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                    U.S. SECURITIES AND EXCHANGE COMMISSION
                              WASHINGTON, DC 20549
 
                            ------------------------
 
                                  FORM 10-KSB
 
(MARK ONE)
 
[X] ANNUAL REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
    1934
                  FOR THE FISCAL YEAR ENDED DECEMBER 31, 1997
 
[ ] TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
    OF 1934
          FOR THE TRANSITION PERIOD FROM ____________ TO ____________
 
                        COMMISSION FILE NUMBER: 1-14078
 
                            BLUE FISH CLOTHING, INC.
       (EXACT NAME OF SMALL BUSINESS ISSUER AS SPECIFIED IN ITS CHARTER)
 
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                 PENNSYLVANIA                                    22-2781253
       (STATE OR OTHER JURISDICTION OF                        (I.R.S. EMPLOYER
        INCORPORATION OR ORGANIZATION)                      IDENTIFICATION NO.)
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                NO. 3 SIXTH STREET, FRENCHTOWN, NEW JERSEY 08825
                    (ADDRESS OF PRINCIPAL EXECUTIVE OFFICES)
 
                                 (908) 996-3844
                (ISSUER'S TELEPHONE NUMBER, INCLUDING AREA CODE)
 
                                      N/A
   (FORMER NAME, FORMER ADDRESS AND FORMER FISCAL YEAR, IF CHANGED SINCE LAST
                                    REPORT)
 
         SECURITIES REGISTERED UNDER SECTION 12(b) OF THE EXCHANGE ACT:
 
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<S>                                            <C>
             TITLE OF EACH CLASS                 NAME OF EACH EXCHANGE ON WHICH REGISTERED
   COMMON STOCK, $.001 PAR VALUE PER SHARE                 CHICAGO STOCK EXCHANGE
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     Check whether the issuer: (1) filed all reports required to be filed by
Section 13 or 15(d) of the Exchange Act during the past 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 [ ]
 
     Check if there is no disclosure of delinquent filers in response to Item
405 of Regulation S-B in this form, and no disclosure will 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-KSB or any amendment to
this Form 10-KSB.  [ ]
 
     Issuer's revenues for the fiscal year ended December 31, 1997, were
$13,838,058. The aggregate market value of the voting stock held by
non-affiliates computed by reference to the price at which the stock was sold,
or the average bid and asked prices of such stock, as of April 14, 1998, was
$1,618,400.
 
     As of April 14, 1998, 4,599,200 shares of Common Stock, $.001 par value per
share, were issued and outstanding.
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                                     PART I
 
ITEM 1.  DESCRIPTION OF BUSINESS
 
THE COMPANY
 
     Blue Fish Clothing, Inc. (the "Company") is a designer, manufacturer,
wholesaler and retailer of hand block-printed women's and children's clothing
and accessories for the home. Each piece or garment that the Company sells is
unique in that it is based upon individual artwork applied by brush and
block-print, artist signature and embellishment. The Company's mission, to
inspire creativity and self-expression, is reflected in its products, its
workplace, its selling environments and its community involvement. The Company
markets its products through its wholesale division, as well as its five
Company-owned retail stores and participation in juried arts and craft fairs and
festivals across the United States.
 
COMPANY BACKGROUND
 
     The Company was founded in 1985 by Jennifer Paige Barclay, who, prior to
founding the Company and at the age of 17, began block-printing cotton T-shirts
and dresses in her parents' garage, which she then sold at craft shows and
festivals. In 1986, Blue Fish participated in a New York wholesale show and
received over $100,000 in orders. In March 1987, the Company leased its first
production facility in Frenchtown, New Jersey, and was incorporated in the state
of New Jersey ("Blue Fish-NJ"). In June 1987, the first Blue Fish retail store
was opened in a renovated stone mill in Frenchtown, New Jersey. A second store
followed in June 1989, in Taos, New Mexico, and Blue Fish Taos, Inc. ("Blue
Fish-NM") was incorporated in New Mexico in May 1989. In the Spring of 1988,
Nordstrom became the Company's first major retailer added as a wholesale
account. By 1994, Blue Fish clothing was showcased in the Savvy department in 52
Nordstrom stores across the United States. The Company expanded its product
offerings by introducing a line of sweaters in September 1993, and by
experimenting with different fabrications. In Spring 1994, the Company
introduced a line of children's clothing, and in Spring 1995 it offered its
first home furnishing products, tablecloths and pillows, through its own retail
stores. In December 1994, the Company opened its third retail store in Santa Fe,
New Mexico. The Company opened a wholesale showroom in New York City in February
1996, and opened its fourth retail store in Austin, Texas in September 1996. In
December 1996, the Company signed a lease for a retail store in New York City,
which opened in late March 1997. In January 1997, the Company closed its Taos,
New Mexico store. In May 1997, the Company signed a lease for a retail store in
Westport, Connecticut, which opened in late October 1997.
 
     In September 1995, Blue Fish-NJ, Blue Fish-NM and Blue Fish Clothing, Inc.,
a Pennsylvania corporation incorporated on September 6, 1995 (the "Company"),
entered into a Plan of Merger, pursuant to which the Company was the surviving
corporation.
 
     The Company incurred losses in 1996 and 1997, experienced a reduction in
net sales in the first quarter of 1998 as compared to the first quarter of 1997
and expects to report a loss in the first quarter of 1998. The Company's
existing financing structure is not deemed adequate to support the projected
1998 cash flow needs. As a result, in their report on the Company's financial
statements for the year ended December 31, 1997, the Company's independent
public accountants have included an explanatory paragraph raising substantial
doubt about the Company's ability to continue as a going concern. See
"Management's Discussion and Analysis or Plan of Operation -- Liquidity and
Capital Resources" for management's plans to address these issues. No assurance
can be given that management's actions will be successful.
 
PUBLIC OFFERING
 
     On November 13, 1995, the Company's Registration Statement on Form SB-2 for
800,000 shares of its Common stock was declared effective by the Securities and
Exchange Commission and the Company commenced a public offering of its Common
Stock. The Offering was made directly by the Company on a best-efforts basis at
a price of $5.00 per share for a minimum of 500,000 shares ($2,500,000) (the
"Minimum") and a maximum of 800,000 shares ($4,000,000). The Minimum was raised
as of May 13, 1996, the public offering closed as of May 15, 1996, and 787,200
shares were issued, generating cash of
 
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approximately $3,215,000, net of transaction costs of $721,000, of which
approximately $247,000 was expended in 1995.
 
COMPANY VALUES AND PHILOSOPHY
 
     The Company's goal in its artisan crafted products and through its business
is to encourage people to believe in themselves and to inspire creativity and
self-expression (the "Blue Fish Concept"). The Company seeks to build long-term
relationships with its employees, suppliers, customers, stockholders, community
and environment. The Company has created its own educational outreach program,
called Bluefishgarten(TM), which brings the talents of Blue Fish employees to
art workshops at schools, camps and community organizations.
 
     The Company also strives to be a leader among businesses in addressing
social and environmental concerns. The Company's major impact on the environment
is through its material usage. The Company outsources its dyeing to U.S.
contractors that use energy-efficient dyeing processes and water based, non-
metallic, non-toxic fabric paints. The Company does not use any sizings or acid
washing treatments, which contain formaldehyde and are frequently used
throughout the industry. The Company uses only organic cotton for all of its
jersey garments. In addition, the Company has an aggressive recycling program.
The Company's commitment to social responsibility is evidenced by its support of
community organizations through sponsorships, product donations and donations of
a percentage of certain product proceeds, as well as considerable time and
effort. The Company contributed $19,472 and $21,236 in cash, resources and
products to various organizations during 1996 and 1997, respectively, as well as
donating designs and participating in local events, such as environmental
cleanups. In future years, the Company intends to donate up to 10% of its net
income as determined at the discretion of the Board of Directors.
 
PRODUCTS
 
     The Company designs, hand block-prints and distributes clothing and
accessories for the home. Each product is individually hand block-printed with
evocative designs and symbols and signed by the artist. Many products are
embellished with the distinctive Blue Fish label carrying a poetic message or
graphic design. The clothes are designed to be worn in a variety of ways
befitting the wearer. The Company seeks to produce clothing that is beautiful,
easy to wear, comfortable and practical, and that reflects the lifestyle and
spirit of the wearer and appeals to all age groups.
 
     The Company currently has a women's line, and offers approximately 2,500
stock keeping units (SKUs). In 1997, the women's line was offered for eight
seasons per year. The Company continually researches and develops new products,
which are introduced through its retail stores to test customers' reactions and
gauge the products' sell-through potential before offering them through the
wholesale business.
 
MESSENGER PROGRAM
 
     The Messenger Program, is the Company's direct sales team in the field.
Each member, called a Messenger, is responsible for growing wholesale accounts
in their territory and for relating the Company's philosophy, the Blue Fish
Concept. The Messengers provide personalized service by visiting the Company's
wholesale accounts and by providing merchandising support, which includes
helping with the display of its clothing, teaching the customers how to wear and
combine the clothing, and working with the accounts to provide support for local
communities. By servicing and growing its specialty store and boutique accounts,
the Company intends to reduce dependence on major retailers thereby reducing the
risk of lost revenue from account exodus or from forced price reductions.
 
     To date, the Company has five regional Messengers, who cover the Southwest,
Southeast, Mid-Atlantic, New England and Midwest regions of the United States.
The Company believes that the Messenger program encourages wholesale sales
growth due to the higher level of personal contact and attention being available
in a region, as well as having a Blue Fish employee explain the Blue Fish
Concept. The Messenger Program incurs a higher level of fixed costs than
commission-only sales representatives do; however, the Company believes that the
higher costs of the Messenger Program will be offset by proportionately higher
sales, although no
 
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assurance can be given that this will occur. The Company intends to expand the
Messenger Program to other regions of the United States.
 
OBJECTIVE AND GROWTH STRATEGY
 
     The Company's objective is to consistently offer products that inspire
creativity, self-expression and quality in terms of aesthetics. The Company
believes that this objective can be achieved by making and selling the highest
quality artisan-crafted clothing and related accessories. The Company defines
highest quality in terms of durability, craftsmanship and diversity. The
Company's growth strategy includes designing new product categories such as
men's clothing and home furnishings along with new clothing lines within
existing categories, such as a basics line, and a more ornate Blue Fish line.
Additionally, the Company plans to increase the number of its wholesale accounts
and open new retail stores. This expansion, the Company believes, will enable it
to reach out to more people by attracting new customers, providing jobs and
allowing the Company to expand its community outreach programs. The following
are the principal elements of the Company's growth strategy.
 
     WHOLESALE GROWTH STRATEGY.  The Company's wholesale growth strategy is to
increase the number of wholesale accounts through geographic expansion and by
reaching new market segments through product line extensions.
 
     - Geographic Expansion.  The Company plans to target new wholesale accounts
      that embrace the Company's philosophy of self-expression. The Company
      intends to increase the number of specialty and boutique clothing stores
      as well as major retailers that carry its products. With the Messenger
      Program, the Company intends to focus on developing sales to its specialty
      and boutique accounts across the country. The Messengers are expected to
      attend to smaller, regional markets and travel across their territories to
      attract new customers and grow existing accounts.
 
       In February 1996, the Company opened a showroom in New York City to
       reduce its presence at trade shows and markets in New York. The Company
       believed that a New York showroom would enable wholesale accounts to buy
       directly from the Company at their convenience in a more relaxed and
       unique Blue Fish environment. As a result, in 1997 the Company created a
       stability with current accounts that had not previously existed, enabled
       customer service and account relationships, and gave the Company the
       capability of attracting new wholesale customers.
 
     - Product Line Extensions.  The Company is expanding its use of new
       fabrications to appeal to a broader market with still keeping organic
       cotton jersey as its core group. In addition, to help accomplish its
       growth plans, the Company redefined the National Sales Manager's job
       description and filled this position in 1997. This position was promoted
       to VP of Wholesale Sales in 1997.
 
     RETAIL GROWTH STRATEGY.  Management's decision to build Blue Fish retail
stores was based upon the increased retail margins, the ability to offer a
greater selection by designing small lines exclusively for its retail stores and
the desire to foster increased customer interaction. The Company decided in late
1997 to concentrate on strengthening its existing stores and grow its catalog
business through the acquisition of mailing lists that fit into the Company's
demographics and psychographics. No new retail stores are planned for 1998. The
new retail stores opened in 1997 and previous years were intended to reflect a
lifestyle by offering a wide assortment of distinctive products in unique
shopping environments. Primary elements of the retail growth strategy included:
 
     - Retail Store Location.  The Company selected retail sites that naturally
       attracted large concentrations of its target customers. These are usually
       larger cosmopolitan cities and smaller cities or towns (such as state
       capitals, major university towns and destination locations) that have a
       strong arts, education and craft culture and attract a large number of
       tourists. The Company opened and entered into a lease agreement for three
       new retail stores since the public offering, an approximately 2,000
       selling sq. ft. Austin, Texas store in September 1996, an approximately
       3,000 selling square foot store in New York City in December 1996, and an
       approximately 2,000 selling square foot store in Westport, Connecticut.
 
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       Wherever possible, the Company intended to locate its stores in
       unconventional retail spaces and stand-alone structures.
 
     - Retail Store Environments.  The Company believes that it differentiates
       itself from other retailers by designing distinctive store environments
       and by employing local or regional artisans to assist in the buildout of
       each new store. By creatively using and re-using natural materials, such
       as wood, stone, metal and glass, finishes and existing architectural
       elements, the Company creates a shopping environment that it believes
       appeals to the senses and sensibilities of its customers. Each store is
       unique and a showpiece to local craftsmanship.
 
     - Merchandise Selection.  The Company intends to maintain and increase the
       emphasis on its own merchandise within its stores, as well as broaden its
       range of merchandise by offering a more basic, lower priced women's line,
       and a men's line along with "lifestyle" goods including home furnishings,
       gifts, and other related products. The Company has hired a Product
       Development/Merchandising Manager to design these goods in-house, and
       intends to produce the goods itself wherever economically viable.
 
     - Personal Shopping Service.  The Company provides a personal shopping
       service to customers across the United States who may not have access to
       Blue Fish clothing locally or who do not have the time to visit stores. A
       personal shopper, who gets to know and keeps a record of each customer's
       details (such as height, weight, coloring as well as print, color and
       style preferences), describes and discusses the store's selection with
       the customer over the phone. A personal shopper often spends 30-45
       minutes on the phone with a customer, helping her select garments and
       putting together outfits for her. Customers using this service are sent
       the Blue Fish catalog each major season. The Company intends to expand
       its personal shopping service, currently offered largely through its
       Frenchtown store, by purchasing mailing lists that fit into the Company's
       demographics and psychographics. The Company believes that by increasing
       the level of personalized service offered, the stores will increase their
       average sales per customer as well as move additional merchandise in
       slower months due to increased marketing efforts.
 
     PRODUCTION AND MANAGEMENT EXPANSION.  In order to achieve its objectives
and implement its wholesale and retail growth strategies, the Company
anticipates the need for a significant expansion of its production capacity and
management infrastructure support.
 
     - Move to a New Facility.  In December 1996, the Company entered into an
       agreement to lease and, as amended, to ultimately buy a corporate center
       and production facility. The commencement date is June 1998. The Company
       believes this will meet its space requirements for the foreseeable
       future. See "Description of Property."
 
     - Hire New Key Managers.  In 1996, the Company reorganized its
       infrastructure with the assistance of outside management consultants. In
       1997, the Company redefined the National Sales Manager's job description
       and filled this position in 1997. This position was promoted to VP of
       Wholesale Sales in 1997.
 
     - Invest in Information Systems.  The Company has invested and intends to
       continue to invest in computer hardware, software and training. The
       Company believes that its investment in computer information systems will
       improve its efficiency and decrease its costs by facilitating the
       monitoring of inventory, enabling more accurate sales forecasting,
       ensuring faster, more accurate order processing and refining production
       scheduling and work flows to ensure maximum efficiency and minimum waste.
 
     - Provide Greater Employee Benefits.  In order to continually improve its
       work environment and attract and retain high caliber employees, the
       Company intends to develop a child care center, a fitness center, and a
       workplace lunch program over time when it moves to its new facility. It
       also intends to emphasize continued employee training and development,
       through in-house training courses and workshops.
 
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COMPANY OPERATIONS
 
     DESIGN.  The Company's team of designers create 25 or more designs for each
of the eight seasons per year. Each season has a distinctive color palate and
unique set of prints, inspired by a certain topic or theme. Much of the
Company's inspiration comes from nature, the world around us, poetry, animals
and children. Management believes that the Company maintains freshness in its
product offerings by using different fabrics, such as recycled cotton, acetate
and silk, and by using vintage clothing, as well as having a distinctive
inspiration for each season. The in-house design team also creates home
accessory products, which are offered mainly through the Company's own stores.
 
     PRODUCTION.  The Company's production process is divided into two
production categories, external and internal. External production refers to all
sourcing from outside contractors and vendors. The Company uses different
cutting and sewing houses, depending on the fabrication and the quantities
involved. The Company piece-dyes its jersey fabric, which it believes improves
the quality of the garments produced while reducing cost and waste and favorably
reducing the inventory production cycle. The Company continues to garment-dye
its other fabrications due to the relatively small quantities involved. The
Company strives to maintain numerous vendor relationships in order to generate
the best pricing for materials and external labor. The Company believes that
this strategy will also decrease its reliance upon any one vendor. The cutting,
sewing and dyeing of all the Company's products are by U.S. contractors and
vendors that are currently located within a 100 mile radius of the Company's
facility.
 
     After the garments have been cut, sewn and dyed by outside production, they
are brought into the Company for internal production. The garments are then hand
printed with handcarved blocks and embellished at the Company's production
studio. Each garment is printed, signed by the artist and hung to dry. Most of
the garments are then embellished with the Blue Fish label, handmade clay or
antique buttons or ribbons, as appropriate, before going to the Company's
quality assurance department, where all of the Company's products are inspected.
Finally, the garments are sent to the shipping department to be packed and sent
through the various distribution channels to the customer.
 
     SALES AND DISTRIBUTION.  Blue Fish sells and distributes its products
through three channels:
 
     - Wholesale.  The Company currently sells to approximately 350 specialty
       stores and boutiques, as well as to major retailers such as Nordstrom and
       Neiman Marcus, which the Company believes place a high emphasis on
       personal attention and service. Thirteen West Coast states are covered by
       an independent sales representative based in Los Angeles. Blue Fish
       Messengers currently cover additional states located in five national
       regions, the Southwest, the Southeast, Mid-Atlantic, New England and the
       Midwest.
 
     - Retail.  The Company's first retail store opened in Frenchtown, New
       Jersey in 1987. Subsequent retail expansion involved the opening of a
       second store in Taos, New Mexico in 1989, a third in Santa Fe, New Mexico
       in December 1994, a fourth store in Austin, Texas in September, 1996, a
       fifth in New York City in March 1997 and a sixth in Westport, Connecticut
       in October 1997. The Company's Taos, New Mexico store closed its
       operations on January 31, 1997. Due to the proximity of the Santa Fe
       store (70 miles), sales revenues needed could not be maintained in both
       stores. The Santa Fe location was selected to be maintained because of
       its larger population base as well its larger size. The Company uses
       dynamic visual merchandising, striking store displays and a distinctive
       cross merchandising approach to present its products in a creative and
       inspirational context. Product displays and fixtures are continually
       updated in tandem with the stores' changing merchandise. The Company
       relies heavily on visual merchandising and community involvement, rather
       than traditional forms of advertising, to invite its customers to enter
       and explore its stores and buy its merchandise. Retail stores incorporate
       creative decor, fixtures and leasehold improvements. The Company's
       current policy is to lease retail sites. The Company believes that this
       allows adequate post-opening site evaluation without a long-term
       financial commitment.
 
     - Catalog.  A personal shopping service is provided by telephone, largely
       from the Frenchtown store, for customers to make purchases from the
       Company's catalog, which is mailed out each quarter to
 
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       individuals who request to be on the Company's mailing list. This
       business will begin to carry its own inventory in 1998. In addition, the
       Company intends to grow its catalog business by purchasing mailing lists
       that fit into the Company's demographics and psychographics.
 
     - Craft.  The Company attended 42 juried art and craft fairs and festivals
       and off price events across the United States in 1997. At juried arts and
       craft fairs, merchandiser participation is limited to those invited after
       evaluation of representative product offerings. The Company uses this
       sales vehicle as a means to explore and develop new markets, as well as
       to sell excess inventory. Past season goods are predominantly sold
       between wholesale and retail prices at craft fairs. The Company plans to
       continue using this outlet as a vehicle for public relations, increasing
       its exposure and name recognition, raising money for causes it supports,
       as well as for networking.
 
MARKETING
 
     The Company's strategy is to develop highly interactive relationships with
customers through a variety of means, including: (i) creating very distinctive
sales environments, which encourage customers to explore the creativity of the
Blue Fish Concept; and (ii) creating excitement about the clothes and
encouraging word-of-mouth advertising by creating educational and inspiring
events at the Company's retail stores and at its wholesale account stores,
attending arts and craft fairs, as well as supporting creative events and causes
through sponsorship or product donations. The Company's advertising expenditures
have been limited and have focused on the Company's own stores as well as
cooperative advertising around special events with major wholesale accounts, and
mailings for its arts and craft fairs and events.
 
     - Wholesale.  The Company's Messenger Program provides a high level of
       personalized service on a regional basis. Messengers visit the wholesale
       accounts, assist with the display of clothing, educate the customers on
       how to wear and combine the clothing and work with the accounts to
       provide support for local communities.
 
       By listening to the customers, Messengers provide valuable feedback to
       the Company in terms of design and sales forecasts and, because they are
       out in the field, they can act upon customers' ideas and suggestions
       promptly.
 
     - Retail Stores.  The Company's stores carry a range of related accessories
       and gifts, as well as other designers' merchandise that complement Blue
       Fish clothing. The Company regularly produces a color catalog which is
       mailed to all its retail customers on its mailing list to promote store
       visits and telephone sales. The stores hold frequent events to promote
       new merchandise and to create the spirit of inspiration and sharing, in
       order to make shopping at Blue Fish retail stores a unique experience.
 
     - Craft Fairs and Events.  The Company maintains an extensive mailing list
       with over 45,000 names and sends customers on this mailing list a
       postcard inviting them to the craft fairs or events in their region. At
       craft fairs, the Company hands out a listing of all the specialty stores
       and boutiques in the area that carry its clothing and encourages
       customers to buy current season goods. The Company also provides support
       or sponsorship for conferences, festivals and other events, many of which
       have a similar philosophical approach. In 1997, the Company's sponsorship
       included the Bioneers biodiversity conference, the Taos Film Festival,
       the American Comedy Awards, Citizen's Action, and the National Organic
       Farmers Association in New Jersey.
 
CUSTOMER BRAND LOYALTY
 
     The Company believes that it has a very high degree of customer brand
loyalty. Due to customer demand, the Company reintroduced its former tradition
of sewing its Blue Fish label on the outside of most of its garments in 1996.
Earlier Blue Fish garments, which had dates printed on them, are considered
collectors items by some of the Company's customers. The Company proactively
attempts to communicate directly with its customers and develop a rapport and a
personal relationship through special events at its own stores and through the
Messenger Program. Hang tags on the Company's clothing frequently encourage
interaction with
 
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its customers. The Company is continuing its customer contact through periodic
Company updates and highlights included in its seasonal catalog mailings.
 
     The Company distributes a newsletter to all of its wholesale accounts for
each major season. The newsletter communicates information about the Company,
its philosophy and products, the inspiration for the season, as well as news
from the field and from its customers. The Company has also sent out surveys and
questionnaires to measure customer needs and satisfaction, and to hear their
ideas and feedback.
 
MANAGEMENT INFORMATION SYSTEM
 
     From September 1994 through December 1995, the Company invested
approximately $150,000 to begin the establishment of a fully customized wide
area network, with remote dial-in capability. During 1996, the Company invested
approximately $700,000 from its initial public offering proceeds on the
continued expansion of its management information systems in hardware, software,
consulting, services and supplies. In 1996 the Company completed the
implementation of its retail point-of-sale system and merchandising system. This
system allows the Company to experience greater inventory control, higher retail
gross margins through better monitoring of inventory turn, and more efficient
customer check out. During 1996 the Company also completed the installation of a
Wide Area Network ("WAN") that connects the three primary production and
operational facilities in Frenchtown, New Jersey. The Company has already
experienced improved communications and productivity due to the WAN enabling the
use of messaging software and the sharing of files. Extensive training has and
will accompany each software/system installation.
 
     During 1997, the Company installed a new manufacturing/production software
system which allows the Company to obtain greater inventory control, improve
production management, improve capacity planning, obtain information more
easily, allow for Electronic Data Interchange ("EDI"), and utilize bar coding
and bar code scanners. A new patternmaking system was also installed which
allows the Company to send patterns electronically, develop an electronic/file
library of patterns, and improve pattern, marking, and grading efficiencies. The
Wide Area Network was extended to the Showroom facility in New York City, and
the sales force was equipped with computers allowing access to order status and
availability information while on the road.
 
     During 1998, the Company plans to complete the installation and integration
of numerous software systems. A new accounting package will be installed that
will allow the Company to report on and monitor the Company's financial position
more effectively, automate specific tasks, and improve efficiencies. The
software systems will be integrated, including but not limited to integration of
the accounting package to the existing retail point-of-sale system and the
manufacturing/production system; and integration of the manufacturing/production
system from the retail point-of-sale system to receive purchase orders directly.
The Company will also develop a World Wide Web site on the Internet, primarily
for communication with wholesale customers. By 1999, the Company plans to have a
fully integrated Company-wide computer network with Internet access. The Company
is currently in the process of evaluating its information technology
infrastructure for the Year 2000 compliance. The Company does not expect that
the cost to modify its information technology infrastructure to be Year 2000
compliant will be material to its financial condition or results of operations.
The Company does not anticipate any material disruption in its operations as a
result of any failure by the Company to be in compliance.
 
INVENTORY MANAGEMENT
 
     The Company's designs for its women's line are produced for eight seasons
per year, which limits production, sales and delivery times. The Company has
countered this problem by improving workflows, delivery schedules and by selling
at or above planned production for new seasons, which compensates for returns or
cancellations. Any garments that are unsold go to the Company's inventory
management center which tracks all past season merchandise and handles the sale
of frequently requested garments from wholesale customers, promotional garments,
garments sold at craft fairs, as well as garments sold to employees.
 
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     The Company completed implementation of a customized Point-of-Sale ("POS")
register and polling system in 1996 for its retail stores. The POS provides
register efficiencies, improves customer checkout and overnight polling, and
will become fully integrated with the Company's planned wholesale order entry,
accounting and inventory management systems. The POS system provides management
with accurate and timely information about inventory, pricing, costing,
markdowns, markups, transfers, damages, sales and perpetual inventory counts.
This system also allows items to be monitored by SKU, by location and by day,
and will enable a faster sales cycle to be achieved by transferring merchandise
from one location to another that is selling the item more quickly.
 
EMPLOYEES
 
     As of April 14, 1998, the Company employed 132 full-time and 23 part-time
employees. Approximately 61 of these employees were involved in production, 39
in sales and distribution, 9 in design and creative and 46 in general and
administrative. The Company employs temporary staff as the need arises. The
Company believes it generally has good relations with its employees. None of its
work force is unionized.
 
TRADEMARK AND SERVICE MARKS
 
     The Company is the owner of the trademark and service mark "Blue Fish(R),"
which expires in the year 2000, and the service mark BLUEFISHGARTEN(R), which
expires in 2006 and which is used for its educational outreach program.
Registered Trademarks and service marks expire ten years after issuance but are
renewable indefinitely if still in use at the time of renewal. In the opinion of
management, the Company's trademark and service marks are important to its
business due to their name recognition with the Company's customers.
Accordingly, the Company intends to maintain and preserve its trademark and
service marks and to vigorously protect them from infringement.
 
     The Company regards its trademarks, service marks, trade dress, trade
secrets and other intellectual property as critical to its success. This
intellectual property is protected by common law, as well as by registration and
contract. Nonetheless, given the large number of potentially copyrightable
expressions that the Company could seek to register in the United States and in
other countries, the Company has relied largely on its common law rights, rather
than registration. Merchandising design and artwork are crucial to the success
of Blue Fish, and the Company intends to take action to protect against
imitation of its products and to protect its copyrights as necessary.
 
COMPETITION
 
     The Company's clothing generally competes with other casual weekend wear or
sportswear apparel, in the better sportswear and bridge categories. The
specialty retail and wholesale apparel businesses are highly competitive. Retail
competitive factors include store location; merchandise breadth, quality, style,
and availability; level of customer service; and price. The Company's retail
stores compete against a wide variety of smaller independent specialty stores as
well as department stores and national specialty stores. The Company's wholesale
division competes with numerous companies. To date, the Company has identified
approximately 20 companies that produce clothing with a hand block-printed look,
and there may be others. These companies are generally offering lower-priced
garments, but the Company believes the quality of the printing, the colors used
and the design of the silhouettes are not directly comparable to those of the
Company. At the present time, the Company does not intend to take any legal
action against these particular companies since the Company believes that these
companies are too small to pose any threat to the Company's business, but may do
so in the future. By offering a dressier Blue Fish line with more ornate and
elaborate block-printing, as well as using only organic cotton for all its
jersey garments, the Company plans to further distinguish itself from its
competitors.
 
GOVERNMENT REGULATION
 
     The Company is subject to various federal, state and local environmental
laws and regulations that limit the discharge, storage and disposal of a variety
of substances. Operations of the Company are also governed by laws and
regulations relating to workplace safety and worker health, principally the
Occupational Safety and
 
                                        8
<PAGE>   10
 
Health Administration Act and regulations and applicable state laws and
regulations thereunder. The Company believes that it presently is in compliance
with these laws and regulations.
 
ITEM 2.  DESCRIPTION OF PROPERTY.
 
     The Company has a five-year lease expiring in June 1998 at an annual rent
of $69,413, for an approximately 18,000 sq. ft. facility located in Frenchtown,
New Jersey, which currently accommodates the Company's production,
administrative, accounting, and wholesale functions. The Company also leases a
second facility consisting of approximately 18,000 sq. ft. of additional
production and storage space also located in Frenchtown, New Jersey, for an
annual rental of $50,493, which expires in November 1998. The Company also
leased an 800 sq. ft. design studio located above the Company's Frenchtown
retail store for a monthly rental of $895 in 1997. The Company discontinued this
lease as of January 31, 1998. Effective January, 1, 1996, the Company entered
into a five-year lease to secure a wholesale showroom space in New York City,
New York at an annual rental of $58,800. The Company's five retail stores are
also leased at monthly rental rates ranging from $2,875 to $19,000, as set forth
below.
 
<TABLE>
<CAPTION>
                 LOCATION                    DATE OPENED      LEASE EXPIRES    NET SELLING SQ. FT.
                 --------                   --------------    -------------    -------------------
<S>                                         <C>               <C>              <C>
Frenchtown, NJ
  62 Trenton Avenue.......................  June 1987         April 2001              1,267
Santa Fe, NM
  220 Shelby Street.......................  December 1994     October 1999            1,725
                                                              3 options
                                                              3 years each
Austin, TX
  9901 Capital of Texas
  Hwy, North..............................  September 1996    August 2000             2,000
New York City, NY
  148 Greene Street.......................  March 1997        December 2006           3,000
Westport, CT
  56-58 Post Road East....................  October 1997      June 2007               2,000
</TABLE>
 
     The Frenchtown retail store and design studio are leased from David
Barclay, Jennifer Barclay's father. See "Certain Relationships and Related
Transactions."
 
     The Company believes that, in order to accommodate its growth plans, it
will have to move into additional space. In December 1996, the Company entered
into a lease agreement, for a 60,000 sq. ft. corporate headquarters and
production facility in Palmer Township, Pennsylvania, which was amended in May
1997 and December 1997. The lease commences in June 1998 at an annual rent of
approximately $267,000 during the first year, $275,000 during the second year,
with a three percent (3%) escalator per year thereafter, plus taxes and
operating expenses. The Company plans to consolidate its production and
administrative functions into this single facility. The lease agreement, as
amended, provides that the Company must purchase the leased premises plus
adjoining space and a building comprising a total of approximately 96,000 square
feet and 7.5 acres of land during the sixth year after the Company takes
possession of the leased premises for $3,800,000. Pursuant to the lease
agreement, as amended, the Company paid the lessor $200,000 in July, 1997, which
will be credited against the purchase price. This payment was funded by a
Pennsylvania Opportunity Grant awarded to the Company. The Company believes this
new facility will meet its space requirements for at least the next 10 years.
 
ITEM 3.  LEGAL PROCEEDINGS.
 
     The Company is not currently involved in any material litigation or legal
proceedings and is not aware of any material litigation or proceeding threatened
against it.
 
ITEM 4.  SUBMISSION OF MATTERS TO A VOTE OF SECURITY-HOLDERS.
 
     No matter was submitted to a vote of security holders during the fourth
quarter of the fiscal year ended December 31, 1997 through the solicitation of
proxies or otherwise.
                                        9
<PAGE>   11
 
                                    PART II
 
ITEM 5.  MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.
 
     The Company's Common Stock is currently traded on the Chicago Stock
Exchange under the symbol BLF. The following table sets forth the high and low
sales prices quoted on the Chicago Stock Exchange for the periods indicated.
 
<TABLE>
<CAPTION>
                                                             FISCAL YEAR ENDED
                                                             DECEMBER 31, 1997
                                                             -----------------
                                                             HIGH         LOW
                                                             -----        ----
<S>                                                          <C>          <C>
Quarter Ended March 31, 1997...............................  7 1/4        4 5/8
Quarter Ended June 30, 1997................................  5 1/4        3 3/4
Quarter Ended September 30, 1997...........................  5 3/4        3 3/8
Quarter Ended December 31, 1997............................  4 7/8        2 7/8
</TABLE>
 
<TABLE>
<CAPTION>
                                                             FISCAL YEAR ENDED
                                                             DECEMBER 31, 1996
                                                             -----------------
                                                             HIGH         LOW
                                                             -----        ----
<S>                                                          <C>          <C>
Quarter Ended June 30, 1996*...............................  10 1/8       5 1/2
Quarter Ended September 30, 1996...........................  7 7/8        6 1/2
Quarter Ended December 31, 1996............................  7 1/8        3 3/4
</TABLE>
 
---------------
* Covers the period from the May 15, 1996 closing of the Company's initial
  public offering through June 30, 1996.
 
     As of April 14, 1998, the Company had approximately 2,548 stockholders of
record. As of that date, the last sale price of the Company's Common Stock was
$2 per share.
 
     The Company's Subchapter S election was terminated upon the closing of the
Company's initial public offering on May 15, 1996. Although the Company paid
dividends and made a distribution while an S corporation, the Company intends to
retain any future earnings and pay no dividends for the foreseeable future.
 
ITEM 6.  MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION
 
OVERVIEW
 
     The Company is a designer, manufacturer, wholesaler and retailer of hand
block-printed women's and children's clothing and accessories for the home. Each
product is individually hand block printed with evocative designs and symbols
and is signed by the artist. The Company markets its products to approximately
350 specialty stores and boutiques, as well as to major retailers, such as
Nordstrom and Neiman Marcus, through five regional direct sales personnel known
as Messengers, and one independent sales representative. The Company has five
Company-owned retail stores in Frenchtown, New Jersey; Santa Fe, New Mexico; New
York, New York; Austin, Texas; and Westport, Connecticut and participates in
juried arts and crafts fairs and festivals across the United States.
 
     The Company incurred losses in 1996 and 1997, experienced a reduction in
net sales in the first quarter of 1998 as compared to the first quarter of 1997
and expects to report a loss in the first quarter of 1998. In addition, the
Company has committed to capital and lease obligations which require funding in
1998. The Company's existing financing structure is not deemed adequate to
support the projected 1998 cash flow needs. These factors, among others, raise
substantial doubt about the Company's ability to continue as a going concern for
a reasonable period of time. Management is currently seeking equity investments,
reorganizing its marketing function, refining its operating structure and has
begun negotiations for additional financing so that it can meets its obligations
and sustain operations. There can be no assurance, however, that Management's
efforts will ultimately be successful (See Note 1 to Financial Statements and
Notes thereto elsewhere in this Report).
 
                                       10
<PAGE>   12
 
RESULTS OF OPERATIONS
 
     The following table sets forth, as a percentage of net sales, certain items
included in the Company's Statements of Operations (see Financial Statements and
Notes thereto elsewhere in this Report) for the periods indicated:
 
<TABLE>
<CAPTION>
                                                               YEARS ENDED
                                                               DECEMBER 31,
                                                              --------------
                                                              1996     1997
                                                              -----    -----
<S>                                                           <C>      <C>
Statements of Operations Data:
  Sales.....................................................  100.0%   100.0%
  Cost of goods sold........................................   46.3     47.1
                                                              -----    -----
     Gross margin...........................................   53.7     52.9
  Operating expenses, net...................................   54.7     52.3
                                                              -----    -----
     Income (loss) from operations..........................   (1.0)      .6
  Interest expense, net.....................................    1.4      1.7
                                                              -----    -----
  Historical (loss) before pro forma income tax (benefit)...   (2.4)    (1.1)
  Income tax (benefit) expense -- proforma 1996*............   (0.7)     1.7
                                                              -----    -----
  Net loss -- proforma 1996*................................   (1.7)%   (2.8)%
                                                              =====    =====
</TABLE>
 
---------------
* The pro forma amounts are shown for 1996 and historical amounts for 1997.
 
YEAR ENDED DECEMBER 31, 1997 COMPARED TO YEAR ENDED DECEMBER 31, 1996
 
     Sales.  The Company's sales increased by $2.2 million or 19.2% to $13.8
million in 1997. The Company's wholesale sales increased by 16.1% from $7.5
million in 1996 to $8.8 million in 1997, its retail sales increased by 24.1%
from $3.2 million in 1996 to $4.0 million in 1997, and craft fair sales
increased by 27.8% from $857,000 in 1996 to $1,096,000 in 1997. The Company
attributes the wholesale sales increase during the 1997 period primarily to the
enthusiastic customer response to the Spring and Summer lines, which are
particularly strong selling seasons for the Company, a 40.1% increase in
department store business, and to increased boutique account business resulting
from improved relations with existing wholesale accounts and new business
generated through the Messenger Program. The retail sales increase was primarily
due to an increase in catalog sales of 42.9% and stores which opened in March
1997 and October 1997 generating sales during the 1997 period partially offset
by a same store sales decrease of 10.2%. The Company attributes the increase in
catalog business to successful marketing efforts and a shift of retail customers
into catalog sales. Same store sales decreased primarily due to the Company's
Early Fall and Fall line not being as well received as in prior seasons and a
shift of retail customers into catalog sales. As a result of closing the
Company's Taos, New Mexico retail location in January 1997, sales at this
location decreased $348,000 to $28,000 in the 1997 period. The increase in craft
fair sales was due to the continued sale of past season and slightly damaged
goods at special showplaces.
 
     Gross Margin.  The major components affecting gross margin are raw material
and production costs, wholesale and retail maintained margins and sales mix. The
Company's gross margin decreased, as a percentage of sales, by 0.8 percentage
points from 53.7% in 1996 to 52.9% in 1997. The Company attributes this decrease
to selling prior seasons inventory to a customer at below inventory cost, and
markdown allowances from a customer that did not exist in the 1996 period.
 
     Operating Expenses.  The Company's operating expenses increased by $885,000
or 13.9% from $6.4 million in the 1996 period to $7.2 million in the 1997 period
and decreased as a percentage of sales by 2.4 percentage points from 54.7% in
the 1996 period to 52.3% in the 1997 period. The increase in operating expenses
in the 1997 period was primarily due to the addition of management team members
and staff support and expenses of two new retail stores offset by a discontinued
store. These expenses which did not exist in the 1996 period accounted for 58.7%
of the total dollar increase from 1996 and 1997. Professional expenses also
 
                                       11
<PAGE>   13
 
increased. Operating expenses related to general and administrative functions
have increased throughout 1996 and 1997, providing capacity for future sales
growth. The decline as a percent of sales is primarily attributable to sales
increasing at a faster rate than expenses.
 
     Interest Expense, Net.  The Company's interest expense, net, increased by
$70,000 or 44.7% from $157,000 in the 1996 period to $227,000 in the 1997
period. Interest expense increased by $46,000 due to increased borrowings for
the Company's working capital needs, an increase in assigned wholesale credit
receivables as a result of increased wholesale sales, and an increase in
interest on capitalized leases. Interest income decreased by $24,000 as a result
of spending a portion of the Company's initial investment of approximately $3.9
million of cash raised from the initial public offering which was held in
interest bearing instruments in 1996.
 
     Net Loss.  The net loss before income taxes of $145,000 represents a
decrease of $130,000 or 47.4% reduction in net loss from 1996 to 1997. The
income tax benefit of $238,000 in 1996 includes a one time benefit of $174,000
due to reinstatement of deferred income taxes upon conversion of the Company to
a C corporation prior to the closing of the initial public offering. The income
tax expense in 1997 is due to an increase in the valuation allowance to adjust
deferred tax assets to their net realizable value. Net loss after tax of
$383,000 in 1997 increased $190,000 from a pro forma net loss after pro forma
income taxes of $193,000.
 
YEAR ENDED DECEMBER 31, 1996 COMPARED TO YEAR ENDED DECEMBER 31, 1995
 
     Sales.  The Company's sales increased by $2.0 million or 20.2% to $11.6
million in 1996. The Company's wholesale sales increased by 16.0% from $6.5
million in 1995 to $7.5 million in 1996, its retail sales increased by 22.6%
from $2.6 million in 1995 to $3.2 million in 1996, and craft fair sales
increased by 59.5% from $538,000 in 1995 to $857,000 in 1996. The Company
attributes the wholesale sales increase during the 1996 period primarily to an
increase in the number of wholesale accounts, and improved relations with
wholesale accounts through the Messenger Program. The increase in retail sales
is primarily attributed to same store sales increases of $384,000 or 14.7%, and
a store opened during 1996 generating sales of $207,000. The Company attributes
these increases to greater marketing efforts and repeat customer business. Same
store sales for the Taos retail store declined due to the close proximity of its
Santa Fe store, which is only 70 miles away. This was instrumental in the
Company's decision to close the Taos store in first quarter 1997. The increase
in craft fair sales was due to an increase in the number of fairs and festivals
the Company attended.
 
     Gross Margin.  The major components affecting gross margin are raw material
and production costs, wholesale and retail maintained margins and sales mix. The
Company's gross margin decreased, as a percentage of sales, by 2.2 percentage
points from 55.9% in 1995 to 53.7% in 1996. The Company attributes this decrease
to increased customer returns from specialty stores, higher markdowns at retail,
the planned closing of the Taos retail store resulting in markdown driven sales,
and an increase in sales of past season inventory yielding lower gross margins.
 
     Operating Expenses.  The Company's operating expenses increased by $1.8
million from $4.6 million in 1995 to $6.4 million in 1996. Operating expenses
increased as a percentage of sales, from 47.6% during 1995 to 54.7 in 1996. This
was a result of the Company growing its infrastructure with the proceeds of the
public offering. The increase in the Company's operating expenses was primarily
due to expenses of approximately $1,100,000 in connection with the addition of
corporate management team members and staff support, $114,000 increase in
marketing and public relation activities, $248,000 in connection with the New
York showroom and Austin retail store in 1996 and $121,000 relating to
consultant fees associated with the ongoing systems selection process. The
Company anticipates continued investment in the manufacturing, wholesale and
retail operations throughout 1997.
 
     Interest Expense, Net.  The Company's interest expense, net, decreased by
$10,000 from $167,000 in 1995 to $157,000 in 1996. Interest expense increased by
$76,000 primarily due to increased borrowings for the Company's working capital.
Interest income increased by $86,000 as a result of the Company investing cash
raised from the initial public offering in interest-bearing instruments.
 
                                       12
<PAGE>   14
 
     Net Income or Loss.  The net loss before income taxes of $275,000
represents a decrease of $914,000 or 143% in net income, which would have been
$639,000 in 1995 after removing the impact of the 1995 compensation charge
relating to a stock grant. The income tax benefit of $238,000 includes a one
time benefit of $174,000 due to reinstatement of deferred income taxes upon
conversion of the Company to a C corporation prior to the closing of the initial
public offering. Pro forma net loss after pro forma income taxes increased 19.4%
to $(193,000).
 
SEASONALITY AND QUARTERLY RESULTS
 
     The Company's sales are seasonal and therefore its operating results are
subject to seasonal fluctuations. Historically, wholesale sales have been
highest during the Company's third and early fourth quarter (July through
October) when it ships fall and winter merchandise in advance of the apparel
sector's peak holiday selling season. The Company's wholesale sales are the
lowest during January and February. The Company's highest levels of retail sales
have historically occurred during June through August and November through
December. Certain of the Company's retail stores are currently located in
tourist destinations and are therefore affected by each location's overall level
of tourism. Wholesale and retail sales generated during the aforementioned
periods have traditionally had a significant impact on the Company's results of
operations, and any decrease in sales for these periods or in the availability
of working capital needed in the months preceding these periods could have a
material adverse effect on the Company's results of operations. The Company's
continued growth tends to mask seasonal fluctuations.
 
     The Company's results of operations in one quarter are not necessarily
indicative of the results of operations that can be expected for any other
quarter or for the full year. The Company's results of operations may also
fluctuate from quarter to quarter as a result of the addition or loss of
wholesale accounts, the amount and timing of expenses incurred in connection
with the expansion and integration of new retail stores into the operations of
the Company, as well as other factors.
 
LIQUIDITY AND CAPITAL RESOURCES
 
     Since its inception, the Company has financed its operations through bank
lines of credit, factoring agreements, bank notes and capital lease financing.
In May 1996, the Company completed an initial public offering which generated
approximately $3.2 million in proceeds in 1996, net of expenses. At December 31,
1997, the Company had $467,000 in cash and cash equivalents (of which $116,000
was restricted), a $500,000 certificate of deposit, a receivable purchase line
of credit for up to $1,500,000 (with a $1,161,000 outstanding balance), a demand
bank line of credit for up to $500,000 (with a $500,000 outstanding balance)
with borrowing limits subject to 50% of finished goods and 25% of work in
progress inventory levels, an $800,000 note payable to a bank (with an $800,000
outstanding balance) which requires a $300,000 certificate of deposit as
security and a $345,000 loan from a shareholder. The Company had working capital
of $2.2 million on December 31, 1997, reflecting a decrease in working capital
of $700,000 from $2.9 million on December 31, 1996. Working capital is defined
as current assets less current liabilities.
 
     On September 11, 1995 the Company's then sole stockholder Ms. Barclay
requested a distribution of $450,000 of the taxed but undistributed S
corporation earnings. Ms. Barclay received this distribution on January 2, 1996.
Ms. Barclay loaned these funds back to the Company on an unsecured basis. The
Company issued her a promissory note in the principal amount of $450,000 and
bearing interest of 7% per annum, payable monthly. At December 31, 1997,
$345,000 was outstanding. The principal amount of the note will be payable upon
demand by Ms. Barclay, subject to the following limitations upon repayment: (i)
the maximum amount of principal that the Company is required to pay in any
3-month period is $50,000 and in any 12-month period is $100,000; (ii) the
Company is not required to make any repayments of principal when its current
assets to current liabilities ratio as set forth in its latest quarterly balance
sheet is below 1.0, excluding liabilities related to amounts due pursuant to the
note; and (iii) no repayment of principal will be paid in the event that a
disinterested majority of the Company's Board of Directors determines that it is
not advisable to make a repayment of principal based upon the Company's then
current cash flow or liquidity needs. Although the restrictions imposed on
repayment were designed to protect the Company from experiencing liquidity
 
                                       13
<PAGE>   15
 
problems, no assurance can be given that a demand for repayment by Ms. Barclay
will not result in a shortage of cash available to the Company for operations.
See "Certain Relationships and Related Transactions."
 
     Net cash used in operations was $284,000 during 1997, consisting primarily
of a net loss of $383,000 and an increase in accounts receivable of $701,000
partially offset by depreciation and amortization of $429,000 and deferred tax
expense of $238,000. Net cash used by operating activities during the same
period for 1996 was $1.2 million, consisting primarily of a net loss before
deferred tax benefit, an increase in inventories of $979,000 for store stock
levels and planned 1997 wholesale shipments, and a decrease in accrued
bonus-stock grant of $403,000 partially offset by a decrease in accounts
receivable of $293,000.
 
     Net cash used in investing activities in 1996 and 1997 was $425,000 and
$2,192,000, respectively. Net cash used in investing activities in 1997
consisted primarily of capital expenditures to purchase property and equipment,
including construction and buildout of the Company's New York retail store which
opened in March, 1997, and the Company's Westport, Connecticut retail store
which opened in October, 1997, the implementation of new software, ongoing
implementation of the Company's Management Information System, and the purchase
of $800,000 in certificates of deposits. A certificate of deposit of $300,000 is
restricted as collateral on the $800,000 note payable to the bank. The remaining
$500,000 was used to maintain a minimum deposit with the bank. The majority of
the 1996 expenditures consisted of the buildout of the wholesale showroom in New
York and Austin retail store.
 
     Net cash provided by financing activities in the 1997 period was
$1,014,000, consisting primarily of an increase in the Company's receivable
purchase line of credit of $757,000, a $200,000 economic development grant and
additional net borrowings on debt of $101,000. Net cash provided by financing
activities in 1996 was $3.3 million, consisting primarily of net cash proceeds
received from the public offering of $3.5 million in 1996, an increase on
borrowings on the Company's line of credit of $500,000, and $450,000 of
borrowings from a majority shareholder. This funding was offset in part by
equity distributions of $556,000 to pay stockholder taxes and distribute S
corporation earnings.
 
     On June 25 and June 27, 1997, the Company refinanced its existing debt and
increased its borrowings. On June 25, 1997, the Company entered into a Business
Loan Agreement with a bank and received a promissory note in the amount of
$800,000. This note is subject to monthly interest payments beginning July 25,
1997, with interest calculated on the unpaid principal balances at an interest
rate of two percentage points over the Index. The Index represents the bank's
one year certificate of deposit yield. Four principal payments of $50,000 are to
be paid in annual installments commencing June 25, 1998 through June 25, 2001,
and one principal payment of $600,000 is to be paid on June 25, 2002. This note
was initially secured by an $842,000 certificate of deposit and guaranteed by
Jennifer Barclay, a principal shareholder. On September 30, 1997, this Agreement
was modified and the bank reduced its security interest in the certificate of
deposit to $300,000. In addition, the Company agreed to maintain a minimum
deposit account with the bank in an amount not less than $500,000. At December
31, 1997, $800,000 was outstanding on this note and the interest rate was 7.9%.
 
     As of June 27, 1997, the Company had an outstanding line of credit of
$1,000,000 subject to a maximum outstanding amount not to exceed 50% of finished
goods inventory plus 25% of work in process. On that date, the Company modified
this Note and Security Agreement and paid $500,000, thereby reducing the
outstanding principal balance due to $500,000 and extended the term through
April 1998. The Security Agreement shall continue to be a first lien on the
Collateral and shall secure the Note as extended. This line of credit bears
interest at the bank's prime interest rate plus 0.75% payable on demand or
monthly. At December 31, 1997, outstanding borrowings under the line of credit
were $500,000, and the interest rate was 9.25%. The line of credit is subject to
a maximum outstanding balance not to exceed 50% of finished goods inventory plus
25% of work in process. In March 1998, the line was increased to $1,000,000
subject to borrowing limits based on inventory and extended the line to April
1999. As of April 14, 1998, the Company had borrowed $950,000 under the line.
The Company also has a receivable purchase line of credit agreement, which
provides for the assignment and processing of Company receivables with recourse
to a maximum outstanding assigned amount of $1,500,000 for a term of one year.
The Company assigns 100% of its wholesale credit sales. The Company can borrow
up to 90% of these assigned receivables, with the remaining 10% held in reserve
in the event of customer payment default. The receivable purchase line of credit
bears interest at 1.5% as a discount to all receivables assigned, and the
Company is responsible for reimbursing the bank for all uncollectible accounts.
Interest expense under this agreement was $117,000 and $131,000 during 1996 and
 
                                       14
<PAGE>   16
 
1997, respectively. Both the line of credit and the receivable purchase line of
credit are secured by a stockholder guarantee and have a first lien on all
accounts receivable, inventory, equipment, fixtures and deposit accounts. In
March 1998, the receivable purchase line of credit was renewed and extended
through March 1999, however, this line can be terminated by either party upon
notice, as defined.
 
     Borrowings under this agreement, the line of credit, and the note payable
to a bank contain cross-default and cross-collateralization provisions.
 
     The Company has three other notes payable to banks with outstanding
balances of $34,000 on December 31, 1997 and mature October 1998 through
November 2000. As of December 31, 1997, the Company has $99,000 outstanding in
capital lease obligations for various pieces of equipment. Four leases expire in
1998, and two leases expire in 1999.
 
     The Company repurchased 2,048,696 shares of the Company's Common Stock in
1993. These shares were held in Treasury by the Company (the "Treasury Stock").
Pursuant to a Security Agreement, the Treasury Stock, together with all accounts
receivable, inventories, work-in-progress, bank accounts, trademarks, choses in
action, leasehold interests, and fixed assets now or hereafter acquired, served
as collateral to secure the Company's obligations under certain promissory
notes. The Company satisfied all of its obligations pursuant to the Agreement
and promissory notes on April 5, 1997. On April 20, 1997 the Company retired the
Treasury Stock and returned it to the status of authorized but unissued shares.
 
     In December 1996, the Company entered into a lease agreement for a new
corporate headquarters and production facility in Palmer Township, Pennsylvania,
commencing in June 1998 at an annual rent of approximately $267,000 during the
first year, $275,000 during the second year, with a three percent (3%) escalator
per year thereafter, plus taxes and operating expenses. This rent, plus
anticipated moving expenses, constitutes a significant increase over the
Company's current occupancy cost. In addition, the Company has committed to pay
approximately $340,000 related to building improvements at this site during
1998. If the Company is unable to generate sufficient funds from operations to
finance these additional costs, the Company will require additional debt or
equity financing. In addition, the lease agreement, as amended, provides that
the Company must purchase the leased premises plus adjoining space and a
building comprising a total of approximately 96,000 square feet and 7.5 acres of
land during the sixth year after the Company takes possession of the leased
premises for $3,800,000. The Company plans to pursue mortgage financing for this
purchase.
 
     During the first quarter of 1998, the Company experienced diminishing cash
flow, due primarily to a significant drop in wholesale sales. The Company
experienced a reduction in net sales in the first quarter of 1998 as compared to
the first quarter of 1997 and expects to report a loss in the first quarter of
1998. In response, the Company has undertaken cost reductions, including
personnel, and is negotiating with its existing lender and new lender(s) for an
increased debt facility. No assurance can be given that the Company will be
successful in securing this increased debt facility. In their report on the
Company's financial statements for the year ended December 31, 1997, the
Company's independent public accountants have included an explanatory paragraph
raising substantial doubt about the Company's ability to continue as a going
concern, unless the Company is able to secure additional financing to meet it
obligations on a timely basis and to increase sales. Management intends to
continue to make cost reductions where possible and to initiate various
management actions to address the sales shortfall, as well as to pursue
aggressively additional sources of financing. No assurance can be given that
such management actions or attempts to raise additional financing or increase
sales will be successful.
 
ITEM 7.  FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
 
     See Item 14 and the Index therein for a listing of the financial statements
which are a part of this Report.
 
ITEM 8.  CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
         FINANCIAL DISCLOSURE
 
     There have been no changes in or disagreements with accountants on
accounting and financial disclosure items.
 
                                       15
<PAGE>   17
 
                                    PART III
 
ITEM 9.  DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS;
         COMPLIANCE WITH SECTION 16(a) OF THE EXCHANGE ACT.
 
     The names and ages of the executive officers and directors of the Company
are as follows:
 
<TABLE>
<CAPTION>
                NAME                   AGE                           POSITION
                ----                   ---                           --------
<S>                                    <C>    <C>
Jennifer Barclay(1)(4)...............   31    Chairman of the Board of Directors
Jeffrey Haims........................   34    Acting Chief Executive Officer
Richard Swarttz......................   41    Vice President of Finance, Chief Financial Officer and
                                              Treasurer
Tina Woolverton......................   31    Treasurer Corporate Secretary
Ben Cohen(2)(3)(4)...................   47    Director
Gary Hirshberg(2)(3)(4)..............   43    Director
John May(2)(3)(4)....................   51    Director
</TABLE>
 
---------------
(1) Member of Executive Committee
 
(2) Member of Audit Committee
 
(3) Member of Compensation Committee
 
(4) Member of Search Committee
 
     JENNIFER BARCLAY founded Blue Fish in 1985, and has been its Chairman of
the Board of Directors since the Company's incorporation in March 1987. She also
served as the Company's Chief Executive Officer from March 1987 until September
1994, its President from March 1987 until September 1996, and as its Treasurer
from August 1993 through August 1995.
 
     JEFFREY HAIMS was appointed Acting Chief Executive Officer on March 27,
1998, upon the resignation of Marc Wallach, the Company's former President and
Chief Executive Officer. Mr. Haims has been actively engaged in the retail and
wholesale apparel industry for 12 years. Prior to his appointment, Mr. Haims
served as a consultant to the Company from October 1997 until March 1998 and was
responsible for the design of the Company's anticipated men's line. From
November 1995 until September 1997, Mr. Haims was a principal of The Apparel
Resource Group ("ARG") of New York, New York, which provided consulting services
and strategic planning support to companies in the apparel industry. ARG
provided services to the Company from January 1996 until August 1997. Mr. Haims
was Corporate Director of Information Technology for Charming Shoppes, Inc. from
January 1995 until October 1995. From 1989 until January 1995, he held a variety
of positions in production and information systems at Liz Claiborne, Inc. and
most recently, served as Director of Design Systems from 1993 until 1995. Prior
to his employment by Liz Claiborne, Inc., Mr. Haims was a Co-Designer for Donna
Karan, DKNY from 1988 to 1989 and was the Menswear Design Director for Salvatore
Ferragamo, Spa. in 1988. Mr. Haims attended Fashion Institute of Technology in
New York, New York for both men's and women's design and the Art Center School
of Design in Los Angeles, California, where he was awarded the Ford Scholarship
for Industrial Design.
 
     RICHARD SWARTTZ joined the Company in May 1996 as Chief Financial Officer
and was appointed Treasurer in August 1996. In September 1996, Mr. Swarttz's
position was changed to Vice President of Finance, Chief Financial Officer and
Treasurer. Prior to joining the Company, Mr. Swarttz was most recently Vice
President of Finance at International Women's Apparel, Inc., from May 1994 to
May 1996, and Vice President and Controller of McBriar Sportswear, Inc. from
October 1990 to May 1994. Mr. Swarttz is a Certified Public Accountant, and
holds a Bachelor of Science degree in Accounting and a Masters in Business
Administration from Philadelphia College of Textiles and Science.
 
     TINA WOOLVERTON was appointed Corporate Secretary in August 1997. She
joined the Company in August 1995 and held various administrative positions. She
currently serves as Administrative Assistant to the
 
                                       16
<PAGE>   18
 
Chairman of the Board of Directors. Prior to joining the Company, Ms. Woolverton
served as Office Manager of Palmer Nursery in Easton, Pennsylvania from April
1992 to June 1995.
 
     BEN COHEN has served as a member of the Board of Directors since June 1995.
Mr. Cohen is the Co-Founder and Chairman of the Board of Ben and Jerry's
Homemade, Inc., a public company, and served as its Chief Executive Officer
until February 1995. He presently serves as a member of the Board of Directors
of The Social Venture Network and Greenpeace USA. Mr. Cohen also serves as a
member of the Board of Directors of Community Products, Inc., a privately held
buttercrunch candy manufacturer, which filed a petition for federal bankruptcy
protection in April 1997. In October 1997, the assets of Community Products,
Inc. were sold at a bankruptcy auction to the Rainforest Co., St. Louis,
Missouri.
 
     GARY HIRSHBERG has served as a member of the Board of Directors since June
1995. Mr. Hirshberg has been the Chief Executive Officer of Stonyfield Farm,
Inc., a privately held yogurt and ice cream company, since September 1983 and
its President since June 1989. He is the former Chairman of The Social Venture
Network and a Trustee of Leadership New Hampshire, Inc. Mr. Hirshberg has
extensive experience as an environmental activist, including terms as the
founding President of the Cape and Island Self Reliance Corporation, as founding
President of the Cape Cod Environmental Alliance and as a Director of the New
Hampshire Audobon Society and the Association for the Preservation of Cape Cod.
Mr. Hirshberg holds a Bachelor of Arts degree from Hampshire College, an
honorary Doctor of Science degree from New Hampshire College and an honorary
Doctor of Laws degree from Notre Dame College (Manchester, New Hampshire).
 
     JOHN MAY has served as a member of the Board of Directors since November
1997. Mr. May has been the Chief Executive Officer of Common Sense Management,
Inc., a business advisory service since 1981, Chief Executive Officer of Silby
Guffey & Co., Inc., a venture fund manager since 1989, and Managing Partner of
New Vantage Partners, LLC since 1997. He currently serves as a Director of
Lipton Corporate Child Care, Inc., Tilden Press, Inc., Ocean Optics, Inc., Silby
Guffey and Co., Inc., Common Sense Management, Inc., and ReGain, Inc., all
private companies. Mr. May holds a Bachelor of Arts degree from Earlham College
and a Masters of Public Administration from Maxwell School, Syracuse University.
 
BOARD COMMITTEES
 
     The Company's Board of Directors has established various committees. The
Executive Committee is authorized to take any action upon which the Board of
Directors is authorized to act, except as reserved by law or the Company's
Bylaws. The Executive Committee also administers the Company's 1995 Non-Employee
Directors' Stock Option Plan. Ms. Barclay is currently the only member of the
Executive Committee. The Audit Committee consists of Messrs. Cohen, Hirshberg
and May. The Audit Committee, which will meet periodically with management and
the Company's independent public accountants, will review the results and scope
of the audit and other services provided by the Company's independent public
accountants, the need for internal auditing procedures and the adequacy of
internal controls. The Compensation Committee consists of Messrs. Cohen,
Hirshberg and May. The Compensation Committee has the responsibility and
authority to establish and administer compensation policies for all executive
officers and employees of the Company, including the Chief Executive Officer.
The Compensation Committee also administers the Company's 1995 Stock Option
Plan. The Search Committee consists of Ms. Barclay and Messrs. Cohen, Hirshberg
and May. The Search Committee has the authority and responsibility to review the
management structure of the Company and make recommendations for changes to it,
as well as to identify a successor to Marc Wallach, who resigned as President
and Chief Executive Officer in March 1998.
 
     The personal liability of the Company's directors is limited to the fullest
extent permitted by Pennsylvania law. Under the Company's Bylaws and
Pennsylvania Business Corporation Law ("PBCL"), a director shall not be
personally liable for monetary damages for his or her actions as a director
unless: (1) the director has breached or failed to perform the duties of his
office under subchapter 17B of PBCL; and (2) the breach or failure to perform
constitutes self-dealing, willful misconduct or recklessness. Pennsylvania law
further provides that this limitation is not available with respect to the
responsibility or liability of a director
 
                                       17
<PAGE>   19
 
pursuant to any criminal statute or the liability of a director for the payment
of taxes pursuant to Federal, state or local law.
 
     The Company's Bylaws provide that the Company will indemnify directors and
officers, and may indemnify its employees and other agents, to the fullest
extent permitted by law. Indemnified parties are covered in all cases except
where such indemnification is prohibited by law, or where the conduct of the
indemnified party (i) constitutes willful misconduct or recklessness, or (ii) is
based upon receipt by the indemnified representative from the Company of a
personal benefit to which the indemnified party is not legally entitled. The
Company shall pay the expenses incurred in good faith by an indemnified party,
against an undertaking by the indemnified party to repay such expenses if it is
ultimately determined that the indemnified party is not entitled to
indemnification. Any dispute related to the right of indemnification will be
decided by arbitration. The Company also maintains liability insurance for its
directors and officers.
 
     Insofar as indemnification for liabilities arising under the Securities
Act, indemnification may be permitted to directors, officers, or persons
controlling the Company pursuant to the foregoing provisions. The Company has
been informed that, in the opinion of the Securities and Exchange Commission,
such indemnification is against public policy as expressed in the Securities Act
and is therefore unenforceable. The Company believes that its Bylaws provisions
and indemnification agreements are necessary to attract and retain qualified
persons as directors and officers.
 
NUMBER OF DIRECTORS, DIRECTORS' TERM OF OFFICE AND DIRECTOR COMPENSATION
 
     The Company's Bylaws provide that the Company may have up to eight
directors. At each annual meeting of stockholders, directors will be elected to
hold office until the next annual meeting. The Company currently has four
directors. The Company's employee directors do not receive any cash compensation
for their service on the Board of Directors. Directors who are not otherwise
employees of the Company are eligible to receive stock options under the
Company's 1995 Non-Employee Directors' Stock Option Plan. See "1995 Non-Employee
Directors' Stock Option Plan." All directors may be compensated for certain
expenses in connection with their attendance at Board meetings.
 
COMPLIANCE WITH SECTION 16(a) OF THE SECURITIES EXCHANGE ACT OF 1934.
 
     Section 16(a) of the Securities and Exchange Act of 1934 requires the
Company's directors and executive officers, and persons who own more than 10% of
the Company's Common Stock ("10% Stockholders"), to file with the Securities and
Exchange Commission (the "SEC") initial reports of ownership of the Company's
Common Stock and other equity securities on Form 3 and reports of changes in
such ownership on a Form 4 and Form 5. Executive officers, directors and 10%
Stockholders are required by SEC regulations to furnish the Company with copies
of all Section 16(a) forms they file.
 
     To the Company's knowledge, based solely on review of the copies of such
reports furnished to the Company during, and with respect to, its most recent
fiscal year and written representation that no other reports were required, all
Section 16(a) filing requirements applicable to its officers, directors and 10%
Stockholders were satisfied.
 
ITEM 10.  EXECUTIVE COMPENSATION
 
     The following table sets forth for the years ended December 31, 1995,
December 31, 1996, and December 31, 1997 the annual compensation, including
salary, bonuses and certain other compensation, paid
 
                                       18
<PAGE>   20
 
by the Company to its President, Chief Executive Officer, and any executive
officers whose annual compensation exceeded $100,000 (the "Named Executive
Officers").
 
<TABLE>
<CAPTION>
                                                                                       LONG TERM COMPENSATION
                                                                                  --------------------------------
                                                    ANNUAL COMPENSATION                  AWARDS           PAYOUTS
                                            -----------------------------------   ---------------------   --------
              (a)                  (b)         (c)        (d)          (e)           (f)         (g)        (h)
              ---                --------   ---------   --------   ------------   ----------   --------   --------
                                                                      OTHER
                                                                      ANNUAL      RESTRICTED                LTIP       DEFERRED
           NAME AND               FISCAL                           COMPENSATION     STOCK      OPTIONS/   PAYOUTS    COMPENSATION
      PRINCIPAL POSITION           YEAR     SALARY($)   BONUS($)       ($)         AWARD(S)    SARS(#)      ($)          ($)
      ------------------         --------   ---------   --------   ------------   ----------   --------   --------   ------------
<S>                              <C>        <C>         <C>        <C>            <C>          <C>        <C>        <C>
Jennifer Barclay...............  12/31/97   $100,000    $   -0-      $  2,224(3)   $     --         --    $     --     $     --
  Chairman(1)                                                        $  5,014(4)
                                                                     $  2,000(5)
                                 12/31/96   $100,000    $   -0-      $  2,178(3)   $     --         --    $     --     $     --
                                                                     $  4,905(4)
                                                                     $  1,985(5)
                                 12/31/95   $100,000    $ 1,923      $  1,968(3)   $     --         --    $     --     $     --
                                                                     $  5,420(4)
                                                                     $  2,038(5)
 
Marc Wallach...................  12/31/97   $108,000    $   -0-      $  4,647(3)   $     --         --    $     --     $     --
President & Chief                                                    $  5,400(4)
Executive Officer(2)                                                 $  2,063(5)
                                 12/31/96   $105,000    $   -0-      $  4,581(3)
                                                                     $    900(4)
                                                                     $  2,355(5)
                                 12/31/95   $105,000    $21,576      $  5,163(3)   $480,320    114,000    $     --     $     --
                                                                     $    900(4)
                                                                     $  2,532(5)
                                                                     $392,989(6)
</TABLE>
 
---------------
(1) Ms. Barclay served as Chairman and President until September 1996, when she
    relinquished the title of President.
 
(2) Mr. Wallach served as Chief Executive Officer until September 1996, when he
    assumed the additional title of President. He resigned as President, Chief
    Executive Officer and a Director, effective March 27, 1998.
 
(3) Company contribution for healthcare premiums.
 
(4) Allowance for automobile lease.
 
(5) 401(k) Company match accrued at December 31.
 
(6) Deferred grossed up bonus to pay taxes due on the restricted stock grant.
 
     The following table sets forth the aggregated option/SAR exercises and
fiscal year end option/SAR values by the Company to each executive officer of
the Company who earned $100,000 or more for the year ended December 31, 1997.
 
<TABLE>
<CAPTION>
                                                            NUMBER OF UNEXERCISED       VALUE OF UNEXERCISED
                                                            SECURITIES UNDERLYING           IN-THE-MONEY
                                 SHARES                        OPTIONS/SARS AT             OPTIONS/SARS AT
                              ACQUIRED ON      VALUE             FY-END (#)                  FY-END ($)
            NAME              EXERCISE(#)     REALIZED    EXERCISABLE/UNEXERCISABLE   EXERCISABLE/UNEXERCISABLE
            ----              ------------    --------    -------------------------   -------------------------
            (a)                   (b)           (c)                  (d)                         (e)
            ---               ------------    --------    -------------------------   -------------------------
<S>                           <C>             <C>         <C>                         <C>
Marc Wallach................      -0-           $-0-            68,400/45,600                 $-0-/-0-
  President & Chief
  Executive Officer
</TABLE>
 
EMPLOYMENT, NON-COMPETITION AND NON-DISCLOSURE AGREEMENTS
 
     The Company entered into an Employment Agreement with Marc Wallach to serve
as the Company's General Manager and Chief Operating Officer, effective January
1, 1994, for a period of three years, subject to termination by the Company for
cause or, by either party, at any time upon ninety (90) days prior written
notice. On September 7, 1994, Mr. Wallach was appointed Chief Executive Officer.
Although Mr. Wallach's
 
                                       19
<PAGE>   21
 
Employment Agreement expired on December 31, 1996, he continued to work for the
Company on the same terms. Mr. Wallach resigned as President, Chief Executive
Officer and Director, effective March 27, 1998. Mr. Wallach's annual base
compensation is $111,000 which shall be paid through August 28, 1998 and he
received an annual bonus of 3% of the Company's net after-tax profits for each
year that the Employment Agreement was in effect. Mr. Wallach will also receive
an additional bonus of 1% of the Company's net after-tax profits for each of the
four years commencing January 1, 1994 and for the quarter ended March 31, 1998.
This additional bonus will be paid by the Company in five equal annual
installments commencing on January 1, 1999. Mr. Wallach is also entitled to
participate in the Company's employee benefit plans through August 28, 1998. Mr.
Wallach is also subject to certain non-disclosure covenants and has agreed not
to compete with the Company during the term of the Employment Agreement and for
two years thereafter. On September 15, 1995, the Company granted to Mr. Wallach
304,000 shares of Common Stock in consideration of services rendered. In
connection with this stock grant, Ms. Barclay contributed 304,000 shares of her
Common Stock to the capital of the Company and Ms. Barclay, Mr. Wallach and the
Company entered into a Restricted Stock Agreement which expired on September 16,
1997. In 1995, the Company recognized a compensation expense of $873,309,
representing the fair market value of the Common Stock plus a bonus to cover
income taxes payable in connection with the stock grant. Mr. Wallach also waived
his right to receive any portion or all of his undistributed S corporation
earnings other than to pay taxes on S corporation earnings. See "Certain
Relationships and Related Transactions." As of March 27, 1998, Mr. Wallach's
option had vested to purchase 68,400 shares of Common Stock. The Compensation
Committee amended the terms of Mr. Wallach's Stock Option Grant to allow him to
exercise his option through June 24, 2003 provided, however, that the option
will be a nonqualified stock option if exercised after June 25, 1998.
 
     The Company has also executed stock option agreements containing
non-competition and non-disclosure provisions with each of the Company's
officers and key employees who have been granted stock options under the
Company's 1995 Stock Option Plan.
 
401(K) PLAN
 
     In March 1995, the Company adopted an employee savings and retirement plan
(the "401(k) Plan") covering all of the Company's employees who have attained
the age of 21 and who normally work 20 hours per week. The 401(k) Plan is
intended to be a tax-qualified plan under Section 401(a) of the Internal Revenue
Code. The 401(k) lan enables employees to reduce their taxable compensation by
electing to defer current compensation into the 401(k) Plan, up to the
statutorily prescribed annual limit ($9,500 in 1997). The trustees of the 401(k)
Plan, at the direction of each participant, invest the assets of the 401(k) Plan
in the various investment alternatives offered under the 401(k) Plan. The
Company may, but is not required to, make matching contributions to the 401(k)
Plan based on the amounts participants contribute to the 401(k) Plan, but in no
event may the Company's contribution exceed 10% of the participant's gross
compensation. The Company presently makes monthly matching contributions of up
to 2% of a participant's gross compensation. The 401(k) Plan is administered by
Merrill Lynch.
 
1995 STOCK OPTION PLAN
 
     The 1995 Stock Option Plan (the "Option Plan") was adopted by the Board of
Directors and approved by the stockholders in September 1995. The Option Plan is
intended to motivate and reward employees and selected consultants by granting
them stock options to acquire shares of Common Stock.
 
     Grants of stock options under the Option Plan may be made to the Company's
employees, officers (including officers who are directors), and consultants. A
total of 570,000 shares of Common Stock has been reserved for issuance under the
Option Plan. The Option Plan is administered by the Compensation Committee of
the Board of Directors.
 
     Both stock options intended to qualify as incentive stock options under the
Code and nonqualified stock options may be granted under the Option Plan. No
employee may receive options in any given calendar year to purchase more than
200,000 shares. The exercise price of incentive stock options granted under the
Option Plan will be at least equal to the fair market value of the Common Stock
of the Company on the date of the
 
                                       20
<PAGE>   22
 
grant. The exercise price of nonqualified stock options granted under the Option
Plan will be not less than eighty-five percent (85%) of the fair market value of
the Common Stock of the Company on the date of the grant. In addition, any
option granted under the Option Plan will have an exercise price of one hundred
and ten percent (110%) of the fair market value on the date of the grant in the
case of any person who owns stock possessing more than 10% of the total combined
voting power. Options granted under the Option Plan will vest at such times as
are specified by the Compensation Committee. If an individual with outstanding
stock options terminates employment on account of death, disability or
retirement approved by the Company, all of the individual's stock options will
become immediately exercisable. Once exercisable, stock options granted under
the Option Plan remain exercisable for nine years from the date of grant, unless
the individual terminates his or her relationship with the Company other than
described above. However, if an option holder wishes to preserve the status of
an option as an incentive stock option, the holder must exercise the option
within three months of his or her termination of employment or within one year
from a termination of employment on account of disability.
 
     Prior to October 23, 1995, the Option Plan provided that all outstanding
stock options granted under the Option Plan, whether or not vested, would become
immediately exercisable upon a "change of control of the Company" (as defined in
the Option Plan). In certain circumstances, if an individual who has received an
option grant under the Option Plan terminates employment within 18 months of a
"change of control of the Company," the Company is required to make a cash
payment to the individual in an amount equal to the difference between the fair
market value of the shares of Common Stock subject to the option and the
option's exercise price, unless the individual elects otherwise. In addition, if
the Company is not the surviving corporation in a transaction such as a merger,
or sale of substantially all the assets of the corporation, at least 10 days
before the effective date of the transaction, each individual who has an
outstanding and currently exercisable stock option will be entitled to exercise
the option or to receive a cash payment equal to the difference between the fair
market value of the shares of Common Stock subject to the option and the
option's exercise price if a cash payment of the stock option would not affect
the accounting treatment of any such transaction in the judgment of the
Compensation Committee. The Option Plan was amended such that the provision
relating to individuals who terminate employment within 18 months of a change of
control was deleted, and for options granted on or after October 23, 1995, only
vested options are subject to immediate exercise or cash payment upon a change
of control.
 
     On September 11, 1995 the Compensation Committee authorized the grant of
nine-year incentive stock options with an effective date of September 15, 1995
to purchase an aggregate of 60,000 shares of the Company's Common Stock to its
officers and key employees pursuant to the Option Plan. Options to purchase an
aggregate of only 55,000 shares were actually granted. Twenty percent were
immediately exercisable on September 15, 1995 and an additional 20% will become
exercisable on each of the first four anniversaries of the grant date. The
Compensation Committee also granted a nine-year incentive stock option under the
Option Plan with an effective date of September 15, 1995 to the Company's Chief
Executive Officer, Marc Wallach, to purchase 114,000 shares of the Company's
Common Stock. Mr. Wallach's option becomes exercisable according to a schedule
that provides for the most rapid exercise of the option without disqualifying
the option as an incentive stock option under the Code. All of the options were
granted with an exercise price of $4.00 per share. On December 15, 1995, the
Compensation Committee authorized an additional grant of nine-year incentive
stock options to purchase 45,000 shares to its officers and key employees
pursuant to the Option Plan under the same conditions as the September 15, 1995
grant, with an exercise price of $5.00 per share. Options to purchase only
40,000 shares were actually granted. During 1996, the Compensation Committee
granted a nine-year incentive stock option to purchase 14,300 shares of Common
Stock to an officer, with the same vesting schedule as the 1995 grants (other
than to Mr. Wallach), and at an exercise price of $7.00 per share. The
Compensation Committee also granted non-qualified five-year stock options to
purchase an aggregate of 12,000 shares to three consultants, at an exercise
price of $7.25 per share. One-half of the options became exercisable on January
1, 1997 and the balance become exercisable on January 1, 1998. On April 4, 1997
the Compensation Committee granted an incentive option to purchase 10,000 shares
of the Company's Common Stock to an officer of the Company with the same vesting
schedule as the 1995 grants with an exercise price of $4.75 per share. On May
27, 1997 the Compensation Committee granted incentive stock options to two
managers of the Company each to purchase 10,000 shares of the
                                       21
<PAGE>   23
 
Company's Common Stock with the same vesting schedule as the 1995 grants with an
exercise price of $4.50 per share. On July 1, 1997 and October 14, 1997, the
Compensation Committee granted incentive stock options to two managers each to
purchase 5,000 shares of the Company's Common Stock with the same vesting
schedule as the 1995 grants and with exercise prices of $3.75 and $4.50 per
share, respectively.
 
     No options were exercised by employees during 1997. The employment of two
optionees holding options to purchase an aggregate of 20,000 shares terminated
during 1997. The employment of one additional employee terminated during 1997
and her option to purchase 10,000 shares of the Company's Common Stock
terminated unexercised in March 1998. Accordingly, as of the date of this
Report, options to purchase 12,000 shares have been exercised, options to
purchase 72,000 shares (62,000 at December 31, 1997) have expired or have been
canceled, and options to purchase a total of 191,300 shares of Common Stock
granted pursuant to the Option Plan remain outstanding.
 
PERFORMANCE STOCK ESCROW AGREEMENT
 
     Jennifer Barclay, the founder and Chairman of the Board of the Company, has
deposited into escrow all the 3,486,000 shares of the Company's Common Stock
owned by her. Under the terms of the Escrow Agreement, 25% of her shares shall
become transferable on the sixth, seventh, eighth and ninth anniversary dates of
November 13, 1995. No transfer of those shares may be made until November 13,
2001, except as follows: (A) Ms. Barclay may transfer a number of her shares
that, within any three-month period, would equal one percent of the shares of
the Company's Common Stock then outstanding; or (B) all of the shares may
earlier become transferable upon certification by the Company's Chief Financial
Officer that any of the following has been achieved: (i) for two consecutive
fiscal years after November 13, 1995, the Company has minimum annual earnings
equal to $0.25 per share; (ii) for five consecutive fiscal years after November
13, 1995, the Company has an average minimum annual earnings of $0.25 per share;
or (iii) after at least one year from November 13, 1995, the Company's Shares
have traded on a United States stock exchange at a price of at least of $8.75
per share (adjusted for stock splits, stock dividends and recapitalizations) for
at least 90 consecutive trading days.
 
1995 NON-EMPLOYEE DIRECTORS' STOCK OPTION PLAN
 
     In September 1995, the Board of Directors adopted and the stockholders
approved the Company's Non-Employee Directors' Stock Option Plan (the
"Directors' Plan"). The Directors' Plan provides for an annual nondiscretionary
grant of stock options to each director who is not an employee of the Company
(collectively, the "Non-Employee Directors"). The annual grant is in lieu of an
annual retainer for service as a member of the Board of Directors.
 
     A total of 75,000 shares of Common Stock has been reserved for issuance
under the Directors' Plan. On January 1 of each year, each Non-Employee Director
will receive a nondiscretionary grant of options to purchase a total amount of
shares of Common Stock equal in value to $7,500, plus an additional $2,500 for
each Board of Directors' committee on which the Non-Employee Director serves,
based on the fair market value of the Common Stock on the date of grant. The
exercise price of options granted under the Directors' Plan will be equal to the
fair market value of the Common Stock on the date of grant, except that the
exercise price shall be one hundred and ten percent (110%) of the fair market
value in the case of any person who owns stock possessing more than 10% of the
total combined voting power. Options will remain exercisable for nine years from
the date of grant.
 
     Pursuant to the terms of the Directors' Plan, each of the Non-Employee
Directors received grants of nonqualified stock options to purchase 2,500 shares
of Common Stock, at an exercise price of $5.00 per share on January 1, 1996,
2,700 shares of Common Stock, at an exercise price of $4.63 per share on January
1, 1997 and 4,340 shares of Common Stock at an exercise price of $2.88 per share
on January 1, 1998. As of the date of this Report, options to purchase a total
of 23,420 shares of Common Stock have been granted under the Directors' Plan, of
which none has been exercised, expired or canceled to date.
 
                                       22
<PAGE>   24
 
ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
 
     The following table sets forth certain information known to the Company
regarding the beneficial ownership of the Company's Common Stock as of April 14,
1998 for (i) each director and executive officer of the Company; (ii) each
stockholder known by the Company to own beneficially 5% or more of the
outstanding shares of its Common Stock; and (iii) all directors and officers as
a group for each class of capital stock of the Company. The Company believes
that the beneficial owners of the Common Stock listed below, based on
information furnished by such owners, have sole investment and voting power with
respect to such shares, subject to community property laws where applicable.
 
<TABLE>
<CAPTION>
                         DIRECTORS,                              SHARES        PERCENTAGE OF
                     EXECUTIVE OFFICERS                       BENEFICIALLY     COMMON SHARES
                    AND 5% STOCKHOLDERS:                        OWNED(1)       OUTSTANDING(1)
                    --------------------                      ------------     --------------
<S>                                                           <C>              <C>
Jennifer Barclay............................................   3,486,000            75.8%
c/o Blue Fish Clothing, Inc. No. 3 Sixth Street Frenchtown,
  NJ 08825
Marc Wallach................................................     372,400(2)          8.0%
Jeffrey Haims...............................................       4,000(3)            *
Richard Swarttz.............................................       5,720(4)            *
Ben Cohen...................................................       9,540(5)            *
Gary Hirshberg..............................................       9,540(5)            *
John May....................................................       4,340(6)            *
All directors and executive officers as a group (seven
  persons)..................................................   3,891,540(7)         82.8%
</TABLE>
 
---------------
 *  Less than 1%
 
(1) Pursuant to the rules of the Securities and Exchange Commission, shares of
    Common Stock which an individual or group has a right to acquire within 60
    days pursuant to the exercise of options or warrants are deemed to be
    outstanding for the purpose of computing the percentage ownership of such
    individual or group, but are not deemed to be outstanding for the purpose of
    computing the percentage ownership of any other person shown in the table.
 
(2) Consists of 304,000 shares of Common stock owned beneficially by Mr. Wallach
    and 68,400 shares of Common Stock issuable upon exercise of currently
    exercisable incentive stock options but excludes 45,600 shares of Common
    Stock issuable upon exercise of incentive stock options granted under the
    Option Plan that are not currently exercisable.
 
(3) Consists of 4,000 shares of Common Stock issuable upon exercise of
    nonqualified stock options issued under the Option Plan.
 
(4) Consists of 5,720 shares of Common Stock issuable upon exercise of currently
    exercisable incentive stock options but excludes 8,580 shares of Common
    Stock issuable upon exercise of incentive stock options granted under the
    Option Plan that are not currently exercisable.
 
(5) Consists of 9,540 shares of Common Stock issuable upon exercise of
    nonqualified stock options issued under the Directors' Plan.
 
(6) Consists of 4,340 shares of Common Stock issuable upon exercise of
    nonqualified stock options issued under the Directors' Plan.
 
(7) Includes an aggregate of 101,540 shares of the Common Stock issuable upon
    exercise of currently exercisable stock options granted under the Option
    Plan and Directors' Plan to executive officers and directors, but excludes
    54,180 shares of Common Stock issuable upon exercise of stock options
    granted under the Option Plan that are not yet exercisable.
 
                                       23
<PAGE>   25
 
ITEM 12.  CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
 
LEASE OF FRENCHTOWN RETAIL STORE
 
     The Company leases its Frenchtown retail store, together with a design
studio located above the store, from David Barclay, the father of Jennifer
Barclay, the Company's Chairman and President, under leases dated April 1, 1991,
and April 11, 1994, respectively. The lease for the retail store, which consists
of 1,267 square feet of selling space, is for a term of ten years. The Company
pays approximately $35,000 in rent on an annual basis for the retail store. The
design studio is leased on a monthly basis for approximately $900 per month and
consists of 800 square feet. The Company discontinued this lease as of January
31, 1998.
 
AGREEMENTS WITH FORMER STOCKHOLDER
 
     Pursuant to an Agreement dated June 30, 1993, the Company repurchased all
of the 2,048,696 shares of the Company's Common Stock then owned by Anne Haag, a
former stockholder and officer of the Company. These shares are currently held
in Treasury by the Company (the "Treasury Stock"). Pursuant to a Security
Agreement, the Treasury Stock, together with all accounts receivable,
inventories, work-in-progress, bank accounts, trademarks, choses in action,
leasehold interests, and fixed assets now or hereafter acquired, served as
collateral to secure the Company's obligations under certain promissory notes
representing the purchase price for Ms. Haag's shares. The total purchase price
of the Treasury Stock was $230,000, of which $162,400 was in the form of a
promissory note due in monthly installments of $3,140 including interest at 6%
and maturing in March 1997. The stockholder's note had an outstanding balance,
as of December 31, 1996, of $24,557. The Company satisfied all of its
obligations to Anne Haag pursuant to the Agreement and promissory notes on April
5, 1997. On April 20, 1997 the Company retired the Treasury Stock and returned
it to the status of authorized but unissued shares.
 
     In addition, the Company executed a separate agreement on August 27, 1993
consisting of a Consulting and Non-Competition Agreement with Ms. Haag which
provided that the Company would retain Ms. Haag for a period of five years to
provide management consulting services to the Company and Ms. Haag agreed not to
compete with the business of the Company during this period of time. During the
period of the Consulting and Non-Competition Agreement, Ms. Haag may not engage
in a competitive business within a twenty-five (25) mile radius of Frenchtown,
New Jersey. Originally, Ms. Haag was to be paid a total of $120,000 over a
period of five years in monthly installments of $2,000 through August 1998 for
such consulting services, and $50,000 over a period of five years in monthly
installments of $833 through August 1998 for her agreement not to compete. In
December 1995, the Company agreed with Ms. Haag to accelerate quarterly payments
by $20,000 ($40,000 in the first quarter of 1996) in anticipation of increased
usage of her consulting contract on a short-term basis. This repayment agreement
is coincident with the existing loan, consulting, and non-compete agreements,
and does not increase the long-term liability of the Company, but rather repays
these agreements in an accelerated fashion. As a result of these accelerated
payments, Ms. Haag was paid in full as of September, 1996.
 
EMPLOYMENT AGREEMENT WITH MARC WALLACH
 
     The Company entered into an Employment Agreement with Marc Wallach to serve
as the Company's General Manager and Chief Operating Officer effective January
1, 1994, for a period of three years, subject to termination by the Company for
cause or, by either party, at any time upon ninety (90) days prior notice. On
September 7, 1994, Mr. Wallach was appointed Chief Executive Officer. Although
Mr. Wallach's Employment Agreement expired on December 31, 1996, he continues to
work for the Company on the same terms. Mr. Wallach resigned as President, Chief
Executive Officer and a Director, effective March 27, 1998. Mr. Wallach's annual
base compensation is $111,000 which shall be paid through August 28, 1998 and he
received an annual bonus of 3% of the Company's net after-tax profits for each
year the Employment Agreement was in effect. Mr. Wallach will also receive an
additional bonus of 1% of the Company's net after-tax profits for each of the
four years commencing January 1, 1994 and for the quarter ended March 31, 1998.
This additional bonus will be paid by the Company in five equal annual
installments commencing on January 1, 1999. Mr. Wallach is also entitled to
participate in the Company's employee benefit plans through
 
                                       24
<PAGE>   26
 
August 28, 1998. Mr. Wallach is also subject to certain non-disclosure covenants
and has agreed not to compete with the Company during the term of the Employment
Agreement and for two years thereafter. Effective September 15, 1995, in
connection with an understanding Mr. Wallach reached with Ms. Barclay in
September 1994 regarding the terms of his service as Chief Executive Officer,
the Company granted to Mr. Wallach 304,000 shares of Common Stock in
consideration for services rendered. In connection with this stock grant, Ms.
Barclay contributed 304,000 shares of her Common Stock to the Company and Ms.
Barclay, Mr. Wallach and the Company entered into a Restricted Stock Agreement
which expired on September 16, 1997. The Company recorded a compensation expense
charge of $873,309 in 1995, representing the fair market value for the Common
Stock plus a bonus to Mr. Wallach to cover income taxes payable in connection
with the stock grant. The Company also granted a nine-year incentive stock
option to Mr. Wallach pursuant to the Option Plan to purchase 114,000 shares of
the Company's Common Stock at an exercise price of $4.00 per share. As of March
27, 1998, Mr. Wallach's option had vested to purchase 68,400 shares of Common
Stock. The Compensation Committee amended the terms of Mr. Wallach's Stock
Option Grant to allow him to exercise his option through June 24, 2003 provided,
however, that the option will be a nonqualified stock option if exercised after
June 25, 1998.
 
DISTRIBUTION OF S CORPORATION EARNINGS AND LOAN FROM STOCKHOLDER
 
     On September 11, 1995, the Company's then sole stockholder Jennifer Barclay
requested a withdrawal of $450,000 of the taxed but undistributed S corporation
earnings. Ms. Barclay received this distribution on January 2, 1996. Ms. Barclay
has loaned these funds back to the Company on an unsecured basis and the Company
issued her a promissory note in the principal amount of $450,000 and bearing
interest of 7% per annum, payable monthly. The principal amount of the note will
be payable upon demand by Ms. Barclay, subject to the following limitations upon
repayment: (i) the maximum amount of principal that the Company is required to
pay in any 3-month period is $50,000 and in any 12-month period is $100,000;
(ii) the Company is not required to make any repayments of principal when its
current assets to current liabilities ratio as set forth in its latest quarterly
balance sheet is below 1.0, excluding liabilities related to amounts due
pursuant to the note; and (iii) no repayment of principal will be paid in the
event that a disinterested majority of the Company's Board of Directors
determines that it is not advisable to make a repayment of principal based upon
the Company's then current cash flow or liquidity needs. Although the
restrictions imposed on repayment were designed to protect the Company from
experiencing liquidity problems, no assurance can be given that a demand for
repayment by Ms. Barclay will not result in a shortage of cash available to the
Company for operations.
 
     The Company believes the foregoing transactions were fair and on terms no
less favorable to the Company than could be obtained from unaffiliated third
parties. The Bylaws of the Company provide that contracts or transactions
between the Company and any of its officers or directors shall not be void or
voidable solely for that reason, or solely because the director or officer is
present at or participates in the meeting of the Board of Directors that
authorizes the contract or transaction, or solely because his, her or their
votes are counted for that purpose, if (i) the contract or transaction is fair
as to the Company as of the time it is authorized, approved or ratified by the
Board of Directors or the stockholders, or (ii) the material facts as to the
relationship or interest are disclosed to or are known either by (a) the Board
of Directors and the Board authorizes the contract or transaction by the
affirmative votes of a majority of the disinterested directors even though the
disinterested directors are less than a quorum; or (b) the stockholders entitled
to vote thereon and the contract or transaction is specifically approved in good
faith by vote of those stockholders.
 
THE APPAREL RESOURCE GROUP
 
     From January 1996 through August 1997, the Company engaged The Apparel
Resource Group ("ARG") of New York, New York to provide consulting services and
strategic planning support to the Company, for which ARG was paid $201,900
during the fiscal year ended December 31, 1996 and $150,423 during the fiscal
year ended December 31, 1997. Jeffrey Haims, the Company's Acting Chief
Executive Officer, was a principal of ARG and was part of the ARG team that
provided services to the Company.
 
                                       25
<PAGE>   27
 
ITEM 13.  EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
 
     (A) Financial Statements.  The financial statements required to be filed by
Item 8 herewith are as follows:
 
<TABLE>
<S>                                                           <C>
Index to Financial Statements...............................  F-1
Report of Independent Public Accountants -- Arthur Andersen   F-2
  LLP.......................................................
Balance Sheet at December 31, 1997..........................  F-3
Statements of Operations for the years ended December 31,     F-4
  1996 and 1997.............................................
Statements of Stockholders' Equity for the years ended        F-5
  December 31, 1996 and 1997................................
Statements of Cash Flows for the years ended December 31,     F-6
  1996 and 1997.............................................
Notes to Financial Statements...............................  F-7
</TABLE>
 
     (B) Exhibits and Reports on 8-K.  The exhibits listed below were filed on
September 27, 1995 pursuant to Item 601 of Regulation S-B as part of the
Registration Statement on Form SB-2, on November 6, 1995 as part of Amendment
No. 1 thereto, on November 13, 1995 as part of Amendment No. 2 thereto, on
December 27, 1995 as part of Form 10-QSB, on April 12, 1996 as part of Form
10-KSB, or on May 20, 1996 as part of Form 10-QSB, on August 11, 1996 as part of
Form 10-QSB, on November 14, 1996, as part of Form 10-QSB, on March 31, 1997 as
part of Form 10-KSB, on May 2, 1997 as part of Amendment No. 1 thereto, on June
17, 1997 as part of Amendment No. 2 thereto, on June 19, 1997 as part of
Amendment No. 3 thereto, on May 13, 1997 as part of Form 10-QSB, on August 14,
1997 as part of Form 10-QSB, on April 15, 1998 as part of Amendment No. 1
thereto, November 13, 1997 as part of Form 10-QSB, and on April 15, 1998 as part
of Amendment No. 1 thereto, except those marked with an asterisk (*), which are
filed herewith. No Reports on Form 8-K were filed with the Commission during the
last quarter of 1997.
 
<TABLE>
<CAPTION>
EXHIBIT
NUMBER                           DESCRIPTION
-------                          -----------
<S>      <C>
 2.1(a)  Articles of Merger merging Blue Fish Clothing, Inc. a New
         Jersey corporation, and Blue Fish Taos, Inc., a New Mexico
         corporation with and into Blue Fish Clothing, Inc., a
         Pennsylvania corporation, dated September 6, 1995
 2.1(b)  Certificate of Merger merging Blue Fish Clothing, Inc. a New
         Jersey corporation, and Blue Fish Taos, Inc., a New Mexico
         corporation with and into Blue Fish Clothing, Inc., a
         Pennsylvania corporation, dated September 6, 1995
 2.1(c)  Merger Agreement and Irrevocable Appointment of the
         Secretary of State of New Mexico as Agent for Service of
         Process, dated September 8, 1995
 3.1     Articles of Incorporation
 3.2     Bylaws, as amended
 4.1     Specimen Stock Certificate
 4.2     Excerpts from Registrant's Bylaws defining the rights of
         security holders
10.1     Employment Agreement between the Registrant and Marc Wallach
         effective as of January 1, 1994
10.2     1995 Stock Option Plan, as amended
10.2(a)  Form of Stock Option Grant and Nondisclosure/Noncompetition
         Agreement
10.3     1995 Non-Employee Directors' Stock Option Plan, as amended
10.4     401(k) Plan
10.5     Restricted Stock Agreement by and among Marc Wallach,
         Jennifer Barclay and the Registrant dated September 15, 1995
10.6     Agreement for Purchase and Sale of Shares by and among Anne
         F. Haag, Blue Fish Clothing, Inc. and Blue Fish Taos, Inc.
         dated June 30, 1993
10.6(a)  Promissory Note dated August 27, 1993 in the principal
         amount of $162,400 by and between the Registrant as Maker
         and Anne Haag as Payee
10.6(b)  Resignations of Anne Haag dated August 27, 1993 as Director,
         Officer and employee of Blue Fish Clothing, Inc. and Blue
         Fish Taos, Inc.
10.6(c)  General Releases dated August 27, 1993 executed by Anne Haag
         in favor of the Registrant
</TABLE>
 
                                       26
<PAGE>   28
 
<TABLE>
<CAPTION>
EXHIBIT
NUMBER                           DESCRIPTION
-------                          -----------
<S>      <C>
10.6(d)  Security Agreement dated August 27, 1993 by and between the
         Registrant as Debtor and Anne Haag as Secured Party
10.6(e)  Consulting and Non-Competition Agreement dated as of August
         27, 1993 by and between the Registrant and Anne Haag
10.7     Lease Agreement between David M. Barclay and the Registrant
         dated April 1, 1991
10.8     Lease Agreement between Frederick A. Krause and the
         Registrant dated July 1, 1993, as amended
10.9     Lease Agreement between T.H. McElvain Oil & Gas Limited
         Partnership and the Registrant dated October 24, 1994 (Santa
         Fe, New Mexico Retail Store)
10.10    $500,000 Line of Credit Agreement between Flemington
         National Bank and Trust Company and the Registrant dated
         February 9, 1995
10.10(a) Loan and Security Agreement and $1,000,000 Line of Credit
         Agreement between Carnegie Bank NA and the Registrant dated
         February 9, 1996
10.11    Business Manager Receivable Purchase Line of Credit
         Agreement between Flemington National Bank and Trust Company
         and the Registrant dated February 9, 1994
10.11(a) Business Manager Receivable Purchase Line of Credit
         Agreement between Carnegie Bank NA and the Registrant dated
         February 9, 1996
10.12    Revised Forms of Subscription and Share Purchase Agreement
10.13    Impound Agreement between Flemington National Bank and Trust
         Company and the Registrant dated September 19, 1995
10.13(a) Impound Account Fee Agreement between Flemington National
         Bank and Trust Company and the Registrant dated September
         19, 1995
10.13(b) Custody Agreement between Flemington National Bank and Trust
         Company and the Registrant dated September 19, 1995 as
         amended
10.13(c) Acknowledgment Letter to Flemington National Bank and Trust
         Company and the Registrant dated September 19, 1995
10.13(d) Acknowledgment Letter between United Jersey Bank (formerly
         Flemington National Bank and Trust Company) and the
         Registrant dated March 5, 1996
10.14    Key Person Life Insurance Policies, National Life of Vermont
10.15    Marketing Agreement between Drew Field/Direct Public
         Offerings and the Registrant dated April 12, 1995
10.16    Lease Agreement between the Ruth Group and the Registrant
         dated as of December 1, 1995
10.17    Form of Escrow Agreement by and between the Registrant,
         Jennifer Barclay and Flemington National Bank
10.18    Form of Lock-in Agreement for the Shares of the Registrant's
         Common Stock
10.19    Lease agreement dated November 15, 1995 with G. Holdings
         Corporation and Blue Fish Clothing, Inc.
10.20    Letter agreement dated December 6, 1995 with Anne Haag and
         Blue Fish Clothing, Inc.
10.21    Promissory Note between the Registrant and Jennifer Barclay
         dated January 2, 1996
10.22    Lease Agreement between Tangmere Ltd. and the Registrant
         dated January 5, 1996
10.23    Employment Agreement by and between the Registrant and
         Richard Swarttz dated April 29, 1995 and effective May 20,
         1996
10.24    Lease Agreement dated December 16, 1996, between William I.
         Roberts and the Registrant
10.25    Lease Agreement dated December 19, 1996, between 150 Greene
         Street Corp. and the Registrant
10.26    Agreement by and between Blue Fish Clothing, Inc.
         (Sub-Tenant), and Michael J. Herbst (Tenant) effective June
         15, 1997.
10.27    Business Loan Agreement by and between Blue Fish Clothing,
         Inc. and Carnegie Bank, N.A. dated June 25, 1997.
10.28    Promissory Note in the principal amount of $800,000 by and
         between Blue Fish Clothing, Inc. and Carnegie Bank, N.A.
         dated June 25, 1997.
</TABLE>
 
                                       27
<PAGE>   29
 
<TABLE>
<CAPTION>
EXHIBIT
NUMBER                           DESCRIPTION
-------                          -----------
<S>      <C>
10.29    Assignment of Deposit Account by and between Blue Fish
         Clothing, Inc. and Carnegie Bank, N.A. dated June 25, 1997.
10.30    Note and Loan Security Agreement Modification Agreement by
         and between Blue Fish Clothing, Inc. and Carnegie Bank, N.A.
         dated June 27, 1997.
10.31    Amendment to Assignment of Deposit Account by and between
         Blue Fish Clothing, Inc. and Carnegie Bank, N.A. dated June
         25, 1997.
10.32    Agreement for Cross-Default and Cross Collateralization by
         and between Blue Fish Clothing, Inc. and Jennifer P. Barclay
         to and for the benefit of Carnegie Bank, N.A. dated
         September 30, 1997.
10.33    First Addendum dated May 19, 1997 to the Lease Agreement
         dated December 16, 1996 between William I. Roberts and the
         Registrant.
10.34    Assignment of Lease and Assumption of Obligations between
         William I. Roberts and Upper Mill, L.P. dated October 21,
         1997.
*10.35   The Business/Manager (R) Agreement with Businesses and
         Professionals dated March 12, 1998 between Carnegie Bank,
         N.A. and the Registrant.
*10.36   Guaranty of Payment dated March 12, 1998 by Jennifer P.
         Barclay in favor of Carnegie Bank, N.A.
*10.37   Subordination of Debt Agreement dated March 12, 1998 between
         the Registrant and Jennifer P. Barclay.
*10.38   Note and Loan and Security Agreement Modification and
         Extension Agreement dated as of April 30, 1998 between
         Carnegie Bank, N.A. and the Registrant.
*10.39   Second Addendum dated December 31, 1997 between Upper Mill,
         L.P. and the Registrant to the Lease Agreement between
         William I. Roberts and the Registrant.
*27.     Financial Data Schedule
</TABLE>
 
                                       28
<PAGE>   30
 
                                   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 April 15, 1998.
 
                                          Blue Fish Clothing, Inc.
 
                                          By:     /s/ JENNIFER BARCLAY
 
                                            ------------------------------------
                                                      Jennifer Barclay
                                             Chairman of the Board of Directors
                                               (Principal Executive Officer)
 
     Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated.
 
<TABLE>
<CAPTION>
                        NAME                                        TITLE                     DATE
                        ----                                        -----                --------------
<C>                                                    <S>                               <C>
 
                /s/ JENNIFER BARCLAY                   Chairman of the Board of          April 15, 1998
-----------------------------------------------------  Directors
                  Jennifer Barclay                     (Principal Executive Officer)
 
                /s/ JEFFREY L. HAIMS                   Acting Chief Executive Officer    April 15, 1998
-----------------------------------------------------  (Principal Executive Officer)
                  Jeffrey L. Haims
 
                 /s/ RICHARD SWARTTZ                   Vice President of Finance, Chief  April 15, 1998
-----------------------------------------------------  Financial Officer, and Treasurer
                   Richard Swarttz                     (Principal Financial Officer and
                                                       Principal Accounting Officer)
 
                 /s/ GARY HIRSHBERG                    Director                          April 15, 1998
-----------------------------------------------------
                   Gary Hirshberg
 
                    /s/ BEN COHEN                      Director                          April 15, 1998
-----------------------------------------------------
                      Ben Cohen
 
                    /s/ JOHN MAY                       Director                          April 15, 1998
-----------------------------------------------------
                      John May
</TABLE>
 
                                       29
<PAGE>   31
 
                               INDEX TO EXHIBITS
 
<TABLE>
<S>      <C>
10.35    The Business/Manager(R) Agreement with Businesses and
         Professionals dated March 12, 1998 between Carnegie Bank,
         N.A. and the Registrant.
10.36    Guaranty of Payment dated March 12, 1998 by Jennifer P.
         Barclay in favor of Carnegie Bank, N.A.
10.37    Subordination of Debt Agreement dated March 12, 1998 between
         the Registrant and Jennifer P. Barclay.
10.38    Note and Loan and Security Agreement Modification and
         Extension Agreement dated as of April 30, 1998 between
         Carnegie Bank, N.A. and the Registrant.
10.39    Second Addendum dated December 31, 1997 between Upper Mill,
         L.P. and the Registrant to the Lease Agreement between
         William I. Roberts and the Registrant.
27       Financial Data Schedule.
</TABLE>
<PAGE>   32
 
                            BLUE FISH CLOTHING, INC.
 
                         INDEX TO FINANCIAL STATEMENTS
 
<TABLE>
<CAPTION>
                                                              PAGE
                                                              ----
<S>                                                           <C>
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS....................  F-2
BALANCE SHEET...............................................  F-3
STATEMENTS OF OPERATIONS....................................  F-4
STATEMENTS OF STOCKHOLDERS' EQUITY..........................  F-5
STATEMENTS OF CASH FLOWS....................................  F-6
NOTES TO FINANCIAL STATEMENTS...............................  F-7
</TABLE>
 
                                       F-1
<PAGE>   33
 
                    REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
 
To Blue Fish Clothing, Inc.:
 
     We have audited the accompanying balance sheet of Blue Fish Clothing, Inc.
(a Pennsylvania corporation) as of December 31, 1997, and the related statements
of operations, stockholders' equity and cash flows for each of the two years in
the period ended December 31, 1997. These financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements based on our audits.
 
     We conducted our audits in accordance with generally accepted auditing
standards. 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 audits provide a reasonable basis for our opinion.
 
     In our opinion, the financial statements referred to above present fairly,
in all material respects, the financial position of Blue Fish Clothing, Inc. as
of December 31, 1997, and the results of its operations and its cash flows for
each of the two years in the period ended December 31, 1997, in conformity with
generally accepted accounting principles.
 
     The accompanying financial statements have been prepared assuming that the
Company will continue as a going concern. As discussed in Note 1 to the
financial statements, the Company has suffered recurring losses from operations
which are continuing in 1998 that raise substantial doubt about its ability to
continue as a going concern. Management's plans in regard to these matters are
also described in Note 1. The financial statements do not include any
adjustments relating to the recoverability and classification of asset carrying
amounts or the amount and classification of liabilities that might result should
the Company be unable to continue as a going concern.
 
Philadelphia, PA
March 12, 1998
 
                                       F-2
<PAGE>   34
 
                            BLUE FISH CLOTHING, INC.
 
                                 BALANCE SHEET
                               DECEMBER 31, 1997
 
<TABLE>
<S>                                                           <C>
                                 ASSETS
Current Assets:
  Cash and cash equivalents.................................  $  350,477
  Restricted cash...........................................     116,065
  Certificate of deposit....................................     500,000
  Receivables, net of allowance of $40,000..................   1,180,962
  Inventories, net..........................................   2,944,166
  Other current assets......................................     175,736
                                                              ----------
     Total current assets...................................   5,267,406
Property and equipment, net of accumulated depreciation and
  amortization of $819,575..................................   1,898,489
Other Assets:
  Restricted certificate of deposit.........................     300,000
  Deposits..................................................     254,551
                                                              ----------
     Total assets...........................................  $7,720,446
                                                              ==========
                  LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities:
  Line of credit............................................  $  500,000
  Current portion of long-term debt.........................     222,786
  Receivable purchase line of credit........................   1,160,648
  Accounts payable..........................................     808,893
  Accrued expenses..........................................     364,947
                                                              ----------
     Total current liabilities..............................   3,057,274
                                                              ----------
Deferred rent and other non-current liabilities.............     267,553
                                                              ----------
Long-term debt..............................................   1,055,195
                                                              ----------
Commitments and Contingencies (Note 12)
Stockholders' Equity:
  Common stock, $.001 par value, 11,000,000 shares
     authorized, 4,599,200 shares issued and outstanding....       4,599
  Additional paid-in capital................................   3,799,815
  Retained earnings (deficit)...............................    (463,990)
                                                              ----------
     Total stockholders' equity.............................   3,340,424
                                                              ----------
                                                              $7,720,446
                                                              ==========
</TABLE>
 
         The accompanying notes are an integral part of this statement.
                                       F-3
<PAGE>   35
 
                            BLUE FISH CLOTHING, INC.
 
                            STATEMENTS OF OPERATIONS
 
<TABLE>
<CAPTION>
                                                                YEAR ENDED DECEMBER 31
                                                              --------------------------
                                                                 1996           1997
                                                              -----------    -----------
<S>                                                           <C>            <C>
Sales.......................................................  $11,610,855    $13,838,058
Cost of goods sold..........................................    5,371,707      6,513,563
                                                              -----------    -----------
  Gross margin..............................................    6,239,148      7,324,495
Operating expenses..........................................    6,356,986      7,241,752
                                                              -----------    -----------
  (Loss) income from operations.............................     (117,838)        82,743
Interest expense, net of interest income of $90,062 and
  $65,798...................................................      157,297        227,557
                                                              -----------    -----------
Loss before income taxes....................................     (275,135)      (144,814)
Income tax (benefit) expense................................     (237,995)       237,995
                                                              -----------    -----------
Net loss....................................................  $   (37,140)   $  (382,809)
                                                              ===========    ===========
Net loss per share:
  Basic.....................................................                 $      (.08)
                                                                             ===========
  Diluted...................................................                 $      (.08)
                                                                             ===========
Basic and diluted weighted average shares outstanding.......                   4,599,200
                                                                             ===========
Pro forma data (Note 2) (unaudited):
  Historical loss before income taxes.......................  $  (275,135)
  Pro forma income tax (benefit)............................      (81,990)
                                                              -----------
Pro forma net loss..........................................  $  (193,145)
                                                              ===========
Pro forma net loss per share:
  Basic.....................................................  $      (.04)
                                                              ===========
  Diluted...................................................  $      (.04)
                                                              ===========
Pro forma basic and diluted weighted average shares
  outstanding...............................................    4,300,113
                                                              ===========
</TABLE>
 
        The accompanying notes are an integral part of these statements.
                                       F-4
<PAGE>   36
 
                            BLUE FISH CLOTHING, INC.
 
                       STATEMENTS OF STOCKHOLDERS' EQUITY
 
<TABLE>
<CAPTION>
                                                   ADDITIONAL   RETAINED
                                         COMMON     PAID-IN     EARNINGS    TREASURY
                                          STOCK     CAPITAL     (DEFICIT)     STOCK        TOTAL
                                         -------   ----------   ---------   ---------   -----------
<S>                                      <C>       <C>          <C>         <C>         <C>
Balance, January 1, 1996...............  $ 5,849   $  503,471   $ 711,819   $(230,000)  $   991,139
  Sale of Common stock in initial
     public offering, net of
     expenses..........................      787    3,214,597          --          --     3,215,384
  S corporation distribution...........       --           --    (454,109)         --      (454,109)
  Reclassification of S corporation
     earnings..........................       --      257,710    (257,710)         --            --
  Exercise of Common stock options.....       12       51,988          --          --        52,000
  Net loss.............................       --           --     (37,140)         --       (37,140)
                                         -------   ----------   ---------   ---------   -----------
Balance, December 31, 1996.............    6,648    4,027,766     (37,140)   (230,000)    3,767,274
  S corporation distributions..........       --           --     (44,041)         --       (44,041)
  Retirement of treasury stock.........   (2,049)    (227,951)         --     230,000            --
  Net loss.............................       --           --    (382,809)         --      (382,809)
                                         -------   ----------   ---------   ---------   -----------
Balance, December 31, 1997.............  $ 4,599   $3,799,815   $(463,990)  $      --   $ 3,340,424
                                         =======   ==========   =========   =========   ===========
</TABLE>
 
        The accompanying notes are an integral part of these statements.
                                       F-5
<PAGE>   37
 
                            BLUE FISH CLOTHING, INC.
 
                            STATEMENTS OF CASH FLOWS
 
<TABLE>
<CAPTION>
                                                                YEAR ENDED DECEMBER 31
                                                              --------------------------
                                                                 1996           1997
                                                              -----------    -----------
<S>                                                           <C>            <C>
Operating Activities:
  Net loss..................................................  $   (37,140)   $  (382,809)
  Adjustments to reconcile net loss to net cash used in
     operating activities --
     Deferred tax (benefit) expense.........................     (237,997)       237,995
     Provision for deferred rent............................           --         67,553
     Depreciation and amortization..........................      214,776        428,563
     Provision for losses on accounts receivable............       (1,452)        46,231
     Decrease (increase) in assets --
       Accounts receivable..................................      293,361       (701,036)
       Inventories..........................................     (978,729)        61,551
       Other assets.........................................     (220,010)        30,610
     Increase (decrease) in liabilities --
       Accounts payable.....................................      109,115        (40,774)
       Accrued expenses.....................................      105,812        (32,294)
       Accrued bonus........................................     (402,989)            --
                                                              -----------    -----------
          Net cash used in operating activities.............   (1,155,253)      (284,410)
                                                              -----------    -----------
Investing Activities:
  Payments for purchases of property and equipment..........     (425,476)    (1,191,832)
  Purchases of certificates of deposit......................           --       (800,000)
  Deposit on corporate facility.............................           --       (200,000)
                                                              -----------    -----------
          Net cash used in investing activities.............     (425,476)    (2,191,832)
                                                              -----------    -----------
Financing Activities:
  Borrowings on line of credit, net.........................      500,000       (500,000)
  (Decrease) increase in receivable purchase line of credit,
     net....................................................     (406,699)       757,184
  Borrowing on long-term debt...............................      450,000        800,000
  Repayments on long-term debt..............................     (173,766)      (145,519)
  Payments on capital lease obligations.....................      (24,052)       (53,180)
  S corporation distributions paid..........................     (556,266)       (44,041)
  Proceeds from economic development grant..................           --        200,000
  Net proceeds from initial public offering.................    3,461,974             --
  Exercise of employee stock options........................       52,000             --
                                                              -----------    -----------
          Net cash provided by financing activities.........    3,303,191      1,014,444
                                                              -----------    -----------
Net increase (decrease) in cash and cash equivalents........    1,722,462     (1,461,798)
Cash and cash equivalents, beginning of period..............      205,878      1,928,340
                                                              -----------    -----------
Cash and cash equivalents, end of period....................  $ 1,928,340    $   466,542
                                                              ===========    ===========
Cash paid during the period for:
  Interest..................................................  $   244,438    $   293,261
                                                              ===========    ===========
  Income taxes..............................................  $     3,452    $    34,983
                                                              ===========    ===========
</TABLE>
 
        The accompanying notes are an integral part of these statements.
                                       F-6
<PAGE>   38
 
                            BLUE FISH CLOTHING, INC.
 
                         NOTES TO FINANCIAL STATEMENTS
                               DECEMBER 31, 1997
 
1.  COMPANY BACKGROUND AND BASIS OF PRESENTATION:
 
  Business
 
     Blue Fish Clothing, Inc. is a designer, manufacturer, wholesaler and
retailer of specialty block-printed merchandise sold to upscale department and
specialty stores throughout the United States and through five Company-owned
specialty stores.
 
  Going Concern
 
     As shown in the accompanying financial statements, the Company incurred
losses in 1996 and 1997. The Company experienced a reduction in net sales in the
first quarter of 1998 as compared to the first quarter of 1997 and expects to
report a loss in the first quarter of 1998. In addition, the Company has
committed to capital and lease obligations which require funding in 1998 (see
Note 12). The Company's existing financing structure is not deemed adequate to
support the projected 1998 cash flow needs. These factors, among others, raise
substantial doubt about the Company's ability to continue as a going concern for
a reasonable period of time.
 
     The financial statements do not include any adjustments relating to the
recoverability and classification of recorded asset amounts and the amount and
classification of liabilities that might be necessary should the Company be
unable to continue as a going concern. The Company's continuation as a going
concern is dependent upon its ability to generate sufficient cash flow to meet
its obligations on a timely basis, to comply with the terms of its financing
agreements, to obtain equity investments, additional financing or increased
availability, as may be required and ultimately to attain successful operations.
Management is currently seeking equity investments, reorganizing its marketing
function, refining its operating structure and has begun negotiations for
additional financing so that it can meet its obligations and sustain operations.
There can be no assurance, however, that Management's efforts will ultimately be
successful.
 
2.  SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:
 
  Management's 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 reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
 
  Cash and Cash Equivalents
 
     The Company considers all highly liquid debt instruments purchased with an
original maturity of three months or less, amounts due from bankcard sales,
restricted cash and amounts in transit from bank for factored receivables to be
cash equivalents for the purpose of determining cash flows.
 
  Marketable Securities
 
     The Company's investment in certificates of deposit is reported at fair
value. Interest earned is recorded in interest expense, net, in the accompanying
financial statements.
 
                                       F-7
<PAGE>   39
                            BLUE FISH CLOTHING, INC.
 
                  NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
 
  Accounts Receivable
 
     Accounts receivable are transferred with recourse to a third party for
processing under a business manager receivable purchase line of credit. The
Company borrows against these receivables for working capital purposes (see Note
6).
 
  Preopening Costs
 
     Costs incurred prior to opening a store are charged to expense over a
six-month period after the store commences operations. Preopening costs of
approximately $42,587 are included in other current assets at December 31, 1997.
 
  Advertising Costs
 
     The Company capitalizes and amortizes the costs associated with direct
response advertising over its expected period of future benefit. Direct response
advertising consists primarily of seasonal catalogs. The capitalized costs of
the advertising are amortized throughout the sales season associated with the
catalog. All other advertising costs are expensed as incurred. At December 31,
1997, $19,340 of advertising was recorded in other current assets. Advertising
expense was $311,944 and $153,114 in 1996 and 1997, respectively.
 
  Inventories
 
     Inventories are stated at the lower of cost (first-in, first-out) or
market. Inventories manufactured by the Company include the cost of materials,
freight, direct labor and manufacturing overhead.
 
  Property and Equipment
 
     Property and equipment are stated at cost. Depreciation and amortization is
calculated using the straight-line method based on the estimated useful lives of
the assets as follows:
 
<TABLE>
<S>                                <C>
Automobiles......................  3-5 years
Fixtures and equipment...........  5-7 years
                                   Lesser of useful life or lease
Leasehold improvements...........  term
</TABLE>
 
     Repair and maintenance costs are charged to operations, while additions and
betterments are capitalized. The cost and related accumulated depreciation of
assets sold or retired are eliminated from the accounts, and any gains or losses
are reflected in operations.
 
  Long-lived Assets
 
     Long-lived assets and certain identifiable intangibles are reviewed for
impairment whenever events or changes in circumstances indicate that full
recoverability is questionable. Management evaluates the recoverability of
long-lived assets using several factors in the valuation including, but not
limited to, management's future operating plans, recent operating results and
projected cash flows.
 
  Accrued Expenses
 
     Accrued expenses include payroll and related costs of $210,627 as of
December 31, 1997.
 
  Income Taxes
 
     Effective January 1, 1993, the Company adopted the Statement of Financial
Accounting Standards No. 109 ("SFAS") No. 109, "Accounting for Income Taxes."
The effect of this statement is to take principally a balance sheet approach to
providing deferred income taxes. Deferred tax balances will be
 
                                       F-8
<PAGE>   40
                            BLUE FISH CLOTHING, INC.
 
                  NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
 
adjusted through the income statement to reflect the current year estimate of
future tax payments. In May 1996, the Company elected to terminate its S
Corporation status and become a C Corporation. A deferred tax asset of
approximately $174,000 was recorded by the Company in May 1996, to record the
future tax benefits that will accrue to the C Corporation for tax differences
that existed at the date of the C Corporation election.
 
     Prior to May 1996, the Company had elected not to be taxed as a corporation
and the shareholders had consented to include the income or loss in their
individual federal and state income tax returns. The Company made cash
distributions to shareholders for their estimated tax liability. Prior to May
1996, the Company recorded a provision for state income taxes for those states
that did not recognize or partially recognize S Corporations.
 
  Major Customers and Concentration of Credit Risk
 
     The Company has one significant customer that accounted for 10.4% and 15.1%
of net sales for the years ended December 31, 1996 and 1997, respectively. This
same customer accounted for 10.8% of net accounts receivable at December 31,
1997.
 
     The Company manufactures and retails specialty block-printed merchandise
and accessories, and has five specialty stores located in Frenchtown, New
Jersey; Santa Fe, New Mexico; Soho, New York; Westport, Connecticut, and Austin,
Texas. In addition, the Company sells manufactured merchandise to other
retailers. The Company grants credit to substantially all of its wholesale
customers, the majority of whom are in the apparel industry.
 
  Net Income (Loss) Per Share
 
     In 1997, the Company adopted SFAS No. 128, "Earnings per Share." SFAS No.
128 establishes standards for computing and presenting earnings per share
("EPS"). SFAS No. 128 simplifies the standards for computing earnings per share
previously found in Accounting Principles Board ("APB") Opinion No. 15,
"Earnings per Share." It replaces the presentation of primary EPS with a
presentation of basic EPS and requires dual presentation of basic and diluted
EPS on the face of the income statement.
 
     Basic EPS excludes dilution and is computed by dividing income available to
common stockholders by the weighted-average number of common shares outstanding
for the period. Diluted EPS reflects the potential dilution that could occur if
securities or other contracts to issue Common stock were exercised or converted
into Common stock or resulted in the issuance of Common stock that would then
share in the earnings of the entity.
 
     Due to the Company's net loss position in 1996 and 1997, the inclusion of
common share equivalents had an anti-dilutive effect when calculating diluted
earnings per share and, as a result, diluted EPS was equivalent to basic EPS for
those years.
 
     Pro forma net (loss) per share was calculated by dividing pro forma net
(loss) by the weighted average number of shares of Common stock outstanding for
the respective period. On February 3, 1998, the Securities and Exchange
Commission issued Staff Accounting Bulletin ("SAB") No. 98 which requires
registrants to restate earnings per share in conformity with SFAS No. 128 and
SAB No. 98. This restatement of 1996 pro forma net loss per share had an
immaterial impact.
 
  Recently Issued Accounting Pronouncements
 
     In June 1997, the Financial Accounting Standards Board issued SFAS No. 131,
"Disclosure About Segments of an Enterprise and Related Information." This
statement establishes additional standards for segment reporting in the
financial statements and is effective for fiscal years beginning after December
15,
 
                                       F-9
<PAGE>   41
                            BLUE FISH CLOTHING, INC.
 
                  NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
 
1997. Management is evaluating the effect that SFAS No. 131 will have on its
financial statement presentation.
 
     On March 4, 1998, Statement of Position ("SOP") No. 98-1, "Accounting for
the Costs of Computer Software Developed or Obtained for Internal Use" was
issued which requires capitalization of certain costs related to the development
of software for internal use. This SOP must be adopted for fiscal years
beginning after December 15, 1998. The Company intends to adopt this SOP on
January 1, 1999.
 
3.  PUBLIC OFFERING AND PRO FORMA INFORMATION:
 
     On May 15, 1996, the Company sold 787,200 shares of Common stock in a
public offering at a price of $5 per share. The offering was registered under
the Securities Act of 1933. Net proceeds to the Company, after deducting
offering expenses, were approximately $3,215,000. Upon the closing of the
offering, offering costs deferred prior to the offering were reclassified to
stockholders' equity and the Company converted to C Corporation status and
recorded deferred income tax assets of $174,000 (see Note 11). All S Corporation
earnings were reclassified to additional paid-in capital.
 
     See Notes 2 and 11 for pro forma income statement data relating to earnings
per share and income taxes for 1996.
 
4.  INVENTORIES:
 
<TABLE>
<CAPTION>
                                                          DECEMBER 31,
                                                              1997
                                                          ------------
<S>                                                       <C>
Raw materials...........................................   $  296,700
Work-in-process.........................................      810,737
Finished goods, net.....................................    1,836,729
                                                           ----------
                                                           $2,944,166
                                                           ==========
</TABLE>
 
5.  PROPERTY AND EQUIPMENT:
 
     Property and equipment is made up of the following at December 31, 1997:
 
<TABLE>
<S>                                                        <C>
Automobiles..............................................  $   58,303
Fixtures and equipment...................................   1,885,151
Leasehold improvements...................................     774,610
                                                           ----------
                                                            2,718,064
Less -- Accumulated depreciation and amortization........     819,575
                                                           ----------
     Net property and equipment..........................  $1,898,489
                                                           ==========
</TABLE>
 
     Depreciation and amortization expense was $180,776 and $371,896 for the
years ended December 31, 1996 and 1997, respectively.
 
6.  FACTORING AND FINANCING AGREEMENTS:
 
     During 1997, the Company utilized a business manager receivable purchase
line of credit agreement with a bank which permitted borrowings against
receivables of up to $1.5 million. This line has been extended through March
1999, however can be terminated by either party upon notice, as defined.
 
     Borrowings are collateralized by a stockholder guarantee and a first lien
on all accounts receivable, inventory, equipment, fixtures and deposit accounts.
Borrowings under this agreement, the line of credit (see Note 7) and the note
payable to a bank (see Note 8) contain cross-default and cross-collateralization
 
                                      F-10
<PAGE>   42
                            BLUE FISH CLOTHING, INC.
 
                  NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
 
provisions. The Company can borrow up to 90% of these receivables. This amount
can be adjusted at the discretion of the bank. The remainder is held in escrow
until collected. Restricted cash of $116,065 was held in escrow at December 31,
1997. Interest was charged at 1.75% of all receivables assigned to the bank for
collection. This amount was reduced to 1.5% in January 1997. Interest expense
under these agreements was $116,681 and $130,513 during 1996 and 1997,
respectively. The Company is responsible to reimburse the bank for all
uncollectible accounts previously assigned to the bank for collection. The
accounts receivable assigned to the bank for collection and amounts borrowed
from the bank are included in accounts receivable and receivable purchase line
of credit, respectively, until collected by the bank.
 
7.  LINE OF CREDIT:
 
     In February 1995, the Company entered into an agreement with a bank for a
$500,000 line of credit. In February 1996, the Company entered into a new $1
million revolving line of credit with the bank for the purchase of inventory.
Borrowings are limited to 50% of finished goods plus 25% of work in process
inventory. On June 27, 1997, the Company paid $500,000 and modified the note
reducing the outstanding principal balance to $500,000. Borrowings on this
facility bear interest at prime plus .75% (9.25% at December 31, 1997). Interest
is payable monthly and the principal is payable on demand or in full on April
30, 1998, if no demand has been made.
 
     At December 31, 1997, $500,000 was outstanding under this line and interest
expense under these lines of $62,239 and $73,166 was incurred during 1996 and
1997, respectively. The weighted average interest rate was 9.18%, and 9.17% in
1996 and 1997, respectively. See Note 6 for guarantee, collateral and
cross-default and cross-collateralization provisions also applicable to this
line of credit.
 
     Subsequent to year end, the revolving note was increased to $1,000,000 and
the term was extended to April 30, 1999. As of March 12, 1998, the Company can
borrow up to $1,000,000 based on the above borrowing base of which $500,000 was
outstanding. The Company is continuing to hold discussions with the bank
regarding the terms and conditions under which the remaining availability under
the line could be borrowed.
 
8.  LONG-TERM DEBT:
 
<TABLE>
<CAPTION>
                                                          DECEMBER 31,
                                                              1997
                                                          ------------
<S>                                                       <C>
Note payable to a bank..................................   $  800,000
Note payable to a current stockholder of the Company....      345,000
Obligations under capital leases........................       99,356
Other...................................................       33,625
                                                           ----------
                                                            1,277,981
Less -- Current portion.................................      222,786
                                                           ----------
Long-term debt, net of current portion..................   $1,055,195
                                                           ==========
</TABLE>
 
     On June 25, 1997, the Company obtained a $800,000 note payable to a bank.
Interest is payable monthly beginning July 25, 1997 and is calculated on the
unpaid principal balance at an interest rate of two percentage points over the
index. The index represents the one year certificate of deposit yield (7.9% at
December 31, 1997). Four principal payments of $50,000 are due in annual
installments commencing June 25, 1998 and one principal payment of $600,000 is
due on June 25, 2002. This note is secured by a $300,000 certificate of deposit
and guaranteed by Jennifer Barclay, a principal stockholder. In addition, the
Company agreed to maintain a minimum deposit account with the bank in an amount
not less than $500,000. See Note 6 for cross default and cross collateralization
provisions associated with the factoring agreement.
 
                                      F-11
<PAGE>   43
                            BLUE FISH CLOTHING, INC.
 
                  NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
 
     In January 1996, the Company's majority stockholder withdrew $450,000 of
the taxed but undistributed S Corporation earnings. The stockholder loaned these
funds back to the Company on an unsecured basis. The Company borrowed these
funds from the stockholder and issued a promissory note in the amount of
$450,000 and bearing interest at 7%. Interest is payable monthly, and the
principal is due on demand subject to certain limitations, as defined, including
limiting payment to $100,000 in any 12-month period.
 
     The Company has entered into capital leases for various pieces of equipment
that expire in 1999, with aggregate monthly payments of $6,070 at December 31,
1997. The capitalized costs of $206,780 are included in fixtures and equipment
with accumulated amortization of $118,917 at December 31, 1997. The present
value of the minimum lease payments is as follows:
 
<TABLE>
<CAPTION>
                                                          DECEMBER 31,
                                                              1997
                                                          ------------
<S>                                                       <C>
Total minimum lease payments............................    $111,633
Less -- Amount representing interest....................     (12,277)
                                                            --------
     Present value of net minimum lease payments........    $ 99,356
                                                            ========
</TABLE>
 
     Maturities as of December 31, 1997, are as follows:
 
<TABLE>
<CAPTION>
                                                LONG-TERM     CAPITAL
                                                   DEBT       LEASES
                                                ----------    -------
<S>                                             <C>           <C>
1998..........................................  $  163,911    $58,875
1999..........................................     161,373     40,481
2000..........................................     203,341         --
2001..........................................      50,000         --
2002..........................................     600,000         --
                                                ----------    -------
                                                $1,178,625    $99,356
                                                ==========    =======
</TABLE>
 
     In 1996, the Company entered into a capital lease obligation for $125,469.
This non-cash transaction is reflected in the Company's financial statements.
 
9.  STOCKHOLDERS' EQUITY:
 
     In September 1995, the sole stockholder contributed 304,000 shares of
Common stock to the Company, and the Company granted 304,000 shares of Common
stock to an officer. The market value of the Common stock on the date of grant
was $1.58 per share, which resulted in $480,320 compensation expense charged.
The Company also recorded an increase in paid-in capital for the compensation
expense. In addition, the Company agreed to reimburse the officer for any and
all taxes that may be imposed as a result of this grant. This reimbursement of
$392,989 was deemed additional compensation expense at the date of grant. The
reimbursement was paid in 1996. All shares granted were restricted and are
subject to purchase by the Company for total consideration of $1.00 in the event
the officer voluntarily terminates his employment or is terminated for cause
within two years.
 
10.  SAVINGS PLAN AND STOCK OPTIONS PLAN:
 
     In March 1995, the Company established the Blue Fish 401(k) Savings and
Investment Plan. All employees who have attained age 21 and completed 1,000
hours of service in a plan year are eligible to participate. Employees can
contribute up to 10% of their compensation subject to certain limitations.
Employer contributions are discretionary. During 1996 and 1997, the Company
accrued $45,667 and $42,419 as estimated contributions.
 
                                      F-12
<PAGE>   44
                            BLUE FISH CLOTHING, INC.
 
                  NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
 
     In September 1995, the Company adopted the Blue Fish Clothing, Inc. 1995
Stock Option Plan. A total of 570,000 shares of Common stock have been reserved
for issuance to the Company's employees, officers, directors (who are employees)
and consultants. Qualified and nonqualified stock options will be granted at the
discretion of the Compensation Committee (subject to certain plan limitations)
at exercise prices at least equal to the fair market value of the Common stock
for qualified incentive stock options. The Company issued options to purchase
209,000 shares of Common stock to certain officers and key employees during
1995. During 1996 and 1997, the Company issued options to purchase 26,300 and
40,000 shares, respectively, of Common stock to employees and consultants.
Employee's options vest 20% upon grant and 20% per year thereafter and are
exercisable for nine years. Consultant options vest on January 1, 1997 and
January 1, 1998 and are exercisable for 5 years.
 
Information with respect to the 1995 Stock Option Plan is as follows:
 
<TABLE>
<CAPTION>
                                                                       AGGREGATE    OPTION PRICE
                                                            SHARES       PRICE       PER SHARE
                                                            -------    ---------    ------------
<S>                                                         <C>        <C>          <C>
Outstanding, January 1, 1996..............................  209,000    $ 876,000     $4.00-5.00
  Granted.................................................   26,300      187,100      7.00-7.25
  Exercised...............................................  (12,000)     (52,000)     4.00-5.00
  Canceled................................................  (42,000)    (184,000)     4.00-5.00
                                                            -------    ---------
Outstanding, December 31, 1996............................  181,300      827,100      4.00-7.25
  Granted.................................................   40,000      178,750      3.75-4.75
  Exercised...............................................       --           --             --
  Canceled................................................  (20,000)    (100,000)          5.00
                                                            -------    ---------
Outstanding, December 31, 1997............................  201,300    $ 905,850      3.75-7.25
                                                            =======    =========
</TABLE>
 
     At December 31, 1997, there were 356,700 options available for future grant
under the 1995 Stock Option Plan. In addition, there were 100,720 exercisable
options at prices ranging from $3.75 to $7.25 per share. The aggregate exercise
price of these options was $443,290. The weighted average remaining contractual
life of these options is approximately 7 years.
 
     In September 1995, the Company adopted the Blue Fish Clothing, Inc. 1995
Non-Employee Directors' Stock Option Plan. A total of 75,000 shares of Common
stock have been reserved for issuance to directors who are not employees of the
Company. Non-employee directors will receive non-qualified stock options to
purchase an amount of shares equal to $7,500 at the then fair market value on
January 1 of each year commencing January 1, 1996, and options to purchase
shares equal to $2,500 at the then prevailing fair market value for each
committee on which they serve. On January 1, 1996 and 1997, the Company granted
options to purchase 2,500 shares and 2,700, respectively, to each of the
nonemployee directors at $5.00 and $4.63, respectively, per share. The options
were fully vested on date of grant. No options have been exercised through
December 31, 1997.
 
     The Company has elected to follow APB Opinion No. 25, "Accounting for Stock
Issued to Employees," in accounting for its stock options granted to employees
and directors. Under APB No. 25, no compensation expense is recognized because
the exercise price of the Company's stock options equals the market price of the
underlying stock on the date of the grant. If compensation cost for these plans
had been determined under
 
                                      F-13
<PAGE>   45
                            BLUE FISH CLOTHING, INC.
 
                  NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
 
SFAS No. 123, "Accounting for Stock-Based Compensation," the Company's pro forma
net loss per share for 1996 and net loss per share for 1997 would have been
increased to the following pro forma amounts:
 
<TABLE>
<CAPTION>
                                                 1996         1997
                                               ---------    ---------
<S>                                            <C>          <C>
Net loss -- as reported......................  $(193,145)   $(382,809)
Net loss -- as adjusted......................   (295,670)    (520,256)
Basic and diluted net loss per share --
  as reported................................       (.04)        (.08)
Basic and diluted net loss per share --
  as adjusted................................       (.07)        (.11)
</TABLE>
 
     The fair value of the options were estimated on the date of grant using a
Black-Scholes option pricing model with the following weighted-average
assumptions used for grants in 1996 and 1997, respectively: risk-free interest
rates of 6.6% and 6.8%; no dividend yield for both years; expected volatility of
52% for both years; and a weighted average expected life of the options of 7
years.
 
     Because the accounting under SFAS No. 123 has not been applied to options
granted prior to January 1, 1995, the resulting pro forma compensation cost may
not be representative of that to be expected in future years.
 
11.  INCOME TAXES:
 
     For informational purposes, the accompanying statements of operations for
the year ended December 31, 1996, include an unaudited pro forma adjustment for
the income taxes that would have been recorded if the Company had not been an S
Corporation, based on the tax laws in effect during the respective period.
 
     Income tax (benefit) expense for the years ended December 31, 1996 and 1997
is comprised of the following:
 
<TABLE>
<CAPTION>
                                                   1996
                                                 PRO FORMA      1997
                                                 ---------    --------
<S>                                              <C>          <C>
Current (benefit) expense......................  $     --     $     --
Deferred (benefit) expense.....................   (81,990)     237,995
                                                 --------     --------
                                                 $(81,990)    $237,995
                                                 ========     ========
</TABLE>
 
     The reconciliation of the statutory federal rate to the Company's effective
income tax rate on the loss for the year ended December 31, 1996 and 1997 is as
follows:
 
<TABLE>
<CAPTION>
                                              PRO FORMA
                                              YEAR ENDED      YEAR ENDED
                                             DECEMBER 31,    DECEMBER 31,
                                                 1996            1997
                                             ------------    ------------
<S>                                          <C>             <C>
Federal statutory tax rate.................     (34.0)%         (34.0)%
State tax benefit, net of Federal tax......      (5.1)           (4.5)
Other, predominantly nondeductible travel
  and entertainment........................       4.2             7.8
Valuation allowance........................       5.1           195.0
                                                -----           -----
(Benefit) expense..........................     (29.8)%         164.3%
                                                =====           =====
</TABLE>
 
                                      F-14
<PAGE>   46
                            BLUE FISH CLOTHING, INC.
 
                  NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
 
     The deferred tax effects of temporary differences giving rise to the
Company's deferred income tax assets and liabilities at December 31, 1997 are as
follows:
 
<TABLE>
<S>                                                        <C>
Deferred tax assets:
  Net operating loss carryforwards.......................  $ 395,525
  Accruals and reserves not currently deductible for
     tax.................................................     55,460
  Valuation allowance....................................   (329,786)
                                                           ---------
                                                             121,199
Deferred tax liabilities:
  Depreciation...........................................   (106,719)
  Other deferred tax liabilities.........................    (14,480)
                                                           ---------
                                                           $      --
                                                           =========
</TABLE>
 
     Due to recurring losses, the realization of the deferred tax asset is
uncertain. Therefore, the Company has provided a full valuation allowance. The
Federal net operating loss carryforward begins to expire in 2011.
 
12.  COMMITMENTS AND CONTINGENCIES:
 
  Operating Leases
 
     The Company leases its retail, production, office facilities and other
equipment under various noncancelable operating leases. Operating leases
generally range from 5 to 10 years.
 
     In December 1996, the Company entered into a lease for a new Corporate
facility. The lease is currently scheduled to commence in June 1998. Minimum
lease payments are due monthly and begin at $267,120 per year and increase 3%
per year throughout the term plus a common area maintenance charge of the
greater of $15,000 or 5% of base rent.
 
     In 1997, the lease was amended and obligates the Company to purchase the
Corporate facility and other buildings in the complex for $3,800,000 during the
sixth year after the Company takes possession of the premises. A deposit of
$200,000 was required which will be applied to the purchase price of the
property. This was funded through receipt of an economic development grant and
has been included in other non-current liabilities on the accompanying balance
sheet until all obligations related to the grant have been achieved. In
addition, the Company is obligated to make payments of approximately $340,000
related primarily to building improvements at this site. The lease will be
accounted for as a capital lease upon commencement.
 
     Rental expense, including certain maintenance expenditures, was $395,151
and $696,830 for the years ended December 31, 1996 and 1997, respectively.
Future minimum rental payments due under noncancelable operating leases
(excluding the new Corporate facility) are as follows:
 
<TABLE>
<S>                                                        <C>
1998.....................................................  $  742,477
1999.....................................................     623,221
2000.....................................................     488,705
2001.....................................................     368,702
2002.....................................................     322,090
Thereafter...............................................   1,397,102
                                                           ----------
          Total minimum lease payments...................  $3,942,297
                                                           ==========
</TABLE>
 
     In addition to the above commitment, one store location is currently
operating under a month-to-month lease.
 
                                      F-15
<PAGE>   47
                            BLUE FISH CLOTHING, INC.
 
                  NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
 
  Employment Agreement and Covenant Not to Compete
 
     Effective January 1, 1994, the Company entered into a three-year employment
agreement and covenant not to compete with an officer that provides for annual
compensation of $105,000 per year plus a 3% annual bonus based on Company net
after tax profits (as defined) plus an additional 1% bonus that is calculated
annually and due in five annual installments beginning January 1, 1999. On March
1, 1998, the officer resigned effective March 27, 1998. Salary and benefits will
continue for 6 months and a bonus will be available based on Company performance
for a period of 1998.
 
  Other
 
     From time to time the Company is named as a defendant in legal actions
arising from its normal business activities. Although the amount of any
liability that could arise with respect to currently pending actions cannot be
accurately predicted, in the opinion of the Company, any such liability will not
have a material adverse effect on the financial position or operating results of
the Company.
 
13.  RELATED-PARTY TRANSACTIONS:
 
     The Company leases one of its store locations from the father of the
principal stockholder under a ten-year operating lease for approximately $35,000
per year. The Company also leases additional office space from this individual
on a month-to-month basis for approximately $11,000 per year.
 
                                      F-16