SECURITIES AND EXCHANGE COMMISSION
                             Washington, D.C. 20549

                                   ----------

                                    FORM 10-Q

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

                  For the quarterly period ended March 31, 1998
                           Commission File No. 0-23629

                                Happy Kids, Inc.
             ------------------------------------------------------
             (Exact Name of Registrant as Specified in Its Charter)


         New York                                        13-3473638
-------------------------------             ------------------------------------
(State or Other Jurisdiction of             (I.R.S. Employer Identification No.)
Incorporation or Organization)


100 West 33rd Street, Suite 1100, New York, New York                     10001
--------------------------------------------------------------------------------
(Address of Principal Executive Offices)                            (Zip Code)


                                 (212) 695-1151
                         -------------------------------
                         (Registrant's Telephone Number,
                              Including Area Code)


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

              Yes:                          No:   X*
                  -------                      -------


      Indicate  the number of shares  outstanding  of each of the  Registrant's
classes of common stock, as of April 30, 1998:

           Class                                      Number of Shares
           -----                                      ----------------

  Common Stock, $.01 par value                           10,280,000


*Registrant became subject to the filing requirements of the Securities Exchange
Act of 1934 on April 2, 1998, when its  Registration  Statements on Form S-1 and
Form 8-A were  declared  effective  by the  Commission.  On April 8,  1998,  the
Company  consummated  its initial  public  offering of  2,200,000  shares of its
common stock at a price of $10.00 per share all of which were issued and sold by
the  Company.  On April 23,  1998,  the  Company  issued and sold an  additional
330,000  shares of its Common  Stock at the  initial  public  offering  price of
$10.00 per share upon the  consummation  of the  exercise  of the  underwriters'
over-allotment  option  granted by the  Company in  connection  with its initial
public offering.


<PAGE>


                        HAPPY KIDS, INC. AND SUBSIDIARIES

                                TABLE OF CONTENTS
                                -----------------


                                                                         Page
                                                                         ----


PART I. CONDENSED CONSOLIDATED FINANCIAL INFORMATION....................   1

        Item 1. Condensed Consolidated Financial Statements.............   1

               Condensed Consolidated Balance Sheets as of March
                 31,1998 and Pro Forma March 31, 1998 (unaudited) and
                 December 31, 1997......................................   2

               Condensed Consolidated Statements of Income (unaudited)
                 for the Three Months Ended March 31, 1998 and 1997.....   3

               Condensed Consolidated Statements of Cash Flows for the
                 Three Months Ended March 31, 1998 and 1997
                 (unaudited)............................................   4

               Notes to Condensed Consolidated Financial Statements
                 (unaudited)............................................   5

        Item 2. Management's Discussion and Analysis of Financial
                Condition and Results of Operations.....................  10

               Results of Operations....................................  11

               Liquidity and Capital Resources..........................  12

               Backlog..................................................  14

               Management Information Systems...........................  14

               Effect of Recently Issued Accounting Standards...........  14

PART II. OTHER INFORMATION..............................................  16

        Item 2. Changes in Securities and Use of Proceeds...............  16

        Item 5. Other Information.......................................  17

        Item 6. Exhibits and Reports on Form 8-K........................  18

SIGNATURES..............................................................  19


                                      -i-


<PAGE>




















              PART I. CONDENSED CONSOLIDATED FINANCIAL INFORMATION
              ----------------------------------------------------

               ITEM 1. CONDENSED CONSOLIDATED FINANCIAL STATEMENTS




















                                      -1-


<PAGE>


<TABLE>
<CAPTION>

                                      HAPPY KIDS, INC. AND SUBSIDIARIES
                                    CONDENSED CONSOLIDATED BALANCE SHEETS
                                   (In thousands, except per share amounts)


                                                                                  Pro Forma
                                                                                  March 31,
                                                                    March 31,         1998      December 31,
                                                                      1998          (Note 4)       1997
                                                                  -----------     -----------   ------------
                                                                  (unaudited)     (unaudited)
                  ASSETS
<S>                                                                <C>              <C>           <C>    
CURRENT ASSETS
   Cash ....................................................       $   223          $   223       $   374
   Due from factor .........................................        26,234           26,234        24,232
   Accounts receivable - trade (net of allowance of
     $513 at March 31, 1998 and December 31, 1997) .........           291              291           316
   Inventories .............................................        13,959           13,959        16,316
   Due from shareholders ...................................           347             --             347
   Other current assets ....................................         1,289            2,313         1,139
                                                                   -------          -------       -------
         Total current assets ..............................        42,343           43,020        42,724
FIXED ASSETS - NET .........................................         1,423            1,423         1,476
OTHER ASSETS ...............................................         1,005            1,005           752
                                                                   -------          -------       -------
         Total assets ......................................       $44,771          $45,448       $44,952
                                                                   =======          =======       =======

              LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES
   Due to bank .............................................       $27,181          $27,181       $24,863
   Current portion - capital lease obligations .............            44               44            49
   Accounts payable and accrued liabilities ................         6,986            6,986        11,393
   Due to shareholders .....................................          --              2,863          --
                                                                   -------          -------       -------
         Total current liabilities .........................        34,211           37,074        36,305

DEFERRED RENT PAYABLE ......................................           564              564           584
CAPITAL LEASE OBLIGATIONS ..................................             6                6            19
DUE TO SHAREHOLDERS ........................................         1,400            5,937         1,400
COMMITMENTS
SHAREHOLDERS' EQUITY:
   Preferred stock - 5,000 shares authorized, $.01 par
     value; no shares issued and outstanding ...............          --               --            --
   Common stock - 30,000 shares authorized, $.01 par
     value; 7,750 shares issued and outstanding at March
     31, 1998 and December 31, 1997, respectively ..........            78               78            78
   Additional paid-in capital ..............................         1,119            1,119         1,119
   Retained earnings .......................................         7,393              670         5,447
                                                                   -------          -------       -------
         Total shareholders' equity ........................         8,590            1,867         6,644
                                                                   -------          -------       -------
         Total liabilities and shareholders' equity ........       $44,771          $45,448       $44,952
                                                                   =======          =======       =======


                      The accompanying notes are an integral part of these statements.
</TABLE>


                                                     -2-
<PAGE>


<TABLE>
<CAPTION>

                             HAPPY KIDS, INC. AND SUBSIDIARIES
                        CONDENSED CONSOLIDATED STATEMENTS OF INCOME
                         (In thousands, except per share amounts)

                                                                For the Three Months
                                                                  Ended March 31,
                                                          -------------------------------
                                                              1998                1997
                                                          -----------         -----------
                                                          (unaudited)         (unaudited)

<S>                                                        <C>                 <C>      
Net sales ............................................     $  35,715           $  24,811
Cost of goods sold ...................................        27,084              18,454
                                                           ---------           ---------
     Gross profit ....................................         8,631               6,357
                                                           ---------           ---------
Operating expenses:
     Selling, design and shipping ....................         2,965               2,440
     General and administrative ......................         2,104               1,811
                                                           ---------           ---------
        Total operating expenses .....................         5,069               4,251
                                                           ---------           ---------
        Operating earnings ...........................         3,562               2,106
                                                           ---------           ---------
Interest expense, net ................................           990                 694
                                                           ---------           ---------
        Income before income taxes ...................         2,572               1,412

Income taxes .........................................           260                 143
                                                           ---------           ---------
        Net income ...................................     $   2,312           $   1,269
                                                           =========           =========
Basic and diluted income per common share ............     $    0.30           $    0.16
                                                           =========           =========
Weighted average common shares outstanding ...........         7,750               7,750
                                                           =========           =========
Pro forma data (unaudited):
     Historical income before provision for income
        taxes ........................................     $   2,572           $   1,412
     Income taxes ....................................         1,080                 593
                                                           ---------           ---------
        Net income ...................................     $   1,492           $     819
                                                           =========           =========
Pro forma net income per share .......................     $    0.18           $    0.11
                                                           =========           =========
Pro forma weighted average common shares
  outstanding ........................................         8,521               7,750
                                                           =========           =========


             The accompanying notes are an integral part of these statements.
</TABLE>


                                           -3-
<PAGE>


<TABLE>
<CAPTION>
                            HAPPY KIDS, INC. AND SUBSIDIARIES
                     CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
                                      (In thousands)

                                                                For the Three Months
                                                                   Ended March 31,
                                                             ---------------------------
                                                                1998            1997
                                                             ------------    -----------
                                                             (unaudited)     (unaudited)

<S>                                                           <C>             <C>      
Cash flows from operating activities:
   Net income ...........................................     $   2,312       $   1,269
   Adjustments to reconcile net income to net cash
     used in operating activities:
      Depreciation and amortization .....................            57             115
      Changes in operating assets and liabilities:
         Accounts receivable ............................            25             642
         Due from factor ................................        (2,002)         (4,214)
         Inventories ....................................         2,357           1,046
         Other current assets ...........................          (150)           (140)
         Other assets ...................................           (29)            530
         Accounts payable and accrued liabilities .......        (4,427)         (2,611)
                                                              ---------       ---------
   Net cash used in operating activities ................        (1,857)         (3,363)
                                                              ---------       ---------
Cash flows from investing activities:
   Acquisition of fixed assets ..........................            (4)             (6)
                                                              ---------       ---------
Cash flows from financing activities:
   Net borrowings under line of credit ..................         2,318           3,337
   Payments on capital lease ............................           (18)            (16)
   Dividends paid .......................................          (366)           (334)
   Payments on initial public offering costs ............          (224)           --
                                                              ---------       ---------
     Net cash provided by financing activities ..........         1,710           2,987
                                                              ---------       ---------
     Net decrease in cash ...............................          (151)           (382)
Cash at beginning of year ...............................           374             674
                                                              ---------       ---------
Cash at end of period ...................................     $     223       $     292
                                                              =========       =========


             The accompanying notes are an integral part of these statements.
</TABLE>


                                           -4-
<PAGE>


                                HAPPY KIDS, INC.

              NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
                                   (Unaudited)


NOTE 1 -- BASIS OF PRESENTATION:

      The  information  presented as of March 31, 1998, and for the  three-month
periods ended March 31, 1998 and 1997, is unaudited,  but, in the opinion of the
Happy Kids,  Inc.'s  (the  "Company")  management,  the  accompanying  unaudited
condensed consolidated financial statements contain all adjustments  (consisting
only of normal recurring  adjustments) which the Company considers necessary for
the fair presentation of the Company's  financial  position as of March 31, 1998
and the results of its operations and its cash flows for the three-month periods
ended March 31, 1998 and 1997.  The financial  statements  included  herein have
been prepared in accordance with generally  accepted  accounting  principles and
the  instructions  to Form 10-Q and Rule 10-01 of Regulation  S-X.  Accordingly,
certain  information  and footnote  disclosures  normally  included in financial
statements prepared in accordance with generally accepted accounting  principles
have been condensed or omitted.  These  financial  statements  should be read in
conjunction with the Company's audited  financial  statements for the year ended
December 31, 1997,  which were  included as part of the  Company's  Registration
Statement  on  Form  S-1  (Registration   No.   333-44267)  (the   "Registration
Statement"),  as declared  effective by the Securities  and Exchange  Commission
(the "SEC") on April 2, 1998.

      Results for the interim period are not  necessarily  indicative of results
that may be expected for the entire year.

      The Company was incorporated in 1988 in New York under the name O'Boy Inc.
and changed its name to Happy Kids,  Inc. in December  1997.  Historically,  the
Company operated as separate business entities,  with the first of such entities
commencing   operations  in  1979,  all  under  the  common   ownership  of  the
shareholders  of the  Company.  Immediately  prior to the  effectiveness  of the
Company's initial public offering (the "Initial Public Offering"),  as described
in Note 2, all of such separate entities became wholly-owned subsidiaries of the
Company (the  "Reorganization").  The Company issued 4,262,500 additional shares
of  common  stock,  to its then  current  shareholders,  in  exchange  for their
ownership in these separate business  entities.  All share and per share amounts
throughout  this Form  10-Q have been  restated  to  retroactively  reflect  the
Reorganization.

      The accompanying  condensed  consolidated financial statements include the
consolidated  accounts  of the  Company  and its  wholly-owned  subsidiaries  to
reflect  the  Reorganization  as  stated  above.  All  significant  intercompany
accounts and transactions have been eliminated in consolidation.



                                      -5-
<PAGE>


                                HAPPY KIDS, INC.

              NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
                                   (Unaudited)


NOTE 2 -- INITIAL PUBLIC OFFERING:

      On April 8, 1998, the Company  consummated  its Initial Public Offering of
2,200,000  shares of its Common  Stock at a price of $10.00  per  share,  all of
which  shares were issued and sold by the  Company.  The net  proceeds  from the
Initial Public Offering were $20.5 million.

      On  April  23,  1998,  the  Company   consummated   the  exercise  of  the
underwriters'  over-allotment  option granted by the Company to the underwriters
in connection with the Initial Public Offering.  As a result, the Company issued
and sold an  additional  330,000  shares of the  Company's  Common  Stock at the
Initial  Public  Offering  price of $10.00 per share.  The net  proceeds  to the
Company from such sale were $3.1 million.

      Of the total net proceeds received by the Company upon the consummation of
its Initial Public Offering and the exercise of the over-allotment  option, $2.0
million was  distributed  to certain  shareholders  of the Company in connection
with the  payment of a portion  of the S  Corporation  distribution  made by the
Company in connection with the Reorganization (the "S Corporation Distribution")
and the remaining  amount was utilized to pay down a portion of the  outstanding
balance under the  Company's  bank credit  facility (the "Line of Credit").  See
"Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations -- Liquidity and Capital Resources."


NOTE 3 -- INCOME TAXES:

      Prior to the  completion of the Initial Public  Offering,  the Company had
elected to be treated  as an S  Corporation  for  Federal  income tax  reporting
purposes. An S Corporation is generally treated like a partnership and is exempt
from Federal income taxes,  with certain  exceptions,  and  shareholders  report
their pro rata share of corporate taxable income or loss on their individual tax
returns.  A  provision  for state  income  taxes was made for those  states  not
recognizing  the  Company's S  Corporation  status.  The Company's S Corporation
status terminated on the day prior to the effectiveness of the Company's Initial
Public Offering described in Note 2.

      Subsequent to the termination of the Company's S Corporation  status,  the
Company  uses the  liability  method  for both  Federal  and  state  income  tax
purposes.  The effect of such change is  reflected  in net income and  increases
deferred tax assets and earnings by approximately  $1.0 million in the Company's
second quarter of 1998 when such termination occurs.

      The pro forma  provision  for  income  taxes  represents  the  income  tax
provision  that would have been reported had the Company been subject to Federal
and additional  state and local income taxes as a C Corporation  for all periods
presented.


                                      -6-
<PAGE>


                                HAPPY KIDS, INC.

              NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
                                   (Unaudited)


NOTE 4 -- PRO FORMA INFORMATION:

      a.  Pro Forma Balance Sheet
      ---------------------------

      The pro forma  Balance  Sheet at March 31, 1998 has been  adjusted for the
pro forma  effects  of: (1)  additional  deferred  tax  assets of $1.0  million,
resulting from the termination of the Company's S Corporation status, which will
be credited to operations in the period in which such termination occurs and (2)
the  recording  of  four-year  5.7%,  $7.7  million  notes  payable  to  certain
shareholders  relating to undistributed  equity resulting from the S Corporation
or limited liability  corporation  ("LLC") status of the Company and its related
entities  prior to the  Reorganization,  of which $2.0 million was paid from the
proceeds  of the  Initial  Public  Offering.  The notes  provide  for the timely
distribution  of  amounts  necessary  to  pay  personal  income  taxes  of  such
shareholders or members due on amounts earned by such S Corporations or LLCs for
the period  January 1, 1998  through the  termination  of S  Corporation  or LLC
status,  estimated to be $1.2 million at March 31, 1998; and (3) the payment, by
shareholders, of their outstanding amounts due to the Company at March 31, 1998,
from their portion of the respective amounts distributed to them as set forth in
(2) above.  The existing due to  shareholders  of $1.4 million is subject to the
same terms as the above promissory notes.

      b.  Pro Forma Results of Income and Pro Forma Income Taxes
      ----------------------------------------------------------

      Pro Forma  adjustments  in the statements of income for the quarters ended
March 31, 1998 and 1997 reflect provisions for income taxes based upon pro forma
pretax income as if the Company had been subject to Federal and additional state
and local income taxes.

      As disclosed in Note 3, the Company has, in the past,  elected for certain
of its affiliates to be taxed as S Corporations or to be treated as partnerships
pursuant to the Internal Revenue Code. In connection with the Company's  Initial
Public  Offering,  the Company  terminated such S and Partnership  elections and
became subject to Federal and additional  state and local income taxes.  The pro
forma provision for income taxes represents the income tax provisions that would
have been reported had the Company been subject to Federal and additional  state
and local income taxes.  The effective pro forma tax rate of the Company differs
from the  Federal  rate of 34%  primarily  due to the effects of state and local
income taxes.

      c.  Pro Forma Net Income and Net Income Per Common Share
      --------------------------------------------------------

      Pro forma net income represents the historical amounts after the pro forma
adjustments discussed above.

      Pro forma net income per share is based on the weighted  average number of
shares  outstanding  during the period.  In addition,  with respect to 1998, the
shares  outstanding for the period give retroactive effect to the reorganization
and  recapitalization  of the  Company  as well as 771,000  shares  deemed to be
outstanding, which represent the approximate number of shares


                                      -7-
<PAGE>


                                HAPPY KIDS, INC.

              NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
                                   (Unaudited)


deemed to be sold by the company (at an Initial Public  Offering price of $10.00
per share) to fund the portion of the $7.7 million pro forma distribution during
the quarter ended March 31, 1998.

      d.  Supplemental Pro Forma Net Income and Net Income Per Share
      --------------------------------------------------------------

      The Company's  supplemental  pro forma net income and net income per share
for the quarter ended March 31, 1998 are  approximately  $1.8 million and $0.17,
respectively.  The  supplemental  pro forma net  income and net income per share
reflect the issuance of shares necessary to retire  approximately  $20.5 million
of amounts due to bank and the resulting increase in net income in the amount of
$305,000 for the quarter  ended March 31,  1998,  due to a reduction in interest
expense and related  fees.  The  calculation  is based on the  weighted  average
shares outstanding used in the calculation of net income per share, adjusted for
2.1  million  shares at $10.00 per share that would be issued by the  Company to
retire these obligations.

      Weighted average common shares of 10.6 million  outstanding  represent the
weighted average number of shares of common stock  outstanding  adjusted for the
number of  shares  of common  stock  required  to pay down  approximately  $20.5
million of the outstanding debt and approximately  $7.7 million of notes payable
to  shareholders,  of which $2.0  million  was repaid to  shareholders  from the
proceeds of the Initial Public Offering (see Note 4(a)).


NOTE 5 -- RELATED PARTY TRANSACTIONS:

      The  Board  of  Directors  of  the  Company  voted  to  distribute  to its
shareholders the previously taxed and  undistributed  earnings of the Company as
of the effective date of the Company's  termination of its S Corporation status,
which  termination  occurred on April 1, 1998.  The amount of such S Corporation
Distribution was approximately $7.7 million and represented substantially all of
the previously taxed and  undistributed  earnings of the Company and its related
entities.  Of the total S  Corporation  Distribution,  $2.0  million  of the net
proceeds from the Company's  Initial Public  Offering was used to make a partial
payment of amounts due under the related  promissory notes. The balance of the S
Corporation  Distribution  will  be  paid  in  accordance  with  the  terms  and
provisions of such promissory notes and provides for the timely  distribution of
amounts  necessary to pay  personal  income  taxes of such  shareholders  due on
amounts  earned by the  Company  for the  period  January  1, 1998  through  the
termination of such S Corporation status, which is estimated to be approximately
$1.2 million at March 31, 1998.


NOTE 6 -- EARNINGS PER SHARE:

      The Company has adopted  SFAS No.  128,  "Earnings  Per Share"  ("SFAS No.
128") which requires  public  companies to present basic earnings per share and,
if applicable,  diluted earnings per share. In accordance with SFAS No. 128, all
comparative  periods have been  restated as of December  31, 1997.  Basic EPS is
based on the  weighted  average  number of common  shares  outstanding,  without
consideration of common stock equivalents. Diluted


                                      -8-
<PAGE>


                                HAPPY KIDS, INC.

              NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
                                   (Unaudited)


earnings per share is based on the weighted  average number of common and common
equivalent shares  outstanding.  There were no common stock equivalent shares at
March 31, 1998 or December 31, 1997.


NOTE 7 -- RECLASSIFICATION:

      Certain prior year amounts have been  reclassified  to conform to the 1998
presentation.


NOTE 8 - INVENTORIES:

      Inventories consist of the following finished goods:

                                              March 31,     December 31,
                                                1998            1997
                                             ----------     ------------
                                                   (In thousands)
             Warehouse..................     $  11,303        $   8,716
             In-transit and overseas....         3,013            8,010
             LIFO valuation allowance...          (357)            (410)
                                             ---------        ---------
                                             $  13,959        $  16,316
                                             =========        =========

      For the quarters  ended March 31, 1998 and 1997,  the  liquidation of LIFO
inventories decreased the cost of sales and, therefore,  increased income before
taxes by $53,000 and $251,000, respectively.


                                      -9-
<PAGE>


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


GENERAL
-------

      Happy Kids, Inc. is a designer and marketer of  custom-designed,  licensed
and branded children's apparel. The Company produces  high-quality,  coordinated
apparel programs, including knit tops, bottoms, overalls,  shortalls,  coveralls
and swimwear,  for newborns,  infants,  toddlers,  boys and girls. The Company's
major  licenses  currently  include  Nickelodeon's  Rugrats,  AND 1  and  B.U.M.
Equipment.  The Company also designs and delivers private label branded playwear
programs for leading  retailers and its major programs  currently include Sesame
Street for KMart, New Legends for Kids R Us and Canyon River Blues for Sears.

      Prior to and  including  much of 1995,  the Company's  operating  strategy
primarily focused on developing and marketing its own house brands.  The Company
manufactured  products  for  inventory  under  the  Company's  brands  and often
concentrated  on enhancing sales volume rather than focusing on a combination of
sales volume and gross margins.  The Company  believes that the loss it incurred
in 1995 was primarily  attributable  to these factors.  In 1995, to leverage its
strong customer relationships,  the Company initiated its current sales strategy
under which the  Company's  customers  order  specific  quantities of goods on a
fixed-price  basis six to nine  months in  advance  of a  selling  season.  As a
result, for 1997,  substantially all of the Company's playwear was produced upon
receipt of customer orders.  Also in 1995, the Company elected to concentrate on
developing a diversified  portfolio of popular,  established and well-recognized
licensed  properties  and  private  label  relationships  and  deemphasized  its
reliance on house brands, which have been a declining component of the Company's
net sales in each year since 1995.  Since that time, the Company's  strategy has
been to work  closely  with its  customers  to design  and  market  high-quality
coordinated  apparel  programs  resulting  in gross  margins  that  the  Company
believes are higher than those typically generated from sales of non-licensed or
non-private label branded playwear.

      Statements contained or incorporated by reference in this Quarterly Report
on Form  10-Q  that  are not  based on  historical  facts  are  "forward-looking
statements" within the meaning of Section 21E of the Securities  Exchange Act of
1934,  as amended,  including,  without  limitation,  statements  regarding  the
Company's  sales  strategy,  concentration  on the  development of a diversified
portfolio  of licensed  properties  and private  label  relationships  and gross
margins.  Forward-looking  statements  also  may be  identified  by  the  use of
forward-looking  terminology  such  as  "may",  "will",  "expect",   "estimate",
"anticipate",  "continue",  or similar  terms,  variations  of such terms or the
negative of those terms. This Form 10-Q contains forward-looking statements that
involve risks and uncertainties, including, but not limited to: (i) a dependence
on license arrangements; (ii) a dependence on private label relationships; (iii)
a dependence on contract manufacturers;  (iv) a reliance on key customers; (v) a
dependence  on access  to credit  facilities;  (vi) the  risks  associated  with
significant  growth;  (vii)  competition;  (viii)  seasonality  of  sales;  (ix)
cyclicality and trends in the apparel industry;  and (x) import restrictions and
other


                                      -10-
<PAGE>


risks associated with international  business.  The Company's actual results may
differ materially from the results discussed in the  forward-looking  statements
contained herein.


RESULTS OF OPERATIONS
---------------------

Three Months Ended March 31, 1998 Compared to Three Months Ended March 31, 1997
-------------------------------------------------------------------------------

      Net Sales.  Net sales increased $10.9 million,  or 43.9%, to $35.7 million
in the first  quarter of 1998 from $24.8  million in the first  quarter of 1997.
The  increase  in net sales is  attributable  primarily  to  increased  sales of
playwear of both licensed products and private label programs.

      Gross Profit.  Gross profit  increased by $2.2 million,  or 35.8%, to $8.6
million in the first  quarter of 1998 from $6.4 million in the first  quarter of
1997.  The gross profit  margin  decreased to 24.2% in the first quarter of 1998
from 25.6 % in the first quarter of 1997.  Such decrease was due, in part, to an
allowance  of  $150,000 in  cooperative  advertising  expenses  during the first
quarter  of 1998 for one of the  Company's  major  private  label  programs.  In
addition,  the 1997 gross  margin  amount  includes  $251,000 in income due to a
decrease in LIFO reserves,  which accounted for 1.0% of such gross margin, while
the 1998 gross  margin  amount  includes  $53,000 in income due to a decrease in
LIFO reserves, which accounted for only 0.1% of gross margin in that period.

      Selling,  Design and  Shipping  Expenses.  Selling,  design  and  shipping
expenses  increased by $525,000,  or 21.5%, to $3.0 million in the first quarter
of 1998 from $2.4  million  in the  first  quarter  of 1997.  This  increase  is
attributable primarily to higher sales compensation,  shipping and freight costs
associated with increased sales volumes.  Advertising  expenses increased due to
cooperative  advertising  charges  from  a  licensor  associated  with  a  major
licensing program. In addition,  design salaries and sampling costs increased as
a result of the Company's  expanded product lines. As a percentage of net sales,
selling,  design and shipping expenses decreased to 8.3% in the first quarter of
1998 from 9.8% in the first quarter of 1997.

      General and Administrative  Expenses.  General and administrative expenses
increased $293,000,  or 16.2%, to $2.1 million in the first quarter of 1998 from
$1.8 million in the first quarter of 1997. This increase is primarily the result
of higher factor commissions  associated with increased sales volume, as well as
higher professional and data processing expenses.  As a percentage of net sales,
general and  administrative  expenses  decreased to 5.9% in the first quarter of
1998  from  7.3% in the  first  quarter  of 1997 due to the  operating  leverage
associated with the higher sales.

      Interest Expense, net. Interest expense, net increased $296,000, or 42.7%,
to $990,000 in the first  quarter of 1998 from  $694,000 in the first quarter of
1997.  This increase is a result of an increase in borrowings to support  higher
sales volume. As a percentage of net sales, interest expense remained consistent
at 2.8% for the first quarter of each of 1998 and 1997.


                                      -11-
<PAGE>


      Income  Before Income Taxes.  Income  before income taxes  increased  $1.2
million,  or  82.2%,  to $2.6  million  in the first  quarter  of 1998 from $1.4
million in the first quarter of 1997 due to the reasons  described  above.  As a
percentage of net sales,  income  before  income taxes  increased to 7.2% in the
first quarter of 1998 from 5.7% in the first quarter of 1997.


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

      The  Company  has  financed  its  cash   requirements   primarily  through
operations and borrowings under its Line of Credit. Historically,  the Company's
borrowing  requirements  have been  seasonal,  with peak working  capital  needs
arising during the first and third quarters.

      Through the consummation of the Company's Initial Public Offering on April
8, 1998, the Company's Line of Credit  permitted  borrowings up to $42.0 million
as a revolving  credit line to expire on December  31,  1998,  subject to annual
renewals  (adjusted  seasonally  to $47.0  million  from January 1, 1998 through
April 30,  1998).  The Company  executed an amendment  of its  existing  Line of
Credit  whereby  upon   effectiveness   of  the  Initial  Public   Offering  and
satisfaction of certain conditions,  the Company's Line of Credit was amended to
provide  for a  discretionary  one  year  revolving  Line of  Credit,  renewable
annually,  providing for advances and letter of credit  accommodations up to the
lesser of (a) $49.0 million  through April 30, 1998,  (b) $42.0 million from May
1, 1998  through  December  31,  1998,  (c) $47.0  million  from January 1, 1999
through  March 31,  1999,  or (d) at all times the sum of (i) up to  eighty-five
percent  of  eligible  accounts  receivables,  plus (ii) up to fifty  percent of
finished goods inventory,  plus (iii)  overadvances  approved by the lender. The
maximum  amount of revolving  credit  advances  outstanding  at any time may not
exceed $35.0  million  from January 1, 1998 to April 30, 1998 and $30.0  million
thereafter,  and the maximum amount of letters of credit outstanding at any time
may not exceed $35.0 million.  The interest rate on amounts borrowed will be the
bank's then  prevailing  prime rate (8.5% at March 31,  1998).  In addition,  in
connection  with the  amendment to the Line of Credit,  personal  guarantees  of
certain  of  the  Company's  present  shareholders  under  the  Line  of  Credit
terminated and the collateral pledged by such shareholders was released.

      Prior to such  amendment,  and during the  quarterly  period  reported  on
herein,  the first $5.0  million of  borrowings  under this Line of Credit  bore
interest at the prime rate plus 4.0% (12.5% at March 31,  1998).  The  remaining
borrowings  bore  interest at the prime rate plus 1.0% (9.5% at March 31, 1998).
Additionally,  the Company was subject to certain fees  associated with the Line
of Credit.  The Line of Credit is  collaterialized  by substantially  all of the
assets of the  Company.  As of March 31, 1998 the  Company had $27.2  million of
outstanding direct borrowings and $18.1 million of contingent  liabilities under
open letters of credit.

      The Company used approximately  $17.5 million of the net proceeds from its
Initial Public Offering consummated on April 8, 1998 and all of the net proceeds
(approximately  $3.1 million)  received in  connection  with the exercise of the
underwriters'  over-allotment option consummated on April 23, 1998 to reduce the
outstanding balance of direct borrowings under the Line of Credit.


                                      -12-
<PAGE>


      In addition,  the Company's lender has sole discretion to make or withhold
advances  under the Line of Credit.  There can be no  assurance  that the lender
will  continue  to lend under the Line of Credit.  If the lender  exercises  its
discretion to withhold advances, there would be a material adverse effect on the
Company's business, financial condition and results of operations.

      As of March 31, 1998, the Company's other  principal  sources of liquidity
included  cash of  $223,000,  amounts due from  factor of $26.2  million and net
accounts receivable of $291,000. The Company had working capital of $8.1 million
and long-term debt of $1.4 million as of March 31, 1998.

      For the quarter ended March 31, 1998,  operating  activities  used cash of
$1.9 million  primarily as a result of an increase in amounts due from factor of
$2.0  million due to increased  sales volume and a decrease in accounts  payable
and accrued expenses of $4.4 million. This was partially offset by net income of
$2.3 million and a decrease in inventory of $2.4  million.  Net cash provided by
financing  activities  during  the  same  period  was  $1.7  million  consisting
primarily of net  borrowings of $2.3 million under the Company's  Line of Credit
offset by payments to  shareholders  of $366,000 for their personal income taxes
due on the earnings of the S Corporations,  and payments of deferred expenses of
$224,000 relating to the Initial Public Offering.

      On April 8, 1998, the Company  consummated  its Initial Public Offering of
2,200,000  shares of its Common  Stock at a price of $10.00  per  share,  all of
which  shares were issued and sold by the Company.  The net  proceeds  from such
offering were $20.5 million.

      On  April  23,  1998,  the  Company   consummated   the  exercise  of  the
underwriters'  over-allotment  option granted by the Company to the underwriters
in connection with the Initial Public Offering.  As a result, the Company issued
and sold an  additional  330,000  shares of the  Company's  Common  Stock at the
Initial  Public  Offering  price of $10.00 per share.  The net  proceeds  to the
Company from such sale were $3.1 million.

      Of the total net proceeds received by the Company upon the consummation of
its Initial Public Offering and the exercise of the over-allotment  option, $2.0
million was  distributed  to certain  shareholders  of the Company in connection
with  the  payment  of a  portion  of the S  Corporation  distribution  and  the
remaining  amount was utilized to pay down a portion of the outstanding  balance
under the Company's Line of Credit.

      Historically,  the Company's business has not required significant capital
expenditures.  The Company's  capital  expenditures  were  insignificant for the
quarters ended March 31, 1998 and 1997, respectively.  The Company believes that
cash flow expected to be generated  from  operations,  together with  borrowings
under its  existing  Line of Credit,  as  amended,  will be  adequate to satisfy
current and planned operations for at least the next 12 months.


                                      -13-
<PAGE>


BACKLOG
-------

      The  Company's   customers  order  specific   quantities  of  goods  on  a
fixed-price  basis six to nine  months in  advance  of a  selling  season.  Such
customer  orders are placed in backlog upon their receipt and  acceptance by the
Company.  Customer  orders are  generally  cancellable  on notice to the Company
without penalty.  Although the Company has not had significant  cancellations in
the past,  no assurance  can be given that it will not  experience a significant
level of  cancellations  in the future or that its  backlog at any point in time
will  be  converted  to  sales.  Many  of  the  Company's  orders  are  received
significantly  in advance  of  scheduled  delivery  periods.  Consequently,  the
Company had backlog of $98.7 million at March 31, 1998, all of which is expected
to ship prior to December 31, 1998.


MANAGEMENT INFORMATION SYSTEMS
------------------------------

      The Company believes that advanced information  processing is essential to
maintaining its competitive position. The Company participates in the electronic
data interchange  program maintained by many of its larger customers,  including
J.C.  Penney,  Kids R Us,  Sears,  Target and WalMart.  This program  allows the
Company to receive customer orders,  provide advanced shipping notices,  monitor
store  inventory  and track orders  on-line from the time such orders are placed
through  delivery.  The Company is also able to notify  certain of its  client's
warehouses,  in advance, as to shipments. The Company currently is upgrading its
management  information systems, which it expects to complete in 1998, to ensure
proper  processing  of  transactions  relating to the year 2000 and beyond.  The
Company  continues  to  evaluate  appropriate  courses  of  corrective  actions,
including  replacement of certain systems. The Company does not expect the costs
associated  with ensuring year 2000  compliance to have a material effect on its
financial position or results of operations. All costs associated with year 2000
compliance  are being funded with cash flow  generated  from  operations and are
being expensed as incurred.  Although the Company  believes that the information
systems  of its major  customers  and  vendors  (insofar  as they  relate to the
Company's  business)  comply  with  year  2000  requirements,  there  can  be no
assurance  that the year 2000 issue will not affect the  information  systems of
such customers and vendors as they relate to the Company's business, or that any
such impact on such customers' and vendors' information systems would not have a
material  adverse  effect on the  Company's  business,  financial  condition  or
results of operations.


EFFECT OF RECENTLY ISSUED ACCOUNTING STANDARDS
----------------------------------------------

      SFAS No. 130,  "Reporting  Comprehensive  Income"  ("SFAS No.  130") was
issued in June 1997.  This  statement is effective  for the  Company's  fiscal
year ending  December 31, 1998.  This  statement  addresses  the reporting and
displaying  of  comprehensive  income  and its  components.  EPS will  only be
reported  for net income and not for  comprehensive  income.  Adoption of SFAS
No. 130 is not expected to have a material  effect on the Company's  financial
statement disclosures.

      SFAS No. 131,  "Disclosures  about  Segments of an Enterprise  and Related
Information"  ("SFAS  No.  131") was  issued in June  1997.  This  statement  is
effective for the Company's fiscal


                                      -14-
<PAGE>


year ending December 31, 1998. This statement  changes the way public  companies
report  information  about segments of their business in their annual  financial
statements  and requires them to report  selected  segment  information in their
quarterly  reports.  Adoption of SFAS No. 131 is not expected to have a material
effect on the Company's financial statement disclosures.


                                      -15-
<PAGE>


                           PART II. OTHER INFORMATION

ITEM 2.  CHANGES IN SECURITIES AND USE OF PROCEEDS


CHANGES IN SECURITIES
---------------------

      On April 1,  1998,  the day prior to the  effectiveness  of the  Company's
Initial Public Offering,  the Company acquired all of the issued and outstanding
shares of certain  related  entities of the  Company,  in exchange for shares of
Common  Stock  of the  Company  that  have  not yet been  registered  under  the
securities laws, from each of Jack Benun,  the Company's  Chairman of the Board,
President and Chief Executive  Officer and Mark Benun,  the Company's  Executive
Vice President,  Secretary and a Director of the Company. Each of Jack Benun and
Mark Benun received  2,131,250  shares of the Company's Common Stock in exchange
for each of their then 50% ownership  interests in each of Happy Kids Children's
Apparel,  Ltd., Talk of the Town Apparel Corp., O.P. Kids, L.L.C.,  H.O.T. Kidz,
L.L.C., Hawk Industries, Inc. and J & B 18 Corp.

      In  addition,  the  Company  has  granted  stock  options to  purchase  an
aggregate  of 180,000  shares of its Common  Stock to certain  Directors  and an
officer of the Company  pursuant to the Company's 1997 Stock Plan which have not
yet been  registered  under the  securities  laws.  All of such  options have an
exercise  price of $10.00  per  share,  which  was  based  upon and equal to the
Company's Initial Public Offering price per share of Common Stock.

      The Company did not employ an underwriter in connection  with the issuance
or sale of the securities  described above. The Company claims that the issuance
or sale of the foregoing  securities was exempt from  registration  under either
(i) Section 4(2) of the  Securities  Act of 1933,  as amended  (the  "Act"),  as
transactions  not involving any public offering and such securities  having been
acquired for  investment and not with a view to  distribution,  or (ii) Rule 701
under the Act as transactions  made pursuant to a written  compensatory  benefit
plan or pursuant to a written  contract  relating to  compensation.  Appropriate
legends were affixed to the stock certificates issued in such transactions.  All
recipients had adequate access to information about the Company.


USE OF PROCEEDS AND RESTRICTION ON DIVIDENDS
--------------------------------------------

      On April 2, 1998,  the SEC declared  effective the Company's  Registration
Statement on Form S-1 (Registration Statement No. 333-44267),  as filed with the
SEC in connection  with the Company's  Initial Public  Offering of Common Stock,
which was  co-managed  by Ladenburg  Thalmann & Co.,  Inc. and  Cruttenden  Roth
Incorporated.  Pursuant  to  such  Registration  Statement,  and  the  Company's
Registration  Statement on Form S-1MEF  (Registration  Statement No. 333-49427),
filed with the SEC on April 3, 1998, which became effective as of such date, the
Company  registered  and sold an  aggregate  of  2,530,000  shares of its Common
Stock, including shares underlying the underwriters'  over-allotment option, for
a gross  aggregate  offering  price of $25.3  million.  In connection  with such
offering,  the Company incurred total expenses of approximately $1.3 million. In
addition to such expenses, the Company incurred underwriting


                                      -16-
<PAGE>


discounts and commissions of approximately  $1.8 million.  Of the  approximately
$18.9 million in net proceeds  received by the Company upon  consummation of its
Initial  Public  Offering  and the  approximately  $3.1  million in net proceeds
received by the Company upon  consummation of the exercise of the  underwriters'
over-allotment  option  related  thereto,  an  aggregate  of  $2.0  million  was
distributed to Jack Benun,  the Company's  Chairman of the Board,  President and
Chief Executive  Officer,  Mark Benun,  the Company's  Executive Vice President,
Secretary and a Director and Isaac Levy, the Company's Senior Vice President and
a Director in connection with the payment of the S Corporation Distribution, and
the remaining amount was utilized to pay down the outstanding  balance under the
Company's amended Line of Credit. Under such amended Line of Credit, the Company
is obligated to maintain  certain  financial  covenants and is  restricted  from
paying dividends to its shareholders.


ITEM 5.  OTHER INFORMATION


REORGANIZATION
--------------

      The Company was incorporated in 1988 in New York under the name O'Boy Inc.
and changed its name to Happy Kids, Inc. in December of 1997. Historically,  the
Company operated as separate business entities,  with the first of such entities
commencing  business  operations  in 1979,  all under the  common  ownership  of
certain shareholders of the Company. On April 1, 1998,  immediately prior to the
effectiveness  of the Company's  Initial Public  Offering,  all of such separate
entities became  wholly-owned  subsidiaries  of the Company.  The Company issued
4,262,500  shares of Common  Stock to such  shareholders  in exchange  for their
ownership of these separate business  entities.  All share and per share amounts
throughout  this Form  10-Q have been  restated  to  retroactively  reflect  the
Reorganization.


S CORPORATION DISTRIBUTION
--------------------------

      Prior to the  termination  of the  Company's  S  Corporation  status,  the
Company declared the S Corporation Distribution to the shareholders of record of
the Company on such date. Such shareholders  consisted solely of Jack Benun, the
Company's  Chairman of the Board,  President and Chief Executive  Officer,  Mark
Benun, the Company's  Executive Vice President and Secretary and Isaac Levy, its
Senior Vice  President.  Such  distribution  (estimated to be $7.7 million as of
March  31,  1998)  represented  substantially  all  of the  Company's  remaining
undistributed  S  Corporation  earnings  and  is  evidenced  by  four-year  5.7%
promissory   notes  issued  to  such   shareholders   in  connection   with  the
Reorganization. Of the total S Corporation Distribution, $2.0 million of the net
proceeds from the Company's  Initial Public  Offering was used to make a partial
payment of amounts due under the related  promissory notes. The balance of the S
Corporation  Distribution  will  be  paid  in  accordance  with  the  terms  and
provisions of such promissory notes and provides for the timely  distribution of
amounts  necessary to pay  personal  income  taxes of such  shareholders  due on
amounts  earned by the  Company  for the  period  January  1, 1998  through  the
termination  of such S  Corporation  status  (estimated to be $1.2 million as of
March 31, 1998).


                                      -17-
<PAGE>


INITIAL PUBLIC OFFERING
-----------------------

      On April 8, 1998, the Company  consummated  its Initial Public Offering of
2,200,000  shares of its Common  Stock at a price of $10.00  per  share,  all of
which  shares were issued and sold by the  Company.  The net  proceeds  from the
offering were $20.5 million.

      On  April  23,  1998,  the  Company   consummated   the  exercise  of  the
underwriters'  over-allotment  option granted by the Company to the underwriters
in connection with the Initial Public Offering.  As a result, the Company issued
and sold an  additional  330,000  shares of the  Company's  Common  Stock at the
Initial  Public  Offering  price of $10.00 per share.  The net  proceeds  to the
Company from such sale were $3.1 million.

      Of the total net proceeds received by the Company upon the consummation of
its Initial Public Offering and the exercise of the over-allotment  option, $2.0
million was  distributed  to certain  shareholders  of the Company in connection
with  the  payment  of a  portion  of the S  Corporation  Distribution  and  the
remaining  amount was utilized to pay down a portion of the outstanding  balance
under the Company's Line of Credit.


ELECTION OF INDEPENDENT DIRECTORS
---------------------------------

      Upon the consummation of the Initial Public Offering on April 8, 1998, the
term of office of two  independent  Directors,  Marvin  Azrak and Stephen  Kahn,
commenced.  Messrs.  Azrak and Kahn were also  elected  to the  Company's  Audit
Committee and Option Committee, commencing on such date.


ITEM 6.  EXHIBITS AND REPORTS ON FORM 8-K

      (a)   Exhibits.

            10.1  Amendment No. 5 to the Company's  Financing  Agreement,  dated
                  March 25, 1998, with the CIT Group/Commercial  Services, Inc.,
                  as agent for itself and certain other  lenders,  as previously
                  amended.

            27    Financial Data Schedule

      (b)   Reports on Form 8-K.

            No reports on Form 8-K were filed  during the quarter for which this
            report on Form 10-Q is filed.


                                      -18-
<PAGE>


                                   SIGNATURES


      Pursuant to the  requirements of the Securities  Exchange Act of 1934, the
Registrant  has duly  caused  this  report  to be  signed  on its  behalf by the
undersigned thereunto duly authorized.



                                       Happy Kids, Inc.




DATE: May 13, 1998                     By: /s/ Jack Benun
                                          --------------------------------------
                                          Jack Benun
                                          President and Chief Executive Officer
                                          (Principal Executive Officer)




DATE: May 13, 1998                     By: /s/ Stuart Bender
                                          --------------------------------------
                                          Stuart Bender
                                          Chief Financial Officer
                                          (Principal Financial and Accounting
                                          Officer)




                                      -19-