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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

For the transition period from                to                  

Commission File Number:  0-18926

JOE’S JEANS INC.

(Exact name of registrant as specified in its charter)

(323) 837-3700

(Registrant’s telephone number, including area code)

NO CHANGE

(Former name, former address and former fiscal year, if changed since last report)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  x Yes  o No

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or such shorter period that the registrant was required to submit and post such files).  o Yes  o No

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company.  See definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

Indicate by check mark whether the registrant is a shell company (as defined by Rule 12b-2 of the Exchange Act).  Yes o  No x

The number of shares of the registrant’s common stock outstanding as of October 15, 2009 was 60,455,256.

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JOE’S JEANS INC.

QUARTERLY REPORT ON FORM 10-Q

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PART I — FINANCIAL INFORMATION

Item 1.                   Financial Statements.

JOE’S JEANS INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

(in thousands)

The accompanying notes are an integral part of these financial statements.

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JOE’S JEANS INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF INCOME

(in thousands, except per share data)

The accompanying notes are an integral part of these financial statements.

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JOE’S JEANS INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)

The accompanying notes are an integral part of these financial statements.

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JOE’S JEANS INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY

(in thousands)

The accompanying notes are an integral part of these financial statements.

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JOE’S JEANS INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

NOTE 1 - BASIS OF PRESENTATION

The unaudited condensed consolidated financial statements of Joe’s Jeans Inc., or Joe’s, which include the accounts of its wholly-owned subsidiaries, for the three and nine months ended August 31, 2009 and 2008 and the related footnote information have been prepared on a basis consistent with Joe’s audited consolidated financial statements as of November 30, 2008 contained in Joe’s Annual Report on Form 10-K, or the Annual Report.

Joe’s principal business activity involves the design, development and worldwide marketing of apparel products.  Joe’s primary current operating subsidiary is Joe’s Jeans Subsidiary Inc., or Joe’s Jeans Subsidiary.  All significant inter-company transactions have been eliminated.  Currently, Joe’s has only one segment of operations, primarily apparel, which includes an immaterial amount of revenue from its retail operations and license agreements.  On October 12, 2007, Joe’s filed an amended and restated certificate of incorporation in Delaware to change its corporate name from Innovo Group Inc. to Joe’s Jeans Inc. and to increase the shares of common stock authorized for issuance to 100,000,000.  Joe’s fiscal year end is November 30.

These unaudited condensed consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X.  Accordingly, they do not include all of the information and footnotes required by U.S. generally accepted accounting principles for complete financial statements.  These unaudited condensed consolidated financial statements should be read in conjunction with the audited consolidated financial statements and the related notes thereto contained in Joe’s Annual Report.  In the opinion of management, the accompanying unaudited financial statements contain all adjustments (consisting of normal recurring adjustments), which management considers necessary to present fairly Joe’s financial position, results of operations and cash flows for the interim periods presented.  The results for the three and nine months ended August 31, 2009 are not necessarily indicative of the results anticipated for the entire year ending November 30, 2009.  The preparation of financial statements in conformity with U.S. generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in the financial statements.  Actual results may differ from those estimates.

NOTE 2 —ADOPTION OF ACCOUNTING PRINCIPLES

On December 4, 2007, the FASB issued SFAS No. 141 (Revised 2007), “Business Combinations,” or SFAS No. 141(R).  New requirements under the revised standard include: (i) the fair value of stock provided as consideration be measured as of the acquisition date instead of the announcement date; (ii) acquisition-related costs be recognized separately from the acquisition, generally as an expense, instead of treated as a part of the cost of the acquisition that was allocated to the assets acquired and the liabilities assumed;  (iii) restructuring costs that the acquirer expected, but was not obligated to incur, be recognized separately from the acquisition instead of recognized as if they were a liability assumed at the acquisition date; (iv) contingent consideration be recognized at the acquisition date, measured at its fair value at that date, instead of recognized when the contingency was resolved and consideration was issued or became issuable; (v) recognizing a gain when the fair value of the identifiable net assets acquired exceeds the fair value of the consideration transferred instead of allocating the “negative goodwill” amount as a pro rata reduction of the amounts that otherwise would have been assigned to particular assets acquired; (vi) research and development assets acquired in a business combination will be recognized at their acquisition-date fair values as assets acquired in a business combination instead of being measured at their acquisition-date fair values and then immediately charged to expense; and (vii) changes in the amount of deferred tax benefits created in a business combination, outside of the valuation period, will be recognized either in income from continuing operations or directly in contributed capital, depending on the circumstances, instead of recognized through a corresponding reduction to goodwill or certain noncurrent assets or an increase in so-called negative goodwill.  SFAS No. 141(R) is effective for Joe’s for transactions consummated during annual periods beginning after December 15, 2008, which is the year beginning December 1, 2009 for Joe’s.  Joe’s does not expect that SFAS No. 141(R) will have any impact on its financial statements unless it enters into an applicable transaction in the future.

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In April 2008, the FASB issued FSP SFAS 142-3, “Determination of the Useful Life of Intangible Assets,” or FSP 142-3.  FSP 142-3 amends the factors that should be considered in developing renewal or extension assumptions used to determine the useful life of a recognized intangible asset under SFAS No. 142, “Goodwill and Other Intangible Assets,” or SFAS 142, in order to improve the consistency between the useful life of a recognized intangible asset under SFAS 142 and the period of expected cash flows used to measure the fair value of the asset under SFAS No. 141(R).  FSP 142-3 is effective for financial statements issued for fiscal years beginning after December 15, 2008, is the year beginning December 1, 2009 for Joe’s, and interim periods within that fiscal year.  The adoption of FSP 142-3 did not have a material impact on the Joe’s financial position or results from operations.

In May 2009, the FASB issued SFAS No. 165, “Subsequent Events,” or SFAS No. 165.  SFAS No. 165 establishes general standards of accounting for and disclosure of events that occur after the balance sheet date but before financial statements are issued or are available to be issued. It requires the disclosure of the date through which an entity has evaluated subsequent events and the basis for selecting that date, that is, whether that date represents the date the financial statements were issued or were available to be issued.  SFAS No. 165 is effective for interim or annual financial periods ending after June 15, 2009.  Joe’s adopted SFAS No. 165 in the third fiscal quarter of 2009 and the related disclosure can be found in “Note 12 — Subsequent Events.”

In June 2009, the FASB issued SFAS No. 168, “The FASB Accounting Standards Codification and the Hierarchy of Generally Accepted Accounting Principles, a replacement of FASB Statement No. 162,” or SFAS No. 168.  SFAS 168 replaces SFAS No. 162, “The Hierarchy of Generally Accepted Accounting Principles,” to establish the FASB Accounting Standards Codification as the source of authoritative accounting principles recognized by the FASB to be applied by nongovernmental entities in preparation of financial statements in conformity with generally accepted accounting principles in the United States.  SFAS No. 168 is effective for interim and annual periods ending after September 15, 2009.  The adoption of SFAS No. 168 will not impact Joe’s financial position or results of operations.

NOTE 3 — ACCOUNTS RECEIVABLE, INVENTORY ADVANCES AND DUE TO FACTOR

Joe’s primary method to obtain the cash necessary for operating needs was through the sale of accounts receivable pursuant to factoring agreements and obtaining advances under inventory security agreements with its factor, CIT Commercial Services, Inc., a unit of CIT Group Inc., or CIT.

As a result of these agreements, amounts due to factor consist of the following (in thousands):

Of the total amount of receivables sold as of August 31, 2009 and November 30, 2008, Joe’s bears the risk of payment of $108,000 and $1,444,000, respectively, in the event of non-payment by its customers.

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CIT Commercial Services

On June 1, 2001, the Joe’s Jeans Subsidiary entered into an accounts receivable factoring agreement and an inventory security agreement with CIT.  In prior years, Joe’s other active subsidiaries also entered into substantially identical agreements.  These agreements give Joe’s the ability to obtain cash by selling to CIT certain of its accounts receivable and to obtain advances for up to 50 percent of the value of certain eligible inventory.  The accounts receivable are sold for up to 85 percent of the face amount on either a recourse or non-recourse basis depending on the creditworthiness of the customer.  CIT currently permits Joe’s to sell its accounts receivable at the maximum level of 85 percent and allows advances of up to $6,000,000 for eligible inventory.  CIT has the ability, in its discretion at any time or from time to time, to adjust or revise any limits on the amount of loans or advances made to Joe’s pursuant to these agreements and to impose surcharges on our rates for certain of our customers.  As further assurance to CIT, cross guarantees were executed by and among Joe’s and all of its subsidiaries to guarantee each subsidiary’s obligations.

As of August 31, 2009, Joe’s cash availability with CIT was approximately $720,000.  This amount fluctuates on a daily basis based upon invoicing and collection related activity by CIT for the receivables sold.  In connection with the agreements with CIT, certain assets are pledged to CIT, including all of the inventory, merchandise and/or goods, including raw materials through finished goods and receivables.  However, the Joe’s trademarks are not encumbered.

The agreements may be terminated by CIT upon 60 days written notice or immediately upon the occurrence of an event of default as defined in the agreement.  The agreements may be terminated by Joe’s upon 60 days written notice prior to June 30, 2010, or earlier provided that the minimum factoring fees have been paid for the respective period.

The factoring rate that Joe’s pays to CIT to factor accounts is 0.6 percent for accounts which CIT bears the credit risk, subject to discretionary surcharges, and 0.4 percent for accounts which Joe’s bears the credit risk.  The interest rate associated with borrowings under the inventory lines and factoring facility is 0.25 percent plus the Chase prime rate.  As of August 31, 2009, the Chase prime rate was 3.25 percent.

In addition, Joe’s has also established a letter of credit facility with CIT to allow it to open letters of credit for a fee of 0.25 percent of the letter of credit face value with international and domestic suppliers, subject to cash availability on our inventory line of credit.  At August 31, 2009, Joe’s did not have any letters of credit outstanding.

NOTE 4 — INVENTORIES

Inventories are valued at the lower of cost or market with cost determined by the first-in, first-out method.  Inventories consisted of the following (in thousands):

Joe’s recorded a charge to its inventory reserve allowance of $28,000 for the three months ended August 31, 2009 and did not record any charges for the three months ended August 31, 2008. For the nine months ended August 31, 2009 and 2008, Joe’s recorded charges of $28,000 and $22,000 to its inventory reserve allowance, respectively.

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NOTE 5 - MERGER TRANSACTION

Merger Agreement

Joe’s, Joe’s Subsidiary, JD Holdings, Inc., or JD Holdings, and Joseph Dahan, the sole stockholder of JD Holdings, entered into an initial definitive Agreement and Plan of Merger on February 6, 2007, and amended it on June 25, 2007, or the Merger Agreement.  JD Holdings primary assets included all rights, title and interest in all intellectual property, including the trademarks related to the Joe’s®, Joe’s Jeans™ and JD brand and marks, or the Joe’s Brand.  JD Holdings was the successor to JD Design, the entity from whom Joe’s licensed the Joe’s Brand.  The license agreement terminated automatically upon completion of the merger.  Joe’s acquired JD Holdings in order to acquire the Joe’s Brand which allowed it to expand its product offerings and the brand in the marketplace, including opening Joe’s retail stores and entering into licenses for additional product categories.  Joe’s believed that the combined company created synergies to allow it to generate additional revenue from the brand recognition established by the denim business and increased market opportunity.  Joe’s also believed that the combined company and complete ownership of the Joe’s Brand enhanced the value of Joe’s from a stockholder and market participant point of view.  Joe’s believes that these factors support the amount of goodwill recorded.

Under the terms and subject to the conditions set forth in the Merger Agreement, on October 25, 2007, Joe’s and JD Holdings completed the merger.  In connection with the merger, Joe’s Subsidiary merged with and into JD Holdings, with Joe’s Subsidiary as the surviving entity.  In addition, Joe’s issued 14,000,000 shares of its common stock, made a cash payment of $300,000 to JD Holdings in exchange for all of its outstanding shares and incurred $93,000 of merger related expenses. As a result of the merger, Joe’s now owns all outstanding stock of JD Holdings and all rights, title and interest in the Joe’s Brand.

Under the revised Merger Agreement, Mr. Dahan is entitled to, for a period of 120 months following October 25, 2007, a certain percentage of the gross profit earned by Joe’s in any applicable fiscal year.  See “Note 10 — Commitments and Contingencies — Contingent Consideration Payments” for further discussion of the contingent consideration obligation.  In addition, the Merger Agreement contains a restrictive covenant relating to non-competition and non-solicitation for one year following the termination of Mr. Dahan’s service.

Upon completion of the merger, on October 25, 2007, Mr. Dahan became an officer, director and greater than 10 percent stockholder of Joe’s and an Employment Agreement and Investor Rights Agreement became effective.

The merger has been accounted for as a business combination under U.S. generally accepted accounting principles. Accordingly, management has allocated the purchase price to the assets and liabilities of JD Holdings in Joe’s financial statements as of the completion of the merger at their respective fair values.  At November 30, 2007, the valuations of intangible assets, income taxes and certain other items were preliminary.  Management completed the initial purchase price allocation during the second quarter of fiscal 2008.  In March 2009, management performed a new allocation as a result of the restatement of its first three quarter financial statements for fiscal 2008.

The assets acquired in this merger consisted of all outstanding stock of JD Holdings and intangible assets.  JD Holdings had an immaterial amount of other assets, including incidental office equipment that was distributed to Mr. Dahan as the sole stockholder prior to the closing of the transaction.  Pursuant to the SFAS No. 142, “Goodwill and Other Intangible Assets,” or SFAS No. 142, Joe’s has determined that the useful life of the acquired assets is indefinite and therefore no amortization expense needs to be recognized.  However, Joe’s tests the assets for impairment annually and/or if events or changes in circumstances indicate that the assets might be impaired.  Additionally, a deferred tax liability has been established in the allocation of the purchase price with respect to the identified indefinite long lived intangible assets acquired and contingent consideration payments are recorded as an expense.  Contingent consideration payments recorded as an operating expense were $422,000 and $411,000, respectively, for the three months ended August 31, 2009 and 2008, and $1,238,000, and $1,337,000, respectively, for the nine months ended August 31, 2009 and 2008.

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Employment Agreement

After completion of the merger, Joe’s entered into an employment agreement for Mr. Dahan to serve as Creative Director for the Joe’s Brand.

The initial term of employment is five years with automatic renewals for successive one year periods thereafter, unless terminated earlier in accordance with the agreement. Under the employment agreement, Mr. Dahan is entitled to an annual salary of $300,000 and other discretionary benefits that the Compensation Committee of the Board of Directors may deem appropriate in its sole and absolute discretion.

Under the terms of the employment agreement, Joe’s may terminate Mr. Dahan for cause or if he becomes disabled, as defined in the agreement.  Should Joe’s terminate Mr. Dahan’s employment for cause or disability, Joe’s would only be required to pay him through the date of termination.  Joe’s may terminate Mr. Dahan’s employment without cause at any time upon two weeks notice, provided that it pays to him the present value of the annual salary amounts otherwise due to him for the remainder of the initial term of employment or any renewal term. Mr. Dahan may terminate his employment for good reason at any time with 30 days written notice.  In the event that Mr. Dahan terminates his employment for good reason, then he will be entitled to the present value of the annual salary amounts otherwise due to him for the remainder of the term of employment. Further, Mr. Dahan may terminate his employment for any reason upon ten business days’ notice and only be entitled to his salary as of the date of termination on a pro rata basis.

The employment agreement contains customary terms and conditions related to confidentiality of information, ownership by Joe’s of all intellectual property, including future designs and trademarks, alternative dispute resolution and Mr. Dahan’s duties and responsibilities to Joe’s and the Joe’s Brand as Creative Director.

Investor Rights Agreement

Upon the closing of the merger, Joe’s also entered into an investor rights agreement.  Pursuant to the investor rights agreement, Joe’s agreed to register for resale, on a periodic basis at the request of Mr. Dahan, the shares of common stock eligible for resale issued in connection with the merger.  The shares of common stock issued as merger consideration become eligible for resale beginning on the six month anniversary of the closing date of the merger at an initial rate of 1/6 of the shares issued and every six months thereafter at the same rate until all the shares are fully released on the third anniversary of the closing date.  Joe’s agreed to bear all expenses associated with registering these shares for resale and have granted to Mr. Dahan certain piggyback rights with respect to future registration statements filed by Joe’s. The investor rights agreement contains customary terms and conditions related to registration procedures, trading suspensions and indemnification of the parties.  On March 24, 2008, a registration statement on Form S-3 was declared effective for the resale of up to 2,333,333 shares where the contractual restrictions on resale lapsed on April 25, 2008.   Mr. Dahan has not requested the filing of any additional registration statements.

NOTE 6 —RELATED PARTY TRANSACTIONS

As of August 31, 2009 and November 30, 2008, Joe’s related party balance consisted of amounts due to and due from certain related parties, as further described below, as follows:

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Joe Dahan/JD Holdings Inc.

On February 7, 2001, Joe’s acquired a license for the rights to the Joe’s® brand from JD Design LLC, which was subsequently merged with and into JD Holdings.  Under the license agreement, JD Holdings was entitled to a royalty of three percent on net sales of licensed products.  In October 2005, Joe’s granted JD Holdings the right to develop the children’s branded apparel line under an amendment to its master license agreement in exchange for a five percent royalty on net sales of those products.  On October 25, 2007, in connection with the acquisition of JD Holdings by Joe’s, the license agreement terminated.

As part of the consideration paid in connection with the merger, Mr. Dahan is entitled to a certain percentage of the gross profit earned by Joe’s in any applicable fiscal year until October 2017.  See “Note 5 — Merger Transaction” for a further discussion on the merger agreement and the contingent consideration payments.

Victor Dahan

Victor Dahan, brother of Joe Dahan, is the managing member of Shipson LLC, or Shipson, and Joe’s previously outsourced its E-shop on the Joe’s Jeans website to his company.  Joe’s ceased doing business with Shipson in February 2008.  As of the termination date of the relationship, Shipson owed Joe’s approximately $192,000, for outstanding purchase orders that were fully reserved for in Joe’s year end financial statements for fiscal 2008.  During May 2009, Shipson returned $51,000 in goods and agreed to pay $141,000 for the outstanding purchase orders pursuant to a settlement agreement.

Albert Dahan

In April 2009, Joe’s has entered into a commission-based sales agreement with Albert Dahan, brother of Joe Dahan, for the sale of its products into the off-price channels of distribution.  Under the agreement, Mr. Albert Dahan is entitled to a commission for purchase orders entered into by Joe’s where he acts as a sales person for Joe’s.  The agreement may be terminated at any time for any reason or no reason with or without notice.  For the three months ended August 31, 2009, payments made to Mr. Albert Dahan under this arrangement totaled $180,000.

Effective as of June 1, 2009, Joe’s entered into a license agreement for the license of the children’s product line with Kids Jeans LLC, or Kids LLC, an entity which Mr. Albert Dahan holds an interest where he has voting control over the entity.  Under the terms of the license, Kids LLC has an exclusive right to produce, distribute and sell children’s products bearing the Joe’s® brand on a worldwide basis, subject to certain limitations on the channels of distribution.  In exchange for the license, Kids LLC will pay to Joe’s a royalty payment of 20 percent on the first $5,000,000 in net sales and 10 percent thereafter.  The initial term of the agreement is for three years until June 30, 2012 and is subject to certain guaranteed minimum net sales and royalty payment requirements during the initial term and for renewal.  Kids LLC advanced $1,000,000 as a payment against the first year’s guaranteed minimum royalties.  This amount has been reflected under the caption of “Deferred Licensing Revenue” on the Condensed Consolidated Balance Sheets.  Joe’s expects to recognize the royalty revenue based upon a percentage as set forth in the agreement of the licensees actual net sales or minimum net sales, whichever is greater.  Payments received in consideration of the grant of the license or advanced royalty payments are recognized ratably as revenue over the term of the license agreement.  The revenue recognized ratably over the term of the license agreement will not exceed royalty payments received.  The unrecognized portion of the upfront payments are included in deferred royalties and accrued expenses depending on the long or short term nature of the payments to be recognized.  As of August 31, 2009, $225,000 of the advanced payment has been recognized as income.

FameCast, Inc.

In the first quarter of fiscal 2009, Joe’s entered into an agreement with FameCast, Inc., or FameCast, an entity which Kent Savage, a member of Joe’s Board of Directors, serves as CEO and a founder.  The agreement with FameCast is for web hosting and management for an integrated contest site within the www.joesjeans.com site.  Under the terms of the agreement, the aggregate amount of the transaction with FameCast was $175,000.

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Commerce Investment Group and affiliates

Prior to 2007, Joe’s entered into certain transactions with Commerce Investment Group and its affiliates, or collectively, Commerce.  Commerce is no longer considered a related party nor has Joe’s engaged in any current transactions with them in fiscal 2008 or fiscal 2009.  However, a balance of $9,000 remains owed to Commerce that is included in the due to balance.

NOTE 7— EARNINGS PER SHARE

Earnings per share are computed using weighted average common shares and dilutive common equivalent shares outstanding. Potentially dilutive securities consist of outstanding options and warrants. A reconciliation of the numerator and denominator of basic earnings per share and diluted earnings per share is as follows:

Potentially dilutive options, warrants, restricted stock and restricted stock units in the aggregate of 4,117,340 and 3,007,885 for the three months ended August 31, 2009 and 2008, respectively, and 4,242,340 and 3,007,885 for the nine months ended August 31, 2009 and 2008, respectively, have been excluded from the calculation of the diluted income per share, as their effect would have been anti-dilutive.

Shares Reserved for Future Issuance

As of August 31, 2009, shares reserved for future issuance include (i) 3,226,046 shares of common stock issuable upon the exercise of stock options granted under the incentive plans; (ii) 2,908,038 shares of common stock issuable upon the vesting of RSUs; (iii) an aggregate of 580,030 shares of common stock available for future issuance under the 2004 Stock Incentive Plan; and (iv) 667,500 shares of common stock issuable upon the exercise of outstanding warrants.

NOTE 8 —INCOME TAXES

Joe’s utilizes the liability method of accounting for income taxes in accordance with SFAS No. 109.  Under the liability method, deferred taxes are determined based on the temporary differences between the financial statement and tax bases of assets and liabilities using enacted tax rates.

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Valuation allowances are established, when necessary, to reduce deferred tax assets to the amount expected to be realized. The likelihood of a material change in Joe’s expected realization of these assets depends on its ability to generate sufficient future taxable income. Joe’s ability to generate enough taxable income to utilize its deferred tax assets depends on many factors, among which is Joe’s ability to deduct tax loss carry-forwards against future taxable income, the effectiveness of tax planning strategies and reversing deferred tax liabilities.

In June 2006, the FASB issued FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes — An Interpretation of FASB Statement 109”, or FIN No. 48.  FIN No. 48 establishes a single model to address accounting for uncertain tax positions.  FIN No. 48 clarifies the accounting for income taxes by prescribing a minimum recognition threshold a tax position is required to meet before being recognized in the financial statements.  FIN No. 48 also provides guidance on derecognition, measurement, classification, interest and penalties, accounting in interim periods, disclosure and transition.  Joe’s adopted the provisions of FIN No. 48 on December 1, 2007.  Upon adoption, Joe’s did not recognize an adjustment in the amount of unrecognized tax benefits.  As of the date of adoption, Joe’s had no unrecognized tax benefits.  Joe’s policy is to recognize interest and penalties that would be assessed in relation to the settlement value of unrecognized tax benefits as a component of income tax expense.

Joe’s and its subsidiaries are subject to U.S. federal income tax as well as income tax in multiple state jurisdictions.  To the extent allowed by law, the tax authorities may have the right to examine prior periods where net operating losses were generated and carried forward, and make adjustments up to the amount of the net operating loss carryforward amount.  Joe’s is not currently under an Internal Revenue Service tax examination or an examination by any other state, local or foreign jurisdictions for any tax year.  Joe’s has identified its federal tax return and its state tax return in California as major tax jurisdictions. The only periods subject to examination for Joe’s federal tax returns are years 2006 through 2008. The periods subject to examination for Joe’s state tax returns in California are years 2004 through 2007.

Joe’s currently has a net operating loss carryforward of $48,372,000 for federal tax purposes expiring through 2026. Joe’s also has $18,341,000 of net operating loss carryforwards available for California which begin to expire in 2014.  Joe’s recorded an income tax expense of $824,000 and $368,000 for the three months ended August 31, 2009 and 2008, respectively and $1,190,000 and $631,000 for the nine months ended August 31, 2009 and 2008, respectively.  Joe’s effective tax rate was 30 percent and 23 percent for the three and nine months ended August 31, 2009, respectively, and 17 percent and 14 percent for the three and nine months ended August 31, 2008, respectively.

Certain limitations may be placed on net operating loss carryforwards as a result of “changes in control” as defined in Section 382 of the Internal Revenue Code.  In the event a change in control occurs, it will have the effect of limiting the annual usage of the carryforwards in future years.  Additional changes in control in future periods could result in further limitations of Joe’s ability to offset taxable income.  Management believes that certain changes in control have occurred which resulted in limitations on its net operating loss carryforwards.  Management has determined that realization of the net deferred tax assets does not meet the more likely than not criteria.  As a result, a valuation allowance has been provided for.  The difference between the effective tax rate and the statutory rate is primarily attributable to the utilization of net operating loss tax carryforwards against which a full valuation allowance has been established.

NOTE 9— STOCKHOLDERS’ EQUITY

Warrants

Joe’s has issued warrants in conjunction with various private placements of its common stock, and debt to equity conversions.  All warrants are currently exercisable.  As of August 31, 2009, outstanding common stock warrants are as follows:

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Stock Incentive Plans

In March 2000, Joe’s adopted the 2000 Employee Stock Option Plan, or the 2000 Employee Plan.  In connection with stockholder approval of the 2004 Stock Incentive Plan, Joe’s stated that it would no longer grant options pursuant to the 2000 Employee Plan.  In December 2007, the outstanding options remaining under the 2000 Employee Plan expired and the 2000 Employee Plan automatically terminated.

In September 2000, Joe’s adopted the 2000 Director Stock Incentive Plan, or the 2000 Director Plan, under which nonqualified stock options were granted to members of the Board of Directors in lieu of cash director fees.  After the adoption of the 2004 Stock Incentive Plan in June 2004, Joe’s no longer granted options pursuant to the 2000 Director Plan; however, it remains in effect for awards outstanding as of the adoption of the 2004 Stock Incentive Plan.  As of August 31, 2009, options to purchase up to 203,546 shares of common stock remained outstanding under the 2000 Director Plan.

On June 3, 2004, Joe’s adopted the 2004 Stock Incentive Plan, or the 2004 Incentive Plan, and has subsequently amended it to increase the number of shares authorized for issuance to 12,265,172 shares of common stock as of October 8, 2009.  Under the 2004 Incentive Plan, grants may be made to employees, officers, directors and consultants under a variety of awards based upon underlying equity, including, but not limited to, stock options, restricted common stock, restricted stock units or performance shares.  The 2004 Incentive Plan limits the number of shares that can be awarded to any employee in one year to 1,250,000.  Exercise price for incentive options may not be less than the fair market value of Joe’s common stock on the date of grant and the exercise period may not exceed ten years.  Vesting periods, terms and types of awards are determined by the Board of Directors and/or its Compensation and Stock Option Committee, or Compensation Committee.  The 2004 Incentive Plan includes a provision for the acceleration of vesting of all awards upon a change of control as well as a provision that allows forfeited or unexercised awards that have expired to be available again for future issuance. Since fiscal 2008, Joe’s has issued both restricted common stock and restricted common stock units, or RSUs, to its officers, directors and employees pursuant to the 2004 Stock Incentive Plan.  The RSUs represent the right to receive one share of common stock for each unit on the vesting date provided that the employee continues to be employed by Joe’s.   On the vesting date of the RSUs, Joe’s expects to issue the shares of common stock to each participant upon vesting and expects to withhold an equivalent number of shares at fair market value on the vesting date to fulfill tax withholding obligations.  Any RSUs withheld or forfeited will be shares available for issuance in accordance with the terms of the 2004 Incentive Plan.

The shares of common stock issued upon exercise of a previously granted stock option or a grant of restricted common stock or RSUs are considered new issuances from shares reserved for issuance in connection with the adoption of the various plans.  Joe’s requires that the option holder provide a written notice of exercise in accordance with the option agreement and plan to the stock plan administrator and full payment for the shares be made prior to issuance.  All issuances are made under the terms and conditions set forth in the applicable plan.  As of August 31, 2009, 580,030 shares remained available for issuance under the 2004 Incentive Plan.

For all stock compensation awards that contain graded vesting with time-based service conditions, Joe’s has elected to apply a straight-line recognition method to account for all of these awards.  For existing grants that were not fully vested at November 30, 2008, there was a total of $711,000 of stock based compensation expense recognized in the nine months ended August 31, 2009.

The following summarizes option grants, restricted common stock and RSUs issued to members of the Board of Directors for the fiscal years 2002 through the third quarter of fiscal 2009 (in actual amounts) for service as a member:

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Stock activity in the aggregate for the periods indicated are as follows (in actual amounts):

As of August 31, 2009, there was $1,674,000 of total unrecognized compensation cost related to nonvested share-based compensation arrangements granted under the 2004 Incentive Plan.  That unrecognized compensation cost is expected to be recognized over a weighted-average period of 2.5 years.   The total fair value of shares of stock options that vested during the three months ended August 31, 2009 and 2008 was $0 and $5,000, respectively.  The total fair value of shares of stock options that vested during the nine months ended August 31, 2009 and 2008 was $0 and $17,000, respectively.

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Exercise prices for options outstanding as of August 31, 2009 are as follows:

The following table summarizes the stock option activity by plan:

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A summary of the status of restricted common stock and RSUs as of November 30, 2008, and changes during the three and nine months ended August 31, 2009, are presented below:

In the three months ended August 31, 2009, there were no options granted or exercised or RSUs granted.  In the nine months ended August 31, 2009, Joe’s issued 648,580 shares of its common stock to holders of RSUs and withheld or cancelled 144,764 RSUs.

NOTE 10 — COMMITMENTS AND CONTINGENCIES

Contingent Consideration Payments

As part of the consideration paid in connection with the completion of the merger, Mr. Dahan will be entitled to a certain percentage of the gross profit earned by Joe’s in any applicable fiscal year until October 2017.  Mr. Dahan will be entitled to the following: (i) 11.33 percent of the gross profit from $11,251,000 to $22,500,000; (ii) three percent of the gross profit from $22,501,000 to $31,500,000; (iii) two percent of the gross profit from $31,501,000 to $40,500,000; (iv) one percent of the gross profit above $40,501,000. The payments will be paid in advance on a monthly basis based upon estimates of gross profit after the assumption has been reached that the payments will likely be paid.  At the end of each quarter, any overpayments will be offset against future payments and any significant underpayments will promptly be made.  No payment will be made if the gross profit is less than $11,250,000.  “Gross Profit” is defined as net sales of the Joe’s® brand less cost of goods sold as reported in periodic filings with the SEC.  Contingent consideration payments recorded as operating expense were $422,000 and $411,000 for the three months ended August 31, 2009, and 2008, respectively, and $1,238,000 and $1,337,000 for the nine months ended August 31, 2009 and 2008, respectively.

Retail Leases

Joe’s leases retail store locations under operating lease agreements expiring on various dates through 2019 or 10 years from the rent commencement date. Some of these leases require Joe’s to make periodic payments for property taxes, utilities and common area operating expenses. Certain retail store leases provide for rents based upon the minimum annual rental amount and a percentage of annual sales volume, generally ranging from 6% to 8%, when specific sales volumes are exceeded.  Some leases include lease incentives, rent abatements and fixed rent escalations, which are amortized and recorded over the initial lease term on a straight-line basis.

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As of August 31, 2009, the future minimum rental payments under non-cancelable retail operating leases with lease terms in excess of one year were as follows:

NOTE 11— SEASONALITY

The market for apparel products is seasonal.  The majority of Joe’s sales activities take place from late fall to early spring and the greatest volume of shipments and sales are generally made from late spring through the summer.  This time period coincides with Joe’s second and third fiscal quarters and its cash flow is generally strongest in its third and fourth fiscal quarters when a significant amount of its net sales are realized as a result of shipping orders taken during earlier months.  In the second quarter in order to prepare for peak sales that occur during the second half of the year, Joe’s builds its inventory levels, which results in higher liquidity needs compared to other quarters.

Due to the seasonality of its business, as well as the evolution and changes in its business and product mix, Joe’s quarterly or yearly results are not necessarily indicative of the results for the next quarter or year.

NOTE 12— SUBSEQUENT EVENTS

As of October 15, 2009, the date of issuance of this Form 10-Q for the quarter ended August 31, 2009, there were no items deemed to be reportable as a subsequent event.

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

Forward-Looking Statements

When used in this Quarterly Report on Form 10-Q, or Quarterly Report, the words “may,” “will,” “expect,” “anticipate,” “intend,” “estimate,” “continue,” “believe” and similar expressions are intended to identify forward-looking statements.  Similarly, statements that describe our future expectations, objectives and goals or contain projections of our future results of operations or financial condition are also forward-looking statements.  Statements looking forward in time are included in this Quarterly Report pursuant to the “safe harbor” provision of the Private Securities Litigation Reform Act of 1995.  Such statements are subject to certain risks and uncertainties, which could cause actual results to differ materially, including, without limitation, continued acceptance of our product, product demand, competition, capital adequacy and the potential inability to raise additional capital if required, and the risk factors contained in our reports filed with the Securities and Exchange Commission, or SEC, pursuant to the Securities Exchange Act of 1934, as amended, or Exchange Act, including our Annual Report on Form 10-K for the year ended November 30, 2008.  Readers are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date hereof.  Our future results, performance or achievements could differ materially from those expressed or implied in these forward-looking statements.  We do not undertake and specifically decline any obligation to publicly revise these forward-looking statements to reflect events or circumstances occurring after the date hereof or to reflect the occurrence of unanticipated events.

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