,033,612)           3,770,305
                                                                 ------------         ------------
Net cash used in operating activities                              (2,902,295)         (10,394,842)
                                                                 ------------         ------------
INVESTING ACTIVITIES
Acquisition of property and equipment                                 (70,013)         ( 1,163,376)
Purchase of Sungold                                                        --         ( 11,771,497)
Purchase of Private Eyes                                                   --           (7,914,642)
                                                                 -------------         ------------
                                                                      (70,013)         (20,849,515)
FINANCING ACTIVITIES
Proceeds from stock issuance                                               --               35,135
Net proceeds from revolving of credit                                                   12,658,439
Net proceeds from issuance of long-term debt                        2,894,958           14,559,167
                                                                 ------------         ------------
Net cash provided by financing activities                           2,894,958           27,252,741
                                                                 ------------         ------------
Effect of foreign currency translation on cash                        (16,861)                  --
                                                                 ------------         ------------
Net decrease in cash                                                  (94,211)          (3,991,616)
Cash and cash equivalents, beginning of period                        892,176            4,382,048
                                                                 ------------         ------------
Cash and cash equivalents, end of period                         $    797,965         $    390,432
                                                                 ============         ============
See accompanying notes to the Consolidated Financial Statements
GARGOYLES, INC.
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                                  JUNE 30, 1998
                                   (UNAUDITED)

1.  INTERIM FINANCIAL STATEMENTS

     The accompanying  consolidated financial statements of Gargoyles,  Inc. and
its  subsidiaries  ("Gargoyles" or the "Company") are unaudited and include,  in
the opinion of management, all normal recurring adjustments necessary to present
fairly the  consolidated  financial  position  at June 30,  1998 and the related
consolidated  results of  operations  and cash flows for the periods  presented.
Certain  information  and  footnote  disclosure  normally  included in financial
statements prepared in accordance with generally accepted accounting  principles
have been  condensed  or omitted  pursuant to the rules and  regulations  of the
Securities  and Exchange  Commission.  These  condensed  consolidated  financial
statements should be read in conjunction with the Company's audited consolidated
financial  statements  and the related notes  thereto  included in the Company's
1997 Annual  Report on Form  10-K/A as filed with the  Securities  and  Exchange
Commission.

     The  Company's net sales are subject to seasonal  variations.  Accordingly,
the  results  of  operations  for  the  periods  ended  June  30,  1998  are not
necessarily indicative of the results that may be expected for the entire year.

2.  INVENTORIES

    Inventories consist of the following:

                                                 June 30,      December 31,
                                                   1998            1997
                                               ------------    ------------
Materials ..................................   $  6,789,159    $  7,119,328
Finished goods .............................      6,455,560       7,909,147
   Reserves for excess, slow-moving and
      obsolete inventories .................     (1,845,283)     (1,971,451)
                                               ------------    ------------
           Inventories, net ................   $ 11,399,436    $ 13,057,024
                                               ============    ============

3.  COMMITMENTS AND CONTINGENCIES

     In 1998,  the Company  negotiated  releases  from certain of its  operating
leases  decreasing  its  minimum  future  lease  payments  under   noncancelable
operating leases.  Minimum future lease payments under  noncancelable  operating
leases are as follows:

                                                     June 30,      December 31,
                                                      1998             1997
                                                   -----------     ------------
1998 .........................................     $   306,721       $1,381,397
1999 .........................................         668,923        1,304,276
2000 .........................................         445,209        1,101,755
2001 .........................................         283,277          949,370
2002 .........................................          94,571          700,000
Thereafter ...................................           7,881        3,500,000
                                                   -----------       ----------
                                                   $ 1,806,582       $8,936,798
                                                   ===========       ==========
On June 8, 1998, the Company entered into a lease agreement with respect to
a  warehouse  facility  located in Kent,  Washington.  The lease term  commences
August  1,  1998  and  terminates  July  31,  2001  and is  subject  to  earlier
termination  on July  31,  2000  at the  option  of the  Company.  Base  rent is
$13,411.54 per month.

     The Company is currently  involved in two lawsuits  involving (i) claims by
the  Company  against a third  party  related  to  alleged  infringement  of the
Company's toric curve  technology and (ii) claims by a former  employee  against
the Company alleging wrongful termination and discrimination under various laws.
In the opinion of management,  the ultimate  resolution of such  litigation will
not have a significant  adverse effect on the Company's  financial  condition or
the results of its operations.

4.  INCOME TAXES

     The Company recorded no income tax benefit relating to the net loss for the
three-month and six-month periods ended June 30, 1998, since a future benefit is
not assured.  In 1997, the difference from the federal statutory income tax rate
of 34% resulted from a decrease in the reserve against certain tax assets.

5.  DEBT RESTRUCTURING

     In January 1998, the Company restructured its credit agreement (the "Credit
Agreement") with its primary lender.  The amended Credit  Agreement  consists of
(i) a revolving loan  commitment of up to $14 million,  secured by the assets of
the Company,  (ii) a term loan of $16.47 million,  also secured by the assets of
the  Company  and  (iii)  an  equipment  loan of $3.9  million,  secured  by the
equipment  of the  Company,  resulting in  approximately  $5 million  additional
availability to the Company.  The Credit  Agreement was further amended on March
31, 1998 to reschedule principal payments and to revise financial covenants. The
Credit  Agreement  was  further  amended  on August 13,  1998 to waive  covenant
defaults  through July 30, 1998 and to revise  financial  covenants  for periods
after July 31,  1998.  The revised  Credit  Agreement  requires  $8.8 million of
principal payments due January 4, 1999, with all remaining  outstanding debt due
in April 1999. The Company  believes that it is unlikely it will be able to make
such  principal  payments  when due,  absent the  Company  obtaining  additional
financing  through  the sale of equity or debt  securities,  but there can be no
assurance that such financing will be available on a timely basis,  on favorable
terms or at all.  The  additional  funds are subject to certain  conditions  and
covenants, which include minimum tangible net worth, working capital, net sales,
and EBIDTA  requirements,  as well as ratios  relating  to debt  coverages.  The
Credit  Agreement  also  prohibits  the  Company  from paying  dividends  to its
shareholders.

     In consideration  for the amendments to the Credit  Agreement,  in January,
1998 the Company  issued  400,000  shares of the  Company's  common  stock to an
affiliate of its lender and agreed to file a registration  statement  related to
those shares with the Securities  and Exchange  Commission by November 15, 1998.
The shares were valued at the time of issuance  based on the market price of the
Company's  stock on the date of issuance less an  appropriate  discount based on
the nature of the underlying stock and its  marketability.  The common stock was
valued at  $862,500  and was  recorded  as payment of $200,000 in bank fees that
were due December 31, 1997 and $662,500 in debt issuance costs.

6.  COMPREHENSIVE INCOME (LOSS)

     In 1997,  the  Financial  Accounting  Standards  Board issued  Statement of
Financial Accounting Standards No. 130, "Reporting  Comprehensive Income," which
establishes   display   requirements  of   comprehensive   income  in  financial
statements.  The Company's total  comprehensive  income (loss) for the three and
six  month  periods  of  1998  and  1997  was  ($206,331)  and  $1,112,798,  and
$(1,770,984) and $1,538,331,respectively.
7.  EARNINGS PER SHARE

     The  weighted-average  number of common  shares for the three and six month
periods ended June 30, 1998 and 1997 is 7,837,191 and  7,423,193,  and 7,806,079
and 7,421,613,respectively. The weighted-average number of common shares used in
the  calculation of earnings per share for the three and six month periods ended
June  30,  1997 is  7,689,283  and  7,686,083,  respectively.  For  purposes  of
calculating  diluted  earnings per share for the three and six months ended June
30, 1998, common stock equivalents have not been included as the effect would be
antidilutive.

8.  RECLASSIFICATIONS

    Certain  reclassifications  have been made to the  prior  years'  financial
statements to conform to the current year presentation.

9.  1997 BUSINESS ACQUISITIONS

Sungold Acquisition
-------------------

     On April 11, 1997, the Company  purchased  substantially all the assets and
assumed certain liabilities of Sungold Enterprises, LTD., a New York corporation
("Sungold")  Sungold  manufactured  two principal  lines of premium  sunglasses,
Stussy EyeGear, a young men's fashion brand licensed to Sungold by Stussy, Inc.,
a leading designer of streetwear apparel and accessories, and Anarchy Eyewear, a
cutting-edge brand popular with alternative sports enthusiasts age 15 to 25.

     The  acquisition  was accounted for using the purchase method of accounting
at the date of acquisition.  Accordingly, the allocation of the initial purchase
price of  $10,970,000  was based on the fair  value of the assets  acquired  and
liabilities  assumed.  Costs in excess of the fair value of the assets  acquired
and liabilities  assumed are reflected as  intangibles,  a component of which is
the Stussy license  agreement,  which is being amortized over the remaining term
of the license.

     Proforma  information for the six months ended June 30, 1997,  assuming the
Sungold acquisition had occurred at January 1, 1997, is as follows:

Sales                                $  28,325,752
Gross profit                            17,635,734
Net income (loss)                        1,682,694
Net income (loss) per share          $        0.22

Private Eyes Acquisition
------------------------

     On May 14, 1997,  the Company  purchased  substantially  all the assets and
assumed  certain  liabilities  of  the  Private  Eyes  Sunglass  Corporation,  a
Massachusetts  corporation  ("Private Eyes").  Private Eyes was the licensee for
Ellen Tracy eyewear which  features a collection of  high-quality,  high-fashion
women's  sunglasses,  readers,  optical  frames and  accessories in a variety of
designs ranging from traditional to fashion  forward.  Private Eyes is the North
American distributor for Emmanuelle Khanh Paris Eyewear and also distributes its
own line of prescription frames and eyewear accessories.

     The  acquisition  was accounted for using the purchase method of accounting
at the date of  acquisition.  Accordingly,  the allocation of the purchase price
was based on the fair  value of the assets  acquired  and  liabilities  assumed.
Costs in excess of the fair value of the assets acquired and liabilities assumed
are  reflected as  intangibles,  a component of which is the Ellen Tracy license
agreement, which is being amortized over the remaining term of the license.

     Proforma  information for the six months ended June 30, 1997,  assuming the
Private Eyes acquisition had occurred at January 1, 1997, is as follows:

Sales                                $32,463,817
Gross profit                          19,922,279
Net income (loss)                      1,658,962
Net income (loss) per share          $      0.22
10.  LIQUIDITY

     The Company incurred  significant  operating losses in 1997 and for the six
months ended June 30, 1998.  The Company was unable to make a scheduled  payment
on its bank debt in December  1997,  and at the Company's  request,  its banking
arrangements  were  restructured  in the first quarter of 1998. The Company also
has had difficulty paying suppliers on a timely basis, and has made arrangements
with certain suppliers to provide for payment schedules for past due amounts and
to  provide  letters of credit  for a portion  of the  purchase  price of future
orders.

     The Company is exploring  various options designed to maximize  shareholder
value,  including the possible sale of equity or convertible  debt securities to
fund working capital and, in part, to finance the January 1999 loan payment, but
there can be no assurance  that such  financing or other source of funds will be
available  on a  timely  basis,  on  favorable  terms  or at all.  In  addition,
management  is seeking to reduce  expenses  to levels that can be  sustained  by
operations.  Failure  of  operations  or expense  reduction  efforts to meet the
Company's expectations, unanticipated expenses, loss of continued cooperation of
the  Company's  key  suppliers  or  the  bank,  third-party  claims  or  adverse
developments in pending  litigation could result in additional cash requirements
that could be difficult or  impossible  to satisfy and could require the Company
to further  reduce its  operating  expenditures,  to curtail  operations,  or to
dispose of operating assets to enable it to continue operations through December
31, 1998.

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

FORWARD-LOOKING STATEMENTS

     Certain   statements   within  this  report   constitute   "forward-looking
statements" within the meaning of the Private  Securities  Litigation Reform Act
of  1995.   Forward-looking   statements   involve  known  and  unknown   risks,
uncertainties  and other factors that may cause the actual results,  performance
or achievements of the Company or industry  results,  to differ  materially from
the anticipated  results,  performance or  achievements  expressed or implied by
such forward-looking  statements.  Such factors include, without limitation, the
factors  discussed in the Company's  Annual Report,  as amended,  on Form 10-K/A
under  factors  discussed in  connection  with the  forward-looking  statements.
Forward-looking statements reflect management's views, estimates and opinions at
the date on which the statements are made. The Company  undertakes no obligation
to update  forward-looking  statements to reflect  changes in  circumstances  or
changes in the views,  estimates or opinions of management  that occur after the
statements  are made.  Because of the inherent  uncertainty  of  forward-looking
statements  and because  circumstances  or  management's  views,  estimates  and
opinions may change,  investors  are  cautioned  not to place undue  reliance on
forward-looking  statements.  Certain forward-looking  statements are identified
with a cross reference to this paragraph.

GENERAL

     Gargoyles  designs,  assembles,  markets and  distributes  a broad range of
sunglasses and eyewear products.  The Company competes  primarily in the premium
sunglass markets by offering a diverse line of products  marketed under a number
of brands owned by the Company or licensed  from third  parties.  The  Company's
principal brands include Gargoyles  Performance  Eyewear,  Gargoyles  Protective
Eyewear, Hobie Polarized Sunglasses, Timberland Eyewear, Stussy EyeGear, Anarchy
Eyewear, Angel Eyewear, Ellen Tracy Eyewear, Emmanuelle Khanh Paris Eyewear, and
Private Eyes.  Under the Ellen Tracy  Eyewear,  Emmanuelle  Khanh Paris Eyewear,
Private Eyes and  Timberland  Eyewear  brands,  the Company also offers  diverse
lines of ophthalmic frames.

     The  Company   operates  both  directly  and  through  three   wholly-owned
subsidiaries and one  majority-controlled  subsidiary.  The Company's  operating
subsidiaries include:  H.S.C., Inc., a Washington corporation,  Sungold Eyewear,
Inc., a Washington corporation,  Private Eyes Sunglass Corporation, a Washington
corporation, and the kindling company, a California corporation.
RESULTS OF OPERATIONS

     The following  table sets forth results of  operations,  as a percentage of
net sales, for the periods indicated:

                                                     Three Months            Six Months
                                                        Ended                  Ended
                                                       June 30,               June 30,
                                                 --------------------    -----------------
                                                  1998          1997      1998       1997
                                                 ------        ------    ------     ------
Net sales ...............................        100.0%        100.0%    100.0%     100.0%
Cost of sales ...........................         41.7          38.8      43.0       39.7
Gross profit ............................         58.3          61.2      57.0       60.3
License income ..........................          1.4           1.4        .8        1.4
Operating expenses:
   Sales and marketing ...................        33.0          34.0      35.6       34.0
   General and administrative ............        14.8          10.1      15.5       11.5
   Shipping and warehousing ..............         5.1           3.8       5.3        2.9
   Research and development ..............         1.7           2.5       1.7        3.2
Total operating expenses ................         54.6          50.4      58.0       51.6
Income (loss) from operations ...........          5.1          12.2      (0.3)      10.1
THREE MONTHS ENDED JUNE 30, 1998 COMPARED TO THREE MONTHS ENDED JUNE 30, 1997

     Net sales.  Net sales  decreased  from $15.9  million for the quarter ended
June 30,  1997 to $13.2  million  for the  quarter  ended  June 30,  1998.  This
decrease of $2.7 million (17%) was primarily the result of decreases in sales of
the Company's  Gargoyles,  Hobie and  Timberland  products  that were  partially
offset by increases in sales of the Company's Sungold product lines. The Sungold
operation was acquired during the second quarter of 1997 so the 1997 quarter did
not reflect a full quarter's sales of Sungold  products.  See Note 9 of Notes to
Financial Statements.

     Gross  profit.  Gross  profit  decreased  from $9.7 million for the quarter
ended June 30, 1997 to $7.7 million for the quarter  ended June 30, 1998.  Gross
margin  decreased to 58.3% in the 1998  quarter from 61.2% in the 1997  quarter.
The decrease in gross margin in 1998 was  attributable  to reduced  sales levels
and liquidation of certain inventories in the 1998 quarter at discounted prices.

     License income.  License income decreased to $191,000 for the quarter ended
June 30, 1998 compared to $222,000 for the quarter ended June 30, 1997.  License
income represents  royalties  collected on product sold by others that have been
authorized to utilize the Gargoyles name or technology.

     Operating  expenses.  Operating  expenses decreased to $7.2 million for the
quarter ended June 30, 1998 from $8 million for the quarter ended June 30, 1997.
As a percentage of net sales,  operating expenses increased to 54.6% in the 1998
quarter from 50.4% in the 1997 quarter.  Sales and marketing  expenses decreased
$1.0  million  in the 1998  quarter,  as a result of cost  cutting  efforts  and
reduced sales levels. As a percentage of net sales, sales and marketing expenses
decreased to 33.0% in the 1998 quarter from 34.0% in the 1997  quarter.  General
and  administrative  expenses  increased  $352,000  in the  1998  quarter.  As a
percentage of net sales, general and administrative  expenses increased to 14.8%
in the 1998 quarter  from 10.1% in the 1997  quarter.  Shipping and  warehousing
expenses  increased  $75,000 in the 1998 quarter.  As a percentage of net sales,
shipping  and  warehousing  expenses  increased to 5.1% in the 1998 quarter from
3.8% in the 1997 quarter.  Research and development  expenses decreased $180,000
in the 1998 quarter,  primarily as a result of  management's  efforts to contain
certain costs. As a percentage of net sales,  research and development  expenses
decreased  to 1.7% in the  1998  quarter  from  2.5% in the  1997  quarter.  The
decrease in total operating expenses of $796,000 million is primarily due to the
reduction  in  operating  expenses  resulting  from the  Company's  cost-cutting
measures and reduced sales levels.

     Income (loss) from operations.  The Company realized income from operations
of  $669,000  for the  quarter  ended  June 30,  1998  compared  to income  from
operations of $1,932,000 for the quarter ended June 30, 1997.
Interest income  (expense).  Interest  expense was $881,000 for the quarter
ended June 30, 1998 compared  with interest  expense of $533,000 for the quarter
ended June 30, 1997 as a result of increased  interest-bearing  borrowings.  The
Company's outstanding borrowings were $32.1 million at June 30, 1998 compared to
$27.2 million at June 30, 1997.

     Income tax provision  (benefit).  The Company's income tax benefit was zero
for the quarter  ended June 30,  1998  compared  to an income tax  provision  of
$286,500  for the  quarter  ended June 30,  1997.  Differences  from the federal
statutory  income tax rate of 34% resulted  from changes in the reserve  against
certain tax assets.

     Net income (loss).  As a result of the items discussed above, the Company's
net loss was  $212,000  or $.03 per share for the  quarter  ended June 30,  1998
compared to a net income of $1.1 million or $.14 per share for the quarter ended
June 30, 1997.

SIX MONTHS ENDED JUNE 30, 1998 COMPARED TO SIX MONTHS ENDED JUNE 30, 1997

     Net sales.  Net sales  increased to $24.7  million for the six months ended
June 30, 1998 from $24.1  million for the six months ended June 30,  1997.  This
increase was primarily  the result of sales by Sungold,  acquired by the Company
during the 1997 second quarter,  that was partially offset by decreases in sales
of the Company's Gargoyles, Hobie, and Timberland products.

     Gross  profit.  Gross profit  decreased to $14.0 million for the six months
ended June 30, 1998 from $14.5  million for the six months  ended June 30, 1997.
Gross  margin  decreased  to 57.0% in 1998 from 60.3% in 1997.  The  decrease in
gross margin in 1998 was primarily  attributable to reduced sales levels and the
liquidation of certain inventories in 1998 at discounted prices.

     License  income.  License  income  decreased to $191,000 for the six months
ended June 30, 1998 compared to $332,000 for the six months ended June 30, 1997.
The  decrease  in license  income in 1998 was the  result of a one-time  sale of
product by a licensee in 1997.

     Operating  expenses.  Operating expenses increased to $14.3 million for the
six months ended June 30, 1998 from $12.4  million for the six months ended June
30, 1997. As a percentage of net sales, operating expenses increased to 58.0% in
1998 from 51.6% in 1997. Sales and marketing expenses increased $591,000 in 1998
as compared to the same period in 1997. As a percentage of net sales,  sales and
marketing  expenses  increased  to 35.6% in the 1998  period  from  34.0% in the
comparable  1997 period.  General and  administrative  expenses  increased  $1.1
million for the six months  ended June 30,  1998,  primarily  as a result of the
second  quarter 1997 Sungold and Private Eyes  acquisitions.  As a percentage of
net sales,  general and administrative  expenses increased to 15.5% in 1998 from
11.5% in 1997.  Shipping and warehousing  expenses increased $600,000 in 1998 as
compared to the six months  ended June 30, 1997.  As a percentage  of net sales,
shipping and warehousing  expenses  increased to 5.3% in 1998 from 2.9% in 1997.
Research and  development  expenses  decreased  $348,000 in the six months ended
June 30, 1998,  primarily as a result of management's efforts to contain certain
costs. As a percentage of net sales, research and development expenses decreased
to 1.7% in 1998 from 3.2% in 1997. The increase in total  operating  expenses of
$1.1 million is the result of the Sungold and Private Eyes  acquisitions  during
the  second  quarter  of 1997  which were  partially  offset by a  reduction  in
operating expenses resulting from the Company's cost-cutting measures.

     Income (loss) from operations.  The Company incurred a loss from operations
of  $79,000  for the six months  ended June 30,  1998  compared  to income  from
operations of $2,438,000 for the six months ended June 30, 1997.

     Interest  income  (expense).  Interest  expense was  $1,675,000 for the six
months ended June 30, 1998 compared with interest  expense of $506,  000 for the
six  months  ended  June 30,  1997 as a  result  of  increased  interest-bearing
borrowings.

     Income tax provision  (benefit).  The Company's income tax benefit was zero
for the six months  ended June 30, 1998  compared to an income tax  provision of
$393,500 for the six months ended June 30,  1997.  Differences  from the federal
statutory  income tax rate of 34% resulted  from changes in the reserve  against
certain tax assets.

     Net income (loss).  As a result of the items discussed above, the Company's
net loss was $1.7  million or $.22 per share for the six  months  ended June 30,
1998 compared to a net income of $1,538,000 or $.20 per share for the six months
ended June 30, 1997.
LIQUIDITY AND CAPITAL RESOURCES

     Historically,  the Company has relied  primarily  on cash from  operations,
borrowings  and its  initial  public  offering  of common  stock to finance  its
operations. Cash used in the Company's operating activities totaled $2.9 million
and $10.4 million for the six months ended June 30, 1998 and 1997, respectively.
The  Company  reduced  the cash used in  operating  activities  in the first six
months of 1998 by $7.5  million  compared to the first six months of 1997 by (i)
reducing the buildup of accounts  receivable by $4.7 million,  (ii) reducing net
inventories  by $1.7 million in the first six months of 1998  compared to a $5.8
million  increase in inventories in the first six months of 1997, (iii) reducing
the effect of  changes in other  assets  and  liabilities,  primarily  through a
decrease in  expenditures on prepaid  advertising  costs and (iv) repaying $1.03
million  in  accounts  payable  and  accrued  expenses  in 1998 as  compared  to
incurring $3.8 million in additional  accounts  payable and accrued  expenses in
the similar period in 1997. Cash used in the Company's investing activities,  to
fund acquisitions of property and equipment,  totaled $70,000 and $1,163,000 for
the six  months  ended  June  30,  1998 and  1997,  respectively.  The  purchase
acquisitions of Sungold and Private Eyes required $19,686,139 of cash during the
six  months  ended June 30,  1997.  Cash  provided  by the  Company's  financing
activities,  primarily  proceeds from bank debt,  totaled $2.9 million and $27.2
million  for the six months  ended June 30, 1998 and 1997,  respectively.  As of
June 30, 1998,  the Company had unused  sources of  liquidity  of $2.0  million,
consisting of cash and cash  equivalents  of $798,000 and  borrowings  available
under its revolving loan of $1.2 million.

     The Company has initiated  certain cost  reduction  measures  including the
consolidation of its office and warehouse space.  During April 1998, the Company
vacated its Norwell,  Massachusetts facility and negotiated a termination of the
Norwell lease,  negotiated a termination of the lease for its warehouse facility
in Kent,  Washington  and negotiated an amendment to the lease for its Lynnwood,
Washington  facility,  thereby  decreasing  minimum  future lease payments under
noncancelable  operating  leases from $8.9  million at December 31, 1997 to $1.8
million at June 30, 1998.

     In January 1998, the Company restructured its credit agreement (the "Credit
Agreement") with its primary lender.  The amended Credit  Agreement  consists of
(i) a revolving loan  commitment of up to $14 million,  secured by the assets of
the Company,  (ii) a term loan of $16.47 million,  also secured by the assets of
the  Company  and  (iii)  an  equipment  loan of $3.9  million,  secured  by the
equipment  of the  Company,  resulting in  approximately  $5 million  additional
availability to the Company, subject to certain collateral levels and covenants,
which include minimum tangible net worth, working capital, net sales, and EBIDTA
requirements, as well as ratios relating to debt coverages. The Credit Agreement
was further  amended on March 31, 1998 to reschedule  principal  payments and to
revise financial covenants.  The Credit Agreement was further amended on August,
13,  1998 to  waive  covenant  defaults  through  July 30,  1998  and to  revise
financial  covenants  for  periods  after  July 31,  1998.  The  revised  Credit
Agreement  requires $8.8 million of principal payments due January 4, 1999, with
all remaining  outstanding  debt due April 1999. The Company believes that it is
unlikely it will be able to make such  principal  payments when due,  absent the
Company obtaining additional financing.

     The Company has had difficulty  paying suppliers on a timely basis, and has
made  arrangements  with certain  suppliers to provide for payment schedules for
past due amounts and to provide  letters of credit for a portion of the purchase
price of future orders.  Failure of operations or expense  reduction  efforts to
meet the  Company's  expectations,  unanticipated  expenses,  loss of  continued
cooperation  of the Company's key suppliers or the bank,  third-party  claims or
adverse  developments  in pending  litigation  could result in  additional  cash
requirements  that could be difficult or impossible to satisfy and could require
the Company to further reduce its operating expenditures, to curtail operations,
or to dispose  of  operating  assets to enable it to  continue  operations.  The
Company is exploring  various options  designed to maximize  shareholder  value,
including  the  possible  sale of  common  or  convertible  preferred  stock  or
convertible debt securities to fund working capital and, in part, to finance the
January  1999  loan  payment,  but  there  can be no  assurance  that  any  such
transaction  could be completed on a timely basis, on favorable terms or at all.
See "Forward-Looking Statements."
SEASONALITY

     The Company's net sales generally have been higher in the period from March
to September,  the period  during which  sunglass  purchases  are highest.  As a
result,  operating income is typically lower in the first and fourth quarters as
fixed operating costs are spread over lower sales volume.  See  "Forward-Looking
Statements." The Company has experienced higher accounts receivable during March
through September as a result of higher sales during this period.  The Company's
quarterly  results of operations have fluctuated in the past and may continue to
fluctuate as a result of a number of factors,  including  seasonal  cycles,  the
timing of new  product  introductions,  the  timing  of orders by the  Company's
customers,  the mix of product  sales and the effects of weather  conditions  on
consumer purchases.

                           PART II - OTHER INFORMATION

ITEM 1.  LEGAL PROCEEDINGS

     On November  22,  1996,  the Company  filed an action in the United  States
District Court for the District of Massachusetts,  under Case No.  996-12344RCL,
against Aearo Corporation, a Delaware corporation,  alleging infringement of the
Company's  toric  curve  lens  utility  patent.   Both  the  Company  and  Aearo
Corporation  filed summary judgment motions with the Court. On May 19, the Court
ruled in favor of the  Company  and found  that  product  manufactured  by Aearo
Corporation  infringes the Company's toric curve patent. Aearo Corporation moved
for  reconsideration  of the Court's ruling on infringement,  but Aearo's motion
for  reconsideration  was denied.  Trial is expected to be  scheduled  for early
1999.  The  Company  believes  that the only  significant  issues left for trial
include whether the Company's patent was validly issued,  and, if so, the extent
of  damages  to  be  awarded  to  the  Company  resulting  from  Aearo's  patent
infringement.  Any judgment  awarded in favor of the Company would be subject to
appeal.

     There have been no material changes in other legal proceedings  reported in
the Company's 1997 Annual  Report,  as amended,  on Form 10-K/A  Amendment No. 1
filed with the Securities and Exchange Commission on April 15, 1998.

ITEM 4.  SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

     The Company held its annual meeting of shareholders on June 4, 1998. At the
annual  meeting Class 1 Directors  were up for election,  and a Class 3 Director
was up for  election  as a result  of  resignations  of Class 3  directors.  The
following summarizes all matters voted on at the meeting:

     Election of Directors                       For                  Withheld

     Class 3 Director: Elected to serve
      until the 2000 annual meeting

          Robert G. Wolfe                      6,366,608                 56,890

    Class 1 Directors:  Elected to serve until
      the 2001 annual meeting

          Walter F. Walker                    6,357,686                 65,812
          Timothy C. Potts                    6,340,819                 82,679

ITEM 5. OTHER INFORMATION

     In July,  the Company  received  notice  from Nasdaq that a Nasdaq  Listing
Qualifications  Panel had  determined to delist the Company's  common stock from
the Nasdaq National Market for failure to meet Nasdaq's listing requirement with
respect to net  tangible  assets.  Delisting  was  effective  as of the close of
business July 13, 1998. The Company's common stock has continued to be quoted on
the Nasdaq's over-the-counter bulletin board.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K

(a) EXHIBITS

Exhibit 10.1   Lease  Agreement  dated June 8, 1998, by and between South Valley
               Associates, as Landlord, and the Company, as Tenant.

Exhibit 10.2   Eighth  Amendment to First Amended and Restated Credit  Agreement
               dated  April  30,  1998  by  and  between  U.S.   Bank   National
               Association,  successor  by  merger to U.S.  Bank of  Washington,
               National Association, and Gargoyles, Inc.

Exhibit 27.1   Financial Data Schedule

(b) REPORTS ON FORM 8-K

     Form 8-K with respect to the Company's decision to close its London office,
positive developments in the Company's litigation against Aearo Corporation, and
other matters was filed with the Securities and Exchange  Commission on April 3,
1998.

                                   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 hereunto duly authorized.

                                        Gargoyles, Inc.
                                        (Registrant)

August 14, 1998                         /s/ Leo Rosenberger
                                        -------------------
                                            Leo Rosenberger
                                        Chief Executive Officer, Chief
                                        Financial Officer and Treasurer
EXHIBIT INDEX

EXHIBIT
NUMBER             EXHIBIT DESCRIPTION

Exhibit 10.1      Lease  Agreement  dated June 8, 1998, by and between South
                  Valley Associates,  as Landlord, and Gargoyles,  Inc.,
                  as Tenant.

Exhibit 10.2      Eighth Amendment to First  Amended and  Restated
                  Credit Agreement dated April 30, 1998 by and between U.S.
                  Bank National Association, successor by merger to U.S. Bank
                  of Washington, National Association, and Gargoyles, Inc.

Exhibit 27.1      Financial Data Schedule