GARGOYLES INC, 10-K405, 2000-03-30

GARGOYLES INC
10-K405, 2000-03-30
OPHTHALMIC GOODS

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

FORM 10-K

-----------------------

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

For the fiscal year ended December 31, 1999

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

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
(253) 796-2752
-------------------------------------------------------------------------
(Address and telephone number of registrant's principal executive offices)

Securities Registered Pursuant to Section 12(b) of the Act:

None

-----------------------

Securities registered pursuant to Section 12(g) of the Act:

Common Stock, no par value
(Title of Class)

Indicate by check mark whether the registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ]

Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to
the best of registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [X]

As of March 1, 2000, there were 7,822,191 outstanding shares of the
registrant's common stock, no par value which is the only class of common stock
of the registrant, and 10,000,000 outstanding shares of the registrant's Series
A preferred stock, which is the only series of preferred stock of the
registrant. Each share of preferred stock is convertible into 3.1600342 shares
of common stock, and each share of preferred stock is entitled to 3.1600342
votes. The aggregate market value of the common stock held by non-affiliates of
the registrant on March 1, 2000 was $3,310,351, computed at the closing price
on that date.

The information called for by Part III is incorporated by reference to the
definitive Proxy Statement for the Annual Meeting of Shareholders of the
Company to be held on June 15, 2000.

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<TABLE>
INDEX
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Page
PART I
<S> <C> <C>
Item 1. Business................................................... 1

Item 2. Properties ................................................ 11

Item 3. Legal Proceedings ......................................... 11

Item 4. Submission of Matters to a Vote of Security Holders ....... 12

PART II

Item 5. Market for Registrant's Common Stock and Related
Shareholder Matters ....................................... 12

Item 6. Selected Financial Data ................................... 13

Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations ....................... 15

Item 7A. Quantitative and Qualitative Disclosures About Market Risk. 23

Item 8. Financial Statements and Supplementary Data ............... 24

Item 9. Changes and Disagreements with Accountants on
Accounting and Financial Disclosures ...................... 43

PART III

Item 10. Directors and Executive Officers of the Registrant......... 43

Item 11. Executive Compensation..................................... 45

Item 12. Security Ownership of Certain Beneficial Owners and
Management................................................. 45

Item 13. Certain Relationships and Related Transactions ............ 45

PART IV

Item 14. Exhibits, Financial Statements and Reports on Form 8-K .... 45

</TABLE>

<PAGE>
PART I

ITEM 1. BUSINESS
- -----------------

FORWARD-LOOKING STATEMENTS
- --------------------------

Certain statements within the following description of the business of
Gargoyles, Inc. ("Gargoyles") and its subsidiaries and elsewhere in this Form
10-K constitute "forward-looking statements" within the meaning of the Private
Securities Litigation Reform Act of 1995. Certain of the forward-looking
statements contained in this Report are identified with cross-references to
this section and/or to specific risks identified under "Business -- Risk
Factors." Forward-looking statements included in this report or otherwise
presented by management from time to time 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 achievement expressed or implied by
such forward-looking statements. Such factors include, but are not limited to,
factors involving business cycles and health of the world and national
economies and developments involving consumer products in general and the
sunglass industry in particular, as well as the other risks and uncertainties
described under "Business -- Risk Factors" in Part I of this Annual Report on
Form 10-K. 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.

THE COMPANY
- -----------

The Company operates both directly and through three wholly-owned
subsidiaries: H.S.C., Inc., a Washington corporation ("H.S.C."), Sungold
Eyewear, Inc., a Washington corporation ("Sungold"), and Private Eyes Sunglass
Corporation, also a Washington corporation ("Private Eyes"). During 1997 and
the first eight months of 1998, the Company's Timberland Eyewear business was
operated through its majority-owned subsidiary, the kindling company, a
California corporation ("Kindling"). Substantially all of the assets of
Kindling were sold effective September 1, 1998.

Gargoyles was incorporated under the laws of the state of Washington in
1983. References to the Company in this report include Gargoyles and its
subsidiaries. The Company's principal executive offices are located at 5866
South 194th Street, Kent, Washington 98032, and its telephone number at that
location is (253) 796-2752. Information on the Company and its brands can also
be found on Company web sites at www.gargoylesinc.com and
www.anarchyeyewear.com. The Company's common stock is quoted on the OTC
Bulletin Board under the symbol GOYL.

OVERVIEW
- ---------

The Company was founded in 1983 by Dennis Burns (the "Founder") to develop
a high-performance sunglass using the Company's patented dual-lens toric curve
technology. This toric curve technology continues today to be the foundation
for the Company's Gargoyles Performance Eyewear and Gargoyles Protective
Eyewear brand sunglasses. The Company remained a single-brand company, selling
only Gargoyles branded products until its purchase of the Hobie business in
1996 and its purchase of the Sungold and Private Eyes businesses in 1997.

In 1995, the Founder sold 75% of his stock in the Company to an investor
group led by Trillium Corporation and certain members of the Company's former
management. This investment group took the Company public in late September
1996, raising more than $27 million of net proceeds for the Company, $19
million of which was used to repay debt.

In 1996 and 1997, the Company pursued an aggressive acquisition and
expansion strategy. The Company used short-term borrowings to finance its
acquisitions and expansion which, together with the Company's increase in
operating expenses in anticipation of 1997 growth and the deterioration of
results of operations in late 1997, resulted in a shortage of cash in late
1997. See "Management's Discussion and Analysis of Financial Condition and
Results of Operations."

In early 1998, the Company's board of directors hired a turn-around team
led by Leo Rosenberger, the Company's Chief Executive Officer and Chief
Financial Officer, to restructure the Company. Current management has worked
throughout 1998 and 1999 on this restructure effort. See "Management's
Discussion and Analysis of Financial Condition and Results of Operations."

During 1999, the Company continued the integration of acquired operations,
particularly in management information systems and sales management, continued
cost disciplines, focused on new business development with the promotion of a
member of senior management to Senior Vice President of New Business
Development, and, in June 1999, recapitalized the Company and restructured its
indebtedness in a transaction with its lender, U.S. Bank, National Association
("U.S. Bank").

As a result of the Company's successful turnaround, in 1999 the Company
achieved record sales in fourth quarter of 1999 and earned net income for the
year for the first time since 1994. See "Management's Discussion and Analysis
of Financial Condition and Results of Operations."

The Company is now positioned to grow its business and to take advantage
of opportunities in the marketplace.

Leveraging the Company's experience in distributing sunglasses in non-
traditional channels, its ability to produce high-performance sunglass
products, and its relationships in the country and western channel, in the fall
of 1999 the Company had the opportunity to enter into a License Agreement with
Wrangler Apparel Corp. to design, develop, manufacture and distribute eyewear
and eyewear accessories using the Wrangler and Wrangler Rugged Wear brands in
the United States, Puerto Rico, Canada and Mexico. The license agreement is
for a term of three years, with an option to renew for another three years.
The Company will introduce Wrangler branded sunglasses in Summer 2000 for
distribution into western specialty stores, farm and fleet stores, military
outlets, sunglass specialty stores and through optical distributors and optical
retailers.

INDUSTRY OVERVIEW
- -----------------

According to the Sunglass Association of America, total retail sunglass
sales in the US plano (non-prescription) primary sunglass market has grown from
$1.4 billion in 1989 to $2.4 billion in 1998. Total retail sunglass sales
during the past five years, however, have been relatively flat and declined
2.6% from $2.6 billion in 1997 to $2.4 billion in 1998. The number of units of
plano sunglasses sold in primary distribution channels has been increasing over
the past few years, and increased 4.5% from 113 million units in 1997 to 129
million units in 1998.

The Company believes that Oakley, Inc. and Luxottica Group S.P.A., which
purchased the Ray Ban, Killer Loop, Arnette and Revo brands from Bausch & Lomb
in June 1999 together comprised approximately 60% of the domestic sunglass
market in 1999, with several companies, including the Company, having smaller
market shares. The remainder of the industry is highly fragmented and
comprised of numerous smaller companies.

The average retail price per unit for plano sunglasses at the higher end
retailers was $48.37 in 1998 compared to $53.33 in 1997, a 10% decrease, and
their market share declined to 67.2% in 1998 from 70.7 % in 1997. The average
retail price per unit for plano sunglasses at the lower-end retailers was $8.29
in 1998, compared to $8.01 in 1997, a 3.5% percent increase, and their market
share grew to 32.8% in 1998 from 29.3% in 1997.

The Company believes that this downward price pressure will continue as
consumers increasingly demand more value for a lower price. Sunglass Hut, the
nation's largest sunglass specialty retailer with more than 1700 sunglass
specialty stores worldwide, reported total sales of $602 million in 1998,
compared to $574 million in 1997. Sunglass specialty retailers, of which
Sunglass Hut is the largest, sold 8.1 million units of sunglasses in 1998, an
increase of 17.2% units over 1997 unit sales. The average retail price per
unit for sunglasses sold by sunglass specialty retailers in 1998 was $63.60,
compared to $72.50 per unit in 1997.

Management believes that misperceptions regarding the dynamics of the
sunglass industry in 1995 and 1996 greatly influenced industry results in 1997
and 1998. Management believes that industry consolidation was perceived as
industry growth, and sunglass manufacturers, including the Company, used
industry sell-in statistics to project sell-through volumes and overestimated
1997 and 1998 top-line growth. As a consequence, retail inventory levels in
1996 far exceeded needs, and retailers began a program which has been described
as "reverse distribution" and returned millions of dollars of product to its
vendors in 1997 and 1998. The Company processed $10 million, $4.2 million, and
$1.5 million in returns from customers in 1997, 1998, and 1999, respectively.
Management believes that as a result of overproduction of product manufactured
by the Company and others during 1996 and 1997, significant amounts of unsold
product remained in the market at the beginning of 1998 and affected the
Company's 1998 and, to a lesser extent, its 1999 sales.

BUSINESS STRATEGIES
- -------------------

The Company's objective is to be one of the premier designers and
marketers of sunglasses and eyewear. To achieve this goal, the Company has
developed and is implementing business strategies to capitalize on growth
opportunities within the sunglass and ophthalmic markets. Key elements of the
Company's business strategies are as follows:

FOCUS DISTRIBUTION NETWORK AND EXPAND CUSTOMER BASE. In 1998, the Company
began to restructure its sales and distribution efforts by implementing a
focused, channel distribution strategy. In 1998, the Company reduced the
number of its direct field sales personnel, closed its London sales office and
terminated its European sales force, and established a sales strategy for each
channel using a combination of direct sales personnel, manufacturers'
representatives, and/or distributors as appropriate for the channel. In 1999,
the Company has restructured its sales management, and has refined and focused
its sales efforts channel by channel, concentrating on developing channels
where the Company's brands can have a significant presence and de-emphasizing
channels where the Company's brands are less successful . As new brands, such
as the Wrangler brand, are added to the Company's business, new distribution
channel opportunities will be developed.

USE NON-TRADITIONAL DISTRIBUTION CHANNELS. The premium sunglass industry
has traditionally been perceived as a fashion accessories business with a
primary channel of distribution through sunglass specialty retailers. While the
Company's sunglass products do include fashion brands that sell well in this
traditional channel, the Company also markets sport/function brands which sell
primarily through other, more non-traditional channels. The Company believes
that its ability to provide products appealing to customers in multiple
distribution channels provides the Company with a distinct competitive
advantage.

DEVELOP AN INFRASTRUCTURE TO MANAGE MULTIPLE BRANDS AND CHANGES IN THOSE
BRANDS. In 1998 and 1999, the Company has been working to restructure its
business to integrate the businesses acquired in 1996 and 1997 and to create an
infrastructure that allows the Company to effectively and efficiently manage
the business of multiple brands. Management believes that the long-term
success of the Company depends upon the Company's ability to manage multiple
brands, including from time to time developing new brands, integrating acquired
brands, managing the demands of maturing brands, and discontinuing brands that
are no longer profitable. To that end, the Company has worked in 1998 and 1999
to restructure its systems and operating processes, its sales and marketing
efforts, and its customer service departments to facilitate this multiple-brand
management strategy.

OFFER QUALITY PRODUCTS USING LATEST TECHNOLOGIES. The Company
continuously strives to differentiate its products from those of its
competitors through introductions of quality products using the latest
technologies. The sophisticated geometry of the Company's Gargoyles brand
patented dual lens toric curve design permits the Company to offer consumers an
extreme wraparound sunglass design with wide coverage without sacrificing
overall optical clarity or introducing distortion. In addition, the primary
lens material for Gargoyles products is polycarbonate, which provides
protection from damaging ultraviolet light, is significantly stronger than
safety glass, yet is lightweight. The patented interchangeable lens design of
the Gargoyles brand Legends products allows the consumer to adopt multiple
styles and functions through the use of different lenses in the same frame.
See "Business --Risk Factors -- Dependence on New Product Introductions."

LEVERAGE PRODUCT PRODUCTION AND PRODUCTION PLANNING. Several of the
Company's vendors provide products for a number of the Company's brands. The
Company is continually working with its vendors in an effort to consolidate
production of more products with fewer vendors, thereby strengthening the
Company's relationships with its remaining vendors and making the Company a
more significant customer of those vendors while providing the Company with
greater flexibility in product production scheduling. In 1998 and 1999, the
Company has restructured and improved its production planning processes.
Improved production planning also has resulted in higher product margins as a
result of lower labor costs related to the assembly of the Company's Gargoyles
and Hobie brand products, and in less inventory of slower-moving goods, which
is eventually sold at prices below the Company's list price.

PRODUCTS
- --------

Gargoyles Performance Eyewear Brand Sunglasses
-----------------------------------------------
Gargoyles Performance Eyewear is positioned as premium performance eyewear
for men and women. Gargoyles products combine proprietary optical technology
and polycarbonate lenses with technical mirroring and coating processes and
durable, contemporary frames to satisfy the demand of consumers with active
outdoor lifestyles. Suggested retail prices for the 12 styles in the Gargoyles
Performance Eyewear collection range from $80 to $175. In 1999, Gargoyles
introduced its American Lifestyle Collection. This collection is comprised of
9 styles with the same high-performance features of other Gargoyles products
with eight-base, distortion-free, polycarbonate lenses. Suggested retail
prices for styles in the American Lifestyle Collection range from $50 to $110.

Gargoyles Protection Eyewear
----------------------------
Gargoyles also offers a line of protective eyewear under its Gargoyles
Protective Eyewear collection. There are two styles in the Gargoyles
Protective Eyewear line, both of which are clear, polycarbonate versions of
Gargoyles' Classic style, and a slightly smaller version of the Classic known
as the `85's. In 1997, Gargoyles introduced a line of Gargoyles Protective
Safety Eyewear which includes styles which pass ANSI Z87.1 standards, and are,
therefore, approved for use in industrial applications. Gargoyles Protective
Eyewear also offers a line of accessories including side shields and Rx
inserts, for consumers who require prescription eyewear. All protective
eyewear styles have toric curved lenses. Suggested retail prices for styles in
the Gargoyles Protective Eyewear and Gargoyles Protective Safety Eyewear
collections range from $80 to $115.

Hobie Polarized Sunglasses Brand Sunglasses
------------------------------------------
The Company's Hobie Polarized Sunglasses brand sunglasses are designed
and assembled by Gargoyles' subsidiary, H.S.C., under a license agreement with
Hobie Designs, Inc. All of the Company's Hobie brand sunglasses are positioned
as premium sunglasses for men and women, and all styles have polarized lenses.
Polarized lenses are designed to eliminate glare more effectively than regular
lenses. The Hobie brand traditionally has had a strong following with
consumers active in water sports who seek to eliminate glare from the water.
H.S.C. has expanded its product offerings to bring all the benefits of
polarized sunglasses to a broader audience, and the outdoor enthusiast now can
have both style and function. In addition, in response to the needs of aging
consumers with active outdoor lifestyles, almost all Hobie Polarized Sunglasses
styles are available with prescription polarized lenses. Hobie Polarized
Sunglasses offers 29 styles at suggested retail prices ranging from $90 to
$195.

Stussy Eyegear Brand Sunglasses
-------------------------------
Stussy Eyegear is designed and distributed by Gargoyles' subsidiary,
Sungold, under a license agreement with Stussy, Inc. The roots of the design
of the Stussy Eyegear products are in the surfer beaches of Laguna Beach,
California with the edge of the urban street. This image was first exemplified
by Shawn Stussy in his Stussy clothing line. Stussy Eyegear is designed for
the young consumer aged 18 to 35 who lives a "cool" lifestyle. Stussy Eyegear
offers 23 styles at suggested retail prices ranging from $65 to $140.

Anarchy and Angel Eyewear Brand Sunglasses
-----------------------------------------
Anarchy and Angel Eyewear are brands owned and developed by Sungold and
were introduced by the Company in April 1997 following the purchase of Sungold.
Anarchy and Angel Eyewear are designed for the young consumer aged 18 to 29.
Anarchy Eyewear is designed for young men who want to escape from the norm.
Anarchy Eyewear is marketed as "a revolution against conformity; what to wear
to have attitude." Angel Eyewear is marketed as "divine power for girls who
want big air, not big hair; girls who would rather board than be bored."
Anarchy Eyewear offers 12 styles at suggested retail prices ranging from $45 to
$85. Angel Eyewear offers 6 styles at retail prices ranging from $45 to $65.

Moderate-Priced and Private Label Products
------------------------------------------
Sungold designs and distributes a line of moderate-priced sunglass
products under the name Fusion which are sold in chain stores and specialty
retailers. Suggested retail prices for moderate-priced products range from $7
to $20. Sungold also produces private label products. Currently, Sungold is
producing a line of private label sunglass products for a number of customers
including the Gap and Old Navy.

Wrangler Eyewear
----------------
In Summer 2000, Gargoyles will launch a line of Wrangler Eyewear under a
license agreement with Wrangler Apparel Corp. which initially will be
distributed through western specialty stores, optical stores, sunglass
specialty stores, military outlets, and farm and fleet stores. Wrangler
Eyewear is designed for the western lifestyle consumer and middle-America
consumer aged 24 to 51. Wrangler Eyewear will offer 8 styles of sunglasses at
suggested retail prices of $39 to $49.

Private Eyes Brand Accessories and Tomichi Studio Brand Sunglasses
------------------------------------------------------------------
Gargoyles' subsidiary, Private Eyes, which was acquired in 1997, designs
and distributes eyewear accessories under its Private Eyes brand and a line of
sunglasses and readers under the Company's Tomichi Studio brand. The Private
Eyes and Tomichi Studio products are designed for women and are marketed
through department stores and optical and specialty chain stores.

PRODUCT DEVELOPMENT
- -------------------

The Company strives to be an innovator in the development of new product
styles. Product development personnel dedicated to the development of new
products are in place for the Company's brands. The Company also from time to
time works with outside consultants and with its vendors' design teams on
product development.

The frequency of product introductions and the length of time a style
remains in a particular product line varies with the Company's brands. New
styles of technologically-based products, such as the Gargoyles brand products,
and products marketed to more mature audiences such as the Hobie brand,
historically have been introduced once or twice a year and, although certain
styles which do not achieve anticipated levels of consumer acceptance from time
to time will be discontinued, certain top-selling styles have remained in the
product lines for several years. The Classic style has been in the Gargoyles
Performance Eyewear line since 1983 and remains that brand's number one selling
style. Fashion-based products and products marketed to the younger consumer
such as the Company's Stussy and Anarchy and Angel brand products, are
introduced more frequently, and these styles usually remain in a collection for
a much shorter period of time.

MANUFACTURING
- -------------

During 1999, management has continued to work to simplify its production
policies and procedures and to eliminate redundancies in operations. In
addition, the Company has established relationships with new vendors and
located new sources of supply which have provided the Company with better
quality products at lower prices.

The Company currently sources its frames, lenses and components from a
diverse group of suppliers in the United States, Asia and Europe. Lenses for
Gargoyles toric curve products are molded, hard-coated, and mirrored by two
suppliers in the United States. Frames for Gargoyles products are currently
produced by a network of suppliers in Italy, Japan and the United States.
Assembly of Gargoyles products is performed by the Company's vendors and by the
Company at its Kent, Washington facility. Frames for the Company's Hobie
products are sourced from Europe and Asia, and lenses are sourced from Italy
and Japan. Hobie products are assembled at the Company's facility in Kent,
Washington. The Company's Stussy, Anarchy and Angel products are sourced from
a number of suppliers in Europe and Asia and arrive fully assembled at the
Company's Farmingdale, New York facility where they are inspected and packaged.
The Company's Gargoyles American Lifestyle Collection, Private Eyes and Tomichi
Studio products are sourced from a number of suppliers in Asia, Europe and the
United States and arrive fully assembled at the Company's Kent, Washington
facility where they are inspected and packaged.

The Company's cash-flow problems in 1998 and the first half of 1999
affected its relationships with its vendors and suppliers, but management has
worked diligently to reestablish and rebuild those relationships. Prior to
the June 1999 refinancing, the Company had worked out payment schedules and
promissory notes for past due trade indebtedness. After the refinancing, the
Company was able to settle other past due accounts, and in many cases at
significant discounts. The Company is currently on credit terms with all of
its key vendors. Management believes that the Company is on good terms with
its vendors and will be able to obtain required inventory to fill orders to
meet its sales projections in 2000. See "Business -- Forward-Looking
Statements."

For information concerning backlog and backorders, see "Management's
Discussion and Analysis of Financial Condition and Results of
Operations_Backlog and Backorders."

DISTRIBUTION
- ------------

To preserve the integrity of the Company's branded business, the Company
selectively limits its distribution to retailers that market products
consistent with the Company's image and pricing strategy and that provide a
high level of customer service and technical expertise. Individual accounts
are typically selected based on their potential ability to positively represent
the Company's brands and technological benefits, reputation for advertising
prices at or near the manufacturer's suggested retail price, expected ability
to display a wide assortment of the Company's product selections, and
demonstrated commitment to merchandising and product knowledge that will
support the brand image of the various Company brands.

In 1999, the Company continued to refine its channel distribution strategy
and focused the efforts of its marketing and sales departments on the needs of
customers and consumers in a given channel. The Company sells its products
through a variety of channels including the traditional sunglass specialty,
sport specialty, department store and optical channels. In addition, the
Company distributes its products through non-traditional channels including
automotive, military, industrial and medical-dental channels. In 2000, the
Company will focus on increasing its distribution in existing channels, with
special emphasis on the optical channel, and will expand into new channels.
With the introduction of its Wrangler Eyewear brand in Summer 2000, the Company
will be expanding its distribution in the country western channel.

SALES
- -----

Since its inception, the Company's sales efforts have included use of
manufacturers' representatives, distributors and a direct sales force. The
Company's sales efforts are organized by channel, and the mix of direct sales
personnel, manufacturers representatives and distributors varies by channel.
In addition, the sales force is encouraged to work with customers to help
assure that the volume of product sold to customers will sell through to
consumers, thereby strengthening the Company's customer relationships and
avoiding the expense of processing unnecessary returns.

MARKETING AND PROMOTION
- -----------------------

When the Company was a single-brand company offering only Gargoyles
products, marketing of the Gargoyles brand was narrowly focused. Marketing
initiatives emphasized the performance features and functions of the Gargoyles
products. With the acquisition of the Hobie product lines, the Gargoyles
brand marketing initiatives and brand positioning became less individualized,
and the Gargoyles and Hobie brands were positioned more as fashion brands with
similar marketing images and approaches used for both brands. During the last
two years, the Company has reexamined each of its brands and, as a result,
refocused certain brands, discontinued unprofitable brands, and developed or
acquired other brands.

Products marketed under the Company's oldest brand, Gargoyles Performance
Eyewear, were first sold in 1983 and gained early recognition from consumers
who appreciate high performance and function from their sunglass products.
Placement of the Gargoyles Classic styles on actors such as Arnold
Schwarzenegger in the film The Terminator and Clint Eastwood in Sudden Impact
helped establish the tough, performance characteristics of Gargoyles products
and have been central to Gargoyles brand positioning. The Gargoyles brand also
has had a strong following in NASCAR, and NASCAR champion Dale Earnhardt has
been an endorser of Gargoyles branded products for many years. The Company's
early brand positioning and alliance with Earnhardt and NASCAR continues to
grow. In October 1998, the Company entered into three-year endorsement
contracts with NASCAR drivers, Dale Earnhardt, Dale Earnhardt, Jr., Ron
Hornaday and Steve Park who represent the Company as "Team Gargoyles." In
January 2000, the Company renewed its license agreement with Richard Childress
Racing, and entered into endorsement contracts with Mike Skinner and several
other NASCAR drivers. According to studies published by Performance Research,
NASCAR and other motor sporting events is the fastest growing segment in the
sports industry, creating the potential for growth in the Gargoyles brand.

The Company's Hobie Polarized Sunglasses brand positioning has used
fishing, surfing and other water sports to emphasize the technical features and
benefits of polarized lens technology and the ability of polarized lenses to
block glare off of water. Legendary angler, Lefty Kreh, has been an endorser
of Hobie sunglasses for nearly a decade.

The Company's newer brands include its Anarchy and Angel Eyewear brands,
launched by Sungold in 1996. The Company's use of youthful, free-spirited,
counter-culture brand positioning, extreme wrap product styling, and a close
alliance with young athletes, has resulted in rapid growth of its Anarchy and
Angel branded business to approximately $10 million in 1999. More than 100
athletes endorse Anarchy and Angel Eyewear, including champion surfers, Cory
Lopez and Rochelle Ballard, and competitive snowboarder, Kevin Jones.

Brand positioning of the Company's Stussy Eyegear business is closely
aligned with the fashion positioning of the Stussy clothing line.

Brand positioning for the Company's newest brand, Wrangler Eyewear, to be
launched in Summer 2000, will emphasize the country and western life-style and
will leverage the tremendous market share of the Wrangler brand with middle-
income Americans.

CUSTOMER SERVICE
- ----------------

The Company's ultimate objective with respect to customer service is quite
simple: to make it easier for our customers to do business with us.
Realignment of the sales and marketing efforts of the Company during the past
two years has also affected the Company's customer service department. New
management was hired, certain positions were eliminated, and certain other
positions were realigned and dedicated to the support of individual brands.
Performance goals were established for the department, and performance against
the goals is closely monitored. Signifying its commitment to our customers, in
1999 the department changed its name to the "Customer Satisfaction" department.

PRINCIPAL CUSTOMERS
- -------------------

Net sales to the Company's 10 largest customers during the years ended
December 31, 1999, 1998, and 1997 accounted for approximately 49%, 33% and 50%,
respectively. Sunglass Hut, the Company's largest customer, accounted for
approximately 26%, 14% and 21% of the Company's consolidated net sales for the
same periods. As of December 31, 1999, the Company's Stussy and Anarchy brand
products are sold in more than 1600 Sunglass Hut locations, and Angel Eyewear
in more than 800 locations throughout the world. The Company's Gargoyles
Performance Eyewear brand products are sold in approximately 500 Sunglass Hut
locations in the United States. See "Business -- Forward-Looking Statements
and "Business _- Risk Factors _ Dependence on Sunglass Hut."

INTELLECTUAL PROPERTY
- ---------------------

The Company aggressively asserts its rights under patent, trade secret,
unfair competition, trade dress, trademark and copyright laws to protect its
intellectual property, including product designs, proprietary manufacturing
processes and technologies, product research and concepts and recognized
trademarks. These rights are protected through the acquisition of patents and
trademark registrations, the maintenance of trade secrets, the development of
trade dress (the "look and feel" of a product) and, where appropriate,
litigation against those who are, in the Company's opinion, infringing its
rights.

PATENTS AND TRADEMARKS. As of December 31, 1999, the Company had three
U.S. utility patents in effect relating to eyewear, including patents directed
to the dual lens toric curve technology. As of December 31, 1999, the Company
had one utility patent application pending in the United States.

As part of a structured settlement of a patent infringement case initiated
by the Company against Neoptx, Inc., in May 1997 the Company assigned its
rights in its stick-on lens patent to Neoptx, Inc. in exchange for $300,000 and
a world-wide royalty-free license in the assigned patented technology.

As part of a structured settlement of a patent infringement case initiated
by the Company against Aearo Corporation, in October 1998, the Company granted
to Aearo Corporation a license to continue to make and sell certain infringing
product into certain industrial safety eyewear markets in exchange for a one-
time, lump sum royalty of $1.2 million, which was paid by Aearo upon execution
of the license agreement.

As of December 31, 1999, the Company had registered 35 U.S. trademarks and
36 international trademarks relating primarily to the names Gargoyles and its G
logo, Anarchy and its A logo, and Private Eyes. In addition, the Company has
licensed the right to use the Hobie, Stussy, and Wrangler trademarks for use on
eyewear products pursuant to the terms of agreements with third parties. The
Company has not licensed its trademarks for use by other parties for the
manufacture and sale of sunglass products. See "Business_ Risk Factors _
Uncertain Protection of Intellectual Property Rights."

While there can be no assurance that the Company's patents or trademarks
protect its proprietary information and technologies, the Company intends to
continue to assert its intellectual property rights against any infringer.
Although the Company's assertion of its rights could result in substantial cost
to, and diversion of effort by, the Company, management believes that
protection of the Company's intellectual property rights is a key component of
the Company's business strategy. See "Business-- Forward-Looking Statements."

TRADE SECRETS. The Company also relies on unpatented trade secrets for
the protection of certain intellectual property rights. The Company protects
its trade secrets by requiring its employees, consultants and other agents and
advisors to execute confidentiality agreements upon the commencement of
employment or other relationship with the Company. There can be no assurance,
however, that these agreements will provide meaningful protection for the
Company's proprietary information or adequate remedies in the event of
unauthorized use or disclosure of such information. In addition, there can be
no assurance that others will not independently develop substantially
equivalent proprietary information and technologies, or otherwise gain access
to the Company's trade secrets or disclose such technology, or that the Company
can meaningfully protect its rights to unpatented trade secrets. See "Business
_ Forward Looking Statements."

COMPETITION
- -----------

The Company competes in the premium segment of the sunglass market, which
is fragmented and highly competitive. The Company competes with a number of
established companies, including Luxottica Group S.P.A, which purchased the Ray
Ban, Killer Loop, Arnette and Revo brands from Bausch & Lomb in June 1999, and
Oakley, Inc., which together control more than 60% of the U.S. premium sunglass
market segment. In the polarized sunglass segment, the Company competes
against Maui Jim and Costa del Mar brands. Several of these companies in the
premium sunglass and protective eyewear markets have substantially greater
resources and better name recognition than the Company and sell their products
through broader and more diverse distribution channels. The Company could also
face competition from new competitors that also have greater financial and
other resources than the Company.

The premium sunglass market is susceptible to rapid changes in consumer
preferences that could affect acceptance and sales of the Company's products.
The major competitive factors include brand recognition, methods of
distribution, fashion trends, and the number and range of products offered. In
addition, to retain and increase its market share, the Company must continue to
be competitive in the areas of quality, performance, technology, intellectual
property protection and customer service. See "Business-- Forward-Looking
Statements" and "Business _ Risk Factors _ Highly Competitive Market."

EMPLOYEES
- ---------

As of February 15, 2000, the Company had 197 employees, of which 70 were
full-time salaried, 121 were full-time hourly, 1 was part-time salaried, and 5
were part-time hourly. The Company is not a party to any labor agreement and
none of its employees is represented by a labor union. The Company considers
its relationship with its employees to be very good, and has never experienced
a work stoppage.

RISK FACTORS
- ------------

Investment in securities of the Company involves a high degree of risk, as
the Company's business, results of operations and financial condition are
subject to many risks and uncertainties, including, without limitation, those
set forth below. The following risk factors, among others, could cause the
Company's actual results to differ materially from those expressed in the
Company's forward-looking statements in this report and presented elsewhere by
management from time to time. See "Business --Forward-Looking Statements."

Dependence On Key Personnel
---------------------------
The Company's operations depend to a significant extent on the efforts of
its senior management most of whom have worked together for a relatively short
period of time. Leo Rosenberger, the Company's Chief Executive Officer and
Chief Financial Officer, and Cynthia Pope, the Company's Ex. Vice President,
General Counsel and Secretary, joined the Company February 1, 1998. In 1998
and 1999 there was considerable turnover in management positions below the
senior officer level. The Company is seeking to develop an able, efficient
management team through the proper positioning of existing key employees and
the addition of new management personnel where necessary. The Company's
success is highly dependent on its continuing ability to identify, hire, train,
retain and motivate highly qualified management, product design, marketing,
production and sales personnel. The Company's operations could be adversely
affected if, for any reason, such key personnel do not continue to be active in
the Company's management.

Highly Competitive Market
-------------------------
The premium segment of the sunglass market is highly competitive. The
Company competes with a number of established companies, including Luxottica
Group, S.P.A., the marketer of the Ray Ban, Killer Loop, Arnette and Revo
brands, and Oakley, Inc., which the Company believes together control more than
60% of the premium sunglass market segment, and with several companies having
smaller but significant market shares. Several of these companies have
substantially greater resources and better name recognition than the Company
and sell their products through broader and more diverse distribution channels.
The Company could also face competition from new competitors, including
established branded consumer products companies that also have greater
financial and other resources than the Company. In addition, as the Company
expands internationally, it will face substantial competition from companies
that have already established their products in international markets and
consequently have significantly more experience in those markets than the
Company. The major competitive factors in the premium sunglass market include
method of distribution, brand recognition, fashion trends, and the number and
range of products offered. In addition, to retain and increase its market
share, the Company must continue to be competitive in the areas of quality and
performance, technology, intellectual property protection and customer service.
See "Business _ Competition."

Dependence On Sunglass Hut
--------------------------
Sales to Sunglass Hut, a sunglass specialty retail chain, accounted for
approximately 21%,14% and 26% of the Company's net sales for the years ended
December 31, 1997, 1998 and 1999, respectively. Historically, Sunglass Hut has
contributed significantly to the Company's business and overall growth. The
Company does not have a purchase agreement with Sunglass Hut, and a substantial
decline in purchases of the Company's products by Sunglass Hut could have a
material adverse effect on the Company's business, prospects, financial
condition and operating results. See "Business -- Principal Customers."

Dependence On New Product Introductions
---------------------------------------
The sustainability of the Company's business and its growth potential will
depend, in part, on its continued ability to develop and introduce innovative
products. Innovative designs are often not successful, and successful product
designs can be displaced by other product designs introduced by competitors
that shift market preferences in their favor. The eyewear industry is subject
to changing consumer preferences, and the Company's sunglasses are likely to be
susceptible to fashion trends. As a result of these and other factors, there
can be no assurance that the Company will successfully maintain or increase its
market share.

Reliance On Limited Sources Of Supplies
---------------------------------------
The Company relies on a single source of supply for several of its
products and components, including several of its frames. The effect on the
Company of the loss of any of such sources or of a disruption in their business
will depend primarily on the length of time necessary to find a suitable
alternative source. The loss of a source for a particular product or frame or
any disruption in such source's business or failure by it to meet the Company's
product needs on a timely basis could cause, at a minimum, temporary shortages
in materials and could have a material adverse effect on the Company's
business, prospects, financial condition and operating results. There can be no
assurance that precautions taken by the Company will be adequate or that
alternative sources of supply can be located or developed in a timely manner.
See "Business -- Manufacturing."

The Company's toric curve lens, which is used in manufacturing many of the
Gargoyles Performance Eyewear branded products, can be produced only from the
Company's molds, which are operated by the Company's suppliers. If a mold were
to become damaged or unavailable for an extended period, the Company could
experience a shortage of its Classic lens, which could adversely affect the
Company's operating results.

Litigation Risks
----------------
The Company is involved in certain legal proceedings. See "Legal
Proceedings." While the Company uses its best judgment based on available
information to assess its exposure in pending and threatened legal proceedings,
litigation is inherently uncertain, and the Company's assessment of pending and
threatened claims may change as more information is developed over the course
of the proceeding. Further, it is extremely difficult to predict the outcome
of litigation, even when all the evidence is available. Accordingly, results
of any particular claim may differ significantly from those anticipated by the
Company.

Uncertain Protection Of Intellectual Property Rights
----------------------------------------------------
The Company relies, in part, on patent, trade secret, unfair competition,
trade dress, trademark and copyright laws to protect its rights to certain
aspects of its products and to protect its competitive position and its rights
to certain aspects of its products. There can be no assurance that any pending
trademark or patent application will result in the issuance of a registered
trademark or patent, that any trademark or patent granted will be effective in
discouraging competition or be held valid if subsequently challenged or that
others will not assert rights in, and ownership of, the patents and other
proprietary rights of the Company. In addition, there can be no assurance that
the actions taken by the Company to protect its proprietary rights will be
adequate to prevent imitation of its products, that the Company's proprietary
information will not become known to competitors, that the Company can
meaningfully protect its rights to unpatented proprietary information or that
others will not independently develop substantially equivalent or better
products that do not infringe on the Company's intellectual property rights.
The Company has in the past been, and is currently, involved in litigation
concerning its proprietary rights. In addition, the laws of certain foreign
countries do not protect proprietary rights to the same extent as do the laws
of the United States. See "Business _ Intellectual Property."

Consistent with the Company's strategy of vigorously defending its
intellectual property rights, the Company has devoted substantial resources to
the enforcement of patents issued and trademarks granted to the Company, to the
protection of trade secrets, trade dress or other intellectual property rights
owned by the Company and to the determination of the scope or validity of the
proprietary rights of others that might be asserted against the Company. A
substantial increase in the level of potentially infringing activities by
others could require the Company to increase significantly the resources
devoted to such efforts. In addition, an adverse determination in litigation
could subject the Company to the loss of its rights to a particular patent,
trademark, copyright or trade secret, could require the Company to grant
licenses to third parties, could prevent the Company from manufacturing,
selling or using certain aspects of its products or could subject the Company
to substantial liability, any of which could have a material adverse effect on
the Company's business, prospects, financial condition and operating results.

Seasonality Of Business
-----------------------
The Company's business is affected by economic factors and seasonal
consumer buying patterns. 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. See "Management's
Discussion and Analysis of Financial Condition and Results of Operations _
Seasonality."

ITEM 2. PROPERTIES
- --------------------

The following table sets forth the real property leases to which the Company
was a party as of December 31, 1999.

<TABLE>
<CAPTION>
Location Sq. Ft. Corporate Function
- --------------- ------- -------------------------------------------
<S> <C> <C>
Kent, WA 26,000 Corporate headquarters and product assembly
Kent, WA 25,000 Shipping and warehousing
Farmingdale, NY 26,000 Offices and shipping and warehousing
New York, NY 1,500 Showroom
</TABLE>

Management believes that the Company's current facilities will be sufficient to
meet the Company's operating needs for the foreseeable future. See "Business -
- - Forward Looking Statements."

ITEM 3. LEGAL PROCEEDINGS
- ---------------------------

On November 18, December 4 and December 9, 1998 the State of Washington
Department of Revenue assessed the Company, in the aggregate, $475,830 plus
interest in business and occupation taxes and use taxes allegedly due and
payable related to the Company's operations during various periods between
January 1, 1993 and June 30, 1997. At issue in this matter is the Company's
status as a "manufacturer" or "wholesaler" as such terms are defined by the
state of Washington's business and occupation and use tax statutes. The Company
has reached agreement with the Department of Revenue on the facts of the case,
but a final tax assessment has not yet been calculated by the Department of
Revenue or reviewed and agreed by the Company. The Company has recorded a
provision which management believes is sufficient to cover the tax assessment
in this case when the assessment is finally determined.

On May 11, 1998, Morris Rosenbloom & Co., Inc. filed an action against the
Company in the Supreme Court of the State of New York for Wayne County, under
Index No. 44010. In the lawsuit, plaintiff alleges breach of contract due to
the Company's failure to accept a return of sunglasses under the terms of a
Repurchase Agreement between Morris Rosenbloom and the Company. Plaintiff
claims damages from the Company in excess of $500,000. The Company has
retained counsel to represent it in this matter and is defending vigorously the
plaintiff's claims. The Company believes that the ultimate resolution of this
matter will not have a material adverse effect on its results of operations or
financial position. See " Business -- Forward-Looking Statements."

On December 28, 1999, Hobie Designs, Inc. filed an action against
Gargoyles and H.S.C. in the Superior Court of California, County of Orange
under Case No. 818816. Upon motion of Gargoyles and H.S.C., on February 4,
2000, the case was removed to Federal Court and is now pending in the United
States District Court for the Central District of California under Case No. SA-
CV00-100 DOC. In the lawsuit, Hobie Designs alleges breach of the License
Agreement under which H.S.C. has the right to use the Hobie trademark in
connection with the marketing and sale of eyewear and related products. Hobie
Designs claims damages in an unspecified amount and seeks termination of the
License Agreement. Gargoyles and H.S.C. have retained counsel to represent
them in this matter and intend to defend vigorously the plaintiff's claims. It
is the Company's position that no material breach of the Hobie license
agreement has occurred. There can be no assurance, however, that this case
will be resolved successfully and that the Company's position will ultimately
prevail. Failure to resolve this matter successfully could require the Company
to modify the license agreement to the Company's disadvantage or could result
in the loss of H.S.C.'s right to market eyewear under the Hobie brand. See
"Business -- Forward-Looking Statements, " and "Business -- Risk Factors --
Litigation Risks".

The Company also is a party to various other claims, complaints and legal
actions that have arisen in the ordinary course of business from time to time.
The Company believes that the outcome of all such pending legal proceedings, in
the aggregate, will not have a material adverse effect on its results of
operations or financial position. See "Business -- Forward-Looking Statements"

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

The Company did not submit any matter to a vote of its security holders
during the fourth quarter of its fiscal year ended December 31, 1999.

Part II

ITEM 5. MARKET FOR REGISTRANT'S COMMON STOCK AND RELATED SHAREHOLDER MATTERS
- ------------------------------------------------------------------------------

The Company effected its initial public offering of Common Stock on
September 27, 1996, at a price to the public of $16.00 per share. Between
September 27, 1996 and July 13, 1998 the Company's Common Stock traded on the
Nasdaq National Market. In July, 1998, 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. Since that time, the
Company's Common Stock has continued to be quoted on the OTC Bulletin Board.
The table below shows for the fiscal quarters indicated the reported high and
low last sale prices of the Company's Common Stock, as reported on the Nasdaq
National Market System and as quoted on the OTC Bulletin Board.

<TABLE>
<CAPTION>
1998 HIGH LOW
---- ---- ---
<S> <C> <C> <C>
First Quarter $ 4.50 $ 2.63
Second Quarter $ 3.50 $ 1.00
Third Quarter $ 1.63 $ 0.13
Fourth Quarter $ 0.63 $ 0.15

1999
----
First Quarter $ 0.44 $ 0.19
Second Quarter $ 0.40 $ 0.10
Third Quarter $ 0.57 $ 0.13
Fourth Quarter $ 0.45 $ 0.10
</TABLE>

As of March 1, 2000, there were 138 record holders of Common Stock,
although the Company believes that the number of beneficial owners of its
Common Stock is much higher. On March 1, 2000, the Company's Common Stock
traded at a high of $0.46 and a low of $0.42.

The Company anticipates that for the foreseeable future, all earnings, if
any, will be retained for the operation and expansion of its business and that
it will not pay cash dividends. The payment of dividends, if any, in the
future will be at the discretion of the Board of Directors and subject to the
rights of holders of Series A Preferred Stock, and will depend upon, among
other things, future earnings, capital requirements, restrictions in future
financing agreements, the general financial condition of the Company and
general business conditions. On June 1, 1999, Gargoyles issued 10 million
shares of Series A Preferred Stock. Holders of the Series A Preferred Stock
are entitled to receive dividends payable in preference and priority to any
payment of dividends to holders of Gargoyles common stock. The rights of the
holders of Series A Preferred Stock to such dividends are cumulative and accrue
to the Series A Preferred Stockholders at a rate per annum equal to the rate of
interest declared by U.S. Bank as its Reference Rate plus 75 basis points, but
never less than 8% per annum. Unpaid accumulated dividends are payable by the
Company upon a conversion of Series A Preferred Stock to common stock,
provided, however, that a cash dividend is payable only if the Company has paid
all principal and interest on any indebtedness secured by all of the Company's
assets.

ITEM 6. SELECTED FINANCIAL DATA
- ---------------------------------

The following selected financial data is derived from the audited
consolidated financial statements of the Company. This data should be read in
conjunction with the Company's audited consolidated financial statements and
the related notes thereto and "Management's Discussion and Analysis of
Financial Condition and Results of Operations" included elsewhere in this
Report. Certain reclassifications have been made to the prior years' financial
statements to conform to the current year presentation.

<PAGE>
<TABLE>
<CAPTION>
Fiscal Year Ended
----------------------------------------------------------
December 31,
----------------------------------------------------------
1999 1998 1997(1) 1996(1) 1995
-------- --------- --------- -------- --------
(in thousands, except per share data)
<S> <C> <C> <C> <C> <C>
Net sales
Gargoyles $ 6,776 $ 9,019 $ 12,975 $ 26,994 $ 17,896
Hobie 4,063 5,768 9,562 6,100 -
Kindling - 1,346 2,964 - -
Sungold 21,667 16,927 10,992 - -
Private Eyes 832 3,546 4,504 - -
-------- --------- --------- -------- --------
Total Net Sales 33,338 36,606 40,997 33,094 17,896
Cost of sales 14,095 16,225 18,797 14,231 7,017
-------- --------- --------- -------- --------
Gross profit 19,243 20,381 22,200 18,863 10,879
-------- --------- --------- -------- --------
License income 434 966 526 480 480

Sales and marketing, general and
administrative, shipping and
warehousing, product development,
and stock compensation expenses 16,557 24,488 30,572 19,983 10,482
Provision for doubtful accounts 47 2,630 1,330 166 67
Interest expense 2,644 3,337 1,974 1,988 1,043
Loss on disposition of assets
and related - 11,008 - - -
Severance, relocation and other 352 1,497 3,232 - 2,064
-------- --------- --------- -------- --------
Total expenses 19,600 42,960 37,108 22,137 13,656
-------- --------- --------- -------- --------
Net income (loss) $ 77 $(21,613) $(14,382) $(2,794) $(2,297)
======== ========= ========= ======== ========
Accrued preferred stock dividend 505 - - - -
-------- --------- --------- -------- --------
Net income (loss) available
for common shareholders $ (428) $(21,613) $(14,382) $(2,794) $(2,297)
======== ========= ========= ======== ========
Pro forma net income (loss) $(2,343)
========
Basic and diluted net loss
per common share(2) $ (.05) $ (2.77) $ (1.94) $ (0.47)
======== ========= ========= ========
Pro forma basic and diluted
net income (loss) per share (2) $ (0.43)
========
Weighted average shares used in
computing basic and diluted net
income (loss) per common share and
pro forma basic and diluted net
income (loss) per common share (2) 7,822 7,813 7,428 5,946 5,450
===== ===== ===== ===== =====
Balance Sheet Data (End of Period):
- ----------------------------------
Working capital (deficit) $ 6,206 $(28,545) $11,392 $15,600 $(2,692)
Total assets 28,213 28,008 50,614 27,678 11,476
Current liabilities, less current
maturities of long-term debt 6,699 13,053 14,876 5,728 10,563
Long-term debt, including
current maturities 25,433 28,526 29,160 - 7,367
Shareholder's equity (deficit) (4,824) (14,172) 6,577 20,903 (7,204)

- -------------------------

(1) The selected financial data's comparability is affected by the Company's
acquisitions during 1997 and 1996.
(2) Prior year amounts have been restated to comply with Statements of
Accounting Standards No. 128 "Earnings Per Share" and SEC Staff Accounting
Bulletin No. 98. See Note 1 to the Company's Consolidated Financial
Statements.
</TABLE>

<PAGE>
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
- -------------------------------------------------------------------------

OVERVIEW
- --------

The Company 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 was
founded in 1983 to develop a high-performance sunglass using the Company's
patented dual-lens toric curve technology. This toric curve technology
continues today to be the foundation for the Company's Gargoyles Performance
Eyewear and Gargoyles Protective Eyewear brand sunglasses. The Company
remained a single-brand company, selling only Gargoyles branded products until
its purchase of the Hobie business in 1996 and its purchase of the Sungold and
Private Eyes businesses in 1997.

In a March 22, 1995 recapitalization, an investor group led by Trillium
Corporation acquired a controlling interest in the Company, and took the
Company public in late 1996. 1,954,465 new shares of Gargoyles common stock
were issued at a price of $16 per share. The initial public offering raised
$27 million in net proceeds for the Company, $19 million of which was used to
repay debt.

In 1996 and 1997, the Company pursued an aggressive acquisition and
development strategy designed to broaden its product offerings and customer
base and to expand its distribution network. The Company used short-term
borrowings to finance its acquisitions and expansion which, together with the
Company's increase in operating expenses in anticipation of 1997 growth and the
deterioration of results of operations in late 1997, resulted in a shortage of
cash in late 1997.

In early 1998, the Company's board of directors hired a turn-around team
led by Leo Rosenberger, the Company's Chief Executive Officer and Chief
Financial Officer, to restructure the Company. In January 1998, the Company's
credit facility with the Bank was amended to defer principal payments and to
provide the Company with funds to begin its restructuring. The turn-around team
spent significant time and effort in 1998 examining the Company's operations,
and reviewing and investigating the causes and results of the Company's 1997
financial performance. During 1998, the Company cut its expense levels nearly
in half to levels that could be sustained by operations, sold or discontinued
unprofitable operations, negotiated termination of leases and other endorsement
contracts and license agreements which reduced the Company's contingent
liabilities by more than $24 million, refocused its brands and its marketing
efforts, solidified its relationships with its bank and with its key vendors
and key customers, improved the quality of its products while at the same time
reducing the costs of its products, restructured its operations, and improved
its processes and systems to make it easier for its customers to do business
with the Company. The Company's restructure process was difficult and costly.
See Notes 12, 14, 16 and 17 to Consolidated Financial Statements.

During 1999, the Company continued the integration of acquired operations,
particularly in management information systems and sales management, continued
cost disciplines, focused on new business development with the promotion of a
member of senior management to Senior Vice President of New Business
Development, and in June 1999, recapitalized the Company and restructured its
indebtedness in a transaction with its lender, U.S. Bank. In 1999, the Company
achieved record sales in the fourth quarter and recorded annual profits for the
first time in five years.

YEAR ENDED DECEMBER 31, 1999 COMPARED TO YEAR ENDED DECEMBER 31, 1998
- ---------------------------------------------------------------------

NET SALES. Net sales decreased $3.3 million or 8.9% to $33.3 million for
the year ended December 31, 1999 from $36.6 million for the year ended December
31, 1998. This decrease was primarily due to the disposition of various
unprofitable businesses during 1998, which included the sale of the Company's
Timberland Eyewear division, the termination of the Ellen Tracy License
Agreement and the closing of the Company's London office, and to the Company's
continuing focus on profitable sales practices

GROSS PROFIT. Gross profit decreased $1.1 million or 5.6% to $19.2
million for the year ended December 31, 1999 from $20.4 million for the year
ended December 31, 1998. Gross margin increased to 57.7% in 1999 from 55.7% in
1998 primarily due to an increase in the percentage of total sales from the
Company's Sungold subsidiary which sold products in 1999 at margins generally
higher than margins on other Company products and to reduced sales of excess
inventory in the 1999 period.

LICENSE INCOME. License income was $434,000 and $966,000 for the years
ended December 31, 1999 and 1998, respectively. This decrease was due
primarily to a 1998 royalty payment from Aearo Corporation as part of a
structured settlement of the Company's patent infringement litigation against
Aearo. The Company recognized $600,000 of license income in 1998 as compared to
$200,000 in 1999. The total royalty payment of $1.2 million is recognized over
its estimated economic life, and $400,000 is recorded as deferred income at
December 31, 1999. See "Business -- Intellectual Property" and Note 1 to the
Consolidated Financial Statements.

COSTS AND EXPENSES. Costs and expenses decreased to $19.6 million for the
year ended December 31, 1999 from $43.0 million for the year ended December 31,
1998, primarily as a result of management's cost savings initiatives, including
reducing payroll, closing unprofitable operations, and eliminating unprofitable
license agreements, and recognition of losses on disposition of assets and
related in 1998. As a percentage of net sales, costs and expenses decreased to
58.8% in 1999 from 117.4% in 1998.

Sales and marketing expenses decreased $5.8 million or 38.4% from $15.2
million in 1998 to $9.4 million in 1999 primarily as a result of closing the
Company's London office, terminating the Ellen Tracy license, and reducing
national advertising expenditures. As a percentage of net sales, sales and
marketing expenses decreased to 28.1% in 1999 from 41.5% in 1998.

General and administrative expenses decreased $1.5 million or 21.9% from
$7 million in 1998 to $5.5 million in 1999. $617,000 of the reduction was
related to favorable settlements of various previously estimated trade
liabilities and contingencies. The balance was primarily the result of
management's cost savings initiatives and restructuring activities. As a
percentage of net sales, general and administrative expenses decreased to 16.5%
in 1999 from 19.2% in 1998.

Shipping and warehousing expenses decreased $557,000 or 24.7% in 1999,
primarily as a result of management's cost savings initiatives and reduced
sales levels. As a percentage of net sales, shipping and warehousing expenses
decreased to 5.1% in 1999 as compared to 6.2% in 1998.

Provision for doubtful accounts decreased $2.6 million or 98.2% in 1999,
primarily as a result of the recording of a provision in 1998 for receivable
balances that were no longer deemed collectible. As a percentage of net sales,
provision for doubtful accounts decreased to 0.1% in 1999 from 7.2% in 1998.

Interest expense was $2.6 million for the year ended December 31, 1999 and
was $3.3 million for the year ended December 31, 1998. The decrease in 1999
was due primarily to a decrease in indebtedness resulting from the June 1999
bank debt restructure. See "--Liquidity and Capital Resources."

Loss on disposition of assets and other related costs were $0 in 1999
compared to $11 million in 1998. The 1998 amount included (1) a non-cash
charge of $8.9 million related to the write-down of goodwill, certain
intangible assets, deferred marketing costs and other assets related to the
termination of the Ellen Tracy license agreement and related Ellen Tracy
Eyewear business, see Note 14 to Consolidated Financial Statements, (2) a
charge to earnings of $1.6 million resulting from the sale of the assets of
Kindling and the termination of the related Timberland license, see Note 12 to
Consolidated Financial Statements, and (3) costs of $476,000 relating to the
closing of the London office, consisting principally of a non-cash write-off of
start-up costs of $279,000, severance and other closing costs. See Note 16 to
Consolidated Financial Statements.

The Company recognized other expense of $352,000 in 1999 primarily due to
employee severance payments and benefits and executive bonuses related to
restructuring and recapitalization of the Company. In comparison, severance,
relocation and (net) other expenses of $1.5 million in 1998 included $260,000
of costs associated with the termination of the lease on the Company's
Lynnwood, Washington facility; a $263,000 reserve against certain notes
receivable and guaranteed loans payable related to a former subsidiary; a gain
of $405,000 related to certain notes receivable from the Company's former
president and CEO; write-off of obsolete production related costs and assets
for discontinued product lines of $289,000; write-off of trade credits of
$211,000. Additionally, 1998 other expenses included estimated restructuring
compensation and other related contingencies of $652,000 and other expenses of
$227,000, including termination costs associated with endorsement contracts and
other miscellaneous expenses. See Note 17 to Consolidated Financial
Statements.

INCOME TAX BENEFIT. The Company's income tax benefit was zero for the
years ended December 31, 1999 and 1998. Since the Company could not determine
that it was more likely than not that the deferred tax asset was recoverable,
the Company recorded a 100% valuation allowance against its net tax assets at
December 31, 1999 and 1998.

NET INCOME (LOSS). As a result of the items discussed above, the
Company's net income was $77,000. Net (loss) available for common shareholders
was $(428,000) or $ (.05) per diluted common share for the year ended December
31, 1999 after the deduction of accrued dividends on preferred stock of
$505,000, compared to a net (loss) of $(21.6 million) or $(2.77) per common
share for the year ended December 31, 1998. There were no preferred shares
outstanding in 1998.

YEAR ENDED DECEMBER 31, 1998 COMPARED TO YEAR ENDED DECEMBER 31, 1997
- ---------------------------------------------------------------------

NET SALES. Net sales decreased $4.4 million or 10.7% to $36.6 million for
the year ended December 31, 1998 from $41.0 million for the year ended December
31, 1997. This decrease was primarily the result of lost sales resulting from
the Company's inability to pay for inventory to fill orders, disposition of the
Timberland Eyewear operation, and termination of the Ellen Tracy license
agreement, which were partially offset by increased sales from the Company's
Sungold subsidiary which was acquired in April 1997. Net sales include twelve
months of sales for Sungold in the 1998 period as compared to nine months of
sales in the 1997 period. The Company's net sales also continue to be affected
by returns from Sunglass Hut, the Company's largest customer. Returns from
Sunglass Hut were approximately $1.6 million in 1998 compared to $5.0 million
in 1997. The Company's sales to Sunglass Hut were approximately 14% of net
sales for the year ended December 31, 1998 compared with 21% for the year ended
December 31, 1997.

GROSS PROFIT. Gross profit decreased $1.8 million or 8.1% to $20.4
million for the year ended December 31, 1998 from $22.2 million for the year
ended December 31, 1997. Gross margin increased to 55.7% in 1998 from 54.2% in
1997 primarily due to an increase in the percentage of total sales from the
Company's Sungold subsidiary which sold products in 1998 at margins generally
higher than margins on other Company products.

LICENSE INCOME. License income was $966,000 and $526,000 for the years
ended December 31, 1998 and 1997, respectively. This increase was due to a
royalty payment of $1.2 million from Aearo Corporation as part of a structured
settlement of the Company's patent infringement litigation against Aearo.
$600,000 of the Aearo payment was recorded as deferred license income and is
being amortized over the three-year estimated economic life of the license.
See "Business -- Intellectual Property" and Note 1 to the Consolidated
Financial Statements.

COSTS AND EXPENSES. Costs and expenses increased to $42.9 million for the
year ended December 31, 1998 from $37.1 million for the year ended December 31,
1997, primarily from the recognition of losses on disposition of assets and
related. These costs were partially offset by management's cost savings
initiatives, including reducing payroll, closing unprofitable operations, and
eliminating unprofitable license agreements. As a percentage of net sales,
costs and expenses increased to 117.4% in 1998 from 90.5% in 1997.

Sales and marketing expenses decreased $5.5 million or 26.7% from $20.7
million in 1997 to $15.2 million in 1998 primarily as a result of closing the
Company's London office, terminating the Ellen Tracy license, reducing national
advertising expenditures, and reducing the number of NASCAR race sponsorships.
As a percentage of net sales, sales and marketing expenses decreased to 41.6%
in 1998 from 50.6% in 1997.

General and administrative expenses decreased 10.8% from $7.9 million in
1997 to $7.0 million in 1998, primarily as a result of the acquisition of
Private Eyes and Sungold, which were purchased in March and April of 1997.
General and Administrative expenses for 1998 include a full 12 months of
expenses for Private Eyes and Sungold as compared to 10 months of expenses for
Private Eyes and 9 months of expenses for Sungold in 1997. As a percentage of
net sales, general and administrative expenses were 19.2% in each of 1998 and
1997.

Shipping and warehousing expenses increased $293,000 or 14.9% in 1998,
primarily as a result of the acquisition of Sungold and Private Eyes. As a
percentage of net sales, shipping and warehousing expenses increased to 6.2% in
1998 as compared to 4.8% in 1997.

Provision for doubtful accounts increased $1.3 million or 97.7% in 1998,
primarily as a result of write off of receivable balances that were no longer
deemed collectible. As a percentage of net sales, provision for doubtful
accounts increased to 7.2% in 1998 from 3.2% in 1997.

Interest expense was $3.3 million for the year ended December 31, 1998 and
was $2.0 million for the year ended December 31, 1997. The increase in 1998
was due primarily to increased levels of indebtedness and the amortization of
related loan fees.

Loss on disposition of assets and other related costs of $11 million in
1998 include (1) a non-cash charge of $8.9 million related to the write-down of
goodwill, certain intangible assets, deferred marketing costs and other assets
related to the termination of the Ellen Tracy license agreement and related
Ellen Tracy Eyewear business, see Note 14 to Consolidated Financial Statements,
(2) a charge to earnings of $1.6 million resulting from the sale of the assets
of Kindling and the termination of the related Timberland license, see Note 12
to Consolidated Financial Statements, and (3) costs of $476,000 relating to the
closing of the London office, consisting principally of a non-cash write-off of
start-up costs of $279,000, severance and other closing costs. See Note 16 to
Consolidated Financial Statements.

Severance, relocation and (net) other expenses of $1.5 million in 1998
included $260,000 of costs associated with the termination of the lease on the
Company's Lynnwood, Washington facility; a $263,000 reserve against certain
notes receivable and guaranteed loans payable related to a former subsidiary; a
gain of $405,000 related to certain notes receivable from the Company's former
president and CEO, compared to an expense in 1997 of $611,000 to fully reserve
the notes receivable; write-off of obsolete production related costs and assets
for discontinued product lines decreased to $289,000 from $720,000 in 1997;
write-off of trade credits decreased to $211,000 in 1998 from $729,000 in 1997.
Additionally, 1998 other expenses included estimated restructuring compensation
and other related contingencies of $652,000 and other expenses of $227,000,
including termination costs associated with endorsement contracts and other
miscellaneous expenses. See Note 17 to Consolidated Financial Statements.

INCOME TAX BENEFIT. The Company's income tax benefit was zero for the
years ended December 31, 1998 and 1997. Since the Company could not determine
that it was more likely than not that the deferred tax asset was recoverable,
the Company recorded a 100% valuation allowance against its net tax assets at
December 31, 1998 and 1997.

NET LOSS. As a result of the items discussed above, the Company's net
loss was $21.6 million or $2.77 per share for the year ended December 31, 1998
compared to a net loss of $14.4 million or $1.94 per share for the year ended
December 31, 1997.

LIQUIDITY AND CAPITAL RESOURCES
- -------------------------------

Historically, the Company has relied primarily on cash from operations and
borrowings to finance its operations. In addition, on October 1, 1996, the
Company concluded its initial public offering in which 1,954,465 new shares of
common stock were issued at a price of $16 per share. The initial public
offering raised $27 million in net proceeds for the Company. A portion of
these net proceeds was used to repay $19 million of debt in early October 1996.
At December 31, 1996, the Company had cash and cash equivalents of $4.4
million, current assets of $21.3 million and current liabilities of $5.7
million. The Company had a credit facility of $15 million, under which no
borrowings were outstanding.

In 1997, the Company used $10.9 million of cash in its operating
activities and $21.8 million of cash in its investing activities, primarily to
fund the acquisitions of Sungold and Private Eyes. Cash provided by the
Company's financing activities, which consisted almost exclusively of bank
borrowings, totaled $29.2 million. As of December 31, 1997, the Company had
cash of $900,000, working capital of $11.4 million and bank borrowings of $29.2
million. The Company had no additional borrowings available under its
revolving loan at December 31, 1997.

In 1998, cash provided by the Company's operating activities totaled
$620,000 even though the Company's net loss for 1998 was $21.6 million. The
Company used $731,000 in investing activities, primarily to fund a royalty
payment to the seller of the Sungold business production and office equipment.
No further payments are due under the terms of the Sungold purchase agreement
or royalty agreement. Cash used by the Company's financing activities, which
consisted almost exclusively of bank repayments, totaled $634,000. At December
31, 1998, the Company had unused sources of liquidity of $656,000 consisting of
cash of $194,000 and available bank borrowings of $462,000.

Cash used in the Company's operating activities in 1999 totaled $5.2
million and consisted primarily of payments to vendors on accounts payable and
other payments of $5.1 million. In addition, the Company increased accounts
receivable by $1.6 million, increased inventories by $16,000 and decreased
other current assets and other assets by $169,000. Cash used in the Company's
investing activities in 1999 to fund acquisitions of property and equipment
totaled $223,000. Additional cash used in the Company's 1999 investing
activities in connection with the payment of royalties to the seller pursuant
to the Sungold acquisition was $1.3 million. Cash provided by the Company's
financing activities, primarily proceeds from bank debt, totaled $6.7 million
for 1999. At December 31, 1999, the Company had unused sources of liquidity of
$2.3 million consisting of cash of $161,000 and available bank borrowings of
$2.1 million.

On June 1, 1999, the Company completed a transaction with its lender, U.S.
Bank, for the restructure of its credit facility with the bank and a
recapitalization of the Company. As a result of the refinancing, the Company's
indebtedness to U.S. Bank was decreased by $10 million, and the balance of the
loans were restructured into $19.5 million of term loans with maturity dates of
June 1, 2005, and a commitment for a $9 million revolving loan. The revolving
loan consists of three one-year commitment periods expiring on January 31 of
2000, 2001 and 2002. The commitment periods for the revolving loan are
extended in successive one-year periods subject to the Company's compliance
with loan covenants and repayment obligations. No principal payments are due
under $3 million of the term loans until their maturity date; principal
payments under $7.5 million of the term loans are based on a percentage of
excess cash as defined in the credit agreement; and annual principal payments
under the remaining $9.5 million term loan, which had an outstanding principal
balance at December 31, 1999 of $9.4 million, are scheduled as follows:

Substantially all the assets of the Company are pledged as collateral for
the repayment of borrowings under the credit agreement. The credit agreement
also prohibits the Company from paying dividends to its shareholders.

In exchange for $10 million of debt, Gargoyles issued 10 million shares of
Gargoyles Series A Preferred Stock to U.S. Bank. The Series A Preferred Stock
is immediately convertible into 31,600,342 shares of Gargoyles common stock, or
79% of the authorized capital of Gargoyles on a fully-diluted basis. U.S.
Bank's affiliate, U.S. Bankcorp, owns 400,000 shares of Gargoyles common stock,
or 1% of the authorized capital of Gargoyles, giving US. Bank and its affiliate
beneficial ownership, in the aggregate, of 80% of the authorized capital of
Gargoyles on a fully-diluted basis. The Series A Preferred Stock annually
accrues a cumulative dividend equal to the U.S. Bank Reference Rate plus 75
basis points. See Note 11 to Consolidated Financial Statements.

As a result of the Company's restructure efforts, the costs controls
which have been established, and the restructure of the Company's indebtedness,
management believes that cash flow from operations and available borrowings
will be sufficient to meet its operating needs and capital expenditure
requirements for the foreseeable future. See "Business -- Forward-Looking
statements."

INFLATION
- ---------

General inflation has not had a significant impact on the Company over the
past three years. The Company continues to manage cash flow through programs
designed for cost containment and productivity improvements. Management does
not expect inflation to have a significant impact on the Company's results of
operations or financial condition in the foreseeable future.

NET OPERATING LOSS CARRY-FORWARDS
- ---------------------------------

At December 31, 1999, the Company had net operating loss carry-forwards
for federal tax purposes of at least $20.0 million to offset future taxable
income. This amount is based on U.S. Bank's conversion of $10 million of
secured debt to preferred stock, the subsequent reduction of a corresponding
amount of net operating loss carry-forwards, and the Company's interpretation
of Internal Revenue Code Section 382. Code Section 382 addresses limitations
on the use of net operating loss carry-forwards following a change in
ownership, as defined in Section 382. The Company believes it has a reasonable
basis for its position. If, however, the Company's operations were profitable
in the future and the Company's position were found to be incorrect, there may
be significant limitations on the use by the Company of these net operating
loss carry-forwards. Any significant limitation on the Company's use of its net
operating loss carry-forwards would result in an increase in the Company's tax
liability and a reduction of its net income and available cash resources. See
Note 8 to Consolidated Financial Statements.

SEASONALITY
- -----------

The Company's business is affected by economic factors and seasonal
consumer buying patterns. 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. See "Business -- Risk
Factors _ Seasonality of Business." The following table contains quarterly net
sales for the Company in 1999 and 1998:

<TABLE>
<CAPTION>
Quarter
----------------------------------------------------
Year Ended: First Second Third Fourth
-------- -------- ------ ------
(in thousands)
<S> <C> <C> <C> <C>
December 31, 1999
Net sales $ 9,348 $10,064 $6,631 $7,296
December 31, 1998
Net sales $11,479 $13,176 $9,063 $2,889

</TABLE>

BACKLOG AND BACKORDERS
- ----------------------

The Company's backlog (which represents all unshipped orders, regardless
of the scheduled shipping date) was $4,272,306 and $3,201,116, at December 31,
1999 and 1998, respectively

The Company's backorders (which represent orders for merchandise remaining
unshipped beyond its scheduled shipping date) were at $297,488 and $268,147 on
December 31, 1999 and 1998, respectively.

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
- --------------------------------------------------------------------

None.

<PAGE>

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
- -----------------------------------------------------

<TABLE>
INDEX TO FINANCIAL STATEMENTS
-----------------------------
<CAPTION>
Page
Number
------
<S> <C>
Report of BDO Seidman, LLP, Independent Auditors....................... 22
Report of Ernst & Young LLP, Independent Auditors...................... 23
Gargoyles, Inc. Consolidated Financial Statements
Consolidated Balance Sheets.......................................... 24
Consolidated Statements of Operations................................ 25
Consolidated Statements of Shareholders' Equity...................... 26
Consolidated Statements of Cash Flows................................ 27
Notes to Consolidated Financial Statements........................... 28
Schedule II
Consolidated Valuation and Qualifying Accounts....................... 42
</TABLE>

<PAGE>

Report of Independent Certified Public Accountants
--------------------------------------------------

To the Board of Directors and Shareholders
Gargoyles, Inc.

We have audited the accompanying consolidated balance sheets of Gargoyles, Inc.
and subsidiaries ("the Company") as of December 31, 1999 and 1998, and the
related consolidated statements of operations, shareholders' equity, and cash
flows for each of the two years in the period ended December 31, 1999. Our
audits also included the financial statement schedule listed in the Index at
Item 14(a). These consolidated financial statements and schedule are the
responsibility of the Company's management. Our responsibility is to express
an opinion on these consolidated financial statements and schedule based on our
audits.

We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audits to
obtain reasonable assurance about whether the financial statements and schedule
are free of material misstatement. An audit includes examining, on a test
basis, evidence supporting the amounts and disclosures in the financial
statements and schedule. An audit also includes assessing the accounting
principles used and significant estimates made by management, as well as
evaluating the overall presentation of the financial statements and schedule.
We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of Gargoyles, Inc. and
subsidiaries at December 31, 1999 and 1998, and the related consolidated
results of their operations and their cash flows for each of the two years in
the period ended December 31, 1999, in conformity with generally accepted
accounting principles.

Also, in our opinion, the financial statement schedule presents fairly, in all
material respects, the information set forth therein.

/s/ BDO Seidman, LLP

BDO Seidman, LLP
Seattle, Washington
March 14, 2000

<PAGE>

REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS
-------------------------------------------------

The Board of Directors and Shareholders
Gargoyles, Inc.

We have audited the accompanying consolidated statements of operations,
shareholders' equity, and cash flows of Gargoyles, Inc. for the year ended
December 31, 1997. Our audit also included the financial statement schedule
listed in the index at Item 14(a) relating to the year ended December 31, 1997.
These financial statements and schedule are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statements and schedule based on our audit.

We conducted our audit in accordance with auditing standards generally accepted
in the United States. Those standards require that we plan and perform the
audit to obtain reasonable assurance about whether the financial statements are
free of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements.
An audit also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audit provides a reasonable basis
for our opinion.

In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the consolidated results of operations and
cash flows of Gargoyles, Inc. for the year ended December 31, 1997, in
conformity with accounting principles generally accepted in the United States.
Also, in our opinion, the related financial statement schedule, when considered
in relation to the basic financial statements taken as a whole, presents
fairly, in all material respects, the information set forth therein.

/s/ Ernst & Young LLP

Seattle, Washington
March 30, 2000

<PAGE>
<TABLE>
GARGOYLES, INC.
CONSOLIDATED BALANCE SHEETS
---------------------------
<CAPTION>
A S S E T S
December 31,
-------------------------------
1999 1998
------------- -------------
<S> <C> <C>
Current assets:
Cash and cash equivalents $ 161,472 $ 194,314
Trade receivables, net 3,761,517 2,251,226
Inventories 8,342,717 8,607,357
Other current assets and prepaid expenses 1,539,609 1,982,180
------------- -------------
Total current assets 13,805,315 13,035,077

Property and equipment, net 1,084,051 1,510,333
Intangibles, net 13,049,942 13,004,935
Other assets 273,257 457,599
------------- -------------
Total assets $ 28,212,565 $ 28,007,944
============ ============

LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 3,963,182 $ 5,923,196
Accrued expenses and other current
liabilities 2,735,658 7,130,212
Current maturities of long-term debt 900,000 28,526,379
------------- -------------
Total current liabilities 7,598,840 41,579,787

Long-term debt, net of current maturities 24,533,104 -

Deferred License Income and Other 904,841 600,000

Shareholders' equity:
Preferred stock, no par value,
authorized, issued and outstanding
shares -- 10,000,000 and 0, respectively 9,810,000 -
Common stock, no par value, authorized
shares -- 40,000,000, issued and
outstanding -- 7,822,191 and
7,822,191, respectively 26,529,282 26,529,282
Accumulated (deficit) (41,163,502) (40,735,481)
Translation adjustment - 34,356
------------- -------------
Total shareholders' equity (4,824,220) (14,171,843)
------------- -------------
Total liabilities and shareholders'
equity $ 28,212,565 $ 28,007,944
============ ============

See accompanying notes to Consolidated Financial Statements.
</TABLE>
<PAGE>
<TABLE>
GARGOYLES, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
--------------------------------------
<CAPTION>
Year Ended December 31,
--------------------------------------------
1999 1998 1997
------------- ------------- -------------
<S> <C> <C> <C>
Net sales $ 33,338,118 $ 36,606,338 $ 40,997,127

Cost of sales 14,095,516 16,225,550 18,796,571
------------- ------------- -------------
Gross profit 19,242,602 20,380,788 22,200,556

License income 433,770 965,622 526,462
------------- ------------- -------------
19,676,372 21,346,410 22,727,018
------------- ------------- -------------
Costs and expenses:
Sales and marketing 9,370,765 15,202,523 20,728,633
General and administrative 5,490,326 7,033,120 7,884,281
Shipping and warehousing 1,695,558 2,252,618 1,960,022
Provision for doubtful accounts 46,995 2,629,525 1,329,864
Interest, net 2,644,147 3,336,957 1,974,005
Loss on disposition of assets
and related - 11,007,968 -
Severance, relocation and other 351,760 1,497,185 3,232,014
------------- ------------- -------------
19,599,551 42,959,896 37,108,819
------------- ------------- -------------
Net income (loss) $ 76,821 $(21,613,486) $(14,381,801)

Preferred stock dividends
accrued 504,842 - -
------------- ------------- -------------
Net income (loss) available for
common shareholders $ (428,021) $(21,613,486) $(14,381,801)
============= ============= =============
Basic and diluted net loss
per common share $(.05) $(2.77) $(1.94)
============= ============= =============
Weighted average common
shares used in the calcula-
tion of basic and diluted
net loss per share 7,822,191 7,812,890 7,428,055
============= ============= =============

See accompanying notes to Consolidated Financial Statements.
</TABLE>
<PAGE>
<TABLE>
GARGOYLES, INC
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
-----------------------------------------------
<CAPTION>
Preferred Stock Common Stock Cumulative
----------------------- ---------------------- Accumulated Translation
Shares Amount Shares Amount (Deficit) Adjustment Total
---------- ----------- ---------- ------------ ------------- ----------- -------------
<S> <C> <C> <C> <C> <C> <C> <C>
Balance at December 31, 1996 $ 7,419,008 $25,643,576 $ (4,740,194) - $ 20,903,382

Stock options exercised 18,183 68,206 - - 68,206

Translation adjustment - - - (12,954) (12,954)

Net loss - - (14,381,801) - (14,381,801)
---------- ----------- ---------- ------------ ------------- ---------- -------------
Balance at December 31, 1997 7,437,191 25,711,782 (19,121,995) (12,954) 6,576,833

Stock issued in connection
with restructure of
credit agreement 400,000 862,500 862,500

Stock redemption for
Former CEO (15,000) (45,000) - - (45,000)

Translation adjustment - - - 47,310 47,310

Net loss - - (21,613,486) - (21,613,486)
---------- ----------- ---------- ------------ ------------- ---------- -------------
Balance at December 31, 1998 7,822,191 26,529,282 (40,735,481) 34,356 (14,171,843)

Issuance of Preferred Stock,
net of issuance costs 10,000,000 9,810,000 - - - - 9,810,000

Cumulative preferred
stock Dividends - - (504,842) - (504,842)

Translation adjustment - - - (34,356) (34,356)

Net income - - 76,821 76,821
---------- ---------- ---------- ------------ ------------- ---------- -------------
Balance at December 31, 1999 10,000,000 $9,810,000 7,822,191 $26,529,282 $(41,163,502) $ - $ (4,824,220)
========== =========== ========== ============ ============= ========== =============

See accompanying notes to Consolidated Financial Statements.
</TABLE>

<PAGE>
<TABLE> GARGOYLES, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
--------------------------------------
<CAPTION>
Year Ended December 31,
------------------------------------------
1999 1998 1997
------------ ------------- -------------
<S> <C> <C> <C>
OPERATING ACTIVITIES
- --------------------
Net Income (loss) $ 76,821 $(21,613,486) $(14,381,801)
Adjustments to reconcile
net loss to net cash used
in operating activities:
Depreciation 641,826 781,457 1,109,884
Amortization 738,116 1,300,321 817,121
Deferred income and other (200,000) 44,000 (360,000)
Provision for doubtful accounts 46,995 2,629,525 1,329,864
Severance, relocation and
other expenses - 352,831 2,620,173
Loss on disposition of assets
and related - 10,165,276 -
Changes in assets and liabilities
net of effects from business
acquisitions and dispositions:
Trade receivables (1,557,286) 3,593,100 151,117
Inventories (15,866) 3,166,398 (4,948,762)
Other current assets and
other assets 169,307 (451,484) 422,380
Accounts payable, accrued
expenses and other current
liabilities (5,076,258) 651,683 2,294,171
------------ ------------- -------------
Net cash used in operating
activities (5,176,345) 619,621 (10,945,853)
------------ ------------- -------------
INVESTING ACTIVITIES
- --------------------
Acquisition of property
and equipment (222,759) (104,150) (1,411,021)
Business acquisitions:
Purchase of Private Eyes - - (8,616,304)
Purchase of Sungold (1,316,107) (626,468) (11,732,500)
------------ ------------- -------------
Net cash used in investing
activities (1,538,866) (730,618) (21,759,825)
------------ ------------- -------------
FINANCING ACTIVITIES
- --------------------
Proceeds from stock issuance - - 68,206
Proceeds from issuance
of long-term debt - - 14,870,000
Principal payments on
long-term debt (100,000) - (185,137)
Net proceeds (repayment)
under revolving line
of credit 7,006,725 (634,175) 14,475,691
Preferred stock issuance costs (190,000) - -
------------ ------------- -------------
Net cash provided by (used in)
financing activities 6,716,725 (634,175) 29,228,760
------------ ------------- -------------
Effect of foreign currency
translation (34,356) 47,310 (12,954)
------------ ------------- -------------
Net decrease in cash and
cash equivalents (32,842) (697,862) (3,489,872)

Cash and cash equivalents,
beginning of year 194,314 892,176 4,382,048
------------ ------------- -------------
Cash and cash equivalents,
end of year $ 161,472 $ 194,314 $ 892,176
=========== ============ ============

SUPPLEMENTAL DISCLOSURES OF NON-CASH INVESTING AND FINANCING ACTIVITIES
Preferred stock issued in
exchange for long-term debt
reduction $10,000,000 $ - $ -
Common stock issued for
other than cash $ - $ 862,500 $ -
Common stock redemption $ - $ 45,000 $ -

See accompanying notes to Consolidated Financial Statements
</TABLE>

<PAGE>
GARGOYLES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for each of the three years in the period ended December 31, 1999
-----------------------------------------------------------------

1. SIGNIFICANT ACCOUNTING POLICIES
- ------------------------------------

Principal Industry
------------------
Gargoyles, Inc. and its subsidiaries (the "Company") design, assemble,
market and distribute a broad range of sunglasses and eyewear products. The
Company's products are sold through sunglass specialty, sport specialty,
department stores, warehouse clubs, optical stores and other specialty retail
stores. The Company purchases products from various suppliers. Management
believes there are adequate alternative sources for these products should an
existing supplier be unable to perform.

Principles Of Consolidation
---------------------------
The consolidated financial statements include the accounts of Gargoyles,
Inc. and its subsidiaries. All significant intercompany balances have been
eliminated in consolidation. Included in the consolidation are H.S.C., Inc.
("Hobie"), Sungold Eyewear, Inc. ("Sungold"), and Private Eyes Sunglass
Corporation ("Private Eyes"), all of which are wholly-owned subsidiaries of the
Company. Also included in periods prior to September 1, 1998 is the kindling
company ("Kindling"), 70% of which was owned by the Company. Effective
September 1, 1998, Kindling disposed of its operations (see Note 12).

Cash And Cash Equivalents
-------------------------
The Company considers all highly liquid investments with original
maturities of three months or less when purchased to be cash equivalents.

Inventories
-----------
Inventories are stated at the lower of cost (first-in, first-out method)
or market and consist of direct materials, direct labor, and packaging and
freight charges. Inventories are shown net of reserves established for
obsolete or slow-moving items.

Property And Equipment
----------------------
Property and equipment are stated at cost, net of accumulated depreciation
and amortization. Significant additions and improvements are capitalized.
Maintenance and repairs are expensed as incurred. The Company provides for
depreciation and amortization using the straight-line method which recognizes
the cost over the estimated useful lives of the respective assets, ranging from
3 to 7 years, or, as to leasehold improvements, the term of the related lease,
if less than the estimated useful life.

Intangibles
-----------
Intangible assets primarily result from business acquisitions and consist
of costs in excess of fair value of net assets acquired (which include
trademarks, tradenames and goodwill), licensing and management agreements, and
non-compete agreements. These costs are amortized on a straight-line basis
over periods of 2 to 25 years.

Revenue Recognition
-------------------
Revenue is recognized when merchandise is shipped to a customer. As
necessary, the Company defers revenue related to contractual obligations with
certain customers. The Company records sales net of volume and cash discounts.
Trade receivables are shown net of an allowance for doubtful accounts of
$354,153 and $920,916 at December 31, 1999 and 1998, respectively.

License Income
--------------
On October 20, 1998, as part of a structured settlement of the Company's
patent infringement case against Aearo Corporation, the Company granted to
Aearo a license to use the Company's toric-curve patented technology to make
and sell certain otherwise infringing product into certain industrial safety
markets in exchange for a one-time, lump sum royalty payment of $1.2 million.
After deducting expenses associated with the license agreement and allocating a
portion of the royalty payment for periods prior to the settlement date, the
$600,000 balance was recorded as deferred license income and is being amortized
over the three-year estimated remaining economic life of the license.

Warranties
----------
The Company's products are covered by a warranty against defects in
material and workmanship. The Company has established a reserve for these
anticipated future warranty costs.

Advertising Expense
-------------------
The cost of advertising is expensed as incurred. The Company incurred
$905,476, $1,324,092 and $2,858,517 in advertising costs during the years ended
December 31, 1999, 1998 and 1997, respectively.

Income Taxes
------------
The Company accounts for income taxes under the liability method, whereby
deferred taxes are provided for the temporary differences between the financial
reporting basis and the tax basis of the Company's assets and liabilities.
These deferred tax assets and liabilities are measured under the provisions of
currently enacted tax laws. To the extent it is considered more likely than
not that the Company's deferred tax assets will not be realized, a valuation
allowance is recorded to reduce the deferred tax asset to its net realizable
value.

Concentration Of Credit Risk And Financial Instruments
-------------------------------------------------------
The Company sells its products to local and national companies and
distributors throughout the United States and internationally. Net sales to
the Company's largest customer represented 26%, 14% and 21% of net sales for
the years ended December 31, 1999, 1998 and 1997, respectively. The Company
performs ongoing credit evaluations of its customers and generally does not
require collateral. The Company maintains an allowance for doubtful accounts
at a level which management believes is sufficient to cover probable credit
losses.

The carrying value of financial instruments, which include cash,
receivables, payables and long-term debt, approximates market value at
December 31, 1999.

Foreign Currency
----------------
The Company translated the assets and liabilities of a London, United
Kingdom operation at rates of exchange in effect at year end. Revenues,
expenses, and cash flows of the operation were translated at the average rates
of exchange during the year. Gains and losses resulting from translation of
the London branch balance sheet were accumulated as a separate component of
shareholders' equity. The London operation was closed in 1998, and all the
remaining assets and liabilities were realized or satisfied in 1999.

Stock-Based Compensation
------------------------
The Company grants stock options for a fixed number of shares to
employees, with an exercise price equal or greater than the fair value of the
shares at the time of grant. The Company has elected to apply the disclosure
only provisions of Financial Accounting Standards No. 123, "Accounting for
Stock-Based Compensation" ("Statement No. 123"). Accordingly, the Company
accounts for stock-based compensation using the intrinsic value method
prescribed in Accounting Principles Board Opinion No. 25, "Accounting for Stock
Issued to Employees," and related interpretations. Compensation costs for
stock options are measured at the excess, if any, of the fair value of the
Company's common stock at the date of the grant over the stock option price.
Pro forma net loss information has been disclosed in Note 11.

Earnings Per Share
------------------
In 1997, the Financial Accounting Standards Board (FASB) issued Statement
of Financial Accounting Standards No. 128, "Earnings per Share" ("Statement No.
128"). Statement No. 128 replaced the calculation of primary and fully diluted
earnings per share with basic and diluted earnings per share. Unlike primary
earnings per share, basic earnings per share excludes the dilutive effects of
options, warrants and convertible securities. Diluted earnings per share is
similar to previously reported fully diluted earnings per share. Earnings per
share amounts for all periods have been presented and, where necessary,
restated to conform to Statement No. 128 requirements and SEC Staff Accounting
Bulletin No. 98. For purposes of calculating diluted earnings per share,
effects of options, warrants and convertible securities have not been included
as their effect would be antidilutive.

Impairment Of Long-Lived Assets
--------------------------------
In March 1995, the Financial Accounting Standards Board (FASB) issued
Statement of Financial Accounting Standards No. 121, "Accounting for the
Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of"
("Statement No. 121"). Management continually evaluates the potential
permanent impairment of the net carrying value of certain long-term assets.
For each asset evaluated, the expected undiscounted cash flows have been
compared to the respective asset's net carrying value. Except for those assets
written off as discussed in Note 17, in all cases where evaluation was
performed, the expected undiscounted cash flows exceeded the net carrying value
of the assets. Accordingly, an impairment as defined by Statement No. 121 does
not exist and no loss has been recognized.

Use Of Estimates
----------------
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the amounts reported in the financial statements and
accompanying notes. Actual results could differ from those estimates. In
1999, general and administrative expenses were reduced by $617,000 related to
settlements of various previously estimated trade liabilities and
contingencies.

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

2. INVENTORIES
- ----------------

Inventories consist of the following:

<TABLE>
<CAPTION>
December 31,
--------------------------
1999 1998
----------- -----------
<S> <C> <C> <C>
Materials $3,199,221 $4,204,151
Finished goods 6,010,315 4,983,977
Reserves for excess, slow-moving
and obsolete inventories (866,819) (580,771)
----------- -----------
Inventories, net $8,342,717 $8,607,357
=========== ===========
</TABLE>

3. OTHER CURRENT ASSETS AND PREPAID EXPENSES
- ---------------------------------------------

Other current assets and prepaid expenses consist of the following:

<TABLE>
<CAPTION>
December 31,
---------------------------
1999 1998
------------ ------------
<S> <C> <C> <C>
Prepaid expenses $1,080,167 $1,055,675
Other receivables - 33,159
Income tax refund receivable 35,310 160,217
Deposits 83,328 70,125
Trade credits 100,000 100,000
Note receivable from former CEO 10,000 405,610
Other 230,804 157,394
----------- -----------
$1,539,609 $1,982,180
=========== ===========
</TABLE>

4. PROPERTY AND EQUIPMENT
- ---------------------------

Property and equipment consist of the following:

<TABLE>
<CAPTION>
December 31,
--------------------------
1999 1998
----------- -----------
<S> <C> <C> <C>
Molds and production equipment $1,410,169 $1,417,953
Office furniture and equipment 1,936,206 1,758,401
Exhibit and marketing equipment 457,148 426,496
Transportation equipment 24,718 24,718
Leasehold improvements 101,011 87,562
---------- ---------
3,929,252 3,715,130
Accumulated depreciation
and amortization (2,845,201) (2,204,797)
----------- -----------
Property and equipment, net $1,084,051 $1,510,333
=========== ===========
</TABLE>

5. INTANGIBLES
- ----------------

Intangible assets consist of the following:

<TABLE>
<CAPTION>
December 31,
---------------------------
1999 1998
------------ ------------
<S> <C> <C> <C>
Costs in excess of fair market
value of net assets acquired $12,163,743 $11,547,636
Licensing agreements 2,805,470 2,805,470
------------ ------------
14,969,213 14,353,106

Accumulated amortization (1,919,271) (1,348,171)
------------ ------------
Intangibles, net $13,049,942 $13,004,935
============ ============
</TABLE>

6. ACCRUED EXPENSES AND OTHER CURRENT LIABILITIES
- ---------------------------------------------------

Accrued expenses and other current liabilities consist of the following:

<TABLE>
<CAPTION>
December 31,
---------------------------
1999 1998
----------- -----------
<S> <C> <C> <C>
Payroll taxes and benefits $ 925,300 $ 794,841
Acquisition and other obligations - 700,000
Relocation and closing costs - 166,004
Interest 208,482 208,859
Marketing royalties and other 61,708 515,506
Liability for sales reserve 259,311 500,000
Vendor notes payable
(8% interest, unsecured) 340,232 2,327,179
Other 940,625 1,917,823
---------- ----------
$2,735,658 $7,130,212
========== ==========
</TABLE>

7. DEBT
- ---------

Long-term debt consists of the following:

<TABLE>
<CAPTION>
December 31,
----------------------------
1999 1998
----------- -------------
<S> <C> <C> <C>
Revolving loan payable to bank,
bearing interest at reference rate
plus 0.75%, plus 0% (9.25% and
8.00% at December 31, 1999 and
1998,respectively), interest
due monthly. $ 6,033,104 $ 8,344,841
Note payable to bank, bearing
interest at reference rate
plus 0.75% (9.25% and 8.75%
at December 31, 1999 and 1998,
respectively), interest
due monthly. 9,400,000 13,000,000
Note payable to bank, bearing
interest at reference rate
plus 0.75% (9.25% and 8.75%
at December 31, 1999 and 1998,
respectively), interest due
monthly. 7,000,000 3,470,000
Notes payable to bank, bearing
interest at reference rate
plus 0.75%, plus 0.25%,
(9.25% and 8.25% at December 31,
1999 and 1998, respectively),
interest due monthly. 3,000,000 3,467,500
Notes payable to bank,
bearing interest at reference
rate plus 0.25%, (8.25% at
December 31, 1998), interest
due monthly. - 244,038
------------ ------------
Total long-term debt 25,433,104 28,526,379
Less: current maturities (900,000) (28,526,379)
------------ ------------
Long term debt, net of current maturities $24,533,104 $ 0
============ ============
</TABLE>

The Company had approximately $2.1 million additional borrowings available
under its revolving loan at December 31, 1999.

The Company had $177,790 outstanding under letters of credit at December
31, 1999.

On June 1, 1999, the Company completed a transaction with its lender, U.S.
Bank National Association, for the restructure of its credit facility with the
bank and a recapitalization of the Company. As a result of the refinancing,
the Company's indebtedness to U.S. Bank was decreased by $10 million, and the
balance of the loans were restructured into $19.5 million of term loans with
maturity dates of June 1, 2005, and a commitment for a $9 million revolving
loan. The revolving loan consists of three one-year commitment periods
expiring on January 31 of 2000, 2001 and 2002. The commitment periods for the
revolving loan are extended in successive one-year periods subject to the
Company's compliance with loan covenants and repayment obligations. No
principal payments are due under $3 million of the term loans until their
maturity date; principal payments under $7.5 million of the term loans are
based on a percentage of excess cash as defined in the credit agreement; and
annual principal payments remaining under the $9.5 million term loan are
scheduled as follows:

The Company made interest payments to U.S. Bank totaling $2,356,469,
$2,821,715, and $1,599,857 during the years ended December 31, 1999, 1998 and
1997, respectively.

8. INCOME TAXES
- -----------------

The difference between the income tax provision (benefit), all of which is
current, based upon the federal statutory income tax rate and the income tax
provision (benefit) recorded in the financial statements is attributable to the
following:

<TABLE>
<CAPTION>
Year Ended December 31,
---------------------------------------
1999 1998 1997
---------- ------------ ------------
<S> <C> <C> <C>
Income tax benefit at federal
statutory rate (34%) $ 26,100 $(7,348,000) $(4,890,000)
Change in deferred tax valuation
allowance 132,300 4,467,200 4,861,000
Goodwill, amortization and
losses on disposition of
assets 3,081,000
Other (158,400) (200,200) (29,000)
---------- ------------ ------------
$ - $ - $ -
========== ============ ============
</TABLE>

Deferred income taxes reflect the net tax effects of temporary differences
between the bases of assets and liabilities for financial reporting purposes
and the bases used for income tax return purposes. Significant components of
the Company's deferred tax liabilities and assets are as follows:

<TABLE>
<CAPTION>
December 31,
------------------------------
1999 1998
------------- -------------
<S> <C> <C> <C>
Deferred tax liabilities:
Tax over book depreciation $ (8,000) $ (21,600)
Amortization of intangibles - -
Other (3,600) (3,600)
------------- -------------
Total deferred tax liabilities $ (11,600) $ (25,200)
------------- -------------
Deferred tax assets:
Net operating loss carry-forwards 9,666,000 9,666,000
Sales return allowance 88,200 170,000
Inventory valuation allowance 396,700 299,500
Deferred license income 136,000 204,000
Allowance for doubtful accounts 156,900 349,700
Accrued lease obligations - 14,100
Accrued vacation 82,800 68,600
Warranty reserves 19,000 61,200
Other 299,700 158,100
------------- -------------
Total deferred tax assets 10,845,300 10,991,200
------------- -------------
Net deferred taxes $ 10,833,700 $ 10,966,000
============= =============
Valuation allowance $(10,833,700) $(10,966,000)
============= =============
</TABLE>

At December 31, 1999, the Company had net operating loss carry-forwards
for federal tax purposes of at least $20.0 million to offset future taxable
income. This amount is based on U.S. Bank's conversion of $10 million of
secured debt to preferred stock, the subsequent reduction of a corresponding
amount of net operating loss carry-forwards, and the Company's interpretation
of Internal Revenue Code Section 382. Code Section 382 addresses limitations
on the use of net operating loss carry-forwards following a change in
ownership, as defined in Section 382. The Company believes it has a reasonable
basis for its position. If, however, the Company's operations were profitable
in the future and the Company's position were found to be incorrect, there may
be significant limitations on the use by the Company of these net operating
loss carry-forwards. Any significant limitation on the Company's use of its
net operating loss carry-forwards would result in an increase in the Company's
tax liability and a reduction of its net income and available cash resources.

No income tax payments were made during the years ended December 31, 1999,
1998 and 1997.

9. COMMITMENTS AND CONTINGENCIES
- ----------------------------------

Lease Agreements
----------------
Since 1994, the Company has been leasing its primary operating and office
premises under a non-cancelable operating lease, expiring in March 2002. Terms
of this lease include 4% annual rental payment increases. The owner of these
premises is a current shareholder and the former majority owner of Gargoyles.
Rent expense under this lease totaled $250,611, $240,972 and $231,702 for the
years ended December 31, 1999, 1998 and 1997, respectively.

During 1998, the Company leased additional office and warehouse space
under a non-cancelable lease expiring in August 2001. Terms of this lease
require monthly rental payments of $13,400. In connection with the Company's
1997 acquisition of Sungold, the Company assumed a non-cancelable operating
lease expiring November 2001 for office and warehouse space requiring monthly
payments of approximately $17,000. The Company also leases showroom space in
New York City under a non-cancelable lease expiring 2003 requiring monthly
payments of approximately $4,300.

Minimum future lease payments under non-cancelable operating leases as of
December 31, 1999 are as follows:

<TABLE>
<CAPTION>
Year Ending
December 31,
-------------
<S> <C> <C>
2000 $ 676,378
2001 605,759
2002 120,621
2003 21,750
2004 0
Thereafter 0
----------
$1,424,508
</TABLE>

Endorsement And Licensing Agreements
-------------------------------------
The Company enters into endorsement contracts from time to time with
certain athletes and others to promote the Company's products. The Company has
also entered into license agreements with the owners of the Hobie, Stussy and
Wrangler brands. The license agreements include royalty payments of 2% to 10%
of net sales, minimum payments based on net sales, and annual minimum
advertising expenditures.

Minimum annual payments under these agreements are as follows:

<TABLE>
<CAPTION>
Year Ending License Endorsement
December 31 Agreements Contracts
-------------------- ----------- ------------
<S> <C> <C> <C>
2000 $ 353,897 $335,392
2001 395,344 280,583
2002 189,014 82,550
2003 22,689 --
2004 and thereafter 124,073 --
---------- --------
$1,085,017 $698,525
========== ========
</TABLE>

On February 2, 1999, the Company, Ken Griffey, Jr. and Douglas B. Hauff,
the Company's former president and chief executive officer, entered into an
agreement regarding the termination of the license agreement, and any
amendments thereto, under which the Company used Mr. Griffey's name to market
and sell its Gargoyles Performance Eyewear brand products. Under the terms of
the February 1999 agreement, Mr. Hauff agreed to assume the obligations of the
Company to Mr. Griffey under the license agreement, and the parties settled
disputes and mutually released claims related to the license agreement. The
assumption of the Company's obligations to Griffey and the release of claims
from Griffey were valued by the Company, in the aggregate, at $200,000.

The Company has guaranteed certain obligations of a former affiliate,
which at December 31, 1999, totaled approximately $212,000.

Litigation
----------
On November 18, December 4, and December 9, 1998 the State of Washington
Department of Revenue assessed the Company, in the aggregate, $475,830 plus
interest in business and occupation taxes and use taxes allegedly due and
payable related to the Company's operations during various periods between
January 1, 1993 and June 30, 1997. At issue in this matter is the Company's
status as a "manufacturer" or "wholesaler" as such terms are defined by the
state of Washington's business and occupation and use tax statutes. The Company
has reached agreement with the Department of Revenue on the facts of the case,
but a final tax assessment has not yet been calculated by the Department of
Revenue or reviewed and agreed by the Company. The Company has recorded a
provision which management believes is sufficient to cover the tax assessment
in this case when finally determined.

On May 11, 1998, Morris Rosenbloom & Co., Inc. filed an action against the
Company in the Supreme Court of the State of New York for Wayne County, under
Index No. 44010. In the lawsuit, plaintiff alleges breach of contract due to
the Company's failure to accept a return of sunglasses under the terms of a
Repurchase Agreement between Morris Rosenbloom and the Company. Plaintiff
claims damages from the Company in excess of $500,000. The Company has
retained counsel to represent it in this matter and intends to defend
vigorously the plaintiff's claims. The Company believes that the ultimate
resolution of this matter will not have a material adverse effect on its
results of operations or financial position.

On December 28, 1999, Hobie Designs, Inc. filed an action against
Gargoyles, Inc. and it subsidiary H.S.C. in the Superior Court of California,
County of Orange under Case No. 818816. Upon motion of Gargoyles and, H.S.C.,
on February 4, 2000, the case was removed to Federal Court and is now pending
in the United States District Court for the Central District of California
under Case No. SA-CV00-100 DOC. In the lawsuit, Hobie Designs alleges breach
of the license agreement under which H.S.C. has the right to use the Hobie
trademark in connection with the marketing and sale of eyewear and related
products. Hobie Designs claims damages in an unspecified amount and seeks
termination of the license agreement. Gargoyles and H.S.C. have retained
counsel to represent them in this matter and intend to defend vigorously the
plaintiff's claims. It is the Company's position that no material breach of
the Hobie license agreement has occurred. There can be no assurance, however,
that this case will be resolved successfully and that the Company's position
will ultimately prevail. Failure to resolve this matter successfully could
require the Company to modify the license agreement to the Company's
disadvantage or could result in the loss of H.S.C.'s right to market eyewear
under the Hobie brand.

10. EMPLOYEE BENEFIT PLAN
- --------------------------

The Company maintains a 401(k) savings plan for all full-time employees
age 21 or older with one year of service. The maximum employee contribution is
15% of the participant's compensation and subject to other contribution limits
imposed by federal law. The Company matches 50% of each dollar contributed by
a participant, with a maximum matching contribution of 6% of a participant's
annual earnings. The Company's contributions to the plan vest over six years
and totaled $63,439, $103,372 and $91,864 for the years ended December 31,
1999, 1998 and 1997, respectively.

11. SHAREHOLDERS' EQUITY
- -------------------------

Common Stock
------------
The Company has 40 million shares of authorized common stock. As of
December 31, 1999, 7,822,191 were issued and outstanding, 31,600,342 were
reserved for issuance to the Series A Preferred Stockholders, 539,317 were
reserved for issuance under the Gargoyles, Inc. 1995 Stock Incentive
Compensation Plan, and 38,150 were reserved for issuance under a warrant issued
to a former outside director of the Company.

Preferred Stock
---------------
On June 1, 1999, in exchange for $10 million of debt, the Company issued
10 million shares of Gargoyles, Inc. Series A Preferred Stock to U.S. Bank.
The Series A Preferred Stock is immediately convertible into 31,600,342 shares
of Gargoyles, Inc. common stock, or 79% of the authorized capital of the
Company on a fully-diluted basis. U.S. Bank's affiliate, U.S. Bankcorp,
currently owns 400,000 shares of Gargoyles, Inc. common stock, or 1% of the
authorized capital of the Company, giving U.S. Bank and its affiliate
beneficial ownership, in the aggregate, of 80% of the authorized capital of the
Company on a fully-diluted basis. Holders of Series A Preferred Stock have
voting rights equal to holders of the Company's common stock and are entitled
to 3.1600342 votes for every share of Series A Preferred Stock. Holders of the
Series A Preferred Stock are entitled to receive dividends payable in
preference and priority to any payment of dividends to holders of the Company's
common stock. The rights of the Series A Preferred Stock to such dividends are
cumulative and accrue to the Series A Preferred Stock holders at a rate per
annum equal to the rate of interest declared by U.S. Bank as its Reference Rate
plus 75 basis points (9.25% at December 31, 1999), but never less than 8% per
annum. Unpaid accumulated dividends are payable by the Company upon a
conversion of Series A Preferred Stock to common stock, provided, however, that
a cash dividend is payable only if the Company has paid all principal and
interest on any indebtedness secured by the Company's assets. Upon a
liquidation or dissolution of the Company, holders of Series A Preferred Stock
are entitled to receive an amount equal to $1.00 per share of 10 million Series
A Preferred Stock plus all accumulated dividends on the preferred shares before
any Company funds are available for distribution to holders of the Company's
common stock.

Stock Options
-------------
In March 1995, the Company established the 1995 Stock Incentive
Compensation Plan (the "Plan") that provided for the granting of incentive and
nonqualified options to purchase up to 286,844 shares of common stock. In
September 1996, the Company amended the Plan to increase the number of common
shares reserved for issuance under the Plan to 817,500 shares of common stock.
In May 1999, the Plan was again amended to decrease the number of common shares
reserved for issuance under the Plan to 539,317. Generally, options granted
under the Plan vest over a four-year period. Options have been granted at
prices equal to or greater than the estimated fair value on the date of grant
and expire after ten years. The Plan expires in 2005.

Pro forma information regarding net income and earnings per share is
required by Statement No. 123, and has been determined as if the Company had
accounted for its employee stock options under the fair value method of that
Statement. The fair value for these options was estimated at the date of grant
using a Black-Scholes multiple option pricing model with the following weighted
average assumptions for 1999, 1998, and 1997, respectively: risk-free interest
rates of 6.07%, 5.41%, and 5.71%, expected volatility range for the Company's
common stock of 3.64%, 2.02 and 29.6%, dividend yield of 0.0% and a weighted
average expected option life of 5 years. The Black-Scholes option valuation
model was developed for use in estimating the fair value of traded options
which have no vesting restrictions and are fully transferable. In addition,
option valuation models require the input of highly subjective assumptions
including the expected stock price volatility. Because the Company's employee
stock options have characteristics significantly different from those traded
options, and because changes in the subjective input assumptions can materially
affect the fair value estimate, in management's opinion, the existing models do
not necessarily provide a reliable single measure of the fair value of its
employee stock options and are not likely to be representative of the effects
on reported net income for future periods.

For purposes of pro forma disclosures, the estimated fair value of the
options is amortized to expense over the options' vesting period. The
Company's pro forma information follows:

<TABLE>
<CAPTION>
December 31,
-------------------------------------------
1999 1998 1997
----------- ------------- -------------
<S> <C> <C> <C> <C>
Reported net loss $(428,021) $(21,613,486) $(14,381,801)
Pro forma net loss $(437,621) $(22,156,766) $(14,800,010)
Reported loss per share $(0.05) $(2.77) $(1.94)
Pro forma loss per share $(0.06) $(2.83) $(1.99)
</TABLE>

The following table summarizes the activity under the Plan.

<TABLE>
<CAPTION>
Weighted
Average
Exercise
Options Option Price Price
Outstanding per Share Per Share
----------- -------------- ---------
<S> <C> <C> <C> <C>
Outstanding December 31, 1996 496,164 $3.48 - $16.00 $ 4.48
Granted 205,626 $7.13 - $ 9.38 $ 8.56
Cancelled (67,274) $3.48 - $16.00 $10.16
Exercised (18,183) $3.48 - $ 5.50 $ 3.75
---------
Outstanding December 31, 1997 616,333 $3.48 - $16.00 $ 5.05
Granted 236,500 $1.72 - $ 2.53 $ 2.30
Cancelled (498,427) $1.72 - $ 9.13 $ 4.88
---------
Outstanding December 31, 1998 354,406 $1.72 - $16.00 $ 3.46
Granted 380,000 $0.32 $ 0.32
Cancelled (300,673) $1.72 - $16.00 $ 3.18
---------
Outstanding December 31, 1999 433,733 $0.32 - $ 9.38 $ 0.90
=========
</TABLE>

The weighted average fair value of options granted using the Black-Sholes
multiple option pricing model is $0.32, $2.20 and $3.60 in 1999, 1998 and 1997,
respectively.

The following table summarizes information about stock options outstanding
under the Plan at December 31, 1999.

<TABLE>
<CAPTION>
Options Outstanding Options Exercisable
--------------------------------------------------- ------------------------
Exercise Price Number Weighted Weighted Number Weighted
Per Share Outstanding Average Average Exercisable Average
Remaining Exercise Exercise
Contractual Price Price
Life Per Share Per Share
-------------- ---------- ----------- --------- ------------ ---------
<S><C> <C> <C> <C> <C> <C>
$0.32 - $1.72 405,000 9.59 $0.11 405,000 $0.11
$5.50 - $8.00 11,641 6.43 $6.60 11,641 $6.60
$8.75 - $9.38 17,092 7.12 $8.83 17,092 $8.83
------- -------
$0.32 - $9.38 433,733 9.41 $0.90 433,733 $0.90
======= =======
</TABLE>

12. INVESTMENT IN THE KINDLING COMPANY
- ---------------------------------------

In May 1996, the Company formed Kindling, a majority-owned subsidiary, to
design, develop, manufacture and distribute sunglasses and ophthalmic frames
under the Timberland brand name. The Company contributed $1,200,000 for its
70% interest in Kindling. The Company was also required to contribute an
additional $300,000 to Kindling's capital if Kindling deemed such additional
amount necessary and made a demand prior to January 1, 2000. Included in the
Company's operations were Kindling's operating losses of approximately $579,000
and $477,000 for the periods ended September 1, 1998 and December 31, 1997,
respectively.

Effective September 1, 1998, Kindling sold substantially all of its assets
to Adventure Optics, LLC, a limited liability company majority owned by REM
Optical Company, Inc. and by The Timberland Company and Douglas W. Lauer. The
total purchase price for the assets was $1,008,000, payable in cash and the
assumption of certain liabilities. The Company received $358,000 of the
proceeds from the sale in partial payment of an intercompany loan from
Gargoyles to Kindling. As part of the sale transaction, the license agreement
with The Timberland Company was terminated. $255,000 of the proceeds from the
asset sale were paid to Timberland as a license termination fee. The Company
recorded a charge to earnings of $1,618,000 as a result of the sale of
Kindling's assets and the termination of the Timberland license agreement.

13. ACQUISITION OF SUNGOLD
- ---------------------------

On April 11, 1997, the Company purchased substantially all the assets and
assumed certain liabilities of Sungold Enterprises, LTD., a New York
corporation. Sungold Enterprises manufactured two principal lines of premium
sunglasses, Stussy EyeGear, a young men's fashion brand licensed to Sungold
Enterprises 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.
The initial purchase price of $11,700,000 was allocated to the purchased assets
based on the fair value of the assets acquired and liabilities assumed. Costs
in excess of the fair market value of assets acquired and liabilities assumed
are reflected as intangibles and include trademarks, tradenames, non-
competition agreements, license and distribution agreements and goodwill, which
were amortized over various periods not exceeding 25 years. The Sungold
purchase agreement called for additional purchase price earn-out payments by
the Company, described in the agreement as royalty payments, to the seller if
certain net sales and gross margin targets were achieved by the Sungold
businesses in each of the years ending December 31, 1997, 1998 and 1999. Such
royalty payments were to be made on the first day of April in the following
calendar year and were reflected as adjustments to the purchase price. The
Company paid a royalty payment of $600,000 in 1998 for 1997 operating results,
a royalty payment of $700,000 in May 1999 for 1998 operating results, and an
additional royalty payment in July 1999 of $600,000 against a stipulated amount
for 1999 operating results. No further payments are due under the terms of the
Sungold purchase agreement or royalty agreement.

Pro forma information, assuming the acquisition had occurred at the
beginning of the period presented, is as follows:

<TABLE>
<CAPTION>
Year ended
December 31, 1997
------------------
<S> <C> <C>
Sales $45,258,314
Gross profit 26,376,028
Net loss (13,823,188)
Net loss per share (1.86)
</TABLE>

14. ACQUISITION OF PRIVATE EYES
- --------------------------------

On May 14, 1997, the Company purchased substantially all the assets and
assumed certain liabilities of Private Eyes. Private Eyes was the licensee for
Ellen Tracy eyewear, which featured 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 was also the
North American distributor for Emmanuelle Khanh Paris Eyewear and a designer
and distributor of its own line of prescription frames and eyewear accessories.

The acquisition was accounted for using the purchase method of accounting.
The total purchase price of $8,000,000 was allocated to the purchased assets
based on the fair value of the assets acquired and liabilities assumed. Costs
in excess of the fair market value of assets acquired and liabilities assumed
were reflected as intangibles. Included in the agreement were contingent
payments due to the seller if certain net sales and gross margin targets were
achieved in each of the years ending December 31, 1997, 1998 and 1999. Such
contingent payments were to be made within 55 days following the calendar year.
Private Eyes did not achieve its goals under the contingent price agreement in
1997, 1998, or 1999.

Pro forma information, assuming the acquisition had occurred at the
beginning of the period presented, is as follows:

<TABLE>
<CAPTION>
Year ended
December 31, 1997
------------------
<S> <C> <C>
Sales $43,225,564
Gross profit 25,095,094
Net loss (14,275,353)
Net loss per share (1.92)
</TABLE>

The Company's Ellen Tracy Eyewear business was unable to support the
minimum royalty and advertising obligations under the Ellen Tracy license
agreement. On September 8, 1998, the Company and Ellen Tracy, Inc. mutually
agreed to terminate the license. As a result of the license termination, the
Company recorded a charge to earnings of $8.9 million consisting of:

<TABLE>
<S> <C> <C>
Write-down of identifiable intangibles - Ellen
Tracy license $1,040,000
Impairment of long-lived assets (goodwill) based
on the expected undiscounted cash flows of the
Private Eyes division without the Ellen Tracy
sales. Ellen Tracy product sales accounted for
84% and 75% of the total Private Eyes sales in
1997 and 1998. 7,164,000
Write-off of deferred marketing costs and estimated
sales returns and doubtful accounts associated
with the termination of the Ellen Tracy license 704,000
----------
$8,908,000
==========
</TABLE>

15. RELATED PARTY TRANSACTIONS
- -------------------------------

On July 24, 1997 the Company advanced funds to its then President and
Chief Executive Officer, Douglas B. Hauff, as evidenced by a promissory note
for $118,000, related to an indemnity obligation resulting from a dispute
between the Company and Adidas America, Inc. The note was secured by 15,000
shares of the Company's common stock and matured on July 25, 1998. As part of
a severance agreement between the Company and Mr. Hauff, the note was forgiven
and the outstanding principal balance as well as accrued interest thereon was
written off as of December 31,1997. The 15,000 shares of common stock of the
Company securing the transaction were transferred to the Company.

On April 9, 1997, the Company advanced funds to its then President and
Chief Executive Officer, Douglas B. Hauff, as evidenced by a promissory note in
favor of the Company in original principal amount of $531,299 plus interest at
the rate of 4.75% per annum, relating to an individual income tax payment
resulting from the exercise of a non-qualified stock option. During his
employment with the Company, the Company from time to time had advanced funds
to Mr. Hauff, as evidenced by a second promissory note dated March 11, 1998, in
favor of the Company in original principal amount of $56,307 together with
interest thereon at the rate of 5.75% per annum (the April 1997 note and the
February 1999 note being referred to herein as the "Hauff Notes"). The Hauff
Notes were due on February 15, 1999 and were fully reserved at December 31,
1998. Pursuant to an agreement dated February 2, 1999, Mr. Hauff paid the
Hauff Notes by (1) paying the Company cash in the amount of $185,000, (2)
waiving certain COBRA payments in the amount of $1,330, (3) assigning to the
Company a non-interest bearing promissory note from Trillium Corporation in the
amount of $95,000 payable August 14, 2000 (the "Assigned Note"), (4) executing
and delivering to the Company a new promissory note in original amount of
$32,500 plus interest at 8% per annum, with a maturity date of August 31, 2001
(the "New Hauff Note"), and (5) assuming certain obligations of the Company to
Ken Griffey, Jr. under a License Agreement dated October 30, 1995 between Mr.
Griffey and the Company which the Company valued at $200,000. The Company
reserved all but $10,000 of the Assigned Note and New Hauff Note at December
31, 1999.

In 1997 and during the first eight months of 1998, the Company provided
shipping and receiving, customer service, accounting, administrative support
and operations management to Kindling at no cost to Kindling.

The Company had $0, $600 and $62,227 due from employees at December 31,
1999, 1998 and 1997, respectively.

16. LOSS ON DISPOSITION OF ASSETS AND OTHER RELATED COSTS
- ----------------------------------------------------------

The Company recognized net expense of $11 million in the year ended
December 1998, related to the loss on disposition of assets and other related
costs including, (1) a non-cash charge of $8.9 million related to the write-
down of goodwill, certain intangible assets, deferred marketing costs and other
assets related to the termination of the Ellen Tracy License Agreement and
related Ellen Tracy Eyewear business, see Note 14, and (2) a charge to earnings
of $1.6 million resulting from the sale of the assets of Kindling and the
termination of the related Timberland license, see Note 12.

London Office
-------------
In late 1996 the Company opened a sales and marketing office in London to
manage its European sales efforts. The Company's London office was responsible
for approximately 2.9 percent and 2.2 percent of the Company's sales in 1997
and in 1998, respectively. A significant portion of the Company's European
sales were comprised of Timberland branded products. Costs associated with the
Company's European operations totaled $2.4 million and $1.1 million in 1997 and
1998, respectively. The Company closed its London office July 31, 1998. As a
result of the London office closing, the Company recorded a charge to earnings
of $476,000, consisting principally of the non-cash write-off of start-up costs
of $279,000, severance and other closing costs.

17. SEVERANCE, RELOCATION AND OTHER EXPENSES
- ---------------------------------------------

In 1999, the Company incurred severance expense of $173,000 related to the
termination of an employment agreement with the President of Sungold, $210,000
related to executive bonuses payable upon the restructuring and
recapitalization of the Company and $33,000 of miscellaneous expenses, which
were partially offset by miscellaneous income of $64,000. In 1998, the Company
recognized expenses associated with the relocation of its Kent, Washington and
Norwalk, Massachusetts facilities of $260,000 and established reserves against
certain notes receivable and guaranteed loans payable related to a former
subsidiary of $263,000. In 1998, the Company also incurred expenses related to
write-offs of obsolete production related costs and assets for discontinued
product lines of $289,000, write-offs of trade credits of $211,000, estimated
restructuring compensation and other related contingencies of $652,000, and
other expenses of $227,000, including termination costs associated with
endorsement contracts and other miscellaneous expenses. 1998 expenses were
partially offset by a gain of $405,000 related to certain notes receivable from
the Company's former president and CEO. 1997 expenses included estimated
lease obligations and other costs associated with the relocation of its Kent,
Washington and Norwalk, Massachusetts of $704,000, write-offs of leasehold
improvements associated with the relocated facilities of $201,000, write-offs
of obsolete production-related costs and assets for discontinued product lines
of $720,000, write-offs of trade credits of $729,000, estimated employee
severance payments and benefits of $350,000, and $611,000 to fully reserve
certain notes receivable from the Company's former president and CEO.

<PAGE>
<TABLE>
CONSOLIDATED VALUATION AND QUALIFYING ACCOUNTS
For the Years Ended December 31, 1997, 1998 and 1999
------------------------------------------------------
<CAPTION>
Balance at Charged to Recoveries Balance at
Beginning Costs and and End of
of Period Expense Deductions Period
---------- ----------- ------------ ------------
<S> <C> <C> <C> <C>
DOUBTFUL ACCOUNTS
- -----------------
For the year ended December 31, 1997
Allowance for doubtful accounts.................. $172,600 $1,075,560 $(427,657) $820,503
======== ========== ========== ========

For the year ended December 31, 1998
Allowance for doubtful accounts.................. $820,503 $2,807,390 $(2,706,977) $920,916
======== ========== ============ ========

For the year ended December 31, 1999
Allowance for doubtful accounts ................ $920,916 $46,995 $(613,758) $354,153
======== ======= ========== ========
OBSOLETE, SLOW-MOVING AND EXCESS INVENTORY
- ------------------------------------------
For the year ended December 31, 1997
Inventory Reserve............................... $381,150 $2,539,341 $(949,040) $1,971,451
======== ========== ========== ==========

For the year ended December 31, 1998
Inventory Reserve............................... $1,971,451 $405,657 $(1,796,337) $580,771
========== ======== ============ ========

For the year ended December 31, 1999
Inventory Reserve............................... $580,771 $723,784 $(437,736) $866,819
======== ======== ========== ========
SALES RETURNS
- -------------
For the year ended December 31, 1997
Sales Return Reserve............................ $416,723 $3,212,294 $(1,642,157) $1,986,860
======== ========== ============ ==========

For the year ended December 31, 1998
Sales Return Reserve............................ $1,986,860 $2,755,520 $(4,242,380) $500,000
========== ========== ============ ========

For the year ended December 31, 1999
Sales Return Reserve............................ $500,000 $1,262,838 $(1,503,527) $259,311
======== ========== ============ ========
</TABLE>

<PAGE>

ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURES
- --------------------------------------------------------------------------

None.

<PAGE>
PART III.
---------

ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
- ------------------------------------------------------------

The directors, executive officers, and key operations managers of the
Company, and their ages as of March 30, 2000, are as follows:

<TABLE>
<CAPTION>
Name Age Position
- ---- --- --------
<S> <C> <C>
Leo Rosenberger 49 Chairman of the Board of Directors, Chief
Executive Officer, Chief Financial
Officer and Treasurer
Cynthia L. Pope 48 Ex. Vice President, General Counsel and
Secretary
Scott Davidoff 41 Sr. Vice President Marketing and Product
Development
Nancy Parker 42 Sr. Vice President New Business
Development
Michael Schroeder 33 Vice President Sales
Craig Fels 28 Vice President East Coast Operations
Rick Rae 43 Vice President West Coast Operations
Daniel Regis (1) 60 Director
Paul S. Shipman (2) 47 Director
William Thompson (1) (2) 61 Director

- --------------------

(1) Member of the Audit Committee of the Board of Directors.

(2) Member of the Compensation Committee of the Board of Directors.
</TABLE>

The Company's Board of Directors is comprised of four directors and is
divided into three classes. Each director serves for a three-year term, and
one class will be elected each year by the Company's shareholders. Directors
hold office until their terms expire and their successors are elected and
qualified. Executive officers of the Company are appointed by, and serve at
the direction of, the Board of Directors. There are no family relationships
between any of the directors or executive officers of the Company.

LEO ROSENBERGER, Chief Executive Officer and Chief Financial Officer,
joined the Company in February 1998. From January 1996 to January 1998, Mr.
Rosenberger was President and Chief Financial Officer of Pacific Linen, Inc.
Pacific Linen, Inc. filed a voluntary petition for Chapter 11 bankruptcy in
April 1996 and emerged therefrom in December 1997. In May 1995, Mr.
Rosenberger was appointed by the court as the Chapter 7 Trustee in Bankruptcy
for Waterbed, Inc.. From August 1994 to February 1995, Mr. Rosenberger served
as interim Chief Financial Officer of Jay Jacobs, Inc., a company which filed a
voluntary petition for Chapter 11 bankruptcy protection in May 1994 and emerged
therefrom in November 1995. Mr. Rosenberger was a general partner in a
national accounting and consulting firm and has over twenty years experience as
a turnaround crisis manager and financial restructuring and management
consultant.

CYNTHIA L. POPE joined the Company in February 1998. From July 1995 until
joining the Company, Ms. Pope had a private law practice in Bellingham,
Washington and served as corporate counsel to the Company. From June 1992
until July 1996, Ms. Pope was a partner in the law firm of Brett & Daugert in
Bellingham, Washington. From June 1989 until June 1992, Ms. Pope was an
associate with the law firm of Bogle & Gates in Seattle, Washington. From
January 1985 until June 1989, Ms. Pope was an associate with the law firm of
Ross & Hardies in Chicago, Illinois.

SCOTT DAVIDOFF joined the Company in April 1997 with the acquisition of
Sungold and became Senior Vice President of Marketing and Product Development,
for Stussy, Anarchy and Angel brands in July 1999, and Sr. Vice President of
Marketing and Product Development for all brands in January 2000. Mr. Davidoff
joined Sungold in April 1993 serving as Vice President, Sales.

NANCY PARKER joined the Company in May 1998 and became Sr. Vice President
of New Business Development in January 2000. Ms. Parker served as Sr. Vice
President Marketing and Product Development from June 1999 to January 2000.
From January 1990 to December 1996 Ms. Parker was National Sales Manager for
Outlook Eyewear, a subsidiary of Bausch & Lomb.

MICHAEL SCHROEDER joined the Company in April 1997 with the acquisition of
Sungold. Mr. Schroeder joined Sungold in June 1996 and became Vice President,
Sales for the Company in July 1999. Prior to joining Sungold, Mr. Schroeder
was National Sales Manager for Optic Expression/Vita Frame, a large optical
distributor.

CRAIG FELS joined the Company in April 1997 with the acquisition of
Sungold. Mr. Fels joined Sungold in October 1995 and became Vice President,
East Coast Operations in July 1999. Prior to joining Sungold, Mr. Fels was a
Senior Associate with Coopers & Lybrand LLC.

RICK RAE joined the Company in March 1999 and became Vice President, West
Coast Operations in July 1999. From April 1997 to March 1999, Mr. Rae was the
Plant Manager for Tacoma Guitars, Co., a common carrier. From September 1995
through March 1997, Mr. Rae was the Owner of Rae Trucking, Inc. From February
1980 through August 1995, Mr. Rae served as Manufacturing Manager and then Vice
President of Manufacturing for GT Development Corp., a manufacturer of
electrical, hydraulic, and air system components for the heavy truck industry.

DANIEL C. REGIS is the Managing Director of Digital Partners which
provides investment consulting services to several venture capital funds. From
July 1996 to July 1999, Mr. Regis was President of Kirlan Venture Capital,
Inc., which also provided investment consulting services to venture capital
funds. From July to December 1999, Mr. Regis was a consultant to Kirlan
Venture Capital. Prior to joining Kirlan, Mr. Regis was the Managing Partner
of Price Waterhouse LLP for the Northwest Region.

PAUL S. SHIPMAN has been a Director of the Company since June 1996. Mr.
Shipman has been President since September 1981, Chairman of the Board since
November 1992 and Chief Executive Officer since June 1993 of Redhook Ale
Brewery, Incorporated ("Redhook"), a brewer of craft beers.

WILLIAM C. THOMPSON is the President of Worldwide Marketing Consultants.
From 1996 to 1998, Mr. Thompson was the Executive Vice President and Chief
Marketing Officer of Umbro International, a $600 million brand marketed through
a subsidiary/licensee network in 55 countries. From 1987 to 1995 Mr. Thompson
was Vice Chairman, and Chief Marketing Officer of J. Walter Thompson, a $6
billion international advertising agency.

Compliance with Section 16(a) of the Securities Exchange Act of 1934
--------------------------------------------------------------------
Section 16(a) of the 34 Act requires the Company's Directors and executive
officers, and persons who own more than 10% of a registered class of the
Company's securities, to file with the SEC initial reports of ownership and
reports of changes in ownership of Common Stock and other equity securities of
the Company. Officers, Directors, and greater-than-10% shareholders are
required by SEC regulation to furnish the Company with copies of all Section
16(a) forms they file.

To the best of the Company's knowledge, based solely on a review of the
copies of such reports furnished to the Company during the fiscal year ended
December 31, 1999, all Section 16(a) filing requirements applicable to its
officers, directors and greater-than-10% shareholders were complied with.

ITEM 11. EXECUTIVE COMPENSATION
- --------------------------------

Information regarding executive compensation is incorporated by reference
from the Company's 2000 Proxy Statement for its 2000 Annual Meeting of
Shareholders (the "2000 Proxy Statement") under the caption "Executive
Compensation".

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
- ------------------------------------------------------------------------

Information regarding security ownership of certain beneficial owners and
management is incorporated by reference from the 2000 Proxy Statement under the
caption "Beneficial Ownership of Shares".

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
- --------------------------------------------------------

Information regarding certain relationships and related transactions is
incorporated by reference from the 2000 Proxy Statement under the caption
"Certain Transactions".

PART IV.
--------

ITEM 14. EXHIBITS, FINANCIAL STATEMENTS AND REPORTS ON FORM 8-K
- ----------------------------------------------------------------

(a) Financial Statements and Financial Statement Schedules
------------------------------------------------------
See Index to Consolidated Financial Statements at Item 8 on Page 24
of this report.

(b) Reports on Form 8-K
-------------------
No reports on Form 8-K were filed by the Registrant during the
quarter ended December 31, 1999.

3.1(1) Form of Amended and Restated Articles of Incorporation of the
Registrant currently in effect.
3.2(1) Bylaws of the Registrant currently in effect.
4.1(6) Certificate of Designation of Rights and Preferences of Series A
Preferred Stock of Gargoyles, Inc.
10.1(1) Industrial Real Estate Lease (Single Tenant Facility), dated
December 16, 1993, between Gargoyles, Inc. and DB&D Partnership.
10.2(1) Lease Amendment, dated as of March 17, 1995, between Gargoyles,
Inc. and DB&D Partnership.
10.3(8) Second Amendment to Lease Agreement, dated as of February 24,
2000, between DB&D Partnership and Gargoyles, Inc.
10.4(1)+ Gargoyles, Inc. Common Stock Purchase Warrant, dated January
1996, between Gargoyles, Inc. and Wally Walker.
10.5(1)+ Form of Indemnity Agreement between Gargoyles, Inc. and each of
its directors.
10.6(1)+ 1995 Stock Incentive Compensation Plan.
10.7(1)* Ratification of Settlement Agreement and General Release, dated
April 12, 1995.
10.8(1)* Trademark License Agreement dated as of April 12, 1995.
10.9(1)* License Agreement, effective January 1, 1989, between Hobie
Designs, Inc. and H.S.I.
10.10(2)* Amended and Restated License Agreement dated April 10, 1997,
between Stussy, Inc. and Sungold Enterprises, Ltd.
10.11(2) License Agreement, dated as of June 30, 1997, between Neoptx,
Inc. and Gargoyles, Inc.
10.12(2)+ Employment Agreement, dated as of February 1, 1998, between
Gargoyles, Inc. and Leo Rosenberger.
10.13(8)+ Third Amendment to Employment Agreement of Leo Rosenberger, dated
February 1, 2000.
10.14(2) Lease Agreement, dated November 27, 1996, between Leonard Delalio
and Robert P. Delalio and Sungold Enterprises Limited.
10.15(5)* License Agreement dated October 23, 1998, by and between Dale
Barnhardt and Gargoyles, Inc.
10.16(5)* License Agreement dated October 23, 1998, by and between Dale
Earnhardt, Jr. and Gargoyles, Inc.
10.17(5) Agreement Regarding Hauff Notes dated February 2, 1999 by and
between Gargoyles, Inc. and Douglas B. Hauff.
10.18(3) Lease Agreement dated June 8, 1998, by and between South Valley
Associates, as Landlord, and Gargoyles, Inc., as Tenant.
10.19(4) License Agreement dated October 20, 1998, between Gargoyles, Inc.
and Aearo Company.
10.20(6) Second Amended and Restated Credit Agreement between U.S. Bank
National Association and Gargoyles, Inc.
10.21(8) First Amendment to Second Amended and Restated Credit Agreement
dated January 31, 2000 by and between U.S. Bank National
Association and Gargoyles, Inc.
10.22(6) Stock Purchase Agreement, dated May 28, 1999, by and Between
Gargoyles, Inc. and US. Bank National Association.
10.23(6) Registration Rights Agreement, dated May 28, 1999, by and between
Gargoyles, Inc. and U.S. Bank National Association.
10.24(7)* License Agreement, dated November 3, 1999, by and between
Wrangler Apparel Corp. and Gargoyles, Inc.
10.25(8)+ Employee Retention Agreement, dated February 1, 2000, by and
between Gargoyles, Inc. and Cynthia L. Pope.
10.26(8)+ Amendment to Employment Agreement and Release, dated January 21,
2000, by and between Donald J. Wanat and Gargoyles, Inc.
21.1(8) Subsidiaries of the registrant.
23.1(8) Consent of Ernst & Young LLP, Independent Accountants.
23.2(8) Consent of BDO Seidman, LLP, Independent Accountants
27.1(8) Financial Data Schedule.

- ---------------------------------
* Subject to Confidential Treatment
+ Executive Compensation Plan and Arrangements
(1) Incorporated by reference to the Company's Registration Statement on
Form S-1 (Registration No. 333-07573).
(2) Incorporated by reference to the Company's Annual Report on Form 10-K
for the Fiscal Year ended December 31, 1997.
(3) Incorporated by reference to the Company's Quarterly Report on Form 10-Q
for the Quarterly Period Ended June 30, 1998.
(4) Incorporated by reference to the Company's Quarterly Report on Form 10-Q
for the Quarterly Period Ended September 30, 1998.
(5) Incorporated by reference to the Company's Annual Report on Form 10-K for
the Fiscal Year ended December 31, 1998.
(6) Incorporated by reference to the Company's Report on Form 8-K filed
June 7, 1999.
(7) Incorporated by reference to the Company's Quarterly Report on Form 10-Q
for the Quarterly Period Ended September 30, 1999.
(8) Filed herewith.

<PAGE>
SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this Report to be signed
on its behalf by the undersigned, thereunto duly authorized, on the 30th day of
March, 2000.

GARGOYLES, INC.

/s/ LEO ROSENBERGER
By: ---------------------------
Leo Rosenberger
Chief Executive Officer and Chief Financial Officer

Pursuant to the requirements of the Securities Exchange Act of 1934, this
Report has been signed by the following persons on behalf of the Registrant and
in the capacities indicated below on the 30th day of March, 2000.

Signature Title
--------- -----

/s/ LEO ROSENBERGER Chairman of the Board of Directors, Chief
- -------------------------- Executive Officer and Chief Financial Officer
Leo Rosenberger (Principle Executive Officer)

/s/ CHERYL JORDAN Corporate Comptroller
- -------------------------- (Principle Accounting Officer)
Cheryl Jordan

/s/ DANIEL C. REGIS Director
- --------------------------
Daniel C. Regis

/s/ PAUL S. SHIPMAN Director
- --------------------------
Paul S. Shipman

/s/ WILLIAM C. THOMPSON Director
- --------------------------
William C. Thompson

EXHIBIT 10.3

SECOND AMENDMENT TO LEASE AGREEMENT

THIS SECOND AMENDMENT TO LEASE AGREEMENT (this "Amendment") is made as of
this 24th day of February, 2000 by and between DB&D PARTNERSHIP, a Washington
general partnership ("Landlord"), and GARGOYLES, INC., a Washington corporation
("Tenant").

RECITALS

A. Landlord and Tenant are parties to that certain Industrial Real
Estate Lease dated December 16, 1993, as amended by that certain Lease
Amendment dated March 17, 1995, for the premises located at 5866 S. 194th
Street, Kent, Washington 98032, containing approximately 25,841 square feet.
The Industrial Real Estate Lease as amended by the Lease Amendment shall be
referred to herein as the "Lease".

B. Subject to the terms and conditions set forth in this Amendment,
Landlord and Tenant desire to further amend the Lease to extend the term
thereof.

C. Capitalized terms used but not otherwise defined herein shall have
the meanings given them in the Lease.

AGREEMENT

NOW, THEREFORE, in consideration of the premises and the mutual agreements
of the parties set forth herein, the parties hereby agree as follows:

1. TERM. Section 1.05 of the Lease shall be amended as follows:

(a) EXTENSION OF TIME. The Lease Term shall be extended to March
31, 2002 (the "Expiration Date").

(b) TENANT'S OPTION FOR EARLY TERMINATION OF LEASE TERM. Tenant
shall have the option to terminate this Lease any time after August 1, 2001 by
giving Landlord at least four months' advance written notice of Tenant's desire
to exercise this early termination option. In consideration for the early
termination of this Lease, on the termination date Tenant shall pay Landlord a
termination fee equal to thirty percent (30%) of the Base Rent otherwise due
until the Expiration Date. For example: If Tenant desires to terminate the
Lease as of August 1, 2001, then Tenant shall give notice on or before April 1,
2001 of its exercise of this early termination clause and on July 31, 2001
shall pay Landlord a termination fee of $54,737 ($22,807 X 8 months X 30%).

2. RENT. Section 1.12 of the Lease shall be amended to provide that
Base Rent during the extended term of the Lease shall be as follows:

<TABLE>
<S> <C> <C>
April 1, 2000 through March 31, 2001 $21,903 per month; and
April 1, 2001 through March 31, 2002 $22,807 per month.
</TABLE>

3. WHOLE AGREEMENT; NO OTHER AMENDMENTS. This Amendment sets forth the
entire agreement between the parties with respect to the matters set forth
herein, and the Lease shall remain in full force and effect except as amended
by this Amendment.

IN WITNESS WHEREOF, the parties have executed this Second Amendment to
Lease Agreement as of the date first above written.

LANDLORD: TENANT:

DB&D PARTNERSHIP GARGOYLES, INC.

By: /s/ Dennis Burns By: /s/ Leo Rosenberger
------------------------ ---------------------------
Name Dennis Burns Leo Rosenberger, CEO and CFO
Its Partner

EXHIBIT 10.13

THIRD AMENDMENT TO EMPLOYMENT AGREEMENT
OF
LEO ROSENBERGER

THIS THIRD AMENDMENT TO EMPLOYMENT AGREEMENT (this "Amendment") is made as
of this First day of February, 2000 by and between GARGOYLES, INC., a
Washington corporation (the "Company"), and LEO ROSENBERGER ("Employee").

RECITALS

A. The Company and Employee are parties to that certain Employment
Agreement dated as of February 1, 1998, which was amended by those certain
Amendments to Employment Agreement dated March 31, and June 1, 1999 (the
"Employment Agreement"); and

B. The Company and Employee desire to further amend the Employment
Agreement in accordance with the terms hereof.

AGREEMENT

NOW, THEREFORE, in consideration of the premises and other good and
valuable consideration, the receipt and sufficiency of which are hereby
acknowledged, the parties hereto hereby agree as follows:

1. TERM. The Term of Employment set forth in Section 3 of the
Employment Agreement shall continue until the earlier of (i) the date upon
which Employee ceases to be the Chief Executive Officer of the Company, or (ii)
January 31, 2001; each of the dates described in (i) and (ii) being referred to
in the Employment Agreement as the "Expiration Date."

2. BASE SALARY. Employee's Base Salary set forth in Section 4 of the
Employment Agreement is hereby amended, and effective as of the date of this
Amendment, Employee's annual Base Salary shall be Two Hundred Ninety-Five
Thousand Dollars ($295,000).

3. DEFINITION OF CHANGE IN CONTROL. For purposes of this Amendment, a
Change in Control shall mean the earliest date upon which one of the following
occurs: (i) the sale or other disposition of all or substantially all of the
assets of the Company, except pursuant to a proceeding involving a foreclosure
and liquidation of the assets, (ii) the sale or other transfer of voting
securities representing a majority of the votes entitled to be cast for the
election of directors of the Company, (iii) the sale or other transfer of a
majority of the value of the equity of the Company, or (iv) a merger,
consolidation, reorganization or other similar transaction involving the
Company.

4. BONUS UPON A CHANGE IN CONTROL. Upon the occurrence of a Change in
Control which occurs on or before January 31, 2000, Employee shall have earned
a bonus of Two Hundred Ninety-Five Thousand Dollars ($295,000), payable upon
the date of the occurrence of the Change in Control.

5. SEVERANCE. If prior to January 31, 2001, Employee's employment with
the Company is terminated for any reason other than for cause or due to the
death or voluntary resignation of Employee, the Company shall pay Employee
severance in the amount of Two Hundred Ninety-Five Thousand Dollars ($295,000),
payable on the date of termination of Employee's employment with the Company.
If Employee has received the consideration set forth in Section 4 hereof due to
a Change in Control, then no severance shall be due and payable to Employee
under this Section 5.

6. NO OTHER AMENDMENTS. The terms and provisions of the Employment
Agreement are hereby ratified and confirmed and remain in full force and effect
except as amended by this Amendment.

IN WITNESS WHEREOF, the parties hereto have executed this Amendment to
Employment Agreement as of the date first above written.

GARGOYLES, INC.

/s/ Paul S. Shipman

By
--------------------------------------------
Paul S. Shipman, Member of the Board
of Directors of Gargoyles, Inc. and Chair of
the Compensation Committee of the Board

/s/ Leo Rosenberger
- --------------------
LEO ROSENBERGER

Exhibit 10.21

FIRST AMENDMENT TO SECOND AMENDED
AND RESTATED CREDIT

This first amendment to second amended and restated credit agreement
("Amendment") is made and entered into as of January 31, 2000, by and between
U.S. BANK NATIONAL ASSOCIATION ("U.S. Bank"), and GARGOYLES, INC., a Washington
corporation ("Borrower").

RECITALS:

A. On or about May 28, 1999, U.S. Bank and Borrower entered into that
certain second amended and restated credit agreement (together with all
amendments, supplements, exhibits, and modifications thereto, the "Credit
Agreement") whereby U.S. Bank agreed to extend certain credit facilities to
Borrower.

B. The purpose of this Amendment is to set forth the terms and
conditions upon which U.S. Bank will extend the expiry and maturity dates of
the Loans and modify the Financial Covenants.

NOW, THEREFORE, in consideration of the mutual covenants and conditions
set forth herein, the parties agree as follows:

ARTICLE I. AMENDMENT; DEFINITIONS
- ----------------------------------

1.1 AMENDMENT

The Credit Agreement and each of the other Loan Documents are hereby
amended as set forth herein. Except as specifically provided for herein, all
of the terms and conditions of the Credit Agreement and each of the other Loan
Documents shall remain in full force and effect throughout the terms of the
Loans, as well as any extensions or renewals thereof.

1.2 DEFINITIONS

As used herein, capitalized terms shall have the meanings given to them in
the Credit Agreement, except as otherwise defined herein, or as the context
otherwise requires.

ARTICLE II. MODIFICATION OF EXPIRY AND MATURITY DATES
- --------------------------------------------------------

2.1 REVOLVING LOAN AND LETTERS OF CREDIT

Section 2.1 of the Credit Agreement is hereby deleted in its entirety and
replaced with the following:

Subject to and upon the terms and conditions set forth herein and in
reliance upon the representations, warranties, and covenants of Borrower
contained herein or made pursuant hereto, U.S. Bank will make Fundings to
Borrower from time to time during the period ending January 31, 2001
("Commitment Period"), but such Fundings (together with any outstanding
Letters of Credit) shall not exceed, in the aggregate principal amount at
any one time outstanding, $9,000,000 (the "Revolving Loan"). Borrower may
borrow, repay, and reborrow hereunder either the full amount of the
Revolving Loan or any lesser sum. The Commitment Period shall be extended
for one 1-year period, provided that (a) there exist no Events of Default
as of January 31, 2001, (b) U.S. Bank and Borrower agree on financial
covenants for each extension period at least 30 days prior to the
expiration of the Commitment Period, and (c) the terms of such an
extension are confirmed by an amendment to this Agreement in a form
acceptable to U.S. Bank and Borrower.

2.2 AMENDMENT OF NOTE

The Revolving Note is hereby amended to reflect that the maturity date of
the Revolving Loan has been modified to January 31, 2001.

ARTICLE III. MODIFICATION OF FINANCIAL COVENANTS
- --------------------------------------------------

3.1 WORKING CAPITAL

Section 9.15 of the Credit Agreement is hereby deleted in its entirety and
replaced with the following:

Permit Working Capital to be less than the following as of the
last day of the applicable month:

<TABLE>
<CAPTION>
MONTH MINIMUM WORKING CAPITAL
-------------- -----------------------
<S> <C> <C>
January 2000 $1,000,00
February 2000 $1,700,000
March 2000 $2,200,000
April 2000 $2,700,000
May 2000 $3,000,000
June 2000 $3,500,000
July 2000 $3,600,000
August 2000 $3,600,000
September 2000 $3,300,000
October 2000 $2,700,000
November 2000 $2,700,000
December 2000 $1,900,000
</TABLE>

3.2 DEBT SERVICE COVERAGE RATIO

Section 9.16 of the Credit Agreement is hereby deleted in its entirety and
replaced with the following:

Permit the Debt Service Coverage Ratio to be less than the
following, calculated on a year to date basis as of the last
day of each month:

<TABLE>
<CAPTION>
MONTH DEBT SERVICE COVERAGE
-------------- ---------------------
<S> <C> <C>
January 2000 1.9:1.0
February 2000 2.6:1.0
March 2000 2.6:1.0
April 2000 2.6:1.0
May 2000 2.5:1.0
June 2000 2.5:1.0
July 2000 2.4:1.0
August 2000 2.2:1.0
September 2000 1.9:1.0
October 2000 1.6:1.0
November 2000 1.6:1.0
December 2000 1.3:1.0
</TABLE>

ARTICLE IV. CONDITIONS PRECEDENT
- ---------------------------------

The modifications set forth in this Amendment shall not be effective
unless and until the following conditions have been fulfilled to U.S. Bank's
satisfaction:

(a) U.S. Bank shall have received this Amendment, duly executed and
delivered by Borrower, H.S.C., Inc., Sungold Eyewear, Inc. and Private Eyes
Sunglass Corporation.

(b) There shall not exist any Default or Event of Default.

(c) All representations and warranties of Borrower contained in the
Credit Agreement or otherwise made in writing in connection therewith or
herewith shall be true and correct and in all material respects have the same
effect as though such representations and warranties had been made on and as of
the date of this Amendment.

(d) U.S. Bank shall have received a certified resolution of the board of
directors of Borrower and each of the undersigned guarantors in a form
acceptable to U.S. Bank.

ARTICLE V. GENERAL PROVISIONS
- ------------------------------

5.1 REPRESENTATIONS AND WARRANTIES

Borrower hereby represents and warrants to U.S. Bank that as of the date
of this Amendment and after having given effect to any waivers and
modifications to definitions set forth in this Amendment, there exists no
Default or Event of Default. All representations and warranties of Borrower
contained in the Credit Agreement and the Loan Documents, or otherwise made in
writing in connection therewith, are true and correct as of the date of this
Amendment. Borrower acknowledges and agrees that all of Borrower's
Indebtedness to U.S. Bank is payable without offset, defense, or counterclaim.

5.2 SECURITY

All Loan Documents evidencing U.S. Bank's security interest in the
Collateral shall remain in full force and effect, and shall continue to secure,
without change in priority, the payment and performance of the Loans, as
amended herein, and any other Indebtedness owing from Borrower to U.S. Bank.

5.3 GUARANTIES

The parties hereto agree that the Guaranties shall remain in full force
and effect and continue to guarantee the repayment of the Loans to U.S. Bank as
set forth in such Guaranties.

5.4 PAYMENT OF EXPENSES

Borrower shall pay on demand all costs and expenses of U.S. Bank incurred
in connection with the preparation, negotiation, execution, and delivery of
this Amendment and the exhibits hereto, including, without limitation,
attorneys' fees incurred by U.S. Bank.

5.5 SURVIVAL OF CREDIT AGREEMENT

The terms and conditions of the Credit Agreement and each of the other
Loan Documents shall survive until all of Borrower's obligations under the
Credit Agreement have been satisfied in full.

5.6 RELEASE OF CLAIMS

IN CONSIDERATION FOR U.S. BANK'S AGREEMENT TO ENTER INTO THIS AMENDMENT,
BORROWER, H.S.C., INC., SUNGOLD EYEWEAR, INC., AND PRIVATE EYES SUNGLASS
CORPORATION EACH HEREBY RELEASES AND FOREVER DISCHARGES U.S. BANK, ITS
PREDECESSORS AND SUCCESSORS-IN-INTEREST, AND THEIR RESPECTIVE DIRECTORS,
OFFICERS, EMPLOYEES, REPRESENTATIVES AND AGENTS FROM ANY AND ALL CLAIMS,
DEMANDS, DAMAGES, LIABILITIES, CHARGES, ACTIONS, LOSSES, CAUSES OF ACTION,
COSTS, EXPENSES, COMPENSATION, AND SUITS OF ANY KIND, PAST, PRESENT OR FUTURE,
ARISING FROM OR ALLEGED TO ARISE FROM THEIR BUSINESS RELATIONSHIP, INCLUDING
THE RELATIONSHIP PROVIDED FOR IN THE CREDIT AGREEMENT THROUGH THE DATE OF THIS
AMENDMENT, WHETHER KNOWN OR UNKNOWN. THIS RELEASE IS INTENDED TO BE COMPLETE
AND COMPREHENSIVE WITH RESPECT TO ALL SUCH CLAIMS. THIS RELEASE OF CLAIMS HAS
BEEN COMPLETELY READ AND FULLY UNDERSTOOD AND VOLUNTARILY ACCEPTED FOR THE
PURPOSE OF MAKING A FULL AND FINAL COMPROMISE AND SETTLEMENT WITH RESPECT TO
ALL CLAIMS, DISPUTED OR OTHERWISE.

5.7 COUNTERPARTS

This Amendment may be executed in one or more counterparts, each of which
shall constitute an original agreement, but all of which together shall
constitute one and the same agreement.

5.8 STATUTORY NOTICE

ORAL AGREEMENTS OR ORAL COMMITMENTS TO LOAN MONEY, EXTEND CREDIT, OR TO
FORBEAR FROM ENFORCING REPAYMENT OF A DEBT ARE NOT ENFORCEABLE UNDER WASHINGTON
LAW.

IN WITNESS WHEREOF, U.S. Bank and Borrower have caused this Amendment to
be duly executed by their respective duly authorized signatories as of the date
first above written.

GARGOYLES, INC., a Washington corporation

/s/ Leo Rosenberger

By:
--------------------------------
Title: CEO and CFO

U.S. BANK NATIONAL ASSOCIATION

/s/ David C. Larsen

By:
--------------------------------
David C. Larsen, Vice President

Each of the undersigned Guarantors hereby (i) reaffirms its Guaranty and
its Security Agreement, (ii) agrees that its Guaranty guarantees the repayment
of the Loans, as amended herein, (iii) agrees that its respective Security
Agreement and related collateral documents secures the payment and performance
of the Secured Obligations described in such Security Agreement, (iv)
acknowledges that its obligations pursuant to its Guaranty and Security
Agreement are enforceable without defense, offset, or counterclaim, and (v)
agrees to the release of claims set forth in Section 5.6 of this Amendment.

H.S.C., Inc., a Washington corporation

/s/ Leo Rosenberger

By:
--------------------------------
Title: CEO and CFO

SUNGOLD EYEWEAR, INC., a Washington
corporation

/s/ Leo Rosenberger

By:
--------------------------------
Title: CEO and CFO

PRIVATE EYES SUNGLASS CORPORATION,
a Washington corporation

/s/ Leo Rosenberger

By:
--------------------------------
Title: CEO and CFO

EXHIBIT 10.25

EMPLOYEE RETENTION AGREEMENT

THIS EMPLOYEE RETENTION AGREEMENT (this "Agreement") is made as of this
First day of February, 2000, by and between GARGOYLES, INC., a Washington
corporation (the "Company"), and CYNTHIA L. POPE ("Employee").

RECITAL

The Company desires to retain the services of Employee to assist in the
continued restructure and growth of the Company and to provide for severance in
the event of a change in control of the Company, and Employee is willing to
assist in such efforts.

AGREEMENT

NOW, THEREFORE, in consideration of the premises, the parties hereto
hereby agree as follows:

1. CHANGE IN CONTROL. For purposes of this Agreement, a Change in
Control shall mean the earliest date upon which one of the following occurs:
(i) the sale or other disposition of all or substantially all of the assets of
the Company, except pursuant to a proceeding involving a foreclosure and
liquidation of the assets, (ii) the sale or other transfer of voting securities
representing a majority of the votes entitled to be cast for the election of
directors of the Company, (iii) the sale or other transfer of a majority of the
value of the equity of the Company, or (iv) a merger, consolidation,
reorganization or other similar transaction involving the Company.

2. BONUS UPON A CHANGE IN CONTROL. Upon the occurrence of a Change in
Control which occurs on or before January 31, 2001, Employee shall have earned
a bonus of One Hundred Sixty-Five Thousand Dollars ($165,000), payable upon the
date of the occurrence of the Change in Control.

3. SEVERANCE. If prior to January 31, 2001, Employee's employment with
the Company is terminated for any reason other than for cause or due to the
death or voluntary resignation of Employee, the Company shall pay Employee
severance in the amount of One Hundred Sixty-Five Thousand Dollars ($165,000)
payable on the date of termination of Employee's employment with the Company.
If Employee has received the consideration set forth in Section 2 hereof due to
a Change in Control, then no severance shall be due and payable to Employee
under this Section 3.

IN WITNESS WHEREOF, the parties hereto have executed this Employee
Retention Agreement as of the date set forth above.

GARGOYLES, INC.

/s/ Leo Rosenberger
- ------------------------------
Leo Rosenberger, CEO and CFO

/s/ Cynthia L. Pope
- ------------------------------
CYNTHIA L. POPE

EXHIBIT 10.26

AMENDMENT TO EMPLOYMENT AGREEMENT
AND RELEASE

THIS AMENDMENT TO EMPLOYMENT AGREEMENT AND RELEASE (this "Amendment") is
dated as of the 21st day of January 2000 by and between DONALD J. WANAT
("Employee"), and GARGOYLES, INC., a Washington corporation (the "Company").

RECITALS

A. Employee and the Company are parties to that certain Employment
Agreement dated as of June 14, 1999 (the "Employment Agreement").

B. Subject to the terms and conditions set forth herein, the parties
desire to terminate the Employment Agreement and to resolve all matters related
thereto.

C. Capitalized terms used but not otherwise defined herein shall have
the meanings set forth in the Employment Agreement.

AGREEMENT

1. TERMINATION OF EMPLOYMENT AGREEMENT. Subject to the terms and
conditions of this Amendment, the parties have agreed to terminate the
Employment Agreement as of January 21, 2000 (the "Termination Date").

2. SEVERANCE BENEFITS.

(a) AMENDMENT TO SECTION 6.5. Section 6.5 of the Employment
Agreement shall be amended to provide that the $200,000 severance payment (the
"Severance Payment") to be made to Employee upon termination of the Employment
Agreement shall be paid in four equal installments of $50,000 on each the date
of this Amendment, February 22, March 22, and April 21 in the year 2000. If
Employer fails to pay an installment of the Severance Payment on the date
specified, then the Company's obligation to pay the Severance Payment shall be
accelerated, and the entire balance of the Severance Payment shall be due and
payable to Employee.

(b) EXPENSE REIMBURSEMENT. Employee will be reimbursed for any
reasonable expenses incurred by Employee prior to the Termination Date on
behalf of the Company, subject to the receipt by the Company of all supporting
documentation. Employee understands that after the Termination Date Employee is
no longer authorized to incur expenses or to make commitments on behalf of the
Company.

(c) FTO. Employee understands that he will accrue no further
Flexible Time Off from and after the Termination Date. On the Termination
Date, Employee will be paid for any earned but unused Flexible Time Off
benefits, less all required and authorized deductions.

(d) COBRA; LIFE AND DISABILITY INSURANCE. In accordance with
Section 6.5 of the Employment Agreement, for a period of twelve (12) months
after the Termination Date or until Employee is covered under another Employer-
sponsored medical plan, the Company will reimburse Employee for such portion of
Employee's COBRA benefits equal to the contribution amount the Company would
otherwise have paid towards Employee's medical and dental coverages under the
Company's group medical and dental benefits plans if Employee had been employed
by the Company during such twelve-month period. After that time, Employee may
elect to pay for COBRA medical and dental plan continuation coverage for
another six months, until Employee is entitled to Medicare, or until Employee
is covered under other plans with no pre-existing exclusion. The insurance
provider will provide Employee with further information about his COBRA rights
after the Termination Date.

It is the understanding of the Company that the Company can maintain Employee's
life and disability coverage for the next twelve months through Fortis Benefits
Insurance Company, the provider of the Company's Group Life and Long-term
Disability coverage, so long as Employee completes the Extended Employee
Enrollment form to be provided by Fortis. The Company will continue Employee's
life and disability coverage through Fortis on condition that Employee
completes such forms and satisfies any conditions precedent for Employee's
continued coverage.

(e) ELIGIBILITY FOR UNEMPLOYMENT. Employee understands that while
the Company has no authority to determine unemployment benefits, the Company
will not attempt to interfere or deny such benefits if and when they should
become available to Employee.

3. STOCK OPTIONS. As of the Termination Date, Employee is vested in
17,500 options to purchase the Company's common stock, at an exercise price of
$0.32 per share. Employee understands that he will not continue to vest in any
more options, that his rights to unvested options shall immediately terminate,
and that the vested options will continue to be governed by the Gargoyles, Inc.
1995 Stock Incentive Compensation Plan, as Amended and Restated on July 22,
1996 (the "Plan"). Under the terms of the Plan, Employee's right to exercise
the vested options shall terminate on April 21, 2000.

4. COMPLETE RELEASE OF CLAIMS. By signing this Agreement, the Company
and Employee agree not to start any lawsuits, charges, or other legal action
against the other relating to Employee's employment with the Company or the
benefits that Employee received or should have received from the Company
(except with respect to a breach of the Company's obligations under this
Amendment or the Employee's obligations under Section 7 through 9 of the
Employment Agreement, which are not released by this Section 4). In addition,
the Company and Employee, for itself and himself and for each of their
respective heirs, representatives, executors, and successors or assigns, waives
any rights or claims each may have against the other, any employee benefit
plans sponsored by the Company in which Employee participated, and any of the
Company's or Employee's affiliated and related entities, owners, shareholders,
officers, directors, trustees, agents, spouses. employees, employees' spouses,
insurers, either past or present, and all of their successors, agents or
assigns (collectively "Releasees"). The Company and Employee each hereby
releases the Releasees from any and all claims, actions, causes of action,
obligations, costs, expenses, damages, losses, debts, and demands, including
attorneys' fees and costs actually incurred (collectively "Claims") of whatever
kind, in law or in equity, known or unknown, suspected or unsuspected, which
arose prior to the Termination Date.

This release includes, but is not limited to: (i) any Claims under any
local, state or federal laws regulating employment, including without
limitation, the Civil Rights Acts, the Age Discrimination and Employment Act,
the Americans with Disabilities Act, the Workers' Adjustment and Retraining
Notification Act, and the Washington State Law Against Discrimination; (ii)
Claims under the Employee Retirement Income Security Act; (iii) Claims under
any local, state or federal wage and hour laws; or (iv) Claims alleging any
legal restriction on the Company's right to terminate their employees, or
personal injury claims, including without limitation wrongful termination,
discrimination, harassment, breach of contract, defamation, tortuous
interference with business expectancy, black listing, or infliction of
emotional distress, whether arising under statute or common law.

5. CONTINUATION OF CONFIDENTIALITY PROVISIONS. Employee understands
that as of the Termination Date the Term of the Employment Agreement is
terminated and Employee has no further obligations to the Company under the
Employment Agreement, or otherwise, except for the terms set forth in Sections
7 through 9 of the Employment Agreement relating to "Intellectual Property;
Nondisclosure of Confidential Information; Covenant Not to Compete, Dispute
Resolution, and Enforcement", which shall remain in effect following the
Termination Date in accordance with their terms.

6. CONSULTATION WITH LEGAL COUNSEL. Employee has carefully read all of
the provisions of this Amendment, and further acknowledges that the Company has
encouraged Employee to review and discuss all aspects of this Amendment with
legal counsel and that he has taken advantage of that opportunity to the full
extent that he deemed appropriate.

7. CONSIDERATION PERIOD; REVOCATION PERIOD. Employee acknowledges that
he has been given 21 days to consider this Amendment, and that he was given the
option to sign the Amendment in fewer than twenty-one (21) days if he so
desired. Employee understands that this Amendment will not be effective for
seven (7) days after it is signed by the Company and Employee, and that
Employee may revoke this Amendment at any time during that seven-day period.
Employee acknowledges, however, that any severance payments made to Employee in
accordance with this Amendment prior to any revocation must be repaid to the
Company in full as a condition to any such revocation becoming effective.

8. VOLUNTARY AGREEMENT. Employee understands and acknowledges the
significance and consequences of this Amendment, that it is voluntary, that it
has not been given as a result of any coercion, and expressly confirms that it
is to be given full force and effect according to all of its terms, including
those relating to unknown Claims.

9. SUCCESSORS. This Amendment shall be binding upon the parties hereto
and their heirs, representatives, executors, administrators, successors and
assigns, and shall inure to the benefit of each and all of the Releasees, and
to their heirs, representatives, executors, administrators, successors and
assigns.

IN WITNESS WHEREOF, the parties hereto have executed this Agreement as of
the date first above written.

ARGOYLES, INC.,
a Washington corporation

By /s/ Leo Rosenberger
--------------------------------
Leo Rosenberger, CEO and CFO

/s/ Donald J. Wanat
- ------------------------------------
DONALD J. WANAT

Exhibit 10.21

FIRST AMENDMENT TO SECOND AMENDED
AND RESTATED CREDIT

RECITALS:

B. The purpose of this Amendment is to set forth the terms and
conditions upon which U.S. Bank will extend the expiry and maturity dates of
the Loans and modify the Financial Covenants.

NOW, THEREFORE, in consideration of the mutual covenants and conditions
set forth herein, the parties agree as follows:

ARTICLE I. AMENDMENT; DEFINITIONS
- ----------------------------------

1.1 AMENDMENT

1.2 DEFINITIONS

As used herein, capitalized terms shall have the meanings given to them in
the Credit Agreement, except as otherwise defined herein, or as the context
otherwise requires.

ARTICLE II. MODIFICATION OF EXPIRY AND MATURITY DATES
- --------------------------------------------------------

2.1 REVOLVING LOAN AND LETTERS OF CREDIT

Section 2.1 of the Credit Agreement is hereby deleted in its entirety and
replaced with the following:

2.2 AMENDMENT OF NOTE

The Revolving Note is hereby amended to reflect that the maturity date of
the Revolving Loan has been modified to January 31, 2001.

ARTICLE III. MODIFICATION OF FINANCIAL COVENANTS
- --------------------------------------------------

3.1 WORKING CAPITAL

Section 9.15 of the Credit Agreement is hereby deleted in its entirety and
replaced with the following:

Permit Working Capital to be less than the following as of the
last day of the applicable month:

3.2 DEBT SERVICE COVERAGE RATIO

Section 9.16 of the Credit Agreement is hereby deleted in its entirety and
replaced with the following:

Permit the Debt Service Coverage Ratio to be less than the
following, calculated on a year to date basis as of the last
day of each month:

ARTICLE IV. CONDITIONS PRECEDENT
- ---------------------------------

The modifications set forth in this Amendment shall not be effective
unless and until the following conditions have been fulfilled to U.S. Bank's
satisfaction:

(a) U.S. Bank shall have received this Amendment, duly executed and
delivered by Borrower, H.S.C., Inc., Sungold Eyewear, Inc. and Private Eyes
Sunglass Corporation.

(b) There shall not exist any Default or Event of Default.

(d) U.S. Bank shall have received a certified resolution of the board of
directors of Borrower and each of the undersigned guarantors in a form
acceptable to U.S. Bank.

ARTICLE V. GENERAL PROVISIONS
- ------------------------------

5.1 REPRESENTATIONS AND WARRANTIES

5.2 SECURITY

5.3 GUARANTIES

The parties hereto agree that the Guaranties shall remain in full force
and effect and continue to guarantee the repayment of the Loans to U.S. Bank as
set forth in such Guaranties.

5.4 PAYMENT OF EXPENSES

5.5 SURVIVAL OF CREDIT AGREEMENT

The terms and conditions of the Credit Agreement and each of the other
Loan Documents shall survive until all of Borrower's obligations under the
Credit Agreement have been satisfied in full.

5.6 RELEASE OF CLAIMS

5.7 COUNTERPARTS

This Amendment may be executed in one or more counterparts, each of which
shall constitute an original agreement, but all of which together shall
constitute one and the same agreement.

5.8 STATUTORY NOTICE

ORAL AGREEMENTS OR ORAL COMMITMENTS TO LOAN MONEY, EXTEND CREDIT, OR TO
FORBEAR FROM ENFORCING REPAYMENT OF A DEBT ARE NOT ENFORCEABLE UNDER WASHINGTON
LAW.

IN WITNESS WHEREOF, U.S. Bank and Borrower have caused this Amendment to
be duly executed by their respective duly authorized signatories as of the date
first above written.

GARGOYLES, INC., a Washington corporation

/s/ Leo Rosenberger

By:
--------------------------------
Title: CEO and CFO

U.S. BANK NATIONAL ASSOCIATION

/s/ David C. Larsen

By:
--------------------------------
David C. Larsen, Vice President

H.S.C., Inc., a Washington corporation

/s/ Leo Rosenberger

By:
--------------------------------
Title: CEO and CFO

SUNGOLD EYEWEAR, INC., a Washington
corporation

/s/ Leo Rosenberger

By:
--------------------------------
Title: CEO and CFO

PRIVATE EYES SUNGLASS CORPORATION,
a Washington corporation

/s/ Leo Rosenberger

By:
--------------------------------
Title: CEO and CFO

<PAGE>
Exhibit 23.1

Consent of Ernst & Young LLP, Independent Auditors

We consent to the incorporation by reference in the Registration Statement
(Form S-8 No. 333-1663) pertaining to the 1995 Stock Incentive Compensation
Plan of Gargoyles, Inc. of our report dated April 2, 1998 with respect to the
consolidated financial statements and schedule for the year ended December 31,
1997 included in the Annual Report on Form 10-K for the year ended December 31,
1999.

Seattle, Washington
March 30, 2000

<PAGE>

EXHIBIT 23.2

CONSENT OF BDO SEIDMAN, LLP, INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS

We consent to the incorporation by reference in the Registration Statement
(Form S-8, No. 333-16633) pertaining to the Gargoyles, Inc. 1995 Stock
Incentive Compensation Plan of our report dated March 14, 2000, with respect to
the consolidated financial statements and schedule of Gargoyles, Inc. included
in the Annual Report (Form 10-K) for the year ended December 31, 1999.

BDO Seidman, LLP
Seattle, Washington
March 30, 2000

<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
CONSOLIDATED BALANCE SHEETS AND CONSOLIDATED STATEMENTS OF OPERATIONS FOUND ON
PAGES 24 AND 25 OF THE COMPANY'S FORM 10-K FOR THE YEAR ENDED DECEMBER 31, 1999,
AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>

<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-START> JAN-01-1999
<PERIOD-END> DEC-31-1999
<CASH> 161,472
<SECURITIES> 0
<RECEIVABLES> 4,115,670
<ALLOWANCES> (354,153)
<INVENTORY> 8,342,717
<CURRENT-ASSETS> 13,805,315
<PP&E> 3,929,252
<DEPRECIATION> (2,845,201)
<TOTAL-ASSETS> 28,212,565
<CURRENT-LIABILITIES> 7,598,840
<BONDS> 0
0
9,810,000
<COMMON> 26,529,282
<OTHER-SE> (41,163,502)
<TOTAL-LIABILITY-AND-EQUITY> 28,212,565
<SALES> 33,338,118
<TOTAL-REVENUES> 33,771,888
<CGS> 14,095,516
<TOTAL-COSTS> 19,599,551
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 46,995
<INTEREST-EXPENSE> 2,644,148
<INCOME-PRETAX> 76,821
<INCOME-TAX> 0
<INCOME-CONTINUING> 76,821
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 76,821
<EPS-BASIC> (.05)
<EPS-DILUTED> (.05)

</TABLE>