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 June 30, 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:    X*                                       No:
             ---------                                       ---------

      Indicate  the  number of shares  outstanding  of each of the  Registrant's
classes of common stock, as of July 31, 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 June 30,
                   1998 (unaudited) and December 31,1997................   2

                  Condensed Consolidated Statements of Income for the
                   Three and Six Months Ended June 30, 1998 and 1997
                   (unaudited)..........................................   3

                  Condensed Consolidated Statements of Cash Flows for
                   the Six Months Ended June 30, 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.................   9

                  Results of Operations.................................  10

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

                  Backlog...............................................  13

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

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

PART II. OTHER INFORMATION..............................................  15

         Item 2.  Changes in Securities and Use of Proceeds.............  15

         Item 5.  Other Information.....................................  16

         Item 6.  Exhibits and Reports on Form 8-K......................  16

SIGNATURES..............................................................  17


                                      -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)


                                                                     June 30,     December 31,
                                                                       1998           1997
                                                                     -----------  ------------
                                   ASSETS                            (unaudited)

<S>                                                                 <C>           <C>        
CURRENT ASSETS
    Cash ........................................................   $       388   $       374
    Due from factor .............................................        19,445        24,232
    Accounts receivable - trade (net of allowance of $513
     at June 30, 1998 and  December 31, 1997)....................           146           316
    Inventories .................................................        21,873        16,316
    Due from shareholders .......................................          --             347
    Prepaid royalties ...........................................         2,614           147
    Other current assets ........................................         2,706           992
                                                                    -----------   -----------
              Total current assets ..............................        47,172        42,724
FIXED ASSETS - NET ..............................................         1,373         1,476
OTHER ASSETS ....................................................           545           752
                                                                    -----------   -----------
              Total assets ......................................   $    49,090   $    44,952
                                                                    ===========   ===========

                    LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES
    Due to bank .................................................   $     3,780   $    24,863
    Current portion - capital lease obligations .................            44            49
    Accounts payable and accrued liabilities ....................        13,032        11,393
    Due to shareholders .........................................           314          --
                                                                    -----------   -----------
              Total current liabilities .........................   $    17,170   $    36,305

DEFERRED RENT PAYABLE ...........................................           544           584
CAPITAL LEASE OBLIGATIONS .......................................          --              19
DUE TO SHAREHOLDERS .............................................         5,574         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; 10,280 and  7,750 shares issued and outstanding
        at June 30, 1998 and December 31, 1997, respectively ....           103            78
    Additional paid-in capital ..................................        23,263         1,119
    Retained earnings ...........................................         2,436         5,447
                                                                    -----------   -----------
               Total shareholders' equity .......................        25,802         6,644
                                                                    -----------   -----------
               Total liabilities and shareholders' equity .......   $    49,090   $    44,952
                                                                    ===========   ===========


               The accompanying notes are an integral part of these statements.


                                            - 2 -


</TABLE>
<PAGE>


<TABLE>
<CAPTION>

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


                                                  For the Three Months          For the Six Months
                                                     Ended June 30,               Ended June 30,
                                                ------------------------    ------------------------
                                                    1998         1997           1998          1997
                                                ----------    ----------    ----------    ----------

<S>                                             <C>           <C>           <C>           <C>       
Net sales ...................................   $   32,013    $   14,746    $   67,728    $   39,557
Cost of goods sold ..........................       23,468        11,095        50,552        29,549
                                                ----------    ----------    ----------    ----------
    Gross profit ............................        8,545         3,651        17,176        10,008
                                                ----------    ----------    ----------    ----------
Operating expenses:
    Selling, design and shipping ............        3,040         2,280         6,005         4,720
    General and administrative ..............        2,472         1,900         4,576         3,711
                                                ----------    ----------    ----------    ----------
          Total operating expenses ..........        5,512         4,180        10,581         8,431
                                                ----------    ----------    ----------    ----------
          Operating earnings (loss) .........        3,033          (529)        6,595         1,577
                                                ----------    ----------    ----------    ----------
Interest expense, net .......................          328           674         1,318         1,368
                                                ----------    ----------    ----------    ----------
Income (loss) before income taxes ...........        2,705        (1,203)        5,277           209
Provision for income taxes:
     Income taxes (benefit) .................        1,136          (122)        1,396            21
     Deferred tax benefit ...................       (1,024)           --        (1,024)           --
                                                ----------    ----------    ----------    ----------
          Total income taxes ................          112          (122)          372            21
                                                ----------    ----------    ----------    ----------
          Net income (loss) .................   $    2,593    $   (1,081)   $    4,905    $      188
                                                ==========    ==========    ==========    ==========
Basic income (loss)
    per common share ........................   $     0.25    $    (0.14)   $     0.55    $     0.02
                                                ==========    ==========    ==========    ==========
Weighted average common
    shares outstanding ......................       10,188         7,750         8,976         7,750
                                                ==========    ==========    ==========    ==========
Diluted income (loss)
    per common share ........................   $     0.25    $    (0.14)   $     0.55    $     0.02
                                                ==========    ==========    ==========    ==========
Weighted average common
    shares outstanding ......................       10,221         7,750         8,985         7,750
                                                ==========    ==========    ==========    ==========

Pro forma data (unaudited) :
    Historical income (loss) before
          provision for income taxes ........   $    2,705    $   (1,203)   $    5,277    $      209
    Income taxes (benefit) ..................        1,136          (505)        2,216            88
                                                ----------    ----------    ----------    ----------
          Net income (loss) .................   $    1,569    $     (698)   $    3,061    $      121
                                                ==========    ==========    ==========    ==========
Pro forma basic income (loss) per share .....   $     0.15    $    (0.09)   $     0.34    $     0.02
                                                ==========    ==========    ==========    ==========
Pro forma weighted average
    common shares outstanding ...............       10,188         7,750         8,976         7,750
                                                ==========    ==========    ==========    ==========
Pro forma diluted income (loss) per share ...   $     0.15    $    (0.09)   $     0.34    $     0.02
                                                ==========    ==========    ==========    ==========
Pro forma weighted average
    common shares outstanding ...............       10,221         7,750         8,985         7,750
                                                ==========    ==========    ==========    ==========

                  The accompanying notes are an integral part of these statements.

                                                - 3 -
</TABLE>
<PAGE>


<TABLE>
<CAPTION>

                            HAPPY KIDS INC. AND SUBSIDIARIES
                     CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
                                       (unaudited)
                                     (in thousands)


                                                                   For the Six Months
                                                                      Ended June 30,
                                                               -------------------------
                                                                  1998           1997
                                                               ----------    -----------

<S>                                                            <C>           <C>       
Cash flows from operating activities:
  Net income ...............................................   $    4,905    $      188
  Adjustments to reconcile net income
      to net cash provided by operating activities:
      Depreciation and amortization ........................          114           230
      Deferred taxes .......................................       (1,024)           --
      Changes in operating assets and liabilities:
          Accounts receivable ..............................          170           963
          Due from factor ..................................        4,787         6,347
          Inventories ......................................       (5,557)       (6,581)
          Prepaid royalties ................................       (2,467)          (35)
          Other current assets .............................         (617)          656
          Other assets .....................................          (28)          457
          Accounts payable and accrued liabilities .........        1,599          (980)
          Due from shareholders ............................          347            72
                                                               ----------    ----------

  Net cash provided by operating activities ................        2,229         1,317
                                                               ----------    ----------

Cash flows from investing activities:
  Acquisition of fixed assets ..............................          (11)          (48)
                                                               ----------    ----------

Cash flows from financing activities:
  Net borrowings under line of credit ......................      (21,083)          837
  Payments on capital lease ................................          (24)          (33)
  Borrowings from shareholders .............................           --          (160)
  Dividends paid ...........................................       (3,428)       (2,435)
  Issuance of common stock .................................       22,331            --
                                                               ----------    ----------
      Net cash used in  financing activities ...............       (2,204)       (1,791)
                                                               ----------    ----------

      Net increase (decrease) in cash ......................           14          (522)
Cash at beginning of year ..................................          374           674
                                                               ----------    ----------
Cash at end of period ......................................   $      388    $      152
                                                               ==========    ==========


            The accompanying notes are an integral part of these statements.


                                         - 4 -


</TABLE>
<PAGE>


                                 HAPPY KIDS INC.

              NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
                                   (Unaudited)


Note 1 -- Basis of Presentation:
--------------------------------

      The  information  presented for June 30, 1998 and for the  three-month and
six-month  periods  ended  June 30,  1998 and 1997 are  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
June 30,  1998 and the  results  of its  operations  and its cash  flows for the
three-month  and six-month  periods ended June 30, 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 Company's
then-current  shareholders.  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. 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 sales was approximately $22.3 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.

      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  (totaling $7.9 million)  represented
substantially  all  of  the  Company's  remaining  undistributed  S  Corporation
earnings as of the date of termination of S Corporation status, 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  


                                     - 6 -


<PAGE>


                                 HAPPY KIDS INC.

              NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
                                   (Unaudited)


Company  for the  period  January  1, 1998  through  the  termination  of such S
Corporation status, currently estimated to be $ 314,000 as of June 30, 1998.

      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 was  reflected in net income for the second
quarter of 1998 when such  termination  occurred  and resulted in an increase in
deferred tax assets and earnings of approximately $1.0 million.

      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.


Note 4 -- Due to Shareholders:
------------------------------

      In connection with the termination of the Company's S Corporation  status,
the Company  agreed to distribute an aggregate of $ 7.9 million to the Company's
pre-Initial  Public  Offering   shareholders,   such  amounts  representing  the
Company's total 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 balance is due pursuant to four-year 5.7% notes
payable to such shareholders.  Such notes provide for the timely distribution of
amounts   necessary  to  pay  the  remaining   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  of  approximately  $  314,000.  In  addition,  existing  amounts  due to
shareholders  of $1.4  million  are  subject  to the  same  terms  as the  above
promissory notes.


Note 5 -- Pro forma Information:
--------------------------------

      a.    Pro Forma Results of Income and Pro Forma Income Taxes:
      -------------------------------------------------------------

      Pro  Forma  adjustments  in the  statements  of  income  for the three and
six-month  periods  ended June 30, 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 pursuant to the Internal Revenue
Code. In connection  with the Company's  Initial  Public  Offering,  the Company
terminated such S elections and partnership status 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.


                                     - 7 -


<PAGE>


                                 HAPPY KIDS INC.

              NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
                                   (Unaudited)


      b.    Pro Forma Net Income
      --------------------------

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


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, the
Company has retroactively restated earnings per share. Basic EPS is based on the
weighted average number of common shares outstanding,  without  consideration of
common stock  equivalents.  Diluted  earnings per share is based on the weighted
average number of common and common  equivalent shares  outstanding.  There were
approximately 33,000 common stock equivalent shares at June 30, 1998 and none at
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:

                                                 June 30,    December 31,
                                                  1998          1997
                                               ----------    ------------
                                                      (in thousands)

               Warehouse ....................  $   15,658    $    8,716
               In-transit and overseas ......       6,572         8,010
               LIFO valuation allowance .....        (357)         (410)
                                               ----------    ----------
                                               $   21,873    $   16,316
                                               ==========    ==========

      For the six months ended June 30, 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.  For the quarters ended June 30,
1998 and 1997 there was no liquidation of the LIFO reserve.


                                     - 8 -


<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 and New Legends for Kids R Us.

      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 and for the first six months of 1998,  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 de-emphasized 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


                                     - 9 -


<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 June 30, 1998 Compared to Three Months Ended June 30, 1997
-----------------------------------------------------------------------------

      Net Sales.  Net sales  increased  $ 17.3  million,  or  117.1%,  to $ 32.0
million in the second  quarter of 1998 from $14.7 million in the second  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 $ 4.9 million,  or 134.0 %, to $
8.5  million  in the  second  quarter  of 1998 from $ 3.7  million in the second
quarter  of 1997.  The gross  profit  margin  increased  to 26.7 % in the second
quarter of 1998 from 24.8 % in the second  quarter of 1997.  Such  increase  was
due, in part, to increased sales in certain higher margin  licensed  products as
well as efficiencies in transportation and handling costs.

      Selling,  Design and  Shipping  Expenses.  Selling,  design  and  shipping
expenses  increased  by $  760,000,  or 33.3 %, to $3.0  million  in the  second
quarter of 1998 from $ 2.3 million in the second quarter of 1997.  This increase
is attributable primarily to higher sales compensation, warehousing and shipping
costs  associated  with increased  sales volumes.  In addition,  design salaries
increased as a result of the Company's  expanded  product lines. As a percentage
of net sales,  selling,  design and shipping expenses  decreased to 9.5 % in the
second quarter of 1998 from 15.5 % in the second quarter of 1997.

      General and Administrative  Expenses.  General and administrative expenses
increased $ 572,000,  or 30.1 %, to $ 2.5 million in the second  quarter of 1998
from $ 1.9 million in the second 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 and contributions. As a
percentage of net sales, general and administrative  expenses decreased to 7.7 %
in the second  quarter of 1998 from 12.9 % in the second  quarter of 1997 due to
the operating leverage associated with the higher sales.

      Interest Expense,  net. Interest expense, net decreased $ 346,000, or 51.3
%, to $ 328,000  in the  second  quarter  of 1998 from  $674,000  in the  second
quarter of 1997.  This decrease is a result of the  application of a substantial
portion of the  proceeds  from the  Company's  Initial  Public  Offering  to the
repayment  of the  Company's  bank  debt in the  second  quarter  of 1998.  As a
percentage  of net sales,  interest  expense  decreased  to 1.0 % for the second
quarter of 1998, as compared to 4.6 % for the second quarter of 1997.

      Income  Before Income  Taxes.  Income before income taxes  increased $ 3.9
million,  to $ 2.7  million  in the  second  quarter of 1998 from a loss of $1.2
million in the second quarter of 1997 due to the reasons  described  above. As a
percentage of net sales,  income  before income


                                     - 10 -


<PAGE>


taxes  increased  to 8.5 % in the  second  quarter  of 1998  from (8.2 %) in the
second quarter of 1997.


Six Months Ended June 30, 1998 Compared to Six Months Ended June 30, 1997
-------------------------------------------------------------------------

      Net Sales. Net sales increased $ 28.1 million,  or 71.2%, to $67.7 million
in the first six  months of 1998 from $ 39.6  million in the first six months 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 $ 7.2 million,  or 71.6 %, to $
17.2  million in the first six  months of 1998 from $ 10.0  million in the first
six months of 1997. The gross profit margin increased to 25.4 % in the first six
months of 1998 from 25.3 % in the first six months of 1997.  Such  increase  was
due to increased sales in certain licensed products. In addition, the 1997 gross
margin amount  includes  $251,000 in income due to a decrease in LIFO  reserves,
which  accounted  for 0.6 % of such gross  margin,  while the 1998 gross  margin
amount includes $53,000 in income due to a decrease in LIFO reserves,  which had
no affect on gross margin for that period.

      Selling,  Design and  Shipping  Expenses.  Selling,  design  and  shipping
expenses  increased by $ 1.3  million,  or 27.2 %, to $ 6.0 million in the first
six  months of 1998 from $ 4.7  million  in the first six  months of 1997.  This
increase is attributable primarily to higher sales compensation, warehousing and
shipping costs associated with increased sales volumes. In addition, advertising
expenses  increased  due to  cooperative  advertising  charges  from a  licensor
associated with a major licensing  program.  Also,  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 8.9
% in the first six months of 1998 from 11.9 % in the first six months of 1997.

      General and Administrative  Expenses.  General and administrative expenses
increased $865,000 , or 23.3 %, to $ 4.6 million in the first six months of 1998
from $ 3.7 million in the first six months 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 and contributions.
As a percentage of net sales,  general and administrative  expenses decreased to
6.8 % in the first six months of 1998 from 9.4 % in the first six months of 1997
due to the operating leverage associated with the higher sales.

      Interest Expense, net. Interest expense, net decreased $ 50,000, or 3.7 %,
to $ 1.3 million in the first six months of 1998 from $ 1.4 million in the first
six  months  of  1997.  This  decrease  is a  result  of  the  application  of a
substantial  portion of the  proceeds  from its Initial  Public  Offering to the
repayment  of the  Company's  bank  debt in the  second  quarter  of 1998.  As a
percentage of net sales,  interest  expense  decreased to 2.0% for the first six
months of 1998, as compared to 3.5 % for the first six months of 1997.


                                     - 11 -


<PAGE>


      Income  Before Income  Taxes.  Income before income taxes  increased $ 5.1
million,  to $ 5.3 million in the first six months of 1998 from $ 209,000 in the
first six months of 1997 due to the reasons  described above. As a percentage of
net sales, income before income taxes increased to 7.8 % in the first six months
of 1998 from 0.1 % in the first six months 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 could 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 June 30,  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 were 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 June 30,  1998).  The  remaining
borrowings  bore  interest at the prime rate plus 1.0% (9.5% at June 30,  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 June 30,  1998 the  Company  had $ 3.8 million of
outstanding direct borrowings and $ 18.7 million of contingent liabilities under
open letters of credit.

      The Company used approximately  $17.1 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.

      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. 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 sales was approximately $22.3 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.

      As of June 30, 1998, the Company's  other  principal  sources of liquidity
included  cash of $ 388,000,  amounts due from factor of $ 19.4  million and net
accounts  receivable  of $ 146,000.  The Company  had working  capital of $ 30.0
million and long-term debt of $ 6.1 million as of June 30, 1998.

      For the six months ended June 30, 1998, operating activities provided cash
of $ 2.2 million primarily as a result of net income of $4.9 million, a decrease
in amounts due from factor of $ 4.8 million and an increase in accounts  payable
and accrued expenses of $ 1.6 million.  This was partially offset by an increase
in inventory of $ 5.6 million.  Net cash used in financing activities during the
same  period was $ 2.2  million  consisting  primarily  of the  proceeds  of the
Company's  Initial Public  Offering,  offset by reduced net borrowings of $ 21.1
million under the Company's Line of Credit and payments to shareholders of $ 3.4
million.

      Historically,  the Company's business has not required significant capital
expenditures.  The Company's  capital  expenditures  were  insignificant for the
quarters ended June 30, 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.


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  cancelable  on notice to the  Company
without penalty.  Although the Company has not had significant  cancellations


                                     - 13 -
<PAGE>


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 $ 107.0  million  at June  30,  1998,  all of which is
expected to ship prior to March 31, 1999.


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. 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 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.


                                     - 14 -


<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.

      During the quarter,  upon  consummation  of the Company's  Initial  Public
Offering on April 8, 1998,  the  Company  granted  stock  options to purchase an
aggregate of 80,000  shares of its Common  Stock to certain of its  non-employee
Directors  pursuant to the Company's 1997 Stock Plan. The shares underlying such
options 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


                                     - 15 -


<PAGE>


approximately $1.3 million.  In addition to such expenses,  the Company incurred
underwriting  discounts and commissions of  approximately  $1.8 million.  Of the
approximately  $19.1  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.

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.

               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.


                                     - 16 -


<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: August 10 , 1998                 By:/s/ Jack Benun
                                          --------------------------------------
                                           Jack Benun
                                           President and Chief Executive Officer
                                           (Principal Executive Officer)


DATE: August 10, 1998                  By:/s/ Stuart Bender
                                          --------------------------------------
                                           Stuart Bender
                                           Chief Financial Officer
                                           (Principal Financial and Accounting
                                            Officer)


                                     - 17 -