HAPPY KIDS INC, S-1/A, 1998-03-06

HAPPY KIDS INC
S-1/A, 1998-03-06
WOMEN'S, MISSES', AND JUNIORS OUTERWEAR

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<PAGE>

AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON MARCH 6, 1998
REGISTRATION NO. 333-44267

AMENDMENT NO. 2
TO
FORM S-1
REGISTRATION STATEMENT
UNDER
THE SECURITIES ACT OF 1933
----------------

HAPPY KIDS INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)

NEW YORK 5130 13-3473638
(STATE OR OTHER (PRIMARY STANDARD INDUSTRIAL (I.R.S. EMPLOYER
JURISDICTION OF CLASSIFICATION CODE NUMBER) IDENTIFICATION NO.)
INCORPORATION OR
ORGANIZATION)

100 WEST 33RD STREET, SUITE 1100
NEW YORK, NEW YORK 10001
(212) 695-1151
(ADDRESS, INCLUDING ZIP CODE, AND TELEPHONE NUMBER, INCLUDING
AREA CODE, OF REGISTRANT'S PRINCIPAL EXECUTIVE OFFICES)
----------------

JACK M. BENUN
CHAIRMAN OF THE BOARD, PRESIDENT AND
CHIEF EXECUTIVE OFFICER
HAPPY KIDS INC.
100 WEST 33RD STREET, SUITE 1100
NEW YORK, NEW YORK 10001
(212) 695-1151
(NAME, ADDRESS, INCLUDING ZIP CODE, AND TELEPHONE NUMBER,
INCLUDING AREA CODE, OF AGENT FOR SERVICE)
----------------

COPIES TO:
DAVID J. SORIN, ESQ. ERIC M. LERNER, ESQ.
RICHARD S. MATTESSICH, ESQ. ROSENMAN & COLIN LLP
BUCHANAN INGERSOLL 575 MADISON AVENUE
500 COLLEGE ROAD EAST NEW YORK, NY 10022-2585
PRINCETON, NJ 08540 (212) 940-8800
(609) 987-6800 ----------------
APPROXIMATE DATE OF COMMENCEMENT OF PROPOSED SALE OF THE SECURITIES TO THE
PUBLIC: As soon as practicable after this Registration Statement becomes
effective.

If any of the securities being registered on this Form are to be offered on
a delayed or continuous basis pursuant to Rule 415 under the Securities Act of
1933, check the following box. [_]

If this Form is filed to register additional securities for an offering
pursuant to Rule 462(b) under the Securities Act, check the following box and
list the Securities Act registration statement number of the earlier effective
registration statement for the same offering. [_]

If this Form is a post-effective amendment filed pursuant to Rule 462(c)
under the Securities Act, check the following box and list the Securities Act
registration statement number of the earlier effective registration statement
for the same offering. [_]

If this Form is a post-effective amendment filed pursuant to Rule 462(d)
under the Securities Act, check the following box and list the Securities Act
registration statement number of the earlier effective registration statement
for the same offering. [_]

If delivery of the prospectus is expected to be made pursuant to Rule 434,
check the following box. [_]

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

THE REGISTRANT HEREBY AMENDS THIS REGISTRATION STATEMENT ON SUCH DATE OR
DATES AS MAY BE NECESSARY TO DELAY ITS EFFECTIVE DATE UNTIL THE REGISTRANT
SHALL FILE A FURTHER AMENDMENT WHICH SPECIFICALLY STATES THAT THIS
REGISTRATION STATEMENT SHALL THEREAFTER BECOME EFFECTIVE IN ACCORDANCE WITH
SECTION 8(A) OF THE SECURITIES ACT OF 1933 OR UNTIL THE REGISTRATION STATEMENT
SHALL BECOME EFFECTIVE ON SUCH DATE AS THE SECURITIES AND EXCHANGE COMMISSION,
ACTING PURSUANT TO SAID SECTION 8(A), MAY DETERMINE.

- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
<PAGE>

++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++
+INFORMATION CONTAINED HEREIN IS SUBJECT TO COMPLETION OR AMENDMENT. A +
+REGISTRATION STATEMENT RELATING TO THESE SECURITIES HAS BEEN FILED WITH THE +
+SECURITIES AND EXCHANGE COMMISSION. THESE SECURITIES MAY NOT BE SOLD NOR MAY +
+OFFERS TO BUY BE ACCEPTED PRIOR TO THE TIME THE REGISTRATION STATEMENT +
+BECOMES EFFECTIVE. THIS PROSPECTUS SHALL NOT CONSTITUTE AN OFFER TO SELL OR +
+THE SOLICITATION OF AN OFFER TO BUY NOR SHALL THERE BE ANY SALE OF THESE +
+SECURITIES IN ANY STATE IN WHICH SUCH OFFER, SOLICITATION OR SALE WOULD BE +
+UNLAWFUL PRIOR TO REGISTRATION OR QUALIFICATION UNDER THE SECURITIES LAWS OF +
+ANY SUCH STATE. +
++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++

SUBJECT TO COMPLETION, DATED MARCH 6, 1998

PROSPECTUS

2,000,000 SHARES

[LOGO] HAPPY KIDS

COMMON STOCK

-----------

All of the shares of Common Stock offered hereby (the "Offering") are being
issued and sold by Happy Kids Inc. ("Happy Kids" or the "Company"). Prior to
the Offering, there has been no public market for the Common Stock of the
Company. It is currently anticipated that the initial public offering price
will be between $9.00 and $11.00 per share. See "Underwriting" for information
relating to the factors considered in determining the initial public offering
price.

The Company's Common Stock has been approved for quotation, subject to notice
of effectiveness, on the Nasdaq National Market under the trading symbol
"HKID."

SEE "RISK FACTORS" COMMENCING ON PAGE 7 FOR A DISCUSSION OF CERTAIN FACTORS
THAT SHOULD BE CONSIDERED BY PROSPECTIVE PURCHASERS OF THE COMMON STOCK OFFERED
HEREBY.

-----------

THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE SECURITIES
AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION PASSED UPON THE
ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE
CONTRARY IS A CRIMINAL OFFENSE.

- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
UNDERWRITING
PRICE DISCOUNTS AND PROCEEDS TO
TO PUBLIC COMMISSIONS (1) COMPANY (2)
- --------------------------------------------------------------------------------
<S> <C> <C> <C>
Per Share................................. $ $ $
- --------------------------------------------------------------------------------
Total (3)................................. $ $ $
</TABLE>
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
(1) For information regarding indemnification of the Underwriters by the
Company and certain shareholders and certain compensation payable to the
Representatives of the Underwriters, see "Underwriting."
(2) Before deducting expenses of the Offering estimated to be approximately
$800,000. Of such proceeds, the Company will use $2.0 million to make a
partial payment of amounts due to current shareholders of the Company. See
"Use of Proceeds."
(3) The Underwriters have been granted a 30-day option to purchase up to an
additional 300,000 shares of Common Stock from the Company solely to cover
over-allotments, if any, on the same terms and conditions as the shares
offered hereby. If the Underwriters exercise such option in full, the total
"Price to Public," "Underwriting Discounts and Commissions" and "Proceeds
to Company" will be $ , $ and $ , respectively. See "Underwriting."

-----------

The shares of Common Stock are offered by the several Underwriters, when, as
and if delivered to and accepted by the Underwriters, subject to their right to
reject any order in whole or in part and to certain other conditions. It is
expected that delivery of the Common Stock will be made on or about , 1998
at the offices of Ladenburg Thalmann & Co. Inc., New York, New York.

LADENBURG THALMANN & CO. INC. CRUTTENDEN ROTH
INCORPORATED

The date of this Prospectus is , 1998
<PAGE>

[The inside front cover contains a picture of a child dressed in certain of
the Company's apparel products and a bubble expression "Everyday is a Happy
Kids day!" In the lower right hand corner of the inside front cover are
pictures of the Company's clothing. The inside front cover is followed by a
two page gatefold layout containing children dressed in certain of the
Company's apparel products beneath which appear the words "We put the fun in
activewear!" and pictures of certain articles of the Company's clothing. Above
the children appear logos relating to the Company's licensing or private label
relationships with each of: Ocean Pacific, Sesame Street for KMart, B.U.M.
Equipment, Nickelodeon's Rugrats and AND 1.]

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

CERTAIN PERSONS PARTICIPATING IN THIS OFFERING MAY ENGAGE IN TRANSACTIONS
THAT STABILIZE, MAINTAIN OR OTHERWISE AFFECT THE PRICE OF THE COMMON STOCK,
INCLUDING MAINTAINING A MARKET IN THE COMMON STOCK ON BEHALF OF THE
UNDERWRITERS. FOR A DESCRIPTION OF THESE ACTIVITIES, SEE "UNDERWRITING."

All trade names, trademarks or service marks appearing in this Prospectus
are the property of their respective owners and are not the property of the
Company.
<PAGE>

PROSPECTUS SUMMARY

The following material is qualified in its entirety by the more detailed
information and the financial statements, including the notes thereto,
appearing elsewhere in this Prospectus. Unless otherwise indicated, all
information in this Prospectus (i) gives effect to the Reorganization (as
defined below) that will be effected immediately prior to the effectiveness of
this Offering (see "The Company," "Capitalization" and "Management --
Compensation Committee Interlocks and Insider Participation"), (ii) gives
effect to a 34,875-for-1 split of the Common Stock effected December 31, 1997
and (iii) assumes no exercise of the Underwriters' over-allotment option. In
this Prospectus, the term "Company" includes Happy Kids Inc. and its wholly-
owned subsidiaries, after giving effect to the Reorganization. This Prospectus
contains forward-looking statements that involve material risks and
uncertainties. The Company's actual results could differ materially from the
results discussed in such forward-looking statements. Factors that could cause
or contribute to such differences include, but are not limited to, those set
forth in the section entitled "Risk Factors" and elsewhere in this Prospectus.

THE COMPANY

Happy Kids 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 (collectively,
"playwear"). The Company's major licenses include Nickelodeon's Rugrats, AND 1,
B.U.M. Equipment and Ocean Pacific. In late 1997, the Company acquired licenses
to Warner Brothers' Scooby Doo, ACA Joe and E.N.U.F. Internationale, and, in
early 1998, the Company reached an agreement in principle to acquire a license
for Jim Henson's Kermit the Frog and Friends. The Company also designs and
delivers private label branded playwear programs for leading retailers,
including Sesame Street for KMart, New Legends for Kids R Us and Canyon River
Blues for Sears and recently began participating in Nickelodeon's Nick Universe
program being launched by Kids R Us. The Company's strategy is to work closely
with its customers to design and market coordinated playwear 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.

In 1995, to leverage its customer relationships, its popular licenses and
brand names and its reputation for quality products and reliable delivery, the
Company initiated its current sales strategy under which customers order
specific quantities of goods on a fixed-price basis six to nine months in
advance of a selling season. For 1997, substantially all of the Company's
apparel was produced upon receipt of customer orders. Based on orders received
as of January 31, 1998, the Company had backlog of $107.7 million, which it
expects to fill over the following six to nine months.

Also in 1995, the Company began focusing on the development of a diversified
portfolio of popular, established and well-recognized licensed properties and
branded private label arrangements. Consequently, the Company has shifted its
product mix to higher margin licensed and private label apparel programs from
lower margin house brands. As a result of this change in product mix combined
with the implementation of the Company's sales strategy, net sales and gross
margins increased to $106.7 million and 25.2% in 1997, from $90.7 million and
23.0% in 1996, and from $79.8 million and 18.5% in 1995. Additionally, the
Company has been able to leverage the popularity and goodwill associated with
its licensed properties and brand names to promote sales, rather than
undertaking costly marketing initiatives.

The Company's playwear is designed by 42 in-house designers and graphic
artists organized in teams dedicated to each of the Company's licensed
properties and private label programs. Each team works closely with licensors,
customers and contract manufacturers, utilizing state-of-the-art CAD

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<PAGE>

systems, to design coordinated products featuring textured fabrications and
detailed graphics. The Company believes that its customers rely on its ability
to design, have manufactured and deliver on a timely basis commercially
successful apparel programs. The Company markets its playwear primarily to
mass-market retailers, mid-tier distributors and department stores, including
KMart, Kids R Us, Price/Costco, Sears and WalMart.

The Company's products are manufactured to exacting quality standards and
specifications by over 50 unaffiliated, foreign and domestic contract
manufacturers. The Company uses third-party manufacturers to eliminate the
significant capital investment requirements associated with maintaining
manufacturing facilities. The Company has developed long-standing relationships
with many of its contract manufacturers and, in 1997, approximately 66.8% of
the Company's products were manufactured by contract manufacturers which have
been utilized by the Company for over three years. The Company's ability to
design and have manufactured high-quality playwear is evidenced by the
Company's product return rates of 1.9% and 3.3% in 1997 and 1996, respectively.

The Company's growth strategy is to continue to leverage the strength of its
diversified portfolio of licensed properties, private label relationships and
the quality of its playwear products. The key elements of this strategy
include: (i) to increase sales to existing accounts by expanding product
categories and sizes incorporating the Company's existing licensed properties
and private label relationships; (ii) to expand the Company's customer base by
selling to additional mass-market retailers, mid-tier distributors, department
stores, specialty retailers and sporting goods chains; (iii) to leverage newly
acquired licensed properties and private label relationships; and (iv) to add
new licenses and private label relationships based on established and popular
brands.

THE OFFERING

<TABLE>
<C> <S>
Common Stock offered hereby............. 2,000,000 shares
Common Stock to be outstanding after the
Offering(1)............................ 9,750,000 shares
Use of proceeds......................... Repayment of a portion of the
Company's outstanding line of credit;
repayment of a $2.0 million portion
of promissory notes to be issued to
current shareholders in connection
with the termination of the Company's
S Corporation status.
Nasdaq National Market symbol........... HKID
</TABLE>
- --------
(1) Excludes 800,000 shares of Common Stock reserved for issuance upon the
exercise of options or stock purchase rights issuable under the Company's
1997 Stock Option Plan, none of which shares or options had been issued or
granted as of December 31, 1997. On February 24, 1998, the Company issued
options to purchase 100,000 shares of Common Stock, none of which are
presently exercisable. See "Management--1997 Stock Option Plan."

4
<PAGE>

SUMMARY CONSOLIDATED FINANCIAL DATA

The following summary consolidated financial data should be read in
conjunction with the Consolidated Financial Statements and related Notes
thereto appearing elsewhere in this Prospectus and "Management's Discussion and
Analysis of Financial Condition and Results of Operations." The selected
financial data have been derived from the Consolidated Financial Statements of
the Company. The consolidated statements of operations for each of the three
years in the period ending December 31, 1997 have been audited by the Company's
independent auditors and are included elsewhere in this Prospectus. The
selected statement of operations data for the year ended December 31, 1994 have
been derived from the audited Consolidated Financial Statements of the Company
not included herein. The selected statement of operations data for the year
ended December 31, 1993 have been derived from the unaudited Consolidated
Financial Statements of the Company not included herein, which, in the opinion
of management, reflect all adjustments (consisting solely of normal recurring
adjustments) necessary for a fair presentation of the results for these periods
and as of such dates. The selected financial data provided below is not
necessarily indicative of the future results of operations or financial
performance of the Company.

<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
-----------------------------------------
1993 1994 1995 1996 1997
------- ------- ------- ------- --------
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<S> <C> <C> <C> <C> <C> <C> <C>
STATEMENT OF OPERATIONS DATA:
Net sales................... $64,747 $74,520 $79,828 $90,723 $106,673
Gross profit................ 15,279 15,276 14,792 20,837 26,925
Operating expenses:
Selling, design and
shipping................. 5,765 5,962 7,986 7,686 10,058
General and
administrative........... 5,413 6,358 6,830 7,684 8,399
------- ------- ------- ------- --------
Total operating
expenses............... 11,178 12,320 14,816 15,370 18,457
------- ------- ------- ------- --------
Operating income (loss)..... 4,101 2,956 (24) 5,467 8,468
Interest expense, net....... 1,160 1,631 2,375 2,980 3,803
------- ------- ------- ------- --------
Income (loss) before pro
forma income taxes......... 2,941 1,325 (2,399) 2,487 4,665
Pro forma net income(1)..... $ 1,657 $ 703 $(1,463) $ 1,497 $ 2,704
======= ======= ======= ======= ========
Pro forma net income per
share...................... $ 0.20 $ 0.08 $ (0.18) $ 0.18 $ 0.33
======= ======= ======= ======= ========
Pro forma weighted average
shares outstanding(2)...... 8,305 8,305 8,305 8,305 8,305
Supplemental pro forma net
income per share(3)........ $ 0.42
========
Supplemental pro forma
weighted average shares
outstanding(2)(4).......... 9,885
</TABLE>

<TABLE>
<CAPTION>
DECEMBER 31, 1997
-----------------------------------
PRO FORMA
ACTUAL PRO FORMA(5) AS ADJUSTED(6)
------- ------------ --------------
<S> <C> <C> <C>
BALANCE SHEET DATA:
Working capital........................... $ 6,419 $ 5,028 $22,828
Total assets.............................. 44,952 45,561 45,561
Due to bank............................... 24,863 24,863 9,063
Due to shareholders....................... 1,400 6,954 4,954
Capital lease obligations................. 68 68 68
Shareholders' equity...................... 6,644 1,699 19,499
</TABLE>

5
<PAGE>

(1) The Company has operated as an S Corporation for federal and New York state
income tax purposes since 1988. Two of the wholly-owned subsidiaries are C
Corporations and, accordingly, have been taxed at the appropriate corporate
federal and state tax rates. The historical Consolidated Financial
Statements do not include a provision for federal and state income taxes
for such periods for those subsidiaries which have elected to be treated as
S Corporations. A provision for state income taxes has been made for those
states not recognizing S Corporation status. Pro forma net income has been
computed as if the Company had been fully subject to federal and state
income taxes based on the tax laws in effect during the respective periods.
See Notes A and P to the Consolidated Financial Statements.
(2) Reflects the weighted average shares outstanding and gives pro forma effect
to the additional shares that the Company would have to sell at the assumed
initial public offering price of $10.00 per share to repay the estimated
$5.6 million of promissory notes to be issued to the shareholders in
connection with the termination of the Company's S Corporation status. The
Company intends to repay $2.0 million of these notes with a portion of the
net proceeds of the Offering.
(3) Supplemental pro forma net income per share was computed by adjusting pro
forma net income per share to reflect a reduction in interest expense and
related fees, net of taxes, of $1.4 million in the year ended December 31,
1997, resulting from the assumed repayment of debt with a portion of the
net proceeds of the Offering as if such repayment had occurred on January
1, 1997, consisting solely of repayment of $15.8 million outstanding under
the Company's $42.0 million line-of-credit (of which $24.9 million was
outstanding at December 31, 1997).
(4) Gives pro forma effect to the additional shares that the Company would have
to sell at the assumed initial public offering price of $10.00 per share to
repay the debt referenced in footnote 3 above.
(5) Adjusted to give effect to (i) the deferred tax asset of approximately
$609,000, resulting from the termination of the Company's status as an S
Corporation and (ii) approximately $5.6 million decrease in shareholders'
equity and a corresponding increase in due to shareholders at December 31,
1997, of which $2.0 million has been classified as a current liability to
be repaid with a portion of the net proceeds of the Offering, resulting
from an issuance of promissory notes to certain shareholders related to the
termination of the Company's status as an S Corporation. See "The Company,"
"Capitalization," "Management--Compensation Committee Interlocks and
Insider Participation" and Note P to the Consolidated Financial Statements.
(6) Adjusted to reflect the sale of 2,000,000 shares of common stock at an
assumed offering price of $10.00 per share and the anticipated application
of the net proceeds therefrom. See "Use of Proceeds" and "Capitalization."

6
<PAGE>

RISK FACTORS

In addition to the other information contained in this Prospectus, the
following risk factors should be carefully considered before investing in the
Common Stock. Except for historical information contained herein, the
information in this Prospectus contains forward-looking statements that
involve risks and uncertainties, such as statements concerning the Company's
plans, objectives, expectations and intentions. The cautionary statements made
in this Prospectus should be read as being applicable to all related forward-
looking statements wherever they appear in this Prospectus. The Company's
actual results could differ materially from those discussed in the Prospectus.
Factors that could cause or contribute to such differences include those
discussed below, as well as those discussed elsewhere herein.

DEPENDENCE ON LICENSE AGREEMENTS

A majority of the Company's net sales are derived from the sale of products
incorporating licensed properties. For 1997, B.U.M. Equipment, Nickelodeon's
Rugrats and Ocean Pacific accounted for 18.9%, 11.3% and 11.1%, respectively,
of the Company's net sales. In 1996, B.U.M. Equipment, Ocean Pacific and
Jordache accounted for 19.8%, 14.5% and 12.4%, respectively, of the Company's
net sales. No other licensed property accounted for over 10% of the Company's
net sales in 1997 or 1996. The Company's current licensing arrangements
contain initial terms of between eighteen months and five years, and typically
include multiple renewal options of between one and five years, subject to
certain conditions. The present terms of the Company's current license
arrangements will expire between December 1999 and December 2002. The
Company's license arrangements also include payment obligations and certain
covenants, the breach of which by the Company could result in the termination
of the applicable licensing arrangement. The Company believes that it is
currently in compliance with all material provisions of its existing licensing
arrangements and has no reason to believe that any events are likely to occur
that would permit any of its licensors to terminate their respective licenses.
In addition, to maintain and renew such licenses, the Company must continue to
satisfy certain conditions, including minimum sales requirements. There can be
no assurance that the Company will achieve such minimum sales requirements or
that any of its licenses will be extended beyond their current expirations on
terms acceptable to the Company, if at all. The Company has limited prior
license renewal experience. The loss of any major license could materially
adversely affect the Company's business, financial condition or results of
operations.

The Company's future success and growth is dependent, in part, upon its
diversified portfolio of licensed properties and its ability to identify
properties that will appeal to consumers, its ability to obtain licenses for
such properties and its ability to produce marketable playwear products based
upon such licenses. There can be no assurance, however, that the Company will
be able to identify suitable properties, secure additional licenses, maintain
such a portfolio or produce marketable playwear.

Apparel industry licenses typically are granted with respect to specific
product categories, sizes and channels of distribution, and may be either
exclusive or non-exclusive. Certain of the Company's licenses are non-
exclusive. The granting of licenses by any of the Company's licensors within
the Company's licensed product categories, sizes or channels of distribution
may materially adversely affect the Company's future sales generated under any
such licenses. In addition, as a result of increased competition among
children's apparel companies for licenses, the Company may, in the future, be
required to pay licensors higher royalties and higher minimum guaranteed
payments in order to obtain attractive licenses. There can be no assurance
that licenses will not be granted to the Company's competitors within
categories in which the Company has a non-exclusive license. In addition, the
Company relies upon its licensors to protect licensed properties and to
enforce trademark and tradename rights. There can be no assurance that
licensors will adequately protect the licensed properties or enforce such
rights, if at all. Failure to protect and enforce trademark and tradename
rights by such licensors

7
<PAGE>

could reduce the value of such rights and have a material adverse effect on
the Company's business, financial condition or results of operations. See
"Business--Products and Licenses."

DEPENDENCE ON PRIVATE LABEL RELATIONSHIPS

From time to time the Company enters into private label relationships for
the design and marketing of children's apparel. For 1997, 14.3% of the
Company's net sales were derived from its arrangement with KMart for the
Company's Sesame Street products. No other private label relationship
accounted for over 10% of the Company's net sales in 1997, and there were no
private label relationships accounting for over 10% of the Company's net sales
in 1996. All sales made under a private label relationship are made on a
purchase order basis, rather than pursuant to contract, and there are no long-
term contracts with respect to any private label relationships. There can be
no assurance that existing private label relationships will continue in the
future or that the Company will be able to obtain new private label
relationships on an ongoing basis, if at all.

DEPENDENCE ON CONTRACT MANUFACTURERS

Substantially all of the Company's products are manufactured by unaffiliated
foreign and domestic contract manufacturers. During 1997 and 1996, foreign
manufacturers produced approximately 93.4% and 91.2% of the Company's
products, respectively, with the remainder of products produced domestically.
The Company does not have long-term contracts or formal arrangements with any
of these manufacturers. Foreign manufacturing is subject to a number of risks,
including transportation delays and interruptions, political and economic
disruptions, tariffs, import and export controls and changes in governmental
policies. In addition, stringent controls, such as review and inspection of
fabrics, samples, specifications, fit and completed garments and factory
visits, must be undertaken to ensure the production of quality products.
Although the Company believes that it has instituted such controls, there can
be no assurance that such events will not occur in the future, resulting in
possible increases in costs and delays of product deliveries resulting in
losses of revenue and goodwill. During 1997 and 1996, various production
facilities located in Thailand accounted for an aggregate of 41.4% and 40.3%
of the Company's manufactured products, respectively, and various production
facilities in Hong Kong accounted for an aggregate of 30.7% and 37.5% of the
Company's manufactured products, respectively. No other country accounted for
10% or more of the Company's manufactured products during 1997 or 1996. In
addition, two manufacturing facilities located in Hong Kong accounted for
10.6% and 12.6%, respectively, of the Company's manufactured products during
1997 and 11.1% and 23.3%, respectively, of the Company's manufactured products
during 1996. No other single manufacturer accounted for 10% or more of the
Company's manufactured products during 1997 or 1996. There is competition for
production capacity of children's apparel manufacturers and the Company has,
in the past, temporarily lost access to the manufacturing capacity of its
preferred manufacturers to its competitors. While the Company believes that
alternate sources of manufacturing are available if the need were to arise,
there can be no assurance that the supply of such alternate facilities would
be available on commercially reasonable terms, if at all. Any substantial
delay in locating, or inability to locate, acceptable alternate sources of
manufacturing could have a material adverse affect on the Company's business,
financial condition or results of operations. See "Business--Manufacturing."

RELIANCE ON KEY CUSTOMERS

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<PAGE>

and recent results and existing relationships with customers, the Company
believes that a substantial portion of its net sales and gross profits will
continue to be derived from a small number of large customers. The Company had
backlog of $107.7 million as of January 31, 1998, which it expects to fill in
the following six to nine months; however, consistent with industry practice,
these orders are not contractual commitments by customers to purchase products
from the Company and, therefore, may be cancelled by such customers. Although
the Company has not experienced significant cancellations in the past, there
can be no assurance that some portion of these orders will not be cancelled. A
significant reduction in orders from, the cancellation of a significant
portion of orders by, or the termination of the Company's relationship with,
any of its larger customers could have a material adverse effect on the
Company's business, financial condition or results of operations. There can be
no assurance that the Company's larger customers will continue to place orders
with the Company or that orders by such customers will continue at their
previous levels. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations" and "Business--Merchandising" and "--
Backlog."

DEPENDENCE ON ACCESS TO CREDIT FACILITIES

Historically, the Company has relied heavily on its access to credit
facilities to fund its operations. Substantially all of the Company's assets
are subject to security interests granted by the Company to its lenders.
Although the Company has never had a payment default, it has, from time to
time, been in violation of certain financial covenants under its credit
facilities. While the Company's lenders have waived such violations in the
past, there can be no assurance that such violations may not recur in the
future or that if such violations do recur, that the Company's lenders will
grant waivers in the future on terms acceptable to the Company, if at all. In
addition, the loss by the Company of the services of Jack M. Benun, the
Company's Chairman of the Board, President and Chief Executive Officer, could
trigger an event of default under such credit facilities. Accordingly, there
can be no assurance that the Company will be able to retain its current access
to credit in the future or successfully obtain alternative sources of credit
on commercially reasonable terms. In addition, the Company's lenders have sole
discretion to make or withhold advances under the Company's existing credit
line. There can be no assurance that the lenders will continue to lend under
the credit line. If the lenders were to exercise their discretion to withhold
advances, there could be a material adverse effect on the Company's business,
financial condition or results of operations.

RISKS ASSOCIATED WITH SIGNIFICANT GROWTH

The Company has enjoyed rapid growth which has placed, and could continue to
place, a significant strain on the Company's management, administrative and
operational resources. The Company remains vulnerable to a variety of business
risks generally associated with rapidly growing companies as well as risks
related to the broadening of its product offerings and the expansion of its
distribution channels. To manage growth effectively, the Company will be
required to continue to implement changes in certain aspects of its business,
expand its information systems and operations to respond to increased demands
and to develop, train and manage an increasing number of management level and
other employees. None of the Company's senior management previously has
managed a business of the Company's scale or scope or has experience managing
a publicly-held company. Accordingly, the Company's past growth cannot be
assumed to be indicative of its future operating results. In addition, failure
by the Company to continue to enhance operating control systems or the
encountering of unexpected difficulties during a continued stage of expansion
could adversely affect the Company's business, financial condition or results
of operations.

COMPETITION

9
<PAGE>

are substantially greater than those of the Company. There can be no assurance
that other companies will not attempt to enter or expand their presence in any
of the Company's existing product categories or in new categories in which the
Company plans or may plan to develop products. The Company also faces
competition from its existing customers, who may themselves begin to produce
children's playwear directly. In addition, such customers have in the past
competed, and may continue in the future to compete, for available licensed
properties. Further, to the extent that the Company's customers or competitors
maintain or initiate private label programs, such customers or competitors
will compete with the Company's licensed and branded properties. The Company
also competes with other manufacturers of children's apparel for retail floor
space. No assurance can be given that additional floor space will be available
in retail stores to support expansion of products offered by the Company, or
that the floor space currently allocated to the Company's products will not be
reduced in the future. There can be no assurance that competition from the
foregoing sources will not adversely affect the Company's business, financial
condition or results of operations. See "Business--Products and Licenses" and
"--Industry and Competition."

SEASONALITY

Sales of children's apparel are seasonal. Consequently, the Company's
operating results have varied substantially from quarter to quarter, and the
Company expects that they will continue to do so. Generally, the Company has
experienced significantly higher net sales in the first and third quarters as
compared to the second and fourth quarters, although this may change from time
to time. The seasonality of the Company's business also affects borrowings
under the Company's lines of credit and its level of backlog, which fluctuate
in response to demand for the Company's products. Therefore, the results of
any interim period are not necessarily indicative of the results that may be
achieved for an entire year. See "Management's Discussion and Analysis of
Financial Condition and Results of Operations."

CYCLICALITY AND TRENDS IN THE APPAREL INDUSTRY

The apparel industry is subject to rapidly changing consumer demands and
preferences. Although the Company focuses on what it believes to be
established and popular properties, there can be no assurance that consumers
will continue to favor the properties licensed by the Company or the products
designed and produced by the Company under private label relationships, and a
significant shift in consumer preferences could have a material adverse effect
on the Company's business, financial condition or results of operations. The
apparel industry is a cyclical industry heavily dependent upon the overall
level of consumer spending, with purchases of apparel and related goods
tending to decline during recessionary periods when disposable income is low.
A difficult retail environment could result in downward price pressure which
could adversely impact the Company's gross profit margins. Additionally, all
of the Company's customers are in the retail industry, which industry has
experienced significant changes and difficulties over the past several years,
including consolidation of ownership, increased centralization of buying
decisions, restructurings, bankruptcies and liquidations. While various
retailers, including some of the Company's customers, experienced financial
difficulties in the past few years, thereby increasing the Company's risk of
extending credit to such retailers, the Company's bad debt experience has been
immaterial. Financial problems of a retailer could cause the Company's factor
to limit the amount of credit extended to such retailer. If the Company's
factor were to impose such limitation, the Company could be required
to curtail business with such retailer or to assume additional credit risk
relating to such customer's receivables. The Company cannot predict what
effect, if any, continued or additional changes within the retail industry
will have on its business, financial condition or results of operations.

IMPORT RESTRICTIONS AND OTHER RISKS ASSOCIATED WITH INTERNATIONAL BUSINESS

During 1997 and 1996, foreign manufacturers produced approximately 93.4% and
91.2% of the Company's products, respectively. Specifically, during 1997 and
1996, various production facilities located in Thailand accounted for 41.4%
and 40.3% of the Company's manufactured products,

10
<PAGE>

respectively, and various production facilities in Hong Kong accounted for
30.7% and 37.5% of the Company's manufactured products, respectively. No other
country accounted for 10% or more of the Company's manufactured products
during 1997 or 1996. The Company's products are subject to bilateral textile
agreements between the United States and a number of foreign countries. Such
agreements, which have been negotiated under the framework established by the
Arrangement Regarding International Trade in Textiles, allow the United States
to impose restraints at any time on the importation of categories of
merchandise that, under the terms of the agreements are not currently subject
to specified limits. The Company does not own the right to import finished
garments into the United States, but relies on its contract manufacturers to
obtain the necessary quotas. In the past, to the extent that necessary import
quotas have not been available with respect to a particular source of supply,
the Company has been able to find an alternative source of supply.
Accordingly, the availability of quotas has not had a material effect upon the
Company's business, financial condition or results of operations. The
Company's continued ability to source imported products may be adversely
affected by a significant decrease in available import quotas as well as any
additional bilateral agreements or unilateral trade restrictions. In addition,
a significant portion of the Company's products are manufactured in Hong Kong.
China recently resumed sovereignty over Hong Kong. The Company cannot predict
the effect, if any, this event will have on its contract manufacturers in Hong
Kong and there can be no assurance that Hong Kong will not experience
political, economic or social disruption as a result of the resumption of
Chinese sovereignty. In addition, there have been a number of recent trade
disputes between China and the United States during which the United States
has threatened to impose tariffs and duties on some products imported from
China and to withdraw China's "most favored nation" trade status. The loss of
such status for China, changes in current tariff structures or the adoption by
the United States of trade policies or sanctions adverse to China could have a
material adverse effect on the Company's business, financial condition or
results of operations. See "Business--Manufacturing."

DEPENDENCE ON KEY PERSONNEL

The Company is substantially dependent upon the efforts and skills of its
executive officers, particularly Jack M. Benun, the Company's Chairman of the
Board, President and Chief Executive Officer, Mark J. Benun, the Company's
Executive Vice President and Secretary and Isaac Levy, the Company's Senior
Vice President. The loss of the services of any of these executive officers
could have a material adverse effect on the Company. The Company has entered
into an employment agreement with each of these three individuals and
maintains key man life insurance on Jack Benun in the amount of $3.0 million.
There can be no assurance that the departure of one or more of such key
personnel would not have a material adverse effect on the Company's results of
operations. Furthermore, there can be no assurance that the Company will be
successful in attracting and retaining the personnel it requires to conduct
its operations or to meet its future needs. See "Management--Executive
Compensation," "--Employment Agreements and Indemnification Agreements" and
"--Key Man Insurance."

CONTROL BY CURRENT SHAREHOLDERS

After consummation of the Offering, Jack Benun, Mark Benun and Isaac Levy
together will own an aggregate of approximately 79.5% of the outstanding
shares of Common Stock of the Company. As a result, such individuals will be
able to control the outcome of all matters requiring shareholder approval and
will be able to elect all of the Directors of the Company. Such control, which
may have the effect of delaying, deferring or preventing a change of control
of the Company, is likely to continue for the foreseeable future and
significantly diminishes control and influence which future shareholders may
have in the Company. See "Principal Shareholders."

11
<PAGE>

of first refusal to purchase any shares of Common Stock offered for sale by
any other party to the agreement. Finally, Mark Benun has granted Jack Benun
an irrevocable proxy to vote any of the Company's voting securities
beneficially owned by Mark Benun for the life of Jack Benun.

SHARES ELIGIBLE FOR FUTURE SALE

Sales of substantial amounts of Common Stock in the public market after the
Offering, or the perception that such sales could occur, could adversely
affect the market price for the Common Stock. In addition to the 2,000,000
shares offered hereby which will be freely tradable in the public market,
3,487,500 shares of Common Stock held by the existing shareholders will be
immediately eligible for sale in the public market in the quantities and
manner permitted by Rule 144 promulgated under the Securities Act of 1933, as
amended (the "Act"). Each officer, director and current holder of the
Company's Common Stock has agreed with the Underwriters not to offer, sell,
pledge or otherwise dispose of any shares of Common Stock for 180 days after
the date of this Prospectus without the prior written consent of Ladenburg
Thalmann & Co. Inc., on behalf of the Representatives. In addition, up to
800,000 shares of Common Stock reserved for issuance pursuant to the exercise
of options or stock purchase rights will be available for sale in the public
market from time to time pursuant to exemptions from registration requirements
or upon registration. See "Management--1997 Stock Option Plan" and "Shares
Eligible for Future Sale."

NO PRIOR PUBLIC MARKET FOR COMMON STOCK; DETERMINATION OF OFFERING PRICE;
VOLATILITY

Prior to the Offering, there has been no public market for the Common Stock.
Although the Company's Common Stock has been approved for quotation, subject
to notice of effectiveness, on the Nasdaq National Market, there can be no
assurance that an active trading market for the Common Stock will develop or
be sustained. The initial public offering price of the Common Stock offered
hereby will be determined by negotiations between the Company and the
Representatives of the Underwriters. There can be no assurance that the price
at which the Common Stock will trade in the public market after the Offering
will not be lower than the initial public offering price. The market price of
the Common Stock could be subject to significant fluctuations in response to
such factors as, among others, variations in the Company's anticipated or
actual results of operations, limited trading volume in the Common Stock,
general market conditions or the children's apparel industry in general. See
"Underwriting."

DILUTION

Purchasers of Common Stock in the Offering will experience immediate
substantial dilution in net tangible book value per share of Common Stock. See
"Dilution."

ANTI-TAKEOVER EFFECT OF CERTAIN CHARTER AND BY-LAW AND OTHER PROVISIONS

The Company's Restated Certificate of Incorporation (the "Certificate of
Incorporation") authorizes the Board of Directors to issue, without
shareholder approval, 5,000,000 shares of Preferred Stock with voting,
conversion and other rights and preferences that could adversely affect the
voting power or other rights of the holders of Common Stock. The issuance of
Preferred Stock or of rights to purchase Preferred Stock could be used to
discourage an unsolicited acquisition proposal. In addition, the possible
issuance of Preferred Stock could discourage a proxy contest, make more
difficult the acquisition of a substantial block of the Company's Common Stock
or limit the price that investors might be willing to pay in the future for
shares of the Company's Common Stock. The Certificate of Incorporation also
provides that: (i) the affirmative vote of the holders of at least 80% of the
voting power of all outstanding shares of the capital stock of the Company
shall be required to adopt, amend or repeal any provision of the bylaws of the
Company or the provisions in the Certificate of Incorporation limiting the
liability of directors and provisions relating to certain management issues;
(ii) shareholders of the Company may not take any action by written consent;
(iii) special meetings of shareholders may be called only by the President,
the Chairman of the Board or a majority of the

12
<PAGE>

Board of Directors and business transacted at any such special meeting shall
be limited to matters relating to the purposes set forth in the notice of such
special meeting; and (iv) the Board of Directors, when evaluating an offer
related to a tender or exchange offer or other business combination, is
authorized to give due consideration to any relevant factors, including the
social, legal and economic effects upon employees, suppliers, customers,
creditors, the community in which the Company conducts its business, and the
economy of the state, region and nation. The foregoing provisions of the
Certificate of Incorporation could have the effect of delaying, deterring or
preventing a change in control of the Company. In addition, the Company is
subject to Section 912 of the New York Business Corporation Law (the "New York
Act") which, subject to certain exceptions, restricts certain transactions and
business combinations between a corporation and a shareholder owning 20% or
more of the Company's outstanding voting stock (an "interested shareholder")
for a period of five years from the date the shareholder becomes an interested
shareholder. These provisions may have the effect of delaying or preventing a
change of control of the Company without action by the shareholders and,
therefore, could adversely affect the price of the Company's Common Stock. See
"Description of Capital Stock--Preferred Stock," "--Limitation of Director
Liability" and "--Anti-takeover Provisions."

ABSENCE OF DIVIDENDS

The Company does not anticipate paying any dividends on its Common Stock in
the foreseeable future. See "Dividend Policy."

13
<PAGE>

THE COMPANY

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 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 the shareholders of the Company. Immediately prior to the
effectiveness of this Offering, all of such separate entities shall become
wholly-owned subsidiaries of the Company. See "Management--Compensation
Committee Interlocks and Insider Participation." The Company's principal
executive office is located at 100 West 33rd Street, New York, New York,
10001, and its telephone number is (212) 695-1151.

S Corporation Distribution

Prior to the termination of its S Corporation status, the Company intends to
declare a distribution (the "S Corporation Distribution") to the shareholders
of record of the Company on such date. Such shareholders consist 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 at $5.6
million as of December 31, 1997) represents substantially all of the Company's
remaining undistributed S Corporation earnings and will be evidenced by four-
year 5.7% promissory notes to be issued to such shareholders in connection
with the termination of the Company's S Corporation status. The actual amount
of the S Corporation Distribution will be adjusted to include the taxable
income of the Company for the period from January 1, 1998 through the day
preceding the date on which S Corporation status is terminated, less any state
income tax payable by the Company with respect to such income and any
distributions made to the current shareholders during that time period ($3.5
million was distributed to the current shareholders in 1997 and 1998 through
the date of this Prospectus in the form of dividends to fund their 1996 and
1997 tax liabilities resulting from the Company's status as an S Corporation).
Of the total S Corporation Distribution, $2.0 million of the net proceeds from
this Offering will be used to make a partial payment of amounts due under such
notes. The balance of the S Corporation Distribution will be paid in
accordance with the terms and provisions of the promissory notes referred to
above and will provide for the timely distribution of amounts necessary to pay
personal income taxes of the shareholders due on amounts earned by the S
Corporations for the period January 1, 1998 through the termination of such S
Corporation status. See "Use of Proceeds" and "Management--Compensation
Committee Interlocks and Insider Participation."

USE OF PROCEEDS

The net proceeds to the Company from the sale of the 2,000,000 shares of
Common Stock offered by the Company hereby (at an assumed initial public
offering price of $10.00 per share and after deducting estimated underwriting
discounts and commissions and Offering expenses) are estimated to be
approximately $17.8 million ($20.6 million if the Underwriters' over-allotment
option is exercised in full).

The Company expects to repay approximately $15.8 million ($18.6 million if
the Underwriters' over-allotment option is exercised in full) under its $42.0
million line of credit (adjusted seasonally to $47.0 million for the period
January 1, 1998 through April 30, 1998), of which $24.9 million was
outstanding at December 31, 1997. The line of credit terminates on December
31, 1998, and currently bears interest at an effective annual rate of 15.4%,
including a base interest rate of prime plus 4.0% per annum on the first $5.0
million outstanding and prime plus 1.0% per annum on outstanding balances in
excess of $5.0 million, and related fees. The prime rate was 8.5% as of
December 31, 1997. In connection with the Offering, the Company has executed a
letter of intent with respect to an amendment of its line of credit, which
amendment will be effective upon effectiveness of the Offering, subject to
certain conditions. In connection therewith, the personal guarantees of
certain current shareholders under the present terms of the line of credit
will be terminated and the collateral pledged

14
<PAGE>

by such shareholders will be released. See "Management Discussion and Analysis
of Financial Condition and Results of Operations--Liquidity and Capital
Resources." The Company utilizes the line of credit for working capital
purposes. The Company also plans to use $2.0 million of the net proceeds from
the Offering to make a partial payment of amounts due to current shareholders
of the Company pursuant to four-year, 5.7% promissory notes to be issued in
connection with the termination of the Company's S Corporation status. See
"Management--Compensation Committee Interlocks and Insider Participation."

DIVIDEND POLICY

The Board of Directors intends to retain any earnings of the Company to
support operations and to finance expansion and does not intend to pay cash
dividends on the Common Stock in the foreseeable future. Any future
determination as to the payment of dividends will be at the discretion of the
Board of Directors, and will depend on the Company's financial condition,
results of operations, capital requirements and such other factors as the
Board of Directors deems relevant. The Company also currently is restricted by
the terms of its credit facility from paying cash dividends on its Common
Stock. See "Management's Discussion and Analysis of Financial Condition and
Results of Operations--Liquidity and Capital Resources."

Because the Company has operated as an S Corporation and will continue to do
so until immediately prior to the effectiveness of this Offering, a portion of
the net income of the Company in past years has been distributed to each of
Jack Benun, Mark Benun and Isaac Levy, solely for the payment of income taxes,
and an additional aggregate distribution of approximately $5.6 million
(adjusted to include the taxable income of the Company for the period January
1, 1998 to the day preceding the day on which S Corporation status is
terminated), evidenced by four-year, 5.7% promissory notes, will be made to
such individuals upon termination of the Company's S Corporation status. See
"Management--Compensation Committee Interlocks and Insider Participation."

15
<PAGE>

DILUTION

The pro forma net tangible book value of the Company as of December 31, 1997
was approximately $1.5 million or $0.20 per share. Pro forma net tangible book
value per share represents the Company's pro forma tangible assets less total
liabilities divided by the number of shares of Common Stock outstanding as of
December 31, 1997. Dilution per share represents the difference between the
amount per share paid by purchasers of shares of Common Stock in the Offering
made hereby and the pro forma net tangible book value per share of Common
Stock immediately after completion of the Offering. Without taking into
account any changes in such pro forma net tangible book value after
December 31, 1997, other than to give effect to the sale of 2,000,000 shares
of Common Stock by the Company in this Offering at an assumed initial public
offering price of $10.00 per share (after deducting the underwriting discount
and commissions and estimated Offering expenses) and the application of the
estimated net proceeds therefrom, the pro forma as adjusted net tangible book
value of the Company as of December 31, 1997 would have been $19.5 million, or
$2.00 per share. This represents an immediate increase in pro forma net
tangible book value of $1.80 per share to existing shareholders and an
immediate dilution in pro forma as adjusted net tangible book value of $8.00
per share to new investors. The following table illustrates this dilution on a
per share basis:

<TABLE>
<S> <C> <C>
Assumed initial public offering price per share.................. $10.00
Pro forma net tangible book value per share as of December 31,
1997............................................................ $0.20
Increase per share attributable to the Offering................. 1.80
-----
Pro forma as adjusted net tangible book value per share after the
Offering........................................................ 2.00
------
Dilution per share to new investors.............................. $ 8.00
======
</TABLE>

The following table summarizes, on a pro forma basis as of December 31,
1997, giving effect to the assumed distribution of the Company's previously
undistributed S Corporation earnings through that date, the difference between
the existing shareholders and new investors with respect to the number of
shares purchased from the Company, at the assumed initial public offering
price of $10.00 per share, the total consideration paid and the average price
paid per share:

<TABLE>
<CAPTION>
TOTAL
SHARES PURCHASED CONSIDERATION
----------------- ------------------- AVERAGE PRICE
NUMBER PERCENT AMOUNT PERCENT PER SHARE
--------- ------- ----------- ------- -------------
<S> <C> <C> <C> <C> <C>
Existing shareholders....... 7,750,000 79.5% $ 792,000 3.8% $ 0.10
New investors............... 2,000,000 20.5% 20,000,000 96.2% $10.00
--------- ----- ----------- -----
Total..................... 9,750,000 100.0% $20,792,000 100.0%
========= ===== =========== =====
</TABLE>

16
<PAGE>

CAPITALIZATION

The following table sets forth as of December 31, 1997 (i) the actual
capitalization and short-term borrowings of the Company, (ii) the pro forma
capitalization and short-term borrowings of the Company after giving effect to
an approximately $5.6 million decrease in shareholders' equity resulting from
a distribution of four-year, 5.7 percent promissory notes to certain
shareholders related to the termination of the Company's status as an S
Corporation, but without otherwise giving effect to this Offering and (iii)
the capitalization and short-term borrowings of the Company, as adjusted, to
give effect to the foregoing pro forma adjustments and the issuance and sale
by the Company of 2,000,000 shares of Common Stock offered hereby at an
assumed initial public offering price of $10.00 per share, less Offering
expenses and the anticipated application of the estimated net proceeds
therefrom. See "Use of Proceeds," "Management--Compensation Committee
Interlocks and Insider Participation" and Notes A and P to the Consolidated
Financial Statements. This table should be read in conjunction with the
Consolidated Financial Statements and the Notes thereto, included elsewhere in
this Prospectus.

<TABLE>
<CAPTION>
DECEMBER 31, 1997
-----------------------------------------------
PRO PRO FORMA
ACTUAL FORMA(1) AS ADJUSTED(2)
------------- ------------- ------------------
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<S> <C> <C> <C>
SHORT-TERM DEBT:(3)
Due to bank..................... $ 24,863 $ 24,863 $ 9,063
Due to shareholders............. -- 2,000 --
Capital lease obligations....... 49 49 49
------------- ------------- -------------
Total short-term debt......... $ 24,912 $ 26,912 $ 9,112
============= ============= =============
LONG-TERM DEBT, NET OF CURRENT
PORTION:(3)
Due to shareholders............. $ 1,400 $ 4,954 $ 4,954
Capital lease obligations....... 19 19 19
------------- ------------- -------------
Total long-term debt.......... 1,419 4,973 4,973
------------- ------------- -------------
SHAREHOLDERS' EQUITY:
Preferred Stock, $.01 par value,
5,000 shares authorized; none
outstanding.................... -- -- --
Common Stock, $.01 par value,
30,000 shares authorized; 7,750
shares issued and outstanding
actual and pro forma; 9,750
shares issued and outstanding
pro forma as adjusted(4)....... 78 78 98
Additional paid-in capital...... 1,119 1,119 18,899
Retained earnings............... 5,447 502 502
------------- ------------- -------------
Total shareholders' equity.. 6,644 1,699 19,499
------------- ------------- -------------
TOTAL CAPITALIZATION.............. $ 8,063 $ 6,672 $ 24,472
============= ============= =============
</TABLE>
- -------
(1) Adjusted to give effect to (i) the deferred tax asset of approximately
$609,000, resulting from the termination of the Company's status as a S
Corporation and (ii) approximately $5.6 million decrease in shareholders'
equity and a corresponding increase in due to shareholders at December 31,
1997, resulting from an issuance of four-year, 5.7% promissory notes to
certain shareholders related to the termination of the Company's status as
an S Corporation, $2.0 million of which is short-term debt and the balance
of which is long-term debt. Existing due to shareholders of $1.4 million
shall be subject to the terms of such promissory notes. See
"Capitalization," "Use of Proceeds," "Management--Compensation Committee
Interlocks and Insider Participation" and Note P to Consolidated Financial
Statements.
(2) Adjusted to reflect the sale of 2,000,000 shares of Common Stock offered
by the Company hereby at an assumed offering price of $10.00 per share and
the anticipated application of the estimated net proceeds therefrom. See
"Use of Proceeds."
(3) For information concerning the Company's short-term and long-term debt,
see Notes F and H of Notes to Consolidated Financial Statements.
(4) Excludes 800,000 shares of Common Stock reserved for issuance upon the
exercise of options or stock purchase rights issuable under the Company's
1997 Stock Option Plan, none of which shares or options had been issued or
granted as of December 31, 1997. On February 24, 1998, the Company issued
options to purchase 100,000 shares of Common Stock, none of which are
presently exercisable. See "Management--1997 Stock Option Plan."

17
<PAGE>

SELECTED CONSOLIDATED FINANCIAL DATA

The following selected consolidated financial data should be read in
conjunction with the Consolidated Financial Statements and related Notes
thereto appearing elsewhere in this Prospectus and "Management's Discussion
and Analysis of Financial Condition and Results of Operations." The selected
financial data have been derived from the Consolidated Financial Statements of
the Company. The consolidated statements of operations for each of the three
years in the period ending December 31, 1997 and the consolidated balance
sheets at December 31, 1996 and 1997 have been audited by the Company's
independent auditors and are included elsewhere in this Prospectus. The
selected statement of operations data for the year ended December 31, 1994
have been derived from the audited Consolidated Financial Statements of the
Company not included herein. The selected balance sheet data as of December
31, 1995 have been derived from the audited Consolidated Financial Statements
of the Company not included herein. The selected balance sheet data as of
December 31, 1993 and 1994 and the selected statement of operations data for
the year ended December 31, 1993 have been derived from the unaudited
Consolidated Financial Statements of the Company not included herein, which in
the opinion of management, reflect all adjustments (consisting solely of
normal recurring adjustments) necessary for a fair presentation of the results
for these periods and as of such dates. The selected financial data provided
below is not necessarily indicative of the future results of operations or
financial performance of the Company.

<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
-----------------------------------------
1993 1994 1995 1996 1997
------- ------- ------- ------- --------
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<S> <C> <C> <C> <C> <C>
STATEMENT OF OPERATIONS DATA:
Net sales........................... $64,747 $74,520 $79,828 $90,723 $106,673
Gross profit........................ 15,279 15,276 14,792 20,837 26,925
Operating expenses:
Selling, design and shipping........ 5,765 5,962 7,986 7,686 10,058
General and administrative.......... 5,413 6,358 6,830 7,684 8,399
------- ------- ------- ------- --------
Total operating expenses........... 11,178 12,320 14,816 15,370 18,457
------- ------- ------- ------- --------
Operating income (loss)............. 4,101 2,956 (24) 5,467 8,468
Interest expense, net............... 1,160 1,631 2,375 2,980 3,803
------- ------- ------- ------- --------
Income (loss) before pro forma
income taxes ...................... 2,941 1,325 (2,399) 2,487 4,665
Pro forma net income(1)............. $ 1,657 $ 703 $(1,463) $ 1,497 $ 2,704
======= ======= ======= ======= ========
Pro forma net income per share...... $ 0.20 $ 0.08 $ (0.18) $ 0.18 $ 0.33
======= ======= ======= ======= ========
Pro forma weighted average shares
outstanding(2)..................... 8,305 8,305 8,305 8,305 8,305
Supplemental pro forma net income
per share(3)....................... $ 0.42
========
Supplemental pro forma weighted
average shares outstanding(2)(4)... 9,885
</TABLE>

<TABLE>
<CAPTION>
DECEMBER 31,
---------------------------------------------------------------
1997
-------------------------------
PRO PRO FORMA
1993 1994 1995 1996 ACTUAL FORMA(5) AS ADJUSTED(6)
------- ------- ------- ------- ------- -------- --------------
<S> <C> <C> <C> <C> <C> <C> <C>
BALANCE SHEET DATA:
Working capital........ $ 5,125 $ 5,942 $ 3,260 $ 5,228 $ 6,419 $ 5,028 $22,828
Total assets........... 25,413 27,570 33,568 33,986 44,952 45,561 45,561
Due to bank............ 12,050 14,435 21,340 19,732 24,863 24,863 9,063
Due to shareholders.... 900 1,200 1,500 1,560 1,400 6,954 4,954
Capital lease
obligations........... -- 14 52 123 68 68 68
Shareholders' equity... 5,474 6,135 3,848 5,573 6,644 1,699 19,499
</TABLE>

18
<PAGE>

- --------
(1) The Company has operated as an S Corporation for federal and New York
state income tax purposes since 1988. Two of the wholly-owned subsidiaries
are C Corporations and, accordingly, have been taxed at the appropriate
corporate federal and state tax rates. The historical Consolidated
Financial Statements do not include a provision for federal and state
income taxes for such periods for those subsidiaries which have elected to
be treated as S Corporations. A provision for state income taxes has been
made for those states not recognizing S Corporation status. Pro forma net
income has been computed as if the Company had been fully subject to
federal and state income taxes based on the tax laws in effect during the
respective periods. See Notes A and P to the Consolidated Financial
Statements.
(2) Reflects the weighted average shares outstanding and gives pro forma
effect to the additional shares that the Company would have to sell at the
assumed initial public offering price of $10.00 per share to repay the
estimated $5.6 million of promissory notes to be issued to the
shareholders in connection with the termination of the Company's S
Corporation status. The Company intends to repay $2.0 million of these
notes with a portion of the net proceeds of the Offering.
(3) Supplemental pro forma net income per share was computed by adjusting pro
forma net income per share to reflect a reduction in interest expense and
related fees, net of taxes, of $1.4 million in the year ended December 31,
1997, resulting from the assumed repayment of debt with a portion of the
net proceeds of the Offering as if such repayment had occurred on January
1, 1997, consisting solely of repayment of $15.8 million outstanding under
the Company's $42.0 million line-of-credit (of which $24.9 million was
outstanding at December 31, 1997).
(4) Gives pro forma effect to the additional shares that the Company would
have to sell at the assumed initial public offering price of $10.00 per
share to repay the debt referenced in footnote 3 above.
(5) Adjusted to give effect to (i) the deferred tax asset of approximately
$609,000 resulting from the termination of the Company's status as an S
Corporation and (ii) approximately $5.6 million decrease in shareholders'
equity and a corresponding increase in due to shareholders at December 31,
1997, of which $2.0 million has been classified as a current liability to
be repaid with a portion of the net proceeds of the Offering, resulting
from an issuance of promissory notes to certain shareholders related to
the termination of the Company's status as an S Corporation. See "The
Company," "Capitalization," "Management--Compensation Committee Interlocks
and Insider Participation" and Note P to the Consolidated Financial
Statements.
(6) Adjusted to reflect the sale of 2,000,000 shares of common stock in the
Offering at an assumed offering price of $10.00 per share and the
anticipated application of the net proceeds therefrom. See "Use of
Proceeds" and "Capitalization."

19
<PAGE>

MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS

OVERVIEW

Happy Kids 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 include Nickelodeon's Rugrats, AND 1, B.U.M. Equipment and
Ocean Pacific. In late 1997, the Company acquired licenses to Warner Brothers'
Scooby Doo, ACA Joe and E.N.U.F. Internationale, and, in early 1998, the
Company reached an agreement in principle to acquire a license for Jim
Henson's Kermit the Frog and Friends. The Company also designs and delivers
private label branded playwear programs for leading retailers, including
Sesame Street for KMart, New Legends for Kids R Us and Canyon River Blues for
Sears and recently began participating in Nickelodeon's Nick Universe program
being launched by 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 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-priced 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 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.

RESULTS OF OPERATIONS

The following table sets forth, for the periods indicated, information
derived from the Company's Consolidated Statements of Operations expressed as
a percentage of net sales unless otherwise noted:

<TABLE>
<CAPTION>
YEARS ENDED
DECEMBER 31,
--------------------
1995 1996 1997
----- ----- -----
<S> <C> <C> <C>
Net sales................................................. 100.0% 100.0% 100.0%
Cost of goods sold........................................ 81.5 77.0 74.8
----- ----- -----
Gross profit.............................................. 18.5 23.0 25.2
Operating expenses:
Selling, design and shipping............................. 10.0 8.5 9.4
General and administrative............................... 8.5 8.5 7.9
----- ----- -----
Total operating expenses................................ 18.5 17.0 17.3
----- ----- -----
Operating income (loss)................................... 0.0 6.0 7.9
Interest expense, net..................................... 3.0 3.3 3.6
----- ----- -----
Income (loss) before income taxes......................... (3.0)% 2.7% 4.3%
===== ===== =====
</TABLE>

20
<PAGE>

1997 COMPARED TO 1996

Net Sales. Net sales increased $16.0 million, or 17.6%, to $106.7 million in
1997 from $90.7 million for 1996. The increase in net sales is attributable
primarily to increased sales of playwear incorporating the properties covered
by the Company's Rugrats license with Nickelodeon and increased sales to KMart
resulting in part from the 1997 commencement of its Sesame Street private
label program. This increase was partially offset by a decrease in net sales
of products incorporating properties covered by one of the Company's former
major licenses, which license currently represents only a small percentage of
net sales.

Gross Profit. Gross profit increased by $6.1 million, or 29.2%, to $26.9
million in 1997 from $20.8 million in 1996. The gross profit margin increased
to 25.2% in 1997 from 23.0% in 1996. The increase in the gross margin is
attributable to the implementation of the Company's current sales strategy. As
part of such strategy, initiated in 1995, orders are received six to nine
months in advance of shipment resulting in finished goods being produced
according to customer order. Due to the timing of the order cycle and revenue
recognition (sales are recognized when products are shipped), the Company
first began to fully realize the benefits of such strategy in mid-1996. In
addition, during 1997, there was a decrease in the Company's product return
rates as compared to 1996. Gross profit is net of any royalties associated
with the use of licensed properties.

Selling, Design and Shipping Expenses. Selling, design and shipping expenses
increased by $2.4 million, or 30.9%, to $10.1 million in 1997 from $7.7
million in 1996. This increase is attributable primarily to higher sales
salaries and commissions for existing personnel and the hiring of additional
sales and design personnel during the year, as well as higher travel, shipping
and freight costs associated with increased sales volumes. In addition, other
design costs have increased as a result of the expansion of the Company's
production. As a percentage of net sales, selling, design and shipping
expenses increased to 9.4% in 1997 from 8.5% in 1996.

General and Administrative Expenses. General and administrative expenses
increased $715,000, or 9.3%, to $8.4 million in 1997 from $7.7 million in
1996. This increase is primarily the result of higher factor commissions
associated with increased sales volume, the hiring of additional office
personnel and normal annual salary rate increases. The Company utilized its
factoring arrangement for the entire year in 1997 as compared to only ten
months of the corresponding period in 1996. As a percentage of net sales,
general and administrative expenses decreased to 7.9% in 1997 from 8.5% in
1996.

Interest Expense, net. Interest expense, net increased $823,000, or 27.6%,
to $3.8 million in 1997 from $3.0 million in 1996. This increase is a result
of higher sales volume resulting in an increase in borrowings, interest
expense and fees under the line of credit. As a percentage of net sales,
interest expense, net increased slightly to 3.6% in 1997 from 3.3% in 1996.

Income Before Income Taxes. Income before income taxes increased $2.2
million, or 87.6%, to $4.7 million in 1997 from $2.5 million in 1996 due to
the reasons described above. As a percentage of net sales, income before
income taxes increased to 4.3% in 1997 from 2.7% in 1996.

1996 COMPARED TO 1995

Net Sales. Net sales increased $10.9 million, or 13.6%, to $90.7 million in
1996 from $79.8 million for 1995. The increase in net sales is due primarily
to the introduction by the Company of products incorporating the properties
covered by the B.U.M. Equipment and Nickelodeon's Rugrats licenses, as well as
increases in certain private label programs. The increase in net sales was
partially offset by the reduction of sales under the Company's house brands,
evidencing the continuing shift in the Company's product mix from sales of
house brands to sales of products incorporating licensed and branded
properties.

21
<PAGE>

Gross Profit. Gross profit increased by $6.0 million, or 40.9%, to $20.8
million in 1996 from $14.8 million in 1995. The gross profit margin increased
to 23.0% in 1996 from 18.5% in 1995. The increase in gross margin is
attributable to the Company's successful implementation of its current sales
strategy and a change in product mix toward higher margin licensed and branded
properties from lower margin house brands.

Selling, Design and Shipping Expenses. Selling, design and shipping expenses
decreased $300,000, or 3.8%, to $7.7 million in 1996 from $8.0 million in
1995. This decrease is due primarily to the cost benefits associated with the
installation of an in-house CAD system early in 1996. As a percentage of net
sales, selling, design and shipping expenses decreased to 8.5% in 1996 from
10.0% in 1995.

General and Administrative Expenses. General and administrative expenses
increased $854,000, or 12.5%, to $7.7 million in 1996 from $6.8 million in
1995. This increase is due to charges associated with the Company's factoring
agreement. The Company had no factoring agreement in the comparable period of
the prior year. As a percentage of net sales, general and administrative
expenses remained constant at 8.5% in 1996 and 1995.

Interest Expense, net. Interest expense, net increased $605,000, or 25.5%,
to $3.0 million in 1996 from $2.4 million in 1995. This increase is a result
of higher sales volume resulting in an increase in borrowings, interest
expense and fees under the line of credit. As a percentage of net sales,
interest expense, net increased to 3.3% in 1996 from 3.0% in 1995.

Income (Loss) Before Income Taxes. Income before income taxes increased $4.9
million to $2.5 million in 1996 from a loss of $2.4 million in 1995 due to the
reasons described above. As a percentage of net sales, income before income
taxes was 2.7% in 1996 as compared to (3.0%) in 1995.

LIQUIDITY AND CAPITAL RESOURCES

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

The Company's bank credit facility currently permits borrowings up to $42.0
million as a revolving credit line that expires on December 31, 1998, subject
to annual renewals (adjusted seasonally to $47.0 million from January 1, 1998
through April 30, 1998). The first $5.0 million of borrowings under this line
of credit bear interest at the prime rate plus 4.0% (12.5% at December 31,
1997). The remaining borrowings bear interest at the prime rate plus 1.0%
(9.5% at December 31, 1997). Additionally, the Company is subject to certain
fees associated with the line of credit. The amount available under this line
of credit is dependent upon levels of eligible accounts receivable and
inventory. The credit facility is collateralized by substantially all of the
assets of the Company and is guaranteed by the Company's three major
shareholders. As of December 31, 1997, the Company had $24.9 million of
outstanding direct borrowings and $15.9 million of contingent liabilities
under open letters of credit. The Company intends to use approximately $15.8
million of the net proceeds from this Offering to reduce the outstanding
balance of direct borrowings under the credit facility. In addition, the
Company's lender has sole discretion to make or withhold advances under the
credit line. The loss by the Company of the services of Jack M. Benun, the
Company's Chairman of the Board, President and Chief Executive Officer, could
trigger an event of default under such credit facilities. There can be no
assurance that the lender will continue to lend under the credit line. 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. The Company executed a letter of intent, dated
February 10, 1998, with respect to the amendment of its existing credit
facility. Upon effectiveness of the Offering and satisfaction of certain
conditions, the Company's credit facility will be amended to provide for a

22
<PAGE>

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 receivable, 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. Upon effectiveness of the amended
line of credit, personal guarantees of certain of the Company's present
shareholders under the Company's present line of credit will terminate, and
the collateral pledged by such shareholders will be released. See "Risk
Factors--Dependence on Access to Credit Facilities."

As of December 31, 1997 the Company's principal sources of liquidity
included cash of $374,000, amounts due from factor of $24.2 million and net
accounts receivable of $316,000. The Company had working capital of $6.4
million and long-term debt of $1.4 million as of December 31, 1997.

For the year ended December 31, 1997, operating activities used cash of $1.9
million primarily as a result of an increase in amounts due from factor of
$7.3 million due to increased sales volume, partially offset by net income of
$4.2 million. Net cash used in investing activities during the year ended
December 31, 1997 was $79,000 consisting entirely of capital expenditures,
while net cash provided by financing activities during the same period was
$1.7 million consisting primarily of net borrowings of $5.1 million under the
Company's bank credit facility offset by payments to shareholders of $3.1
million for their personal income taxes due on the earnings of the
S Corporations.

During fiscal 1996, operating activities provided cash of $3.1 million
primarily from net income of $2.4 million and a reduction in inventory levels
of $5.7 million. This cash provided by operations was partially offset by the
cash used by an increase in amounts due from factor of $16.9 million less the
cash generated by a decrease in accounts receivable of $10.5 million due to
the Company's implementation of its factoring program in 1996. Net cash used
in investing activities during fiscal 1996 was $378,000 reflecting the
purchase of certain fixed assets. Net cash used in financing activities during
1996 was $2.3 million consisting primarily of payments under the Company's
bank credit facility and distributions to shareholders for taxes on S
Corporation earnings.

Historically, the Company's business has not required significant capital
expenditures. The Company's capital expenditures were approximately $578,000,
$378,000 and $79,000 for the years ended December 31, 1995, 1996 and 1997,
respectively. The Company believes that cash flow expected to be generated
from operations, together with borrowings under its existing credit facility
and the net proceeds from this Offering, 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 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 $107.7 million and $73.2 million at January 31, 1998
and January 31, 1997, respectively. The Company expects to fill the January
31, 1998 backlog prior to October 31, 1998.

23
<PAGE>

VARIABILITY OF RESULTS; SEASONALITY; CYCLICALITY

Sales of children's apparel are seasonal. Consequently, the Company's
operating results have varied substantially from quarter to quarter, and the
Company expects that they will continue to do so. Generally, the Company has
experienced significantly higher net sales in the first and third quarters as
compared to the second and fourth quarters, although this may change from time
to time. The seasonality of the Company's business also affects borrowings
under the Company's lines of credit and its level of backlog, which fluctuate
in response to demand for the Company's products. Therefore, the results of
any interim period are not necessarily indicative of the results that may be
achieved for an entire year. In addition, the apparel industry is a cyclical
industry heavily dependent upon the overall level of consumer spending, with
purchases of apparel and related goods tending to decline during recessionary
periods when disposable income is low. A difficult retail environment could
result in downward price pressure which could adversely impact the Company's
gross profit margins.

SELECTED QUARTERLY RESULTS OF OPERATIONS

The following table presents certain unaudited condensed consolidated
quarterly financial information for each of the eight most recent quarters in
the period ended December 31, 1997. This information is derived from unaudited
condensed Consolidated Financial Statements of the Company that include, in
the opinion of the Company, all adjustments (consisting only of normal
recurring adjustments) necessary for a fair presentation of results of
operations for such periods, when read in conjunction with the audited
Consolidated Financial Statements of the Company and notes thereto appearing
elsewhere in this Prospectus.

<TABLE>
<CAPTION>
QUARTERS ENDED
---------------------------------------------------------------------------
MAR. 31, JUNE 30, SEPT. 30, DEC. 31, MAR. 31, JUNE 30, SEPT. 30, DEC. 31,
1996 1996 1996 1996 1997 1997 1997 1997
-------- -------- --------- -------- -------- -------- --------- --------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Net sales............... $29,260 $13,472 $27,329 $20,662 $24,811 $14,746 $37,771 $29,345
Gross profit............ 6,536 1,964 7,596 4,741 5,981 3,273 9,412 8,259
Operating income
(loss)................. 2,638 (950) 2,806 973 2,106 (529) 4,010 2,881
Income (loss) before
income taxes........... $ 1,764 $(1,676) $ 2,203 $ 196 $ 1,412 $(1,203) $ 2,856 $1,600
</TABLE>

The operating results for any quarter are not necessarily indicative of
results which may be obtained for any future period. The Company's quarterly
results may fluctuate as a result of a variety of other factors, many of which
are not within the Company's control, including patterns of spending by
customers, the timing, size and receipt of orders, and delays of shipments to
customers due to delays in delivery by suppliers.

PRO FORMA ADJUSTMENTS FOR INCOME TAXES

The Company has operated as an S Corporation for federal and New York state
income tax purposes since 1988. As a result, for such tax periods, the
Company's earnings were taxed directly to the Company's shareholders. The pro
forma adjustments for income taxes reflected in the Prospectus Summary under
the caption "Summary Consolidated Financial Data" and in the accompanying
Financial Statements were calculated as if the Company were subject to tax
under the tax laws in effect for the respective periods using the criteria
established under Statement of Financial Accounting Standards ("SFAS") No. 109
"Accounting for Income Taxes." The effective tax rate (benefit) for the years
ended December 31, 1997, 1996 and 1995 was 10.1%, 4.7% and (31.2%),
respectively. The change in the effective tax rate is the result of the
utilization of Federal net operating loss carryback claims in 1995, payments
in connection with a settlement, in 1996, of an Internal Revenue Service
examination, and State net operating loss carryforward claims in 1997 and
1996.

24
<PAGE>

RECENTLY ISSUED ACCOUNTING STANDARDS

SFAS No. 130, "Reporting Comprehensive Income" 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" 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.

25
<PAGE>

BUSINESS

OVERVIEW

Happy Kids 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 include Nickelodeon's Rugrats, AND 1, B.U.M. Equipment and
Ocean Pacific. In late 1997, the Company acquired licenses to Warner Brothers'
Scooby Doo, ACA Joe and E.N.U.F. Internationale, and, in early 1998, the
Company reached an agreement in principle to acquire a license for Jim
Henson's Kermit the Frog and Friends. The Company also designs and delivers
private label branded playwear programs for leading retailers, including
Sesame Street for KMart, New Legends for Kids R Us and Canyon River Blues for
Sears and recently began participating in Nickelodeon's Nick Universe program
being launched by Kids R Us. The Company's strategy is to work closely with
its customers to design and market coordinated playwear 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.

BUSINESS STRATEGY

The Company's operating strategies include the following:

Focus on Licensed and Branded Products and Private Label Relationships. The
Company designs and markets licensed and branded coordinated apparel programs
at gross margins that the Company believes are higher than those typically
generated from sales of non-licensed or non-private label branded playwear.
The Company's gross margins were 25.2% in 1997, 23.0% in 1996, and 18.5% in
1995, resulting in part from this focus on licensed and branded properties
and private label relationships. The Company maintains a diversified portfolio
of popular, established and well-recognized licensed properties and
private label relationships to reduce its dependence upon any one licensed
property or private label relationship.

Emphasize Advance Sales. In 1995, the Company initiated its current sales
strategy under which customers order specific quantities of goods on a fixed-
price basis six to nine months in advance of a selling season. For 1997,
substantially all of the Company's apparel was produced upon receipt of
customer orders. Based on orders received as of January 31, 1998, the Company
had backlog of $107.7 million, which it expects to fill over the following six
to nine months. The Company intends to continue to utilize its sales strategy
to minimize its inventory risk.

Utilize Contract Manufacturers. The Company utilizes over 50 unaffiliated,
foreign and domestic contract manufacturers. The Company uses third-party
manufacturers to eliminate the significant capital investment requirements
associated with maintaining manufacturing facilities. The Company has
developed long-standing relationships with many of its contract manufacturers
and, during the year ended December 31, 1997, approximately 66.8% of the
Company's products were manufactured by contract manufacturers which have been
utilized by the Company for over three years.

Capitalize on In-House Design Capabilities. The Company's playwear is
designed by 42 in-house designers and graphic artists organized in teams
dedicated to each of the Company's licensed properties and private label
programs. The Company believes that its customers will continue to rely on its
ability to design, have manufactured and deliver on a timely basis
commercially successful apparel programs which foster long-term customer
relationships and result in a high level of customer satisfaction.

The Company's growth strategies include the following:

Increase Sales to Existing Accounts. The Company seeks to increase sales to
its current customers by expanding its product categories and sizes
incorporating the Company's existing

26
<PAGE>

licensed properties and private label relationships. The Company's customer
base includes each of the top ten childrenswear retailers. Historically,
capital constraints have limited the Company's ability to market products
broadly to all children's apparel departments within its current customer
base. Following the completion of this Offering, however, the Company expects
to have improved access to capital which the Company believes will permit it
to market, design and produce additional product categories and sizes under
its existing licenses and private label relationships. For example, the
Company successfully expanded its relationship with KMart from one to five
size categories during 1997. The Company believes there is significant
opportunity to increase sales to its existing customer base.

Expand Customer Base. The Company's customers include mass-market retailers,
mid-tier distributors and department stores, and the Company's current
customers include KMart, Kids R Us, Price/Costco, Sears and WalMart. Within
its current distribution channels, the Company seeks to generate sales from
new accounts by capitalizing on the demand for its licensed products and on
its ability to successfully execute private label programs. In addition, the
Company recently began to market certain licensed products to specialty
retailers, including sporting goods chains such as Champs, FootAction and The
Sports Authority.

Leverage Newly Acquired Licensed Properties and Private Label
Relationships. The Company recently acquired several new licenses, including
ACA Joe, E.N.U.F. Internationale and Warner Brothers' Scooby Doo, and a new
private label arrangement, Nickelodeon's Nick Universe being launched by Kids
R Us. Additionally, the Company has reached an agreement in principle to
acquire a license for Jim Henson's Kermit the Frog and Friends. In acquiring
these new licenses, the Company has relied on its market research and
communications with its customers to assess the marketability of these lines.
The Company's design teams currently are developing apparel programs in
conjunction with its customers and licensors and the Company expects to launch
these apparel programs in late 1998, targeting both its existing and new
customers.

Pursue New Licenses and Private Label Relationships. The Company actively
pursues licensing of additional properties and new private label
relationships. The Company seeks licenses and private label arrangements that
are based on popular and established characters and brand names. The Company
believes that its reputation encourages potential licensors to seek out the
Company as a licensee of their branded properties and encourages retailers to
engage the Company to design and have manufactured coordinated apparel
programs under their own private labels. Furthermore, the Company believes
that its history of successfully executing licensed and private label
coordinated apparel programs provides it with a competitive advantage when
seeking new licenses and private label relationships. For example, the Company
acquired the Nickelodeon's Rugrats license based on a referral from one of the
Company's major customers.

27
<PAGE>

PRODUCTS AND LICENSES

The Company's playwear products are designed and marketed as coordinated
apparel programs and include knit tops, bottoms, overalls, shortalls,
coveralls and swimwear. The Company's products are marketed in a variety of
size categories including newborns, infants, toddlers (2T-4T), boys (4-7 and
8-20) and girls (4-6x and 7-16). The following is a description of the
Company's apparel programs:

<TABLE>
<CAPTION>
EXISTING CURRENT
LICENSED AND BRANDED CURRENT DISTRIBUTION PRODUCT CURRENT SIZE
APPAREL PROGRAMS DESCRIPTION CHANNELS OFFERINGS OFFERINGS
- -------------------- -------------- ------------------------ -------------- --------------
<S> <C> <C> <C> <C>
AND 1........ Basketball Top-line specialty All apparel Toddlers, boys
apparel athletic retailers, mid-
tier athletic retailers
and full-price
department stores with
athletic concept shops
B.U.M. Lifestyle Mass-market retailers, All apparel Newborns,
Equipment... activewear mid-tier distributors infants,
toddlers,
boys, girls
Canyon River Activewear Sears Overalls, Infants,
Blues for shortalls, toddlers, boys
Sears....... tops, bottoms (4-7), girls
(4-6x)
Jordache..... Lifestyle Mass-market retailers Tops, bottoms Infants,
activewear toddlers,
boys, girls
Lullaby Club Infantwear Target Coveralls, Newborns,
for Target.. tops, bottoms infants
New Legends Activewear Kids R Us Overalls, Toddlers,
for Kids R shortalls, girls
Us.......... tops, bottoms
Nickelodeon's Character- Mass-market retailers, Coveralls, Boys, girls
Rugrats..... based mid-tier distributors, overalls,
activewear department stores shortalls,
tops, bottoms,
swimwear
Ocean Surf-inspired Department stores, mid- Swimwear, Toddlers, boys
Pacific..... activewear tier distributors tops, bottoms (4-7)
Sesame Street Character- KMart Coveralls, Infants,
for KMart... based overalls, toddlers, boys
activewear shortalls, (4-7), girls
tops, bottoms, (4-6x)
swimwear
TriStar's Character- Mass-market retailers Swimwear Boys
Godzilla.... based
activewear
</TABLE>

<TABLE>
<CAPTION>
NEW LICENSED AND
BRANDED ANTICIPATED
APPAREL PROGRAMS DESCRIPTION ANTICIPATED DISTRIBUTION CHANNELS LAUNCH (1)
---------------- ------------------------ --------------------------------- ----------------
<S> <C> <C> <C>
ACA Joe.......... Lifestyle activewear Mid-tier distributors Holiday 1998
E.N.U.F. Lifestyle activewear Mid-tier distributors, Spring 1998
Internationale.. department stores
Jim Henson's
Kermit the Frog Character-based Mid-tier distributors, Holiday 1998
and Friends(2).. activewear department stores
Nickelodeon's
Nick Universe Character-based
for Kids R Us... activewear Kids R Us Fall 1998
Warner Brothers' Character-based Mid-tier distributors, Spring 1998
Scooby Doo...... activewear mass-market retailers
</TABLE>
- -------
(1) Initial sales of such products are expected to occur subsequent to
December 31, 1997.

(2) In early 1998, the Company reached an agreement in principle to acquire a
license for Jim Henson's Kermit the Frog and Friends. The Company expects to
execute a definitive licensing agreement in the first quarter of 1998,
although there can be no assurance that such license arrangement will be
finalized.

28
<PAGE>

The Company's current licensing arrangements contain initial terms of
between eighteen months and five years, and typically include multiple renewal
options of between one and five years, subject to certain conditions. The
present terms of the Company's current license arrangements will expire
between December 1999 and December 2002. The Company's licenses generally
require an initiation fee and/or minimum annual royalties to be recouped from
ongoing royalty payment obligations, which currently range from 5.0% to 12.0%
of the Company's net sales of products incorporating a licensed property.
Apparel industry licenses typically are granted with respect to product
categories, sizes and channels of distribution, and may be either exclusive or
non-exclusive. The Company's private label relationships are conducted on a
purchase order basis, rather than pursuant to contract. Net sales by the
Company for 1997 attributable to its licensing or private label arrangements
for B.U.M. Equipment, Nickelodeon's Rugrats, Ocean Pacific and Sesame Street
for KMart accounted for 18.9%, 11.3%, 11.1% and 14.3% of net sales,
respectively. Net sales by the Company in 1996, attributable to the B.U.M.
Equipment, Ocean Pacific and Jordache arrangements, accounted for 19.8%, 14.5%
and 12.4% of net sales, respectively. No other licensing or private label
arrangements accounted for more than 10% of the Company's net sales in either
1997 or 1996.

MERCHANDISING

Design

The Company's playwear products are designed by 42 in-house designers and
graphic artists organized in teams dedicated to each of the Company's licensed
properties and private label programs. Each team works closely with licensors,
customers and contract manufacturers, utilizing state-of-the-art CAD systems,
to design coordinated products featuring textured fabrications and detailed
graphics. The Company believes that its customers rely on its ability to
design, have manufactured and deliver on a timely basis commercially
successful apparel programs.

The design process incorporates product design, merchandising, sourcing and
production. The Company's design and merchandising teams continually monitor
and evaluate the children's playwear market for styles and trends in fabrics,
trims and accessories, as well as analyze online sales information provided by
its customers. In conjunction with its customers and licensors, the Company's
design teams identify specific design needs and develop product programs. The
Company oversees all garment production, including pattern development and
color and sample approval, through regular communication with the Company's
customers and contract manufacturers.

Sales and Marketing

The Company markets and distributes its products through three primary
channels of distribution, including mass-market retailers, mid-tier
distributors and department stores and recently has begun selling to select
specialty retailers, including sporting goods chains. All of the Company's
sales are within the United States. The Company's customers include:

<TABLE>
<CAPTION>
MASS-
MARKET MID-TIER DEPARTMENT SPECIALTY
RETAILERS DISTRIBUTORS STORES RETAILERS
--------- ------------ --------------------------- --------------------
<S> <C> <C> <C>
KMart Kids R Us Dayton Hudson Champs
Target Price/Costco Federated Department Stores FootAction
WalMart Sears JC Penney Foot Locker
The May Company The Sports Authority
</TABLE>

In 1995, to leverage its customer relationships, its popular licenses and
brand names and its reputation for quality products and reliable delivery, the
Company initiated its current sales strategy

29
<PAGE>

under which customers order specific quantities of goods on a fixed-price
basis six to nine months in advance of a selling season. For 1997,
substantially all of the Company's apparel was produced upon receipt of
customer orders. Additionally, the Company has been able to leverage the
popularity and goodwill associated with its licenses and brand names to
promote sales, rather than undertaking costly marketing initiatives.

As of December 31, 1997, the Company maintained a sales and marketing staff
of 14 people, including its senior management. The Company is organized in
account teams led by key account sales executives. Each account sales
executive reports directly to senior management and is responsible for the day
to day customer relationship management and for supervising and monitoring the
sales staff. The Company's sales staff is compensated on a salary plus
commission basis.

The Company's sales and marketing staff works closely with the Company's
designers and graphic artists throughout the design and production process.
The Company's customers often launch a new product line associated with a new
license or private label relationship in a limited number of stores. If the
product is successful, the Company's customers often market the product line
throughout their retail chains or in a significantly larger number of stores.
The Company's design team and sales staff work closely with its customers to
monitor, review and analyze product launches.

The Company's customer base has been and continues to be highly
concentrated. Sales of the Company's products to each of Price/Costco, KMart
and Kids R Us accounted for approximately 17.4%, 14.3% and 11.0% of net sales
for 1997, respectively. In addition, sales of the Company's products to each
of Kids R Us and WalMart accounted for 21.5% and 13.4% of net sales,
respectively, during 1996, while sales of the Company's products to each of
Kids R Us, WalMart and J.C. Penney accounted for 18.3%, 12.9% and 10.0% of net
sales, respectively, during 1995. Based upon historical and recent results and
existing relationships with customers, the Company believes that a substantial
portion of its net sales and gross profits will continue to be derived from a
small number of large customers. There can be no assurance that the Company's
larger customers will continue to place orders with the Company or that orders
by such customers will continue at their previous levels.

MANUFACTURING

Contract Manufacturers

The Company's products are manufactured to exacting quality standards and
specifications by over 50 unaffiliated, foreign and domestic contract
manufacturers. The Company uses third-party manufacturers to eliminate the
significant capital investment requirements associated with maintaining
manufacturing facilities. The Company has developed long-standing
relationships with many of its contract manufacturers and, during 1997,
approximately 66.8% of the Company's products were manufactured by contract
manufacturers which have been utilized by the Company for over three years.
For 1997 and 1996, foreign manufacturers produced approximately 93.4% and
91.2% of the Company's products, respectively, with the remainder of products
produced domestically.

The Company works with independent buying agents in six countries to assist
the Company in selecting a contract manufacturer. The Company and such buying
agents review, among other things, quality of merchandise produced, the
ability of such manufacturer to meet the Company's timing requirements for
delivery and price. The Company is not a party to long-term contractual or
other arrangements with any manufacturer and often uses more than one
manufacturer to produce a coordinated apparel program. The Company believes
that it has ready access to numerous contract manufacturers and that its
existing contract manufacturers have the ability to manufacture across several
product lines.

30
<PAGE>

During 1997 and 1996, various production facilities located in Thailand
accounted for an aggregate of 41.4% and 40.3% of the Company's manufactured
products, respectively, and various production facilities in Hong Kong
accounted for an aggregate of 30.7% and 37.5% of the Company's manufactured
products, respectively. No other country accounted for 10% or more of the
Company's manufactured products during 1997 or 1996. In addition, two
manufacturing facilities located in Hong Kong accounted for 10.6% and 12.6%,
respectively, of the Company's manufactured products during 1997 and 11.1% and
23.3%, respectively, of the Company's manufactured products during 1996. No
other single manufacturer accounted for 10% or more of the Company's
manufactured products during 1997 or 1996.

The Company's products are subject to bilateral textile agreements between
the United States and a number of foreign countries. Such agreements, which
have been negotiated under the framework established by the Arrangement
Regarding International Trade in Textiles, allow the United States to impose
restraints at any time on the importation of categories of merchandise that,
under the terms of the agreements are not currently subject to specified
limits. The Company does not own the right to import finished garments into
the United States, but relies on its contract manufacturers to obtain the
necessary quotas. In the past, to the extent that necessary import quotas have
not been available with respect to a particular source of supply, the Company
has been able to find an alternative source of supply. Accordingly, the
availability of quotas has not had a material effect upon the Company's
business, financial condition or results of operations. The Company's
continued ability to source products that it imports may be adversely affected
by a significant decrease in available import quotas as well as any additional
bilateral agreements or unilateral trade restrictions. In addition, a
significant portion of the Company's products are manufactured in Hong Kong.
China recently resumed sovereignty over Hong Kong. The Company cannot predict
the effect, if any, this event will have on its contract manufacturers in Hong
Kong and there can be no assurance that Hong Kong will not experience
political, economic or social disruption as a result of the resumption of
Chinese sovereignty. In addition, there have been a number of recent trade
disputes between China and the United States during which the United States
has threatened to impose tariffs and duties on some products imported from
China and to withdraw China's "most favored nation" trade status. The loss of
such status for China, changes in current tariff structures or the adoption by
the United States of trade policies or sanctions adverse to China could have a
material effect on the Company's business, financial condition or results of
operations.

The principal raw materials used in the production and sale of the Company's
products are yarn, fabric, trim, buttons and other accessories. Raw materials
are purchased by the manufacturers who deliver finished goods to the Company.
The Company believes that an adequate supply of raw materials used in the
manufacture of its products is readily available from existing and alternative
sources at reasonable prices.

Quality Control

The Company has in place comprehensive quality control procedures to ensure
that fabrics, materials and finished goods meet the Company's exacting quality
standards. The Company utilizes both internal and independent quality control
representatives to monitor contract manufacturers' production processes. In
addition, certain of the Company's buying agents engage their own personnel
who monitor compliance with the Company's quality control specifications.

The Company oversees testing of yarns and trim for colorfastness,
washability and other standards before sample garments are produced. Selected
product samples are sent to independent testing facilities which test garments
for colorfastness, washability, size specifications and other standards.
Sample garments are randomly subjected to similar quality control tests by the
Company for fit and appearance. Foreign and domestic contract manufacturers
are routinely visited on a spot check basis to ensure compliance with the
Company's quality standards. Finished garments are subject to final inspection
in the Company's warehouse for general appearance and quality prior to

31
<PAGE>

shipment to customers. Prior to shipment, inspection certificates are issued
to indicate that the products have been inspected and found to be in
conformity with the order. Products which are manufactured in foreign
countries are tested to ensure that such products meet United States customs
import requirements by the foreign manufacturers prior to shipment, and the
results of such tests, along with samples of each product style, are sent to
the Company. The Company's ability to design and have manufactured high-
quality playwear is evidenced by the Company's product return rates of 3.3%
and 1.9% in 1996 and 1997, respectively.

DISTRIBUTION

Upon completion of the manufacturing process, the Company's products are
shipped from the contract manufacturers by sea, air or land to the Company's
domestic warehouse facilities. The Company utilizes its warehouse facilities
in New Brunswick, New Jersey, or its public warehouse arrangement in Long
Beach, California prior to shipping its products directly to its customers'
stores or distribution centers via common carrier.

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. The Company had
backlog of $107.7 million and $73.2 million at January 31, 1998 and January
31, 1997, respectively. The Company expects to fill the January 31, 1998
backlog prior to October 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 action, 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.

INDUSTRY AND COMPETITION

The domestic children's apparel industry has increased in market size from
$24.7 billion in 1994 to $26.9 billion in 1996, a 4.4% annual increase, as
measured by The NPD Group, an industry trade group. For 1996, according to
Children's Business, the top ten childrenswear retailers, consisting of
WalMart, KMart, J.C. Penney (including the J.C. Penney catalog), Sears,
Federated Department Stores, Target, Kids R Us, Mervyns, May Company and TJX
Company, accounted for 56.4% of the market.

32
<PAGE>

The children's playwear industry is highly competitive and fragmented. The
Company competes with many companies engaged in the design, production and
distribution of children's apparel for newborns, infants, toddlers, boys and
girls. Some of the Company's competitors have longer operating histories and
financial, sales, marketing, design capabilities and other competitive
resources which are substantially greater than those of the Company. The
Company also faces competition from its existing customers, who may themselves
begin to produce children's playwear directly. In addition, such customers
have in the past competed, and may continue in the future to compete, for
available branded programs. Further, to the extent that the Company's
customers or competitors maintain or initiate private label programs, such
customers or competitors will compete with the Company's licensed and branded
properties. The Company also competes with other manufacturers of children's
apparel for retail floor space.

The Company believes that the principal competitive factors affecting its
business include the ability to deliver, on a timely basis, high quality
coordinated playwear apparel; the ability to successfully obtain licensing
arrangements and private label relationships based on characters and brands
that are appealing to children and parents; the ability to successfully design
coordinated apparel programs based on such licensing arrangements and
relationships; and the ability to produce playwear at competitive prices.

EMPLOYEES

As of December 31, 1997, the Company employed 133 persons, consisting of 14
in sales and marketing, 42 in design and graphic arts, 45 in warehousing and
distribution and 32 in finance, administration and management. Forty of the
Company's 45 employees at its New Brunswick, New Jersey warehouse facility are
subject to a collective bargaining agreement (the "Collective Bargaining
Agreement") between Hawk Industries, Inc. ("Hawk"), which upon consummation of
the Offering will be a wholly owned subsidiary of the Company, and
Journeymen's and Production Allied Services of America and Canada
International Union, Local No. 157 (the "Union"). The initial term of such
Collective Bargaining Agreement began on August 1, 1996 and extends to July
31, 1999, and shall continue thereafter from year to year, unless terminated
or modified by written notice within certain time periods. Pursuant to the
Collective Bargaining Agreement, the Company must, among other obligations,
recognize the Union as the exclusive representative of all of the employees
covered under the Collective Bargaining Agreement, endeavor to seek all
employment, new or otherwise, through the Union, require all employees of
Hawk, as a condition to employment, to become members of the Union within a
specified time period and maintain specified hours of work. The Collective
Bargaining Agreement also contains terms governing, among other things,
overtime, holidays, vacations, leave of absence, rest periods, safety and
health, strikes and lockouts, wages, grievance procedures and health and
welfare plans. The Company considers its relations with its employees to be
good.

FACILITIES

The Company currently leases all of its office space. The Company leases
approximately 19,000 square feet for its executive offices and showroom
located at 100 West 33rd Street, New York, New York. Such lease expires in
September 2005 and contains renewal options for an additional three and one
half years. The Company also leases approximately 130,000 square feet for
warehousing and distribution at its warehouse facility in New Brunswick, New
Jersey. Such lease expires in March 2000 and contains renewal options for two
additional five year terms. The Company also maintains a small showroom in
Bentonville, Arkansas. The Company believes that its facilities are sufficient
to meet current needs for its sales, marketing, design, administrative,
warehousing and distribution requirements.

LEGAL PROCEEDINGS

The Company is not a party to any material legal proceedings.

33
<PAGE>

MANAGEMENT

EXECUTIVE OFFICERS AND DIRECTORS

The directors and executive officers of the Company are as follows:

<TABLE>
<CAPTION>
NAME AGE POSITION
---- --- ------------------------------
<C> <C> <S>
Jack M. Benun....... 56 Chairman of the Board,
President and Chief Executive
Officer
Stuart Bender....... 43 Chief Financial Officer and
Treasurer
Mark J. Benun....... 31 Executive Vice President,
Secretary and Director
Isaac Levy.......... 34 Senior Vice President and
Director
Marvin Azrak(1)..... 56 Director
Stephen I. Kahn(1).. 32 Director
</TABLE>
- --------

(1) Term in office will commence upon the consummation of this Offering.

Jack M. Benun. Mr. Benun founded the predecessor to the Company in 1979 and
is the Company's Chairman of the Board, President and Chief Executive Officer.
Mr. Benun has over 30 years experience in the apparel industry. Prior to
founding the Company, Mr. Benun managed a family domestic apparel
manufacturing business.

Mark J. Benun. Mr. Benun joined the Company in 1984 and currently oversees
all sales for the Company. He currently serves as Executive Vice President,
Secretary and as a Director.

Isaac Levy. Mr. Levy joined the Company in 1987 and is responsible for all
operations of the boys division, including buying, design and marketing. He
currently serves as the Company's Senior Vice President and as a Director.

Stuart Bender, CPA. Mr. Bender joined the Company in 1985 as Chief Financial
Officer and Treasurer. Prior to joining the Company, Mr. Bender served as the
corporate controller and divisional controller for two private companies. Mr.
Bender has four years public accounting experience at Grant Thornton LLP.

Marvin Azrak. Mr. Azrak was elected as a Director of the Company in March
1998, effective upon the consummation of this Offering. Marvin Azrak founded
Azrak-Hamway International, Inc., a toy company, in 1964. The company acquired
the Remco Toy name in 1974. Mr. Azrak sold Azrak-Hamway International, Inc. in
late 1997. He established the first Harley Davidson Cafe in New York in 1993,
and, in 1997, he opened a second Harley Davidson Cafe in Las Vegas. He is also
the founder of A.M.E., a childrens underwear and accessory company.

Stephen I. Kahn. Mr. Kahn was elected as a Director of the Company in March
1998, effective upon the consummation of this Offering. Mr. Kahn is the co-
founder and the President, Chief Executive Officer and Chairman of the Board
of dELIA's Inc., a direct marketer of casual apparel and related accessories
to Generation Y consumers. Prior to founding dELIA's, from 1989 to 1993, Mr.
Kahn worked at the PaineWebber Group, Inc. in the merchant banking group where
his focus included retail and apparel companies. Mr. Kahn holds a BA from Yale
College, an MA from Oxford University and an MBA from Columbia Business
School.

Other than Jack Benun and Mark Benun, who are father and son, there are no
family relationships among any of the Directors, executive officers and key
employees of the Company. Each of the above persons has served as an executive
officer and/or a Director since joining the Company.

All Directors hold office until the next annual meeting of shareholders and
until their successors shall be duly elected and qualified. Effective upon the
consummation of this Offering, the Board of Directors will have a Compensation
Committee, which will approve salaries and certain incentive

34
<PAGE>

compensation for management and key employees of the Company; an Audit
Committee, which will review the results and scope of the audit and other
services provided by the Company's independent accountants; and an Option
Committee, which will administer the Company's 1997 Stock Option Plan. The
Compensation and Audit Committees shall be comprised of Messrs. Benun, Azrak
and Kahn and the Option Committee shall be comprised of Messrs. Azrak and
Kahn.

Executive officers of the Company are elected annually by the Board of
Directors and serve until their successors are duly elected and qualified.

DIRECTORS' COMPENSATION

Each of the Company's independent, unaffiliated Directors will receive
compensation of $1,500 per meeting for each regularly-scheduled meeting in
which he or she participates. In addition, each of such members of the Board
who serve on the Audit, Option and/or Compensation Committee of the Board will
receive a $750 fee per meeting for each regularly-scheduled Committee meeting
in which such Committee member participates, as long as such Committee meeting
or meetings is or are held on a day or days other than the day of a regularly-
scheduled Board meeting. The Company also will provide reimbursement to
Directors for reasonable and necessary expenses incurred in connection with
attendance at meetings of the Board of Directors or its Committees. Directors
are eligible to receive stock option grants pursuant to the Company's 1997
Stock Option Plan. In connection with the election of Messrs. Azrak and Kahn
to the Company's Board of Directors, effective upon the consummation of the
Offering, each such Director shall be granted ten-year options to purchase
40,000 shares of Common Stock, exercisable at a price per share equal to the
Offering price, and vesting as follows: 4,000 shares twelve months from the
date of grant, 6,000 shares twenty-four months from the date of grant, 8,000
shares thirty-six months from the date of grant, 10,000 shares forty-eight
months from the date of grant and 12,000 shares sixty months from the date of
grant.

EXECUTIVE COMPENSATION

The following table sets forth information concerning compensation for
services in all capacities awarded to, earned by or paid to the Company's
Chief Executive Officer and each of the other executive officers of the
Company (collectively, the "Named Executives") during the year ended December
31, 1997.

SUMMARY COMPENSATION TABLE

<TABLE>
<CAPTION>
ANNUAL COMPENSATION
---------------------------
OTHER ANNUAL ALL OTHER
SALARY BONUS COMPENSATION COMPENSATION
NAME AND PRINCIPAL POSITION YEAR ($) ($) ($)(1) ($)
(A) (B) (C) (D) (E) (I)(2)
--------------------------- ---- ------- ------ ------------ ------------
<S> <C> <C> <C> <C> <C>
Jack M. Benun..................... 1997 551,064 -- 52,000 2,373
President and Chief Executive Of-
ficer
Mark J. Benun..................... 1997 590,416 -- -- 2,292
Executive Vice President,
Secretary and Director
Isaac Levy........................ 1997 400,242 -- -- 2,266
Senior Vice President and
Director
Stuart Bender..................... 1997 209,803 75,000 -- 2,114
Chief Financial Officer and
Treasurer
</TABLE>
- --------
(1) The costs of certain benefits are not included because, in the aggregate,
they did not exceed, in the case of each Named Executive, the lesser of
$50,000 or 10% of the total annual salary and bonus reported in columns
(c) and (d) of the above table. In the case of Jack M. Benun, $36,842 of
such amount represents payment for automobile allowances.
(2) Represents 401(k) contributions made by the Company on behalf of the Named
Executive.

35
<PAGE>

1997 STOCK OPTION PLAN

The Company's 1997 Stock Option Plan (the "Plan") was adopted by the Board
of Directors and approved by the shareholders of the Company on December 31,
1997. A total of 800,000 shares of Common Stock are reserved for issuance upon
exercise of options and/or stock purchase rights to be granted under the Plan,
100,000 of which have been granted in 1998. No other options or rights have
been granted under the Plan. Those eligible to receive stock option grants or
stock purchase rights under the Plan include employees, non-employee Directors
and consultants. The Plan is administered by the Option Committee of the Board
of Directors of the Company, which is comprised solely of outside directors.

Subject to the provisions of the Plan, the administrator of the Plan has the
discretion to determine the optionees and/or grantees, the type of options to
be granted (incentive stock options ("ISOs") or non-qualified stock options
("NQSOs")), the vesting provisions, the terms of the option grants and such
other related provisions as are consistent with the Plan. The exercise price
of an ISO may not be less than the fair market value per share of the Common
Stock on the date of grant or, in the case of an optionee who beneficially
owns 10% or more of the outstanding capital stock of the Company, not less
than 110% of the fair market value per share on the date of grant. The
exercise price of a NQSO may not be less than 85% of the fair market value per
share of the Common Stock on the date of grant or in the case of any Optionee
who beneficially owns 10% or more of the outstanding capital stock of the
Company, not less than 110% of the fair market value per share on the date of
grant. The purchase price of shares issued pursuant to stock purchase rights
may not be less than 50% of the fair market value of such shares as of the
offer date of such rights.

The options terminate not more than ten years from the date of grant,
subject to earlier termination on the optionee's death, disability or
termination of employment with the Company, but provide that the term of any
options granted to a holder of more than 10% of the outstanding shares of
Common Stock may be no longer than five years. Options are not assignable or
otherwise transferable except by will or the laws of descent and distribution.
In the event of a merger or consolidation of the Company with or into another
corporation or the sale of all or substantially all of the Company's assets in
which the successor corporation does not assume outstanding options or issue
equivalent options, the Board of Directors of the Company is required to
provide accelerated vesting of outstanding options. The Plan terminates on
December 31, 2007.

As of December 31, 1997, no awards have been granted by the Company under
the Plan. In February 1998, the Company granted options to purchase 100,000
shares of Common Stock to Mr. Bender. Such options will be exercisable at a
price per share equal to the Offering price, have an expiration date of
February 24, 2008, and vest at a rate of thirty-three and one-third percent
per year from the date of grant. In addition, the Company has agreed, for a
period of one year commencing on the effective date of this Offering, not to
issue any awards under the Plan at less than the fair market value of the
underlying Common Stock on the date of award.

401(K) PLAN

The Company currently maintains a 401(k) salary reduction plan (the "401(k)
Plan") which is intended to qualify under Section 401(a) and 401(k) of the
Internal Revenue Code of 1986 (the "Code"). Generally, all employees who are
not members of a collective bargaining group and who are 21 years of age or
older are eligible to participate in the 401(k) Plan after they complete 1,000
hours or twelve months of service. All eligible executive officers have
elected to participate in the 401(k) Plan.

Eligible employees electing to participate in the 401(k) Plan may defer a
portion of their compensation on a pre-tax basis, by contributing a percentage
thereof to the 401(k) Plan. There is no minimum contribution, and the maximum
contribution is prescribed in Section 401(k) of the Code. Such

36
<PAGE>

maximum for 1998 is $10,000. The Company makes matching contributions equal to
25% of the first 4% of a participating employee's annual salary. Eligible
employees who elect to participate in a 401(k) Plan are generally vested in
the Company's matching contribution, according to the following schedule: less
than one year of service--0%; one year of service--20%; two years of service--
40%; three years of service--60%; four years of service--80%; and five years
of service--100%.

EMPLOYMENT AGREEMENTS AND INDEMNIFICATION AGREEMENTS

Each of the executive officers of the Company entered into a two-year
employment agreement with the Company commencing January 1, 1998. Under the
terms of the respective agreements, Messrs. Jack Benun, Mark Benun, Isaac Levy
and Stuart Bender are entitled to an annual base salary of $425,000, $300,000,
$300,000 and $225,000, respectively, and bonuses, the amounts and payments of
which are within the discretion of the Compensation Committee of the Board of
Directors. These agreements require each individual to maintain the
confidentiality of Company information. In addition, with the exception of Mr.
Bender, each of such persons has agreed that during the term of his respective
agreement and thereafter for a period of two years, he will not compete with
the Company in any state or territory of the United States where the Company
does business by engaging in any capacity in a business which is competitive
with the business of the Company. Each of the foregoing employment agreements
also provides that, for a period of two years following the termination of
employment, each such individual shall not solicit the Company's licensors,
customers or employees.

In addition to the foregoing employment contracts, the Company has executed
indemnification agreements with each of its executive officers and Directors
pursuant to which the Company has agreed to indemnify such parties to the full
extent permitted by law, subject to certain exceptions, if such party becomes
subject to an action because such party is a Director, officer, employee,
agent or fiduciary of the Company.

KEY MAN INSURANCE

Messrs. Jack Benun, Mark Benun and Isaac Levy are key employees of the
Company and the contribution of each of them to the Company has been and will
be a significant factor in the Company's future success. The loss of any of
them could adversely affect the Company's business and results of operations.
The Company maintains, and is the beneficiary of, a life insurance policy on
the life of Jack Benun, the face amount of which is $3.0 million. The Company
does not maintain key man life insurance on the life of either Mark Benun or
Isaac Levy.

COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION

The Company's Board of Directors currently does not, and during 1997 did
not, have a Compensation Committee. Consequently, all current Directors
participated in deliberations concerning executive officer compensation,
including decisions relative to their own compensation in 1997.

The Company and certain of its subsidiaries have been treated for federal
and state income tax purposes as an S Corporation under Sub-chapter S of the
Code since 1988. As a result of the Company's status as an S Corporation, the
Company's current shareholders, rather than the Company, have been taxed
directly on earnings of the Company for federal and certain state income tax
purposes, whether or not such earnings were distributed. Immediately prior to
the effectiveness of this Offering, the Company will terminate its status as
an S Corporation and will thereafter be subject to federal and state income
taxes at applicable C corporation rates.

Prior to the termination of its S Corporation status, the Company intends to
declare the S Corporation Distribution to the shareholders of record of the
Company on such date. Such shareholders consist solely of Jack Benun, the
Company's Chairman of the Board, President and Chief

37
<PAGE>

Executive Officer, Mark Benun, the Company's Executive Vice President and
Secretary, and Isaac Levy, its Senior Vice President. Such distribution
(estimated at $5.6 million as of December 31, 1997) represents substantially
all of the Company's remaining undistributed S Corporation earnings and will
be evidenced by four-year 5.7% promissory notes to be issued to such
shareholders in connection with the termination of the Company's S Corporation
status. Of this amount, $2.0 million of the net proceeds from this Offering
will be used to make a partial payment of amounts due under such notes. See
"Use of Proceeds." The balance of the S Corporation Distribution will be paid
in accordance with the terms and provisions of the promissory notes referred
to above and will provide for the timely distribution of amounts necessary to
pay personal income taxes of the shareholders due on amounts earned by the S
Corporations for the period January 1, 1998 through the termination of such S
Corporation status. The actual amount of the S Corporation Distribution will
be adjusted to include the taxable income of the Company for the period from
January 1, 1998 through the day preceding the date on which S Corporation
status is terminated, less any state income tax payable by the Company with
respect to such income and any distributions made to the current shareholders
during that time period ($3.5 million was distributed to the current
shareholders in 1997 and 1998 through the date of this Prospectus in the form
of dividends to fund their 1996 and 1997 tax liabilities resulting from the
Company's status as an S Corporation). S Corporation distributions totalled
$721,000 and $3.1 million in 1996 and 1997, respectively.

From time to time, the Company has made loans to Jack Benun, Mark Benun and
Isaac Levy and received loans from Jack Benun. All outstanding loans made to
such individuals by the Company, totalling $347,211 as of December 31, 1997
will be repaid to the Company prior to the consummation of the Offering. Loans
received by the Company from Jack Benun will be repaid to Mr. Benun on the
same terms and conditions as those included in the four-year 5.7% promissory
notes to be issued in connection with the termination of the Company's S
Corporation status.

Immediately prior to the effectiveness of this Offering, the Company will
acquire all of the issued and outstanding shares of certain related entities
of the Company, in exchange for shares of Common Stock of the Company, from
each of Jack Benun and Mark Benun. Each of Jack Benun and Mark Benun will
receive 2,131,250 shares of the Company's Common Stock in exchange for each of
their 50.0% 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.

Jack Benun, Mark Benun and Isaac Levy have entered into a shareholders
agreement dated January 1, 1998. Such agreement provides tag-along rights to
each of the parties thereto in the event that any of the other parties elects
to sell his Common Stock. In addition, each party is granted a right of first
refusal to purchase any shares of Common Stock offered for sale by any other
party to the agreement. Finally, Mark Benun has granted Jack Benun an
irrevocable proxy to vote any of the Company's voting securities beneficially
owned by Mark Benun for the life of Jack Benun.

CERTAIN TRANSACTIONS

For transactions involving Jack Benun, Mark Benun and Isaac Levy, see
"Management--Compensation Committee Interlocks and Insider Participation."

The Board of Directors of the Company has adopted a policy requiring that
any future transactions between the Company and its officers, Directors,
principal shareholders and their affiliates be on terms no less favorable to
the Company than could be obtained from unrelated third parties and that any
such transactions be approved by a majority of the disinterested members of
the Company's Board of Directors.

38
<PAGE>

PRINCIPAL SHAREHOLDERS

The following table sets forth certain information regarding the beneficial
ownership of the Company's Common Stock as of December 31, 1997, and as
adjusted to reflect the sale of the shares of Common Stock offered hereby, by
(i) each person who is known to the Company to own beneficially more than 5.0%
of the outstanding shares of Common Stock, (ii) each of the Company's
Directors and Named Executives, and (iii) all Directors and executive officers
of the Company as a group.

<TABLE>
<CAPTION>
PERCENTAGE OF
SHARES BENEFICIALLY
OWNED(3)
SHARES -----------------------
DIRECTORS, NAMED EXECUTIVES AND 5% BENEFICIALLY BEFORE AFTER
SHAREHOLDERS(1) OWNED(2) OFFERING OFFERING
- ---------------------------------- ------------ ---------- ---------
<S> <C> <C> <C>
Jack M. Benun(4)...................... 6,587,500 85.0% 67.6%
Mark J. Benun......................... 3,293,750 42.5 33.8
Isaac Levy............................ 1,162,500 15.0 11.9
Stuart Bender......................... -- -- --
All Directors and executive officers
as a group (four persons)............ 7,750,000 100.0 79.5
</TABLE>
- --------
(1) The address of each beneficial owner of more than 5% of the outstanding
Common Stock is 100 West 33rd Street, Suite 1100, New York, New York
10001.
(2) Except as set forth in the footnotes to this table and subject to
applicable community property law, the persons named in the table have
sole voting and investment power with respect to all shares of Common
Stock shown as beneficially owned by such Shareholder.
(3) Applicable ownership percentage is based on 7,750,000 shares of Common
Stock outstanding on December 31, 1997, including the shares issued in the
Reorganization, and 9,750,000 shares of Common Stock outstanding after the
completion of this Offering.

(4) Includes 3,293,750 shares of Common Stock owned of record by Mark Benun,
as to which shares Jack Benun exercises voting power. Also includes
300,000 shares of Common Stock owned of record by the Jack M. Benun
Family, L.P., of which Mr. Benun is the general partner with a 1%
interest, and each of Mr. Benun's three daughters is a limited partner
with a 33% interest.

39
<PAGE>

DESCRIPTION OF CAPITAL STOCK

As of December 31, 1997, the Company's authorized capital stock consists of
30,000,000 shares of Common Stock, $.01 par value per share, and 5,000,000
shares of undesignated Preferred Stock, $.01 par value per share. At January
31, 1998, there were 7,750,000 shares of Common Stock issued and outstanding
and held of record by four shareholders. There are no shares of Preferred
Stock designated or issued.

The following statements are brief summaries of certain provisions with
respect to the Company's capital stock contained in its Certificate of
Incorporation and By-Laws, copies of which have been filed as exhibits to the
Registration Statement. The following summary is qualified in its entirety by
reference thereto.

COMMON STOCK

Holders of shares of Common Stock are entitled to one vote for each share
held of record on matters to be voted on by the shareholders of the Company
and such holders are not entitled to cumulative voting rights. Holders of
shares of Common Stock will be entitled to receive dividends, subject to the
rights of preferred shareholders, if any, when, as and if declared by the
Board of Directors (see "Dividend Policy") and to share ratably in the assets
of the Company legally available for distribution to its shareholders in the
event of the liquidation, dissolution or winding-up of the Company. Holders of
Common Stock have no preemptive, subscription, redemption or conversion
rights. All of the issued and outstanding shares of Common Stock are, and all
shares of Common Stock to be sold in this Offering will be, duly authorized,
validly issued, fully paid and nonassessable.

PREFERRED STOCK

The Company's Board of Directors may without further action by the Company's
shareholders, from time to time, direct the issuance of shares of Preferred
Stock in series and may, at the time of issuance, determine the rights,
preferences and limitations of each series. The holders of Preferred Stock
would normally be entitled to receive a preference payment in the event of any
liquidation, dissolution or winding-up of the Company before any payment is
made to the holders of the Common Stock. The Company does not presently intend
to issue any series of Preferred Stock.

The overall effect of the ability of the Company's Board of Directors to
issue Preferred Stock may be to render more difficult the accomplishment of
mergers or other takeover or change-in-control attempts. To the extent that
this ability has this effect, removal of the Company's incumbent Board of
Directors and management may be rendered more difficult. Further, this may
have an adverse impact on the ability of shareholders of the Company to
participate in a tender or exchange offer for the Common Stock and in so doing
diminish the market value of the Common Stock. See "Risk Factors--Control by
Current Shareholders" and "--Anti-takeover Effect of Certain Charter and By-
Law and Other Provisions."

LIMITATION OF DIRECTOR LIABILITY

The Certificate of Incorporation of the Company limits the liability of
Directors of the Company to the Company or its shareholders to the fullest
extent permitted by New York law. Specifically, Directors of the Company will
not be personally liable for money damages for breach of a duty as a Director,
except that a Director shall not be relieved from liability if a judgment or
other final adjudication adverse to him establishes that his acts or omissions
were in bad faith or involved intentional misconduct or a knowing violation of
law, or that such Director personally gained in fact a financial profit or
other advantage to which such Director was not legally entitled, or that such
Director's acts violated Section 719 of the New York Act (which relates to
unlawful declarations of dividends or other distributions of assets to
shareholders or the unlawful purchase of shares of the corporation).

40
<PAGE>

ANTI-TAKEOVER PROVISIONS

The Company is governed by the provisions of Section 912 et seq., of the New
York Act, an anti-takeover law. In general, the statute prohibits a publicly-
held New York corporation from engaging in a "business combination" with an
"interested shareholder" for a period of five years after the date of the
transaction in which the person became an interested shareholder, unless the
business combination is approved in a prescribed manner. A "business
combination" includes mergers, asset sales and other transactions resulting in
a financial benefit to the interested shareholder. An "interested shareholder"
is a person who, together with affiliates and associates, owns (or within five
years, did own) 20% or more of the corporation's voting stock. After the five-
year waiting period has elapsed, a business combination between a corporation
and an interested shareholder will be prohibited unless the business
combination is approved by the holders of at least a majority of the voting
stock not beneficially owned by the interested shareholder, or unless the
business combination otherwise satisfies the provisions of the New York Act.
The New York Act's fair price provision is intended to provide that all
shareholders (other than the interested shareholders) receive a fair price for
their shares.

The Company's Certificate of Incorporation authorizes the Board of Directors
to issue, without shareholder approval, 5,000,000 shares of Preferred Stock
with voting, conversion and other rights and preferences that could adversely
affect the voting power or other rights of the holders of Common Stock. The
issuance of Preferred Stock or of rights to purchase Preferred Stock could be
used to discourage an unsolicited acquisition proposal. In addition, the
possible issuance of Preferred Stock could discourage a proxy contest, make
more difficult the acquisition of a substantial block of the Company's Common
Stock or limit the price that investors might be willing to pay in the future
for shares of the Company's Common Stock. The Certificate of Incorporation
also provides that: (i) the affirmative vote of the holders of at least 80% of
the voting power of all outstanding shares of the capital stock of the Company
shall be required to adopt, amend or repeal any provision of the bylaws of the
Company or the provisions in the Company's Certificate of Incorporation
limiting the liability of directors and provisions relating to certain
management issues; (ii) shareholders of the Company may not take any action by
written consent; (iii) special meetings of shareholders may be called only by
the President, the Chairman of the Board or a majority of the Board of
Directors and business transacted at any such special meeting shall be limited
to matters relating to the purposes set forth in the notice of such special
meeting; and (iv) the Board of Directors, when evaluating an offer related to
a tender or exchange offer or other business combination, is authorized to
give due consideration to any relevant factors, including the social, legal
and economic effects upon employees, suppliers, customers, creditors, the
community in which the Company conducts its business, and the economy of the
state, region and nation. The foregoing provisions of the Certificate of
Incorporation could have the effect of delaying, deterring or preventing a
change in control of the Company. In the event of a merger or consolidation of
the Company with or into another corporation or the sale of all or
substantially all of the Company's assets in which the successor corporation
does not assume outstanding options or issue equivalent options, the Board of
Directors of the Company is required to provide accelerated vesting of
outstanding options.

TRANSFER AGENT AND REGISTRAR

The transfer agent and registrar for the Common Stock is American Stock
Transfer & Trust Company.

41
<PAGE>

SHARES ELIGIBLE FOR FUTURE SALE

Upon completion of this Offering, the Company will have outstanding
9,750,000 shares of Common Stock. Of these shares, the 2,000,000 shares sold
in this Offering will be freely transferable by persons other than affiliates
of the Company without restriction or further registration under the Act. The
remaining 7,750,000 shares of Common Stock outstanding are "restricted
securities" (the "Restricted Shares") within the meaning of Rule 144 under the
Act and may not be sold in the absence of registration under the Act unless an
exemption from registration is available, including an exemption afforded by
Rule 144.

The Company's current shareholders, Directors and executive officers have
entered into "lock-up" agreements with the Representatives of the
Underwriters, providing that, subject to certain exceptions, they will not
offer, sell or otherwise dispose of any shares of Common Stock for a period of
180 days after the date of this Prospectus without the prior written consent
of Ladenburg Thalmann & Co. Inc. acting as one of the Representatives of the
Underwriters. Following the expiration of the "lock-up" period, all of the
Restricted Shares will be eligible for resale in the public market pursuant to
Rule 144, subject to certain limitations described below.

Rule 144, as currently in effect, provides that an affiliate of the Company
or a person (or persons whose sales are aggregated) who has beneficially owned
Restricted Shares for at least one year, or a non-affiliate who has
beneficially owned Restricted Shares for at least one year but less than two
years, is entitled to sell, commencing 90 days after the date of this
Prospectus, within any three-month period, a number of shares that does not
exceed the greater of one percent of the then outstanding shares of Common
Stock (97,500 shares immediately after this Offering) or the average weekly
trading volume in the Common Stock during the four calendar weeks preceding
such sale. Sales under Rule 144 also are subject to certain manner-of-sale
provisions, notice requirements and the availability of current public
information about the Company. However, a person who is not an affiliate of
the Company at any time during the three months preceding a sale, and who has
beneficially owned Restricted Shares for at least two years, is entitled to
sell such shares under Rule 144 without regard to the limitations described
above.

As of the date of this Prospectus, there were outstanding options to
purchase 100,000 shares of Common Stock all of which were granted in February
1998 and none of which are presently exercisable.

Since there has been no public market for shares of the Common Stock prior
to this Offering, the Company is unable to predict the effect that sales made
pursuant to Rule 144, or otherwise, may have on the prevailing market price at
such times for shares of the Common Stock. Nevertheless, sales of a
substantial amount of the Common Stock in the public market, or the perception
that such sales could occur, could adversely affect the market prices. See
"Risk Factors--Shares Eligible for Future Sale."

42
<PAGE>

UNDERWRITING

Subject to the terms and conditions of the Underwriting Agreement, a copy of
which has been filed as an exhibit to the Registration Statement of which this
Prospectus is a part, the underwriters named below (the "Underwriters"), have
severally, and not jointly, agreed, through Ladenburg Thalmann & Co. Inc. and
Cruttenden Roth Incorporated, the Representatives of the Underwriters (the
"Representatives"), to purchase from the Company, and the Company has agreed
to sell to the Underwriters, the aggregate number of shares of Common Stock
set forth opposite their respective names:

<TABLE>
<CAPTION>
NUMBER OF
UNDERWRITER SHARES
----------- ---------
<S> <C>
Ladenburg Thalmann & Co. Inc. .....................................
Cruttenden Roth Incorporated.......................................
---------
Total.......................................................... 2,000,000
=========
</TABLE>

The Underwriters are committed to take and to pay for all of the shares of
Common Stock offered hereby (other than the shares covered by the over-
allotment option described below), if any are purchased.

The Underwriters have advised the Company that they propose to offer all or
part of the Common Stock offered directly to the public initially at the price
to the public set forth on the cover page of this Prospectus, that they may
offer shares to certain dealers at a price that represents a concession of not
more than $ per share, and that the Underwriters may allow, and such dealers
may reallow, a concession of not more than $ per share to certain other
dealers. After the Offering, the price to the public and the concessions may
be changed from time to time by the Representatives.

The Company has granted to the Underwriters an option, exercisable within 30
days after the date of this Prospectus, to purchase up to 300,000 additional
shares of Common Stock at the initial public offering price, less the
underwriting discount set forth on the cover page of this Prospectus. The
Underwriters may exercise such option solely to cover over-allotments, if any,
made in connection with the sale of the shares offered hereby. To the extent
the Underwriters exercise such option, each of the Underwriters will be
committed, subject to certain conditions, to purchase the same percentage
thereof as the percentage of the initial shares to be purchased by that
Underwriter.

The Company and certain shareholders have agreed to indemnify the
Underwriters and certain related persons against certain liabilities,
including certain liabilities under the Act, and to contribute to payments the
Underwriters may be required to make in respect thereof.

The Company and its Directors, officers and all holders of the Common Stock
have agreed that they will not, directly or indirectly, offer, sell or
otherwise dispose of any equity securities of the Company or any securities
convertible into or exchangeable for, or any rights to purchase or acquire,

43
<PAGE>

equity securities of the Company for a period of 180 days after the date of
this Prospectus, without the prior written consent of Ladenburg Thalmann & Co.
Inc.

Prior to the Offering, there has been no public market for the Common Stock.
The initial offering price was determined by negotiations between the Company
and the Representatives. Among the factors considered in such negotiations
were the Company's historical results of operations and financial condition,
prospects for the Company and for the industry in which the Company operates,
the Company's capital structure and the general condition of the securities
market.

The Representatives have informed the Company that the Underwriters do not
expect sales to discretionary accounts to exceed 5% of the total number of
shares offered hereby, and the Representatives do not intend to confirm sales
of shares to any account over which they exercise discretionary authority.

In connection with the Offering, the Underwriters may over-allot or affect
transactions which stabilize or maintain the market price of the Common Stock
at a level above that which might otherwise prevail in the open market. Such
transactions may be effected on the Nasdaq National Market or otherwise. Such
stabilizing, if commenced, may be discontinued at any time.

The Company has granted Ladenburg Thalmann & Co. Inc., one of the
Representatives of the Underwriters, a right of first refusal to act as a
manager or placement agent in connection with any public or private offering
of equity, debt or convertible securities the Company may undertake in the
period ending two years from the consummation of this Offering.

BDO Seidman has provided financial consulting services to the Company. Upon
consummation of this Offering the Company will pay to BDO Seidman a fee for
such services not to exceed 1% of the gross proceeds from this Offering, less
amounts paid to date.

The Company's Common Stock has been approved for quotation, subject to
notice of effectiveness, on the Nasdaq National Market under the trading
symbol "HKID."

LEGAL MATTERS

Certain legal matters in connection with the legality of the shares offered
by this Prospectus will be passed upon for the Company by Buchanan Ingersoll,
Princeton, New Jersey. Certain legal matters in connection with the Offering
will be passed upon for the Underwriters by Rosenman & Colin LLP, New York,
New York.

EXPERTS

The audited Consolidated Financial Statements of the Company included in
this Prospectus have been included herein and in the Registration Statement in
reliance upon the report of Grant Thornton LLP, independent certified public
accountants, appearing elsewhere herein and upon the authority of said firm as
experts in accounting and auditing.

44
<PAGE>

ADDITIONAL INFORMATION

The Company has filed with the Securities and Exchange Commission (the
"Commission") a Registration Statement on Form S-1 (the "Registration
Statement") of which this Prospectus is a part, under the Act and the rules
and regulations promulgated thereunder, with respect to the shares of Common
Stock offered pursuant to this Prospectus. This Prospectus does not contain
all of the information set forth in the Registration Statement and the
exhibits and schedules thereto, certain parts of which are omitted in
accordance with the rules and regulations of the Commission. Statements
contained in this Prospectus as to the content of any contract, agreement or
other document referred to herein are not necessarily complete, and in each
instance reference is made to the copy of such contract, agreement or other
document filed as an exhibit to the Registration Statement, each such
statement being qualified in all respects by such reference.

For further information with respect to the Company and the Common Stock
offered hereby, reference is made to the Registration Statement and such
schedules and exhibits, copies of which may be examined without charge at, or
copies obtained upon payment of prescribed fees from, the Public Reference
Section of the Commission at Judiciary Plaza, 450 Fifth Street, N.W.,
Washington D.C. 20549, and will also be available for inspection and copying
at the regional offices of the Commission located at 7 World Trade Center,
13th Floor, New York, New York 10048 and Citicorp Center, 500 West Madison
Street, Suite 1400, Chicago, Illinois 60661-2511. Such material may also be
accessed electronically by means of the Commission's website on the Internet
at http://www.sec.gov.

The Company intends to furnish to its shareholders annual reports containing
Consolidated Financial Statements audited by its independent public
accountants and quarterly reports containing unaudited Consolidated Financial
Statements for three quarters of each fiscal year.

45
<PAGE>

INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

<TABLE>
<CAPTION>
PAGE
--------
<S> <C>
Report of Independent Certified Public Accountants..................... F-2
Financial Statements
Consolidated Balance Sheets.......................................... F-3
Consolidated Statements of Operations................................ F-4
Consolidated Statement of Shareholders' Equity....................... F-5
Consolidated Statements of Cash Flows................................ F-6
Notes to Consolidated Financial Statements........................... F-7-F-16
Schedule II--Valuation and Qualifying Accounts......................... F-17
</TABLE>

F-1
<PAGE>

REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS

Board of Directors
Happy Kids Inc.

We have audited the accompanying consolidated balance sheets of Happy Kids
Inc. and Subsidiaries as of December 31, 1996 and 1997, and the related
consolidated statements of operations, shareholders' equity, and cash flows
for each of the three years in the period ended December 31, 1997. These
financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.

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

In our opinion, the financial statements referred to above present fairly,
in all material respects, the consolidated financial position of Happy Kids
Inc. and Subsidiaries as of December 31, 1996 and 1997, and the consolidated
results of their operations and their consolidated cash flows for each of the
three years in the period ended December 31, 1997, in conformity with
generally accepted accounting principles.

We have also audited Schedule II of Happy Kids Inc. and Subsidiaries as of
and for the three years ended December 31, 1997. In our opinion, this schedule
presents fairly, in all material respects, the information required to be set
forth therein.

New York, New York
January 29, 1998

The foregoing auditors' report is the form which will be signed upon
consummation of the transaction described in Note A to the financial
statements.

/s/ Grant Thornton LLP
New York, New York

March 5, 1998

F-2
<PAGE>

HAPPY KIDS INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT PER SHARE DATA)

<TABLE>
<CAPTION>
PRO FORMA
DECEMBER 31,
DECEMBER 31, DECEMBER 31, 1997
1996 1997 (NOTE P)
------------ ------------ ------------
(UNAUDITED)
<S> <C> <C> <C>
ASSETS
CURRENT ASSETS:
Cash.................................. $ 674 $ 374 $ 374
Due from factor....................... 16,925 24,232 24,232
Accounts receivable--trade (net of
allowance of $486 and $513 at
December 31, 1996 and 1997,
respectively)........................ 1,084 316 316
Inventories........................... 9,488 16,316 16,316
Due from shareholders................. 405 347 347
Other current assets.................. 2,696 1,139 1,748
------- ------- -------
Total current assets................ 31,272 42,724 43,333
FIXED ASSETS--NET....................... 1,732 1,476 1,476
OTHER ASSETS:
Due from shareholders................. 410 -- --
Other................................. 572 752 752
------- ------- -------
Total other assets.................. 982 752 752
------- ------- -------
Total assets........................ $33,986 $44,952 $45,561
======= ======= =======
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES:
Due to bank........................... $19,732 $24,863 $24,863
Current portion--capital lease obliga-
tions................................ 55 49 49
Accounts payable and accrued liabili-
ties................................. 6,258 11,393 11,393
Due to shareholders................... -- -- 2,000
------- ------- -------
Total current liabilities........... 26,045 36,305 38,305
DEFERRED RENT PAYABLE................... 740 584 584
CAPITAL LEASE OBLIGATIONS............... 68 19 19
DUE TO SHAREHOLDERS..................... 1,560 1,400 4,954
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
December 31, 1996 and 1997,
respectively......................... 78 78 78
Additional paid-in capital............ 1,119 1,119 1,119
Retained earnings..................... 4,376 5,447 502
------- ------- -------
Total shareholders' equity.......... 5,573 6,644 1,699
------- ------- -------
Total liabilities and shareholders'
equity............................. $33,986 $44,952 $45,561
======= ======= =======
</TABLE>

The accompanying notes are an integral part of these statements.

F-3
<PAGE>

HAPPY KIDS INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE DATA)

<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
--------------------------
1995 1996 1997
-------- ------- --------
<S> <C> <C> <C>
Net sales........................................... $ 79,828 $90,723 $106,673
Cost of goods sold.................................. 65,036 69,886 79,748
-------- ------- --------
Gross profit...................................... 14,792 20,837 26,925
Operating expenses:
Selling, design and shipping...................... 7,986 7,686 10,058
General and administrative........................ 6,830 7,684 8,399
-------- ------- --------
Total operating expenses........................ 14,816 15,370 18,457
-------- ------- --------
Operating earnings (loss)....................... (24) 5,467 8,468
Interest expense, net............................... 2,375 2,980 3,803
-------- ------- --------
Income (loss) before income taxes............... (2,399) 2,487 4,665
Income taxes (benefit).............................. (757) 119 473
-------- ------- --------
Net income (loss)............................... $ (1,642) $ 2,368 $ 4,192
======== ======= ========
Basic and diluted income (loss) per common share.... $ (0.21) $ 0.31 $ 0.54
======== ======= ========
Weighted average common shares outstanding.......... 7,750 7,750 7,750
======== ======= ========
Pro forma data (unaudited):
Historical income (loss) before provision for
income taxes..................................... $ (2,399) $ 2,487 $ 4,665
Income taxes (benefit)............................ (936) 990 1,961
-------- ------- --------
Net income (loss)............................... $ (1,463) $ 1,497 $ 2,704
======== ======= ========
Pro forma net income (loss) per share............... $ (0.18) $ 0.18 $ 0.33
======== ======= ========
Pro forma weighted average common shares
outstanding........................................ 8,305 8,305 8,305
======== ======= ========
</TABLE>

The accompanying notes are an integral part of these statements.

F-4
<PAGE>

HAPPY KIDS INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY

YEARS ENDED DECEMBER 31, 1995, 1996 AND 1997
(IN THOUSANDS)

<TABLE>
<CAPTION>
COMMON STOCK ADDITIONAL
------------- PAID--IN RETAINED
SHARES AMOUNT CAPITAL EARNINGS
------ ------ ---------- --------
<S> <C> <C> <C> <C>
Balance at January 1, 1995................... 7,750 $78 $ 976 $ 5,082
Waived payment of interest on shareholder's
note...................................... -- -- 65 --
Dividends.................................. -- -- -- (711)
Net loss................................... -- -- -- (1,642)
----- --- ------ -------
Balance at December 31, 1995................. 7,750 78 1,041 2,729
Waived payment of interest on shareholder's
note...................................... -- -- 78 --
Dividends.................................. -- -- -- (721)
Net income................................. -- -- -- 2,368
----- --- ------ -------
Balance at December 31, 1996................. 7,750 78 1,119 4,376
Dividends.................................. -- -- -- (3,121)
Net income................................. -- -- -- 4,192
----- --- ------ -------
Balance at December 31, 1997................. 7,750 $78 $1,119 $ 5,447
===== === ====== =======
</TABLE>

The accompanying notes are an integral part of this statement.

F-5
<PAGE>

HAPPY KIDS INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)

<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-------------------------
1995 1996 1997
------- ------- -------
<S> <C> <C> <C>
Cash flows from operating activities
Net income (loss)................................. $(1,642) $ 2,368 $ 4,192
Adjustments to reconcile net income (loss) to net
cash (used in) provided by operating activities:
Depreciation and amortization................... 232 388 336
Provision for losses on accounts receivable..... 112 212 354
Deferred income taxes........................... (130) (8) 164
Noncash interest expense........................ 65 78
Changes in operating assets and liabilities:
Accounts receivable........................... 335 10,521 741
Due from factor............................... -- (16,925) (7,307)
Inventories................................... (4,702) 5,669 (6,829)
Other current assets.......................... (463) (471) 857
Other assets.................................. 19 22 13
Accounts payable and accrued liabilities...... 857 919 5,083
Due from shareholders......................... (793) 308 469
------- ------- -------
Net cash (used in) provided by operating
activities....................................... (6,110) 3,081 (1,927)
------- ------- -------
Cash flows from investing activities
Acquisition of fixed assets....................... (578) (378) (79)
------- ------- -------
Cash flows from financing activities
Net borrowings under line of credit............... 6,630 (1,608) 5,131
Payments on capital lease......................... (11) (43) (56)
Borrowings from shareholders...................... 300 60 (160)
Dividends paid.................................... (711) (721) (3,121)
Payments on initial public offering costs......... -- -- (88)
------- ------- -------
Net cash provided by (used in) financing
activities..................................... 6,208 (2,312) 1,706
------- ------- -------
NET (DECREASE) INCREASE IN CASH................. (480) 391 (300)
Cash at beginning of year........................... 763 283 674
------- ------- -------
Cash at end of year................................. $ 283 $ 674 $ 374
======= ======= =======
</TABLE>

The accompanying notes are an integral part of these statements.

F-6
<PAGE>

HAPPY KIDS INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

DECEMBER 31, 1995, 1996 AND 1997
(IN THOUSANDS, EXCEPT PER SHARE DATA)

NOTE A--SUMMARY OF ACCOUNTING POLICIES

The Company was incorporated in 1988 in New York under the name O'Boy Inc.
and changed its name to Happy Kids Inc. (the "Company") 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 Offering as described in Note O, all of such separate
entities shall become wholly-owned subsidiaries of the Company. The Company
will issue 4,263 shares of common stock, to the principal shareholders, in
exchange for their ownership in these separate business entities. All share
and per share amounts have been restated to retroactively reflect the
reorganization.

The accompanying 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.

The Company is a designer and marketer of custom-designed licensed and
branded children's apparel. The Company's revenues are derived from the sale
of children's apparel to mass-market retailers, mid-tier distributors and
department stores.

A summary of the significant accounting policies consistently applied in the
preparation of the accompanying consolidated financial statements follows:

1. Revenue Recognition

Sales are recognized when merchandise is shipped to customers.

2. Inventories

Inventories, consisting primarily of finished goods, are stated at the lower
of cost or market. One subsidiary determines cost by the last-in, first-out
("LIFO") method which represented approximately $3,913, $1,637 and $808 of
total inventory at December 31, 1995, 1996 and 1997, respectively. The other
subsidiaries determine cost by the first-in, first-out ("FIFO") method.

3. Depreciation and Amortization

The Company depreciates fixed assets over their estimated useful lives by
the straight-line method. Leasehold improvements are depreciated over their
expected useful life or the life of the respective leases, whichever is
shorter.

The following are the estimated lives of the Company's fixed assets:

<TABLE>
<S> <C>
Furniture and fixtures 5 years to 10 years
Equipment 5 years to 10 years
Leasehold improvements up to 10 years
</TABLE>

4. Cash and Cash Equivalents

Cash and cash equivalents include cash on hand and demand deposits.

F-7
<PAGE>

HAPPY KIDS INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)

DECEMBER 31, 1995, 1996 AND 1997
(IN THOUSANDS, EXCEPT PER SHARE DATA)

Supplemental disclosures of cash flow information:

<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-------------------------
1995 1996 1997
-------- -------- -------
<S> <C> <C> <C>
Cash paid during the year for
Interest........................................ $ 2,311 $ 2,711 $ 2,992
Income taxes.................................... 116 280 122
</TABLE>

Noncash investing and financing activities:

For the years ended December 31, 1995 and 1996, the Company acquired
equipment totalling approximately $115 and $49, respectively, under capital
leases.

5. Income Taxes

Deferred income taxes are determined based on the difference between the tax
basis of an asset or liability and its reported amount in the financial
statements using enacted tax rates for the year in which the differences are
expected to reverse.

The principal types of differences between assets and liabilities for
financial statement and tax return purposes giving rise to deferred income
taxes are accrued expenses, accumulated depreciation, certain costs
capitalized to inventory and allowance for doubtful accounts. A deferred tax
asset has been recorded for these differences.

Through December 31, 1997, the Company filed separate income tax returns for
its subsidiaries. Two wholly-owned subsidiaries which incurred approximately
$(2,163), $(508) and $999 of pretax (loss) income for the years ended December
31, 1995, 1996 and 1997, respectively, were C Corporations and, accordingly,
were taxed or received tax benefits at the appropriate corporate Federal and
state rates. The remaining subsidiaries are S Corporations or LLCs and income
taxes on the earnings are paid personally by the shareholders of these
companies pursuant to an election for Federal income tax purposes not to be
taxed as a corporation. Accordingly, no provision has been made in the
accompanying financial statements for Federal income taxes on the net earnings
of these companies. Instead, the shareholders report their pro rata share of
corporate taxable income or loss on their respective individual tax returns. A
provision for state income taxes is made for those states not recognizing S
Corporation status.

The S Corporation and Partnership status will terminate immediately prior to
the effective date of the Initial Public Offering. (See Note O.) The Company
will convert to a C Corporation and will be subject to both Federal and state
income taxes and will file a consolidated Federal income tax return. Any
income tax adjustment required as a result of the conversion will be reflected
in the period in which it becomes effective. The effect would increase
deferred tax assets at December 31, 1997 by approximately $609 and net
earnings by the same amount. (See Note P.)

6. Use of Estimates

In preparing financial statements in conformity with generally accepted
accounting principles, management is required to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and revenues and expenses during the reporting period. Actual
results could differ from those estimates.

F-8
<PAGE>

HAPPY KIDS INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)

DECEMBER 31, 1995, 1996 AND 1997
(IN THOUSANDS, EXCEPT PER SHARE DATA)

7. Fair Value of Financial Instruments

Due to the short-term nature of the bank loans, the fair value of the
Company's due to bank approximates carrying value. Furthermore, the carrying
value of all other financial instruments potentially subject to valuation risk
(principally consisting of cash, accounts receivable, due from factor and
accounts payable) also approximates fair value.

8. Future Effect of Recently Issued Accounting Pronouncements

In June 1997, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("SFAS") No. 130, "Reporting
Comprehensive Income," which is effective for the Company's fiscal year ending
December 31, 1998. The statement addresses the reporting and displaying of
comprehensive income and its components. Earnings per share 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.

In June 1997, the FASB also issued SFAS No. 131, "Disclosures About Segments
of an Enterprise and Related Information," which is effective for the
Company's fiscal year ending December 31, 1998. The 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.

9. Earnings Per Share

The Company has adopted SFAS No. 128, "Earnings Per Share," 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 earnings per share is based on the weighted
average number of common and common equivalent shares outstanding. There were
no common stock equivalent shares outstanding at December 31, 1997.

10. Reclassification

Certain prior year amounts have been reclassified to conform to the 1997
presentation.

NOTE B--INVENTORIES

Inventories consist of the following finished goods:

<TABLE>
<CAPTION>
DECEMBER 31,
----------------
1996 1997
------- -------
<S> <C> <C>
Warehouse............................................... $ 5,947 $ 8,716
In-transit and overseas................................. 4,709 8,010
LIFO valuation allowance................................ (1,168) (410)
------- -------
$ 9,488 $16,316
======= =======
</TABLE>

F-9
<PAGE>

HAPPY KIDS INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)

DECEMBER 31, 1995, 1996 AND 1997
(IN THOUSANDS, EXCEPT PER SHARE DATA)

For the years ended December 31, 1996 and 1997, the liquidation of LIFO
inventories decreased cost of sales and, therefore, increased income before
taxes by $521 and $390, respectively.

NOTE C--FACTORED ACCOUNTS RECEIVABLE--WITHOUT RECOURSE AS TO CREDIT RISK

The Company has an agreement with a commercial finance company which
provides for the factoring of trade accounts receivable. The factoring charge
amounts to 0.55% of the receivables assigned. Factor charges for the years
ended December 31, 1996 and 1997 were approximately $643 and $735,
respectively. The commercial finance company also guarantees the Company's
letters of credit and issues letters of guarantee to company suppliers. The
commercial finance company has a first lien on all of the Company's tangible
assets as collateral for all of its obligations under the financing agreement.
Advances and loans under the agreement bear interest at 1% above the prime
rate.

The aggregate amounts of such guarantees and advances are limited by formula
based upon the uncollected balance of 85% of eligible factored receivables,
and 50% of eligible inventory collateral, plus 50% of letters of credit
outstanding, and 25% of open letters of credit and any overadvance amount
permitted by the lender. At December 31, 1996 and 1997, the maximum amount of
guarantees and advances permitted by such formula was approximately $30,534
and $34,723, respectively.

Accounts receivable are factored without recourse as to credit risk but with
recourse for any claims by the customer for adjustments in the normal course
of business relating to price errors, shortages, etc. The uncollected balance
of receivables held by the commercial finance company amounted to
approximately $16,925 and $24,232 at December 31, 1996 and 1997, respectively.

NOTE D--OTHER CURRENT ASSETS

Included in other current assets is the following:

<TABLE>
<CAPTION>
DECEMBER 31,
-------------
1996 1997
------ ------
<S> <C> <C>
Advances to suppliers and others.............................. $1,488 $ 638
Prepaid and refundable income taxes........................... 304 43
Prepaid expenses and other.................................... 753 418
Deferred income taxes......................................... 151 40
------ ------
$2,696 $1,139
====== ======
</TABLE>

NOTE E--FIXED ASSETS

Fixed assets are recorded at cost and consist of the following:

<TABLE>
<CAPTION>
DECEMBER 31,
-------------
1996 1997
------ ------
<S> <C> <C>
Furniture and fixtures........................................ $ 869 $ 893
Equipment..................................................... 602 657
Leasehold improvements........................................ 1,157 1,158
------ ------
2,628 2,708
Less accumulated depreciation and amortization................ 896 1,232
------ ------
$1,732 $1,476
====== ======
</TABLE>

F-10
<PAGE>

HAPPY KIDS INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)

DECEMBER 31, 1995, 1996 AND 1997
(IN THOUSANDS, EXCEPT PER SHARE DATA)

NOTE F--DUE TO BANK

The Company has a $42,000 financing agreement with several banks that
expires on December 31, 1998, subject to annual renewals (adjusted seasonally
to $47,000 for the period January 1, 1998 through April 30, 1998). The first
$5,000 of borrowings under this line of credit bears interest at the prime
rate plus 4% (12.5% at December 31, 1997). The remaining borrowings bear
interest at the prime rate plus 1% (9.5% at December 31, 1997). Borrowings are
collateralized by substantially all of the assets of the Company. In addition,
the shareholders have personally guaranteed the debt. At December 31, 1996 and
1997, the Company has borrowed $19,732 and $24,863, respectively, under this
line. The agreement provides for various restrictive financial covenants,
including the requirement to maintain minimum tangible net worth and working
capital levels.

NOTE G--ACCOUNTS PAYABLE AND ACCRUED LIABILITIES

Accounts payable and accrued liabilities consist of the following:

<TABLE>
<CAPTION>
DECEMBER 31,
--------------
1996 1997
------ -------
<S> <C> <C>
Accounts payable.............................................. $5,280 $ 9,468
Accrued liabilities........................................... 895 1,579
Income taxes payable.......................................... 83 346
------ -------
$6,258 $11,393
====== =======
</TABLE>

NOTE H--TRANSACTIONS WITH SHAREHOLDERS

Notes payable to shareholder consist of:

<TABLE>
<CAPTION>
DECEMBER 31,
-------------
1996 1997
------ ------
<S> <C> <C>
7% loan payable................................................ $ 160 --
7% due to shareholder.......................................... 1,400 $1,400
------ ------
$1,560 $1,400
====== ======
</TABLE>

Interest expense on these notes for the years ended December 31, 1995, 1996
and 1997 was approximately $95, $107 and $98, respectively. Interest totalling
$65 and $78 for the years ended December 31, 1995 and 1996, respectively, was
waived and recorded as additional paid-in capital.

The three principal shareholders have entered into a shareholders' agreement
dated January 1, 1998. Such agreement provides tag--along rights to each of
the parties thereto in the event that any of the other parties elect to sell
their common stock under certain circumstances. In addition, each party is
granted a right of first refusal to purchase any shares of common stock
offered for sale by any other party to the agreement.

For the years ended December 31, 1995, 1996 and 1997, the Company
contributed $143, $127 and $180, respectively, to a charitable foundation
managed by an executive of the Company.

F-11
<PAGE>

HAPPY KIDS INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)

DECEMBER 31, 1995, 1996 AND 1997
(IN THOUSANDS, EXCEPT PER SHARE DATA)

NOTE I--COMMITMENTS

The Company leases showroom, office and warehouse facilities through May 31,
2006 at the following minimum annual rentals:

<TABLE>
<CAPTION>
YEAR ENDING DECEMBER 31, AMOUNT
------------------------ ------
<S> <C>
1998.................................. $1,013
1999.................................. 1,004
2000.................................. 766
2001.................................. 670
2002.................................. 670
Thereafter............................ 2,289
------
$6,412
======
</TABLE>

Rent expense for the years ended December 31, 1995, 1996 and 1997 was
approximately $1,385, $978 and $976, respectively.

At December 31, 1997, the Company is contingently liable under open letters
of credit in the amount of approximately $15,875.

The Company has entered into royalty agreements that provide for royalty
payments from 6% to 12% of net sales of licensed products. The Company
incurred royalty expense (included in cost of goods sold) of approximately
$2,339, $3,685 and $4,113 for the years ended December 31, 1995, 1996 and
1997, respectively. Based on minimum sales requirements, future minimum
royalty payments required under these agreements are:

<TABLE>
<CAPTION>
YEAR ENDING DECEMBER 31, AMOUNT
------------------------ ------
<S> <C>
1998.................................. $2,429
1999.................................. 2,555
2000.................................. 1,788
2001.................................. 1,535
2002.................................. 218
Thereafter............................ 73
------
$8,598
======
</TABLE>

NOTE J--CAPITAL LEASE OBLIGATIONS

Included in fixed assets, as of December 31, 1997, is approximately $215
relating to amounts capitalized under certain equipment leases. Accumulated
depreciation under capital leases, at December 31, 1997, was approximately
$112. The present values of minimum future obligations have been calculated
based on interest rates at the inception of the lease. The following schedule
sets forth the future minimum lease payments under capital leases at December
31, 1997:

<TABLE>
<CAPTION>
YEAR ENDING DECEMBER 31,
------------------------
<S> <C>
1998.................................................................. $54
1999.................................................................. 21
---
Net minimum lease payments............................................ 75
Less amount representing interest..................................... (7)
---
Present value of minimum lease obligations............................ $68
===
</TABLE>

F-12
<PAGE>

HAPPY KIDS INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)

DECEMBER 31, 1995, 1996 AND 1997
(IN THOUSANDS, EXCEPT PER SHARE DATA)

NOTE K--EMPLOYEE BENEFIT PLAN

The Company has established a 401(k) Profit Sharing Plan covering
substantially all eligible employees. The plan allows employees to defer a
percentage of their annual earnings subject to limitation of Section 401(m) of
the Internal Revenue Code.

The plan provides that the Company can make discretionary contributions.
These contributions are allocated to the participant based on the
participant's compensation in proportion to the compensation of all
participants. The Company's contribution to the plan for the years ended
December 31, 1995, 1996 and 1997 was approximately $27, $31 and $34,
respectively.

NOTE L--CONCENTRATIONS

During the years ended December 31, 1995, 1996 and 1997, approximately 41%,
40% and 41%, respectively, of total purchases of the Company were made from
companies located in one overseas country. In addition, for the years ended
December 31, 1995, 1996 and 1997, 35%, 37%, and 31%, respectively, of total
purchases of the Company were made from companies located in a second overseas
country. In addition, the Company relied on two manufacturers for 10% and 18%,
11% and 23%, and 11% and 13%, of the Company's production for the years ended
December 31, 1995 and 1996 and 1997, respectively. The Company's import
operations are subject to constraints imposed by bilateral textile agreements
between the United States and a number of foreign countries. These agreements
impose quotas on the amount and types of goods which can be imported into the
United States from these countries. The Company's operations may be adversely
affected by political instability, resulting in the disruption of trade from
foreign countries in which the Company's contractors and suppliers are
located, the imposition of additional regulations relating to imports or
duties, taxes, quotas and other charges on imports. The Company is unable to
predict whether any additional regulations, duties, taxes, quotas or other
charges may be imposed on the importation of its products. The assessment of
any of these items could result in increases in the cost of such imports and
affect sales and profitability. In addition, the failure of manufacturers to
ship some or all of the Company's orders on time could impact the Company's
ability to deliver products to its customers. The Company does not have long-
term contracts with any of its contract manufacturers. The Company believes
that alternate sources of manufacturing are available if the need were to
arise, although any substantial delay in locating, or inability to locate,
acceptable alternate sources of manufacturing could have a material adverse
effect on the Company's business, financial condition and results of
operations.

The Company's sales are made principally to department stores, mid-tier
distributors and mass market retailers of children's apparel. Sales to
customers that represent more than 10% of the Company's net sales are as
follows:

<TABLE>
<S> <C>
Year ended December 30, 1997................................ 17%, 14% and 11%
Year ended December 30, 1996................................ 22% and 13%
Year ended December 30, 1995................................ 18%, 13% and 10%
</TABLE>

The Company estimates an allowance for doubtful accounts based on the
creditworthiness of their customers as well as general economic conditions.
Consequently, an adverse change in those conditions could affect the Company's
estimate.

F-13
<PAGE>

HAPPY KIDS INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)

DECEMBER 31, 1995, 1996 AND 1997
(IN THOUSANDS, EXCEPT PER SHARE DATA)

NOTE M--INCOME TAXES

The components of income tax expense (benefit) are summarized as follows:

<TABLE>
<CAPTION>
YEAR ENDED
DECEMBER 31,
-----------------
1995 1996 1997
----- ---- ----
<S> <C> <C> <C>
Current
Federal................................................. $(686) $ 17 $347
State and city.......................................... 59 109 (38)
----- ---- ----
(627) 126 309
Deferred.................................................. (130) (7) 164
----- ---- ----
$(757) $119 $473
===== ==== ====
</TABLE>

Income tax expense does not include income taxes for those subsidiaries
which are S Corporations or LLC's. Reference is made to Note A-5.

The tax effect of temporary differences which gave rise to deferred tax
assets and liabilities are as follows:

<TABLE>
<CAPTION>
DECEMBER 31,
--------------
1995 1996 1997
---- ---- ----
<S> <C> <C> <C>
Provision for doubtful accounts.............................. $ 34 $ 72 $ 33
Accrued expenses............................................. 330 327 280
Depreciation................................................. 28 57 (1)
Costs capitalized to inventory............................... 81 36 16
Other........................................................ 13 -- --
---- ---- ----
Net deferred tax asset....................................... $486 $492 $328
==== ==== ====
</TABLE>

During the year ended December 31, 1996, the Internal Revenue Service
("IRS") completed an examination of the tax returns of Happy Kids, Ltd. for
the years ended December 31, 1991, 1992 and 1993. As a result of the
examination, Happy Kids, Ltd. recorded an additional $235 in Federal and state
income taxes and $55 in penalties and interest.

NOTE N--SHAREHOLDERS' EQUITY

1. Stock Option Plan

In December 1997, the Company approved a Stock Option Plan (the "Plan") to
officers, directors and key employees of the Company. Stock options granted
pursuant to the plan shall be authorized by the Board of Directors. The
aggregate number of shares which may be issued under the Plan shall not exceed
800 shares of common stock. As of January 1, 1998, the Company has not granted
any stock options or stock purchase rights to any person. The Company intends
to adopt only the disclosure provisions of SFAS No. 123, "Accounting for
Stock-Based Compensation."

2. Stock Split

As of December 31, 1997, the Company effected a 34,875-for-1 stock split of
the Company's outstanding common stock. A total of 7,750 shares of common
stock will be issued and outstanding

F-14
<PAGE>

HAPPY KIDS INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)

DECEMBER 31, 1995, 1996 AND 1997
(IN THOUSANDS, EXCEPT PER SHARE DATA)

after the split. All share and per share amounts have been restated to
retroactively reflect the stock splits.

NOTE O--SUBSEQUENT EVENTS

1. Initial Public Offering

The Company intends to offer 2,000 shares of common stock to the general
public through an initial public offering (the "Offering"). Effective upon
consummation of the Offering, the common stock of the Company will consist of
30,000 shares of common stock, authorized, par value $.01 per share, of which
9,750 will be issued and outstanding.

At December 31, 1997, included in other assets is approximately $162 of
deferred registration costs incurred in connection with the Offering of the
Company's common stock. These costs will be charged against paid-in capital
upon successful completion of the Offering. If the Offering is unsuccessful,
such costs will be charged to expense.

2. Employment Agreement

Effective January 1, 1998, the Company entered into employment agreements
with its executive officers for initial terms expiring in two years at initial
aggregate annual base salaries of $1,250.

NOTE P--PRO FORMA INFORMATION (UNAUDITED)

1. Pro Forma Balance Sheet

The pro forma balance sheet at December 31, 1997 has been adjusted for the
pro forma effects of: (1) additional deferred tax assets of $609 as a result
of termination of the S Corporation status which will be credited to
operations in the period in which the termination occurs and (2) the recording
of a four-year 5.7%, $5,554 note payable to the shareholders, of which $2,000
will be paid from the proceeds of the Offering, relating to undistributed
equity resulting from the termination of the S Corporation or LLC Status. The
notes will provide for the timely distribution of amounts necessary to pay
personal income taxes of the shareholders or members due on amounts earned by
the S Corporation or LLCs for the period January 1, 1998 through the
termination of the S Corporation or LLC status. The existing due to
shareholders of $1,400 (see Note H) will become subject to the same terms as
the above promissory notes.

2. Pro Forma Results of Operations and Pro Forma Income Taxes

Pro forma adjustments in the statements of operations for the year ended
December 31, 1997 reflect a provision 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 A-5, the Company has elected for certain of its
affiliates to be taxed as an S Corporation or to be treated as a partnership
pursuant to the Internal Revenue Code. In connection with the Offering hereby,
the Company will terminate its S and Partnership elections and become 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
income taxes.

F-15
<PAGE>

HAPPY KIDS INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)

DECEMBER 31, 1995, 1996 AND 1997
(IN THOUSANDS, EXCEPT PER SHARE DATA)

The pro forma provision (benefit) for income taxes, after giving effect to
the Federal statutory rate of 34% and an approximate state tax provision of 8%
after reflecting the Federal tax benefit, consists of the following:

<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
------------------------
1995 1996 1997
------- ---------------
<S> <C> <C> <C>
Federal.............................................. $ (668) $ 661 $ 1,481
State................................................ (268) 329 480
------- ------ --------
$ (936) $ 990 $ 1,961
======= ====== ========
</TABLE>

The differences between pro forma tax expense (benefit) shown in the
statements of operations and the pro forma computed income tax expense based
on the Federal statutory corporate rate are as follows:

<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
--------------------------
1995 1996 1997
------- ------- --------
<S> <C> <C> <C>
Computed income taxes based on Federal statutory
rate of 34%...................................... $ (816) $ 845 $ 1,586
State income taxes, net of Federal benefit........ (177) 217 317
Benefit of Utilization of Net Operating Loss...... -- (160) --
Interest waived on debt........................... 25 33 --
Officer's life insurance.......................... 18 40 32
Other............................................. 14 15 26
------- ------- --------
$ (936) $ 990 $ 1,961
======= ======= ========
</TABLE>

3. 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. The shares outstanding for the period
give retroactive effect to the reorganization and recapitalization of the
Company as well as 555 shares deemed to be outstanding, which represent the
approximate number of shares deemed to be sold by the Company (at an assumed
initial public offering price of $10.00 per share) to fund the portion of the
$5,554 pro forma distribution during the year ending December 31, 1997.

4. 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 year ended December 31, 1997 are $4,147 and $0.42, respectively. The
supplemental pro forma net income and net income per share reflect the
issuance of shares necessary to retire $15,800 of amounts due to bank and the
resulting increase in net income in the amounts of $1,441 for the year ended
December 31, 1997, respectively, as of the beginning of 1997 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 2,000 estimated shares at $10.00 per share that would
be issued by the Company to retire these obligations.

Weighted average common shares of 9,885 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 $15,800 of the outstanding debt
and $5,554 of notes payable, of which $2,000 will be repaid to shareholders
from the proceeds of the offering. (See Note P-3.)

F-16
<PAGE>

HAPPY KIDS INC. AND SUBSIDIARIES

SCHEDULE II--VALUATION AND QUALIFYING ACCOUNTS
(IN THOUSANDS)

<TABLE>
<CAPTION>
COLUMN A COLUMN B COLUMN C COLUMN D COLUMN E
-------- ---------- --------------------- -------------- ----------
ADDITIONS
----------------------------------------------------------
(1) (2)
BALANCE AT CHARGED TO CHARGED TO BALANCE AT
BEGINNING COSTS AND OTHER END OF
DESCRIPTION OF PERIOD EXPENSES ACCOUNTS DEDUCTIONS (A) PERIOD
----------- ---------- ---------- ---------- -------------- ----------
<S> <C> <C> <C> <C> <C>
Year ended December 31,
1995
Deducted from asset
accounts
Allowance for
doubtful accounts... $162 $90 $ 22 -- $274
Year ended December 31,
1996
Deducted from asset
accounts
Allowance for
doubtful accounts... $274 $13 $199 -- $486
Year ended December 31,
1997
Deducted from asset
accounts
Allowance for
doubtful accounts
and other
receivables......... $486 $31 $323 -- $840
</TABLE>
- --------
(a) Accounts written off as uncollectible.

F-17
<PAGE>

[The inside back cover contains a picture of a child dressed in certain of
the Company's apparel products and a bubble expression containing logos
relating to the Company's licensing or private label relationships with each
of: B.U.M. Equipment, AND I, Sesame Street for KMart, Nickelodeon's Rugrats,
ACA Joe (with new for 1998 sticker), New Legends for Kids R Us, Warner
Brothers Scooby Doo (with new for 1998 sticker), Nickelodeon (with new for
1998 sticker), Ocean Pacific, Lullaby Club for Target, Canyon River Blues for
Sears and E.N.U.F. Internationale (with new for 1998 sticker). Below the child
is the language "New for 1998 indicates that initial sales of such products
are expected to occur subsequent to December 31, 1997."]
<PAGE>

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

NO DEALER, SALESPERSON OR OTHER PERSON HAS BEEN AUTHORIZED TO GIVE ANY INFOR-
MATION OR TO MAKE ANY REPRESENTATIONS OTHER THAN THOSE CONTAINED IN THIS PRO-
SPECTUS, AND, IF GIVEN OR MADE, SUCH INFORMATION OR REPRESENTATIONS MUST NOT
BE RELIED UPON AS HAVING BEEN AUTHORIZED BY THE COMPANY OR THE UNDERWRITERS.
THIS PROSPECTUS DOES NOT CONSTITUTE AN OFFER TO SELL OR A SOLICITATION OF AN
OFFER TO BUY ANY SECURITIES OTHER THAN THE COMMON STOCK TO WHICH IT RELATES OR
AN OFFER IN ANY JURISDICTION TO ANY PERSON TO WHOM IT IS UNLAWFUL TO MAKE SUCH
OFFER IN SUCH JURISDICTION. NEITHER THE DELIVERY OF THIS PROSPECTUS NOR ANY
SALE MADE HEREUNDER SHALL, UNDER ANY CIRCUMSTANCES, CREATE ANY IMPLICATION
THAT THE INFORMATION CONTAINED HEREIN IS CORRECT AS OF ANY TIME SUBSEQUENT TO
THE DATE HEREOF OR THAT THERE HAS BEEN NO CHANGE IN THE AFFAIRS OF THE COMPANY
SINCE SUCH DATE.

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

TABLE OF CONTENTS

<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Prospectus Summary....................................................... 3
Risk Factors............................................................. 7
The Company.............................................................. 14
Use of Proceeds.......................................................... 14
Dividend Policy.......................................................... 15
Dilution................................................................. 16
Capitalization........................................................... 17
Selected Consolidated Financial Data..................................... 18
Management's Discussion and Analysis of Financial Condition and Results
of Operations........................................................... 20
Business................................................................. 26
Management............................................................... 34
Certain Transactions..................................................... 38
Principal Shareholders................................................... 39
Description of Capital Stock............................................. 40
Shares Eligible for Future Sale.......................................... 42
Underwriting............................................................. 43
Legal Matters............................................................ 44
Experts.................................................................. 44
Additional Information................................................... 45
Index to Consolidated Financial Statements............................... F-1
</TABLE>

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

UNTIL , 1998 (25 DAYS AFTER THE COMMENCEMENT OF THE OFFERING), ALL DEALERS
EFFECTING TRANSACTIONS IN THE REGISTERED SECURITIES, WHETHER OR NOT PARTICI-
PATING IN THIS DISTRIBUTION, MAY BE REQUIRED TO DELIVER A PROSPECTUS. THIS IS
IN ADDITION TO THE OBLIGATION OF DEALERS TO DELIVER A PROSPECTUS WHEN ACTING
AS UNDERWRITERS AND WITH RESPECT TO THEIR UNSOLD ALLOTMENTS OR SUBSCRIPTIONS.

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

2,000,000 SHARES

LOGO HAPPY KIDS

COMMON STOCK

-------------
PROSPECTUS
-------------

LADENBURG THALMANN & CO. INC.

CRUTTENDEN ROTH
INCORPORATED

, 1998

- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
<PAGE>

PART II

ITEM 13. OTHER EXPENSES OF ISSUANCE AND DISTRIBUTION.

The following table sets forth an itemized estimate of fees and expenses
payable by the Company in connection with the Offering described in this
Registration Statement, other than underwriting discounts and commissions:

<TABLE>
<S> <C>
SEC registration fee............................................ $ 7,463.50
NASD filing fee................................................. 3,030.00
Nasdaq/NNM listing fee.......................................... 75,625.00
Counsel fees and expenses....................................... 180,000.00
Accounting fees and expenses.................................... 150,000.00
Financial consulting fee........................................ 200,000.00
Blue sky fees and expenses...................................... 10,000.00
Printing expenses............................................... 150,000.00
Transfer agent and registrar fees............................... 3,500.00
Miscellaneous................................................... 20,381.50
-----------
Total......................................................... $800,000.00
===========
</TABLE>
- --------
All of the above expenses will be paid by the Company.

ITEM 14. INDEMNIFICATION OF DIRECTORS AND OFFICERS.

Article XI of the Company's By-laws specifies that the Company shall
indemnify its directors and officers because he or she was or is a director or
officer of the Company or was or is serving at the request of the Company as a
director or officer of another entity to the full extent that such right of
indemnity is permitted by the laws of the State of New York. This provision of
the By-laws is deemed to be a contract between the Company and each director
and officer who serves in such capacity at any time while such provision and
the relevant provisions of the New York Act are in effect, and any repeal or
modification thereof shall not offset any action, suit or proceeding
theretofore or thereafter brought or threatened based in whole or in part upon
any such state of facts. The affirmative vote of the holders of at least 80%
of the voting power of all outstanding shares of the capital stock of the
Company is required to adopt, amend or repeal such provision of the By-laws.

The Company has executed indemnification agreements with each of its
officers and directors pursuant to which the Company has agreed to indemnify
such parties to the full extent permitted by law, subject to certain
exceptions, if such party becomes subject to an action because such party is a
director, officer, employee, agent or fiduciary of the Company.

Section 402 of the New York Act enables a corporation in its certificate of
incorporation to limit the personal liability of members of its board of
directors for violation of a director's duty to the corporation. This Section
does not, however, limit the liability of a director for failing to act in
good faith, engaging in intentional misconduct or knowingly violating a law,
or from any transaction in which the director derived an improper personal
benefit. This Section also will have no effect on claims arising under the
federal securities laws. The Company's Certificate of Incorporation limits the
liability of its Directors as authorized by Section 402 of the New York Act.
The affirmative vote of the holders of at least 80% of the voting power of all
outstanding shares of the capital stock of the Company is required to amend
such provisions.

The Company intends to obtain liability insurance for the benefit of its
directors and officers which will provide coverage for losses of directors and
officers for liabilities arising out of claims against such

II-1
<PAGE>

persons acting as directors or officers of the Company (or any subsidiary
thereof) due to any breach of duty, neglect, error, misstatement, misleading
statement, omission or act done by such directors and officers, except as
prohibited by law.

At present, there is no pending litigation or proceeding involving a
director or officer of the Company as to which indemnification is being sought
nor is the Company aware of any threatened litigation that may result in
claims for indemnification by any director or officer.

Reference is made to Section 6 of the underwriting agreement, the proposed
form of which is filed as Exhibit One, in which the underwriters agree to
indemnify the directors and officers of the Company and certain other persons,
against certain civil liabilities, including certain liabilities under the
Act.

ITEM 15. RECENT SALES OF UNREGISTERED SECURITIES.

The Company does not expect to employ an underwriter in connection with the
issuance and sale of the securities described above. The Company claims that
the issuance and sale of the foregoing securities will be exempt from
registration under the Act pursuant to Section 4(2) thereof, no public
Offering having been involved and securities having been acquired for
investment and not with a view to distribution. Appropriate legends will be
affixed to the stock certificates issued in such transactions. All recipients
had adequate access to information about the Company.

ITEM 16. EXHIBITS AND FINANCIAL STATEMENTS.

(a) Exhibits

<TABLE>
<CAPTION>
EXHIBIT NO. DESCRIPTION OF EXHIBIT
----------- ----------------------
<C> <S>
1 Form of Underwriting Agreement.
3.1 Restated Certificate of Incorporation.
3.2 Amended and Restated Bylaws.
4.1 Voting Agreement, dated January 1, 1998, by and between Jack Benun
and Mark Benun.
4.2 Shareholder Agreement, dated January 1, 1998, by and among Jack
Benun, Mark Benun and Isaac Levy.
5 Opinion of Buchanan Ingersoll as to validity of Common Stock.
10.1 1997 Stock Plan.
10.2 Form of Indemnification Agreement executed by each of the Company's
directors and officers.
10.3 Lease Agreement, by and between J & B 18 Corp. and SZS 33 Associates
L.P., as amended.
10.4 Lease Agreement, by and between Hawk Industries, Inc. and Triangle
Fidelco Industrial Center, as amended.
</TABLE>

II-2
<PAGE>

<TABLE>
<CAPTION>
EXHIBIT NO. DESCRIPTION OF EXHIBIT
----------- ----------------------
<C> <S>
10.5 Financing Agreement with the CIT Group/Commercial Services, Inc.,
as Agent for itself and certain other lenders, as amended.
10.6 Notification Factoring Agreement.
10.7 Employment Agreement, by and between the Company and Jack Benun.
10.8 Employment Agreement, by and between the Company and Mark Benun.
10.9 Employment Agreement, by and between the Company and Isaac Levy.
10.10 Employment Agreement, by and between the Company and Stuart
Bender.
10.11 Form of Employee-At-Will, Non-solicitation, Invention Assignment
and Non-Disclosure Agreement.
10.12 Securities Purchase Agreement, dated as of January 1, 1998, by and
among, the Company and Jack M. Benun and Mark J. Benun.
10.13+ License Agreement by and between the Company and MTV Networks,
dated June 15, 1996, as amended.
10.14.1+ License Agreement by and between the Company and B.U.M. Equipment,
dated June 1, 1995, as amended.
10.14.2+ License Agreement by and between the Company and B.U.M. Equipment,
dated October 1, 1997, as amended.
10.15+ License Agreement by and between the Company and Ocean Pacific
Apparel Corp., dated October 1997.
21 Subsidiaries of the Registrant.
23.1* Consent of Grant Thornton LLP.
23.2 Consent of Buchanan Ingersoll (contained in the opinion filed as
Exhibit 5 to the Registration Statement).
23.3 Consent of The NPD Group.
23.4 Consent of Children's Business.
23.5* Consent of Marvin Azrak.
23.6* Consent of Stephen Kahn.
24 Powers of Attorney of certain officers and directors of the
Company (contained on the signature page of this Registration
Statement).
27 Financial Data Schedule.
</TABLE>
- --------
* Filed herewith. All other exhibits previously filed.
+ Confidential treatment has been requested for a portion of this Exhibit.

(b) Financial Statement Schedules

Schedule II--Valuation and Qualifying Accounts filed herewith. All other
financial statement schedules are omitted because the information is not
required, or is otherwise included in the consolidated financial statements or
the notes thereto.

ITEM 17. UNDERTAKINGS.

The undersigned registrant hereby undertakes that:

(1) Insofar as indemnification for liabilities arising under the Act may
be permitted to directors, officers, and controlling persons of the
registrant pursuant to the provisions described in Item 14, or otherwise,
the registrant has been advised that in the opinion of the Securities and
Exchange Commission such indemnification is against public policy as
expressed in the Act and is, therefore, unenforceable. In the event that a
claim for indemnification against such liabilities (other than the

II-3
<PAGE>

payment by the registrant of expenses incurred or paid by a director,
officer or controlling person of the registrant in the successful defense
of any action, suit or proceeding) is asserted by such director, officer or
controlling person in connection with the securities being registered, the
registrant will, unless in the opinion of its counsel the matter has been
settled by controlling precedent, submit to a court of appropriate
jurisdiction the question whether such indemnification by it is against
public policy as expressed in the Act and will be governed by the final
adjudication of such issue.

(2) For purpose of determining any liability under the Act, the
information omitted from the form of prospectus filed as part of this
registration statement in reliance upon Rule 430A and contained in a form
of prospectus filed by the registrant pursuant to Rule 424(b)(1) or (4) or
497(h) under the Act shall be deemed to be part of this registration
statement as of the time it was declared effective.

(3) For the purpose of determining any liability under the Act each post-
effective amendment that contains a form of prospectus shall be deemed to
be a new registration statement relating to the securities offered therein,
and the Offering of such securities at that time shall be deemed to be the
initial bona fide Offering thereof.

(4) At the closing specified in the underwriting agreement, registrant
shall provide the Underwriters certificates in such denominations and
registered in such names as required by the Underwriters to permit prompt
delivery to each purchaser.

II-4
<PAGE>

SIGNATURES

PURSUANT TO THE REQUIREMENTS OF THE SECURITIES ACT OF 1933, THE REGISTRANT
HAS DULY CAUSED THIS AMENDMENT TO THE REGISTRATION STATEMENT TO BE SIGNED ON
ITS BEHALF BY THE UNDERSIGNED, THEREUNTO DULY AUTHORIZED, IN THE CITY OF NEW
YORK, STATE OF NEW YORK, ON MARCH 5, 1998.

Happy Kids Inc.

/s/ Jack M. Benun
By: _________________________________
Jack M. Benun, President and Chief
Executive Officer

PURSUANT TO THE REQUIREMENTS OF THE SECURITIES ACT OF 1933, THIS AMENDMENT
TO THE REGISTRATION STATEMENT HAS BEEN SIGNED BY THE FOLLOWING PERSONS IN THE
CAPACITIES AND ON THE DATES INDICATED.

SIGNATURES TITLE DATE

/s/ Jack M. Benun President and Chief
- ------------------------------------- Executive Officer March 5, 1998
JACK M. BENUN and Director
(Principal
Executive Officer)

/s/ Stuart Bender Chief Financial
- ------------------------------------- Officer and March 5, 1998
STUART BENDER Treasurer
(Principal
Financial and
Accounting Officer)

* Executive Vice
- ------------------------------------- President, March 5, 1998
MARK J. BENUN Secretary and
Director

* Senior Vice
- ------------------------------------- President and March 5, 1998
ISAAC LEVY Director

* By his signature set forth below the undersigned, pursuant to duly
authorized powers of attorney filed with the Securities and Exchange
Commission, has signed this Amendment to the Registration Statement on behalf
of the persons indicated.

/s/ Jack M. Benun
By: _________________________________
Jack M. Benun
(ATTORNEY-IN-FACT)

II-5
<PAGE>

EXHIBIT INDEX

<TABLE>
<CAPTION>
EXHIBIT
NO. DESCRIPTION OF EXHIBIT
------- ----------------------
<C> <S>
1 Form of Underwriting Agreement.
3.1 Restated Certificate of Incorporation.
3.2 Amended and Restated Bylaws.
4.1 Voting Agreement, dated January 1, 1998, by and between Jack Benun
and Mark Benun.
4.2 Shareholder Agreement, dated January 1, 1998, by and among Jack
Benun, Mark Benun and Isaac Levy.
5 Opinion of Buchanan Ingersoll as to validity of Common Stock.
10.1 1997 Stock Plan.
10.2 Form of Indemnification Agreement executed by each of the Company's
directors and officers.
10.3 Lease Agreement, by and between J & B 18 Corp. and SZS 33 Associates
L.P., as amended.
10.4 Lease Agreement, by and between Hawk Industries, Inc. and Triangle
Fidelco Industrial Center, as amended.
10.5 Financing Agreement with the CIT Group/Commercial Services, Inc., as
Agent for itself and certain other lenders, as amended.
10.6 Notification Factoring Agreement.
10.7 Employment Agreement, by and between the Company and Jack Benun.
10.8 Employment Agreement, by and between the Company and Mark Benun.
10.9 Employment Agreement, by and between the Company and Isaac Levy.
10.10 Employment Agreement, by and between the Company and Stuart Bender.
10.11 Form of Employee-At-Will, Non-solicitation, Invention Assignment and
Non-Disclosure Agreement.
10.12 Securities Purchase Agreement, dated as of January 1, 1998, by and
among, the Company and Jack M. Benun and Mark J. Benun.
10.13+ License Agreement by and between the Company and MTV Networks, dated
June 15, 1996, as amended.
10.14.1+ License Agreement by and between the Company and B.U.M. Equipment,
dated June 1, 1995, as amended.
10.14.2+ License Agreement by and between the Company and B.U.M. Equipment,
dated October 1, 1997, as amended.
10.15+ License Agreement by and between the Company and Ocean Pacific
Apparel Corp., dated October 1997.
21 Subsidiaries of the Registrant.
23.1* Consent of Grant Thornton LLP.
23.2 Consent of Buchanan Ingersoll (contained in the opinion filed as
Exhibit 5 to the Registration Statement).
23.3 Consent of The NPD Group.
23.4 Consent of Children's Business.
23.5* Consent of Marvin Azrak.
23.6* Consent of Stephen Kahn.
24 Powers of Attorney of certain officers and directors of the Company
(contained on the signature page of this Registration Statement).
27 Financial Data Schedule.
</TABLE>
- --------
* Filed herewith. All other exhibits previously filed.
+ Confidential treatment has been requested for a portion of this Exhibit.

<PAGE>

EXHIBIT 23.1

CONSENT OF INDEPENDENT CERTIFIED
PUBLIC ACCOUNTANTS

We have issued our report dated January 29, 1998, accompanying the consolidated
financial statements and schedules of Happy Kids Inc. and Subsidiaries contained
in the Registration Statement and Prospectus which will be signed upon
consummation of the transactions described in Note A to the consolidated
financial statements. We consent to the use of the aforementioned reports in
the Registration Statement and Prospectus, and to the use of our name as it
appears under the caption "Experts."

GRANT THORNTON LLP

/s/ Grant Thornton LLP

New York, New York
March 5, 1998

<PAGE>
Exhibit 23.5

Consent of Marvin Azrak

The undersigned hereby consents to the reference to his name and the use
of the information with respect to the undersigned in the Prospectus
constituting part of the Registration Statement.

Dated: March 5, 1998 /s/ Marvin Azrak
---------------------------
Marvin Azrak

<PAGE>

Exhibit 23.6

Consent of Stephen Kahn

The undersigned hereby consents to the reference to his name and the use
of the information with respect to the undersigned in the Prospectus
constituting part of the Registration Statement.

Dated: March 5, 1998 /s/ Stephen Kahn
------------------------
Stephen Kahn