In Los Angeles, humans co-exist with puppets, who are treated as a marginalized group. Phil Phillips (Bill Barretta) is a former cop who is now a private investigator. He goes to his office where his secretary Bubbles (Maya Rudolph) tells him he has a visitor. A female puppet named Sandra White (Dorien Davies) has come to ask Phil for help regarding someone who may be threatening her and has sent her a note. He notices that one of the letters cut to make the message looks familiar, so he decides to get on the case.
Phil goes to a puppet porn shop to find a weird sex scene being filmed involving an octopus milking a cow. He asks the shop owner about the magazine they sell there, which has a font style matching the letters on the note. As Phil goes in the back to check the records, he runs into a familiar puppet named Mr. Bumblypants (Kevin Clash), who is trying to hide his porn addiction. When Phil is gone, a tall hooded person walks into the shop with a shotgun. He aims at Bumblypants until the owner pulls out his own gun in defense, but the gunman shoots the owner before blowing the heads off the octopus and cow, and then proceeds to kill Bumblypants.
The authorities arrive on the scene after Phil discovers the dead puppets. He is dismayed to find his former partner, Detective Connie Edwards (Melissa McCarthy), is there, as the two had a falling out after Phil was kicked off the force. Edwards thinks it was a robbery gone wrong, but Phil notes that it was just murder because the assailant didn't take anything.
Phil later has lunch with his brother Larry (Victor Yerrid), a former actor who starred in the children's program "The Happytime Gang", along with Mr. Bumblypants. Since the show ended, Larry has tried to look less like a puppet by getting a nose job and bleaching his skin. A fan approaches Larry and asks him to say his famous catchphrase ("You're under arrest for being too hot to handle!), which bugs Phil.
Later that night, Larry is in a hot tub with a human woman while watching the show. She leaves to make drinks, and the killer from before sneaks behind the house and sets three dogs loose to grab Larry and tear him to pieces. Police arrive in the morning to the crime scene where Phil makes the horrifying discovery. After Edwards arrives, he tells Lt. Banning (Leslie David Baker) that he thinks Larry's death is connected with the porn shop murders because he feels Bumblypants was the intended victim, so the killer may be targeting members of "The Happytime Gang".
Phil and Edwards reluctantly team up to investigate. They suspect that because the cast of "Happytime Gang" was expected to cement a new deal in which they would split a large amount of money between each other, someone may have wanted to kill them off to get the money to themselves. Phil and Edwards visit Ronovan Scargle (Michael McDonald), one of the show's producers. Phil knocks him out and takes a file on his desk to look over.
The detectives are led to a seedy part of the city where puppets are addicted to sugar and some of them are prostituting. They find Lyle (also Kevin Clash), another former cast member who is now a drug lord. Since it's a strictly puppets only joint, Phil tells Lyle that Edwards can get in because she has a puppet liver. To test this, Lyle makes Edwards snort rock candy through a twizzler. Phil talks to Lyle outside while Edwards plays poker with the other puppet gangsters. One of them makes a sexist remark toward Edwards, as well as mistreating one of the female puppets in there, so Edwards kicks the stuffing out of the gangsters and makes them apologize. Outside, Lyle is shot to death by the killer, and Phil fails to catch him.
Phil later returns to his office to find Sandra in there again. She tells Phil that the person harassing her has sent her another note, along with a picture of Sandra with Jenny (Elizabeth Banks), the only human member of "The Happytime Gang" and former girlfriend of Phil. The killer threatens to expose something involving Jenny and Sandra. After asking for Phil's help, Sandra seduces him and they have sex in his office as Banning arrives with FBI Agent Campbell (Joel McHale). After Phil blows his silly string load and Sandra leaves, Campbell tries to chew Phil out for his failure in stopping the killer.
Edwards goes to find another old Happytime Gang member, Goofer (Drew Massey), a homeless sugar addict who also propositions Edwards for a 50 cent blowjob. He doesn't give Edwards any leads, but she steals some of the sugar he's snorting, unable to hide her own addiction to the stuff. Goofer is later found dead under a pier after supposedly overdosing and falling over into the ocean.
Phil goes to find Jenny at a freaky puppet strip club where she works. She claims to not know Sandra, but she regrets that it didn't work out between her and Phil. He walks her outside to her car before they part ways, but the car explodes and apparently kills her. The police arrive and see Phil, believing him to be responsible for Jenny's death.
Phil goes to Edwards' apartment, where she is passed out from having too much sugar. He has a flashback to the incident that drove a wedge between them - Edwards was being held at gunpoint by a large puppet thug, and Phil tried to take the shot, but he missed and hit a male puppet, killing him in front of his young daughter. The thug shot Edwards, but she killed him before he got away. The wound to her liver was so severe that Phil had to take her to a puppet hospital to get a puppet liver. Edwards later testified against Phil, and he was thrown off the force. After she wakes up, Phil asks for her help.
The two head to find the two remaining Happytime Gang members, Ezra and Cara, also known as the Kissing Cousins. Phil and Edwards head to their house and find their creepy deformed children before coming across Ezra and Cara's mangled bodies on the bed. The killer gets away, and Campbell shows up with other agents to arrest Phil and Edwards.
Campbell later interrogates Sandra, who lies and says that Phil killed Jenny, her wife, and was trying to keep Sandra for himself. She uncrosses her legs, and Edwards sees that Sandra has purple pubic hair. Banning takes Edwards off the case, and she proceeds to curse out all the other cops in the room for being incompetent.
Bubbles finds Edwards in her apartment to ask for her help in proving Phil's innocence. She has Sandra's home address, and they break into her place to find any info they can. They come across a room with pictures and notes planning the deaths of the Happytime Gang, as well as a whole conspiracy against Phil. Edwards then notices a picture of Jasper Jacoby, the man who Phil accidentally shot, along with his daughter who has purple hair. Edwards then realizes what's going on - Sandra was Jasper's daughter, and she has been planning revenge against Phil for her father's death. Bubbles sees a tape recorder and presses the play button, which ignites a fire that destroys all the evidence against Sandra. Edwards goes to tell Phil what she's learned, and they head to stop Sandra.
Phil and Edwards make it to the airport where Sandra is planning to depart. Phil runs up to her and tries to apologize for killing her father, saying it has haunted him all those years, but he asks why the Happytime Gang had to die because of it. Sandra says she wanted Phil to suffer as payback. It also turns out Jenny is alive and in on the scheme with Sandra, but she instead knocks Jenny out to take the money for herself and get away. Edwards runs after Sandra and tries to get in her plane, but Sandra gets the drop on her first and holds her at gunpoint. She steps outside with Edwards, putting her and Phil in the same position as before. Phil takes his shot and doesn't miss this time, hitting Sandra in the head and killing her. Edwards congratulates him for not missing.
Banning arrives to congratulate Phil and Edwards on cracking the case. He reinstates both of them to their old jobs. Phil also asks Bubbles out on a date, and she accepts Campbell shows up to personally show appreciation to Phil, though Phil can't resist continuing to make fun of him with Edwards' help.
*CUT TO THE CHASE*
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In a world where humans and puppets co-exist, someone is killing off members of an old children's program, "The Happytime Gang". Disgraced former detective Phil Phillips reteams with his former partner Connie Edwards to find the killer after Phil's brother Larry is one of the victims.
The killer is Sandra White, a puppet who wanted revenge against Phil because he accidentally shot her father when she was a child after he tried to save Edwards, and the incident cost him his job. Sandra almost escapes and tries to take Edwards with her, but Phil shoots Sandra in the head.
Phil and Edwards are commended by Lt. Banning and they get their jobs back.
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