**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON, D.C. 20549**

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**FORM 10-K**

**ANNUAL REPORTPURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF1934**

**FOR THE FISCAL YEAR ENDED OCTOBER 29, 2005**

**Commission File Number 000-24990**

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**WESTAFF, INC.**

(Exact name of registrant as specified in its charter)

| **DELAWARE**                                                    | **94-1266151**                        |
|-----------------------------------------------------------------|---------------------------------------|
| (State or other jurisdiction of  incorporation or organization) | (I.R.S. Employer  Identification No.) |

 

**298 NORTH WIGET LANE, WALNUT CREEK, CA 94598-2453**

(Address of principal executive offices, including zip code)

**(925) 930-5300**

(Registrant’s telephone number, including area code)

Securitiesregistered pursuant to Section 12(b) of the Act:

**None**

Securitiesregistered pursuant to Section 12(g) of the Act:

**Common Stock, $0.01 par value per share**

(Title of class)

Indicate by check mark ifthe registrant is a well-known seasoned issuer, as defined in Full 405 of theSecurities Act. Yes o No x

Indicate by check mark ifthe registrant is not required to file reports pursuant to Section 13 or Section 15(d) ofthe Exchange Act. Yes o No x

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

Indicate by check mark ifdisclosure of delinquent filers pursuant to Item 405 of Regulation S-K is notcontained herein, and will not be contained, to the best of Registrant’sknowledge, in definitive proxy or information statements incorporated byreference in Part III of this Form 10-K or any amendment tothis Form 10-K. x

Indicate by check markwhether the registrant is a large accelerated filer, an accelerated filer, or anon-accelerated filer. See definition of “accelerated filer and largeaccelerated filer” in Rule 12b-2 of the Exchange.

Large accelerated filer o                           Acceleratedfiler o                               Non-acceleratedfiler x

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

As of April 15, 2005,the aggregate market value of the registrant’s common stock held by non-affiliatesof the registrant was $32,850,107 based on the closing sale price as reportedon the Nasdaq National Market.

As of January 26,2006, the Registrant had outstanding 16,377,958 shares of Common Stock.

**DOCUMENTSINCORPORATED BY REFERENCE**

The following documents (orportions thereof) are incorporated herein by reference:

Portions of the Registrant’s Proxy Statement for the2006 Annual Meeting of Stockholders are incorporated herein by reference into Part IIIof this Form 10-K Report.

 

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**INDEXWESTAFF, INC.**
|                   | ** ** | ** **                                                                                                          | ** ** | **PAGE NO** |
|-------------------|------------|---------------------------------------------------------------------------------------------------------------------|------------|-------------|
| **PART I**   |       |                                                                                                                |       |        |
| ITEM 1.           |       | BUSINESS                                                                                                            |       | 3           |
| ITEM 1A.          |       | RISK FACTORS                                                                                                        |       | 11          |
| ITEM 1B.          |       | UNRESOLVED STAFF  COMMENTS                                                                                          |       | 16          |
| ITEM 2.           |       | PROPERTIES                                                                                                          |       | 16          |
| ITEM 3.           |       | LEGAL PROCEEDINGS                                                                                                   |       | 16          |
| ITEM 4.           |       | SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS                                                                 |       | 17          |
| **PART II**  |       |                                                                                                                |       |        |
| ITEM 5.           |       | MARKET FOR  REGISTRANT’S COMMON EQUITY, RELATED  STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES |       | 19          |
| ITEM 6.           |       | SELECTED FINANCIAL  DATA                                                                                            |       | 20          |
| ITEM 7.           |       | MANAGEMENT’S  DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS                    |       | 20          |
| ITEM 7A.          |       | QUANTITATIVE  AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK                                                         |       | 33          |
| ITEM 8.           |       | FINANCIAL  STATEMENTS AND SUPPLEMENTARY DATA                                                                        |       | 34          |
| ITEM 9.           |       | CHANGES IN AND  DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE                               |       | 34          |
| ITEM 9A.          |       | CONTROLS AND  PROCEDURES                                                                                            |       | 34          |
| ITEM 9B.          |       | OTHER INFORMATION                                                                                                   |       | 34          |
| **PART III** |       |                                                                                                                |       |        |
| ITEM 10.          |       | DIRECTORS AND  EXECUTIVE OFFICERS OF THE REGISTRANT                                                                 |       | 35          |
| ITEM 11.          |       | EXECUTIVE  COMPENSATION                                                                                             |       | 35          |
| ITEM 12.          |       | SECURITY  OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER  MATTERS                    |       | 35          |
| ITEM 13.          |       | CERTAIN  RELATIONSHIPS AND RELATED TRANSACTIONS                                                                     |       | 35          |
| ITEM 14.          |       | PRINCIPAL  ACCOUNTANT FEES AND SERVICES                                                                             |       | 35          |
| **PART IV**  |       |                                                                                                                |       |        |
| ITEM 15.          |       | EXHIBITS AND  FINANCIAL STATEMENT SCHEDULES                                                                         |       | 36          |
|              |       | SIGNATURES                                                                                                          |       | IV-1        |
|              |       | POWER OF ATTORNEY                                                                                                   |       | IV-1        |

 

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**PART I**

**Cautionary Note**

This Annual Report on Form 10-K containsforward-looking statements within the meaning of Section 27A of theSecurities Act of 1933 and Section 21E of the Securities Exchange Act of1934 which are subject to a number of risks and uncertainties. All statementsthat are not historical facts are forward-looking statements, includingstatements about our business strategy, our future research and development,the timing of the introduction of our services, the effect of GAAP accounting pronouncements,uncertainty regarding our future operating results and our profitability,anticipated sources of funds and all plans, objectives, expectations andintentions and the statements regarding revenue, expected domestic revenuegrowth rates for fiscal 2006, gross margins and our prospects for fiscal 2006.These statements appear in a number of places and can be identified by the useof forward-looking terminology such as “may,” “will,” “should,” “expect,” “plan,”“anticipate,” “believe,” “estimate,” “predict,” “future,” “intend,” or “certain”or the negative of these terms or other variations or comparable terminology,or by discussions of strategy.

Actual results may vary materially from those in suchforward-looking statements as a result of various factors that are identifiedin “Item 7—Management’s Discussion and Analysis of Financial Condition andResults of Operations” and elsewhere in this document. No assurance can begiven that the risk factors described in this Annual Report on Form 10-Kare all of the factors that could cause actual results to vary materially fromthe forward-looking statements. All forward-looking statements speak only as ofthe date of this Annual Report on Form 10-K. Readers should notplace undue reliance on these forward-looking statements and are cautioned thatany such forward-looking statements are not guarantees of future performance.We assume noobligation to update any forward-looking statements.

This Annual Report on Form 10-Kincludes service marks of Westaff, Inc. Products or service names of othercompanies mentioned in this Annual Report on Form 10-K may betrademarks or registered trademarks of their respective owners. Investors andsecurity holders may obtain a free copy of the Annual Report on Form 10-Kand other documents filed by Westaff with the Securities and ExchangeCommission (SEC) at the SEC’s website at http://www.sec.gov. Free copies of theAnnual Report on Form 10-K and other documents filed by Westaff withthe SEC may also be obtained from Westaff by directing a request to Westaff,Attention: Linda Gaebler, Vice President, Marketing and  Communications, 298 North Wiget Lane, WalnutCreek, CA 94598-2453, (925) 930-5300.

**ITEM 1.**                BUSINESS.

**General**

The Company provides temporary staffing services primarilyin suburban and rural markets (“secondary markets”), as well as in the downtownareas of certain major urban centers (“primary markets”) in the United States,the United Kingdom, Australia and New Zealand. Through its network of Company-owned,franchise agent and licensed offices, the Company offers a wide range of staffingsolutions, including permanent placement, replacement, supplemental and on-siteprograms to businesses and government agencies. The Company’s primary focus ison recruiting and placing light industrial and clerical/administrativepersonnel. The Company has over 50 years of experience in the staffing industryand, as of October 29, 2005, operated through 239 offices in 44 states andthree foreign countries. As of October 29, 2005, 73% of these offices wereowned by the Company and 27% were operated by franchise agents and a licensee.

The Company was founded in 1948 and incorporated inCalifornia in 1954. In October 1995, the Company reincorporated inDelaware. The Company’s corporate name was changed to Westaff, Inc. in September 1998.The Company’s executive offices are located at 298 North Wiget Lane, WalnutCreek, 

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California 94598-2453,and its telephone number is (925) 930-5300. The Company transactsbusiness through its subsidiaries, the largest of which is Westaff (USA), Inc.,a California corporation, which is the primary operating entity.

During the third quarter of fiscal 2005, the Companysold its subsidiary operations in Norway and Denmark, and, during fiscal 1999,the Company sold its medical business, primarily operated through WesternMedical Services, Inc. (Western Medical), a wholly owned subsidiary of theCompany. As a result, the Company has classified these operations asdiscontinued operations in the Company’s consolidated financial statements.

References in this Form 10-Kto (i) the “Company,” the “Registrant” or “Westaff” refer to Westaff, Inc.,its predecessor and their respective subsidiaries, unless the context otherwiserequires, and (ii) ”franchise agents” refer to the Company’s franchiseesin their roles as limited agents of the Company in recruiting job applicants,soliciting job orders, filling those orders and assisting with collectionmatters upon request, but otherwise refer to the Company’s franchisees in theirroles as independent contractors of the Company.

**Services**

The Company’s service offerings are focused primarilyon placing temporary light industrial and clerical/administrative staffingpersonnel and providing permanent placement services.

*LightIndustrial Services.**  *Light industrialservices personnel are placed for a variety of assignments including generalfactory and manufacturing work (including production, assembly and supportworkers, merchandise packers and machine operators), warehouse work (such asgeneral laborers, stock clerks, material handlers, order pickers, forkliftoperators and shipping/receiving clerks), technical work (such as labtechnicians, inspectors, quality control technicians and drafters) and generalservices (such as maintenance and repair personnel, janitors and food serviceworkers).

*Clerical/AdministrativeServices.**  *Clerical/administrative services personnel areplaced for a broad range of general business positions including receptionists,administrative assistants, data entry operators, word processors, customerservice representatives, telemarketers and various other general office,accounting, bookkeeping and clerical staff. Clerical/administrative positionsalso include call center agents, such as customer service, help desk andtechnical support staff.

*PermanentPlacement Services.**  *Permanent placement services are typicallycontingent fee-based services to recruit and fill regular staff positions forcustomers. These services include locating, screening and assessing candidateson behalf of customers. If the candidate is hired by the customer, the Companyis generally paid a fee based on a percentage of the annual startingcompensation for the candidate placed.

The Company believes that temporary light industrialand clerical/administrative staffing services are the foundation of thestaffing industry and will remain a significant market for the foreseeablefuture. The Company also believes that employees performing temporary lightindustrial and clerical/administrative staffing functions are, and will remain,an integral part of the labor market in local, regional and national economiesaround the world.

The Company alsoprovides other services within the light industrial and clerical/administrativestaffing market such as temp-to-hire services, payrolling, on-site andon-location services, and other professional services including skills andbehavioral assessments and coordination of drug testing and backgroundchecking.

·       Temp-to-hire services represent the placement of temporary staff with acustomer with the option to convert the temporary staff to a regular customeremployee at a later date.

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·       Payrolling typically involves the transfer of a customer’s short-termseasonal or special use employees to the Company’s payroll for a designatedperiod.

·       On-site programs provide administrative services for the Company’scustomers such as coordinating all temporary staffing services throughout acustomer’s location, including skills assessment and training.

·       On-location programs provide for an independent branch office located atthe customer’s facility. They are typically intended for large non-seasonalaccounts with more than $0.5 million in annual revenue. This type of branchoffice is typically staffed by at least one manager-level employee.

Both on-site and on-location relationships providecustomers with dedicated account management which can more effectively meet thecustomer’s changing staffing needs with high quality, consistent service. Theseprograms tend to have comparatively lower operating expenses and relativelylonger customer relationships.

To complement its service offerings, the Companyutilizes a number of tools focused on increasing the pool of qualifiedcandidates using advanced selection procedures for potential candidates (TalentTrak*®*)as well as technology-based management services that allow clients to maximizeworkforce productivity (Time Trak*®*). The Company believes thatthese tools enhance its competitive edge and position it to more effectivelypursue high growth market niches such as financial services, customerinteraction centers and high end administrative placement.

*TalentTrak®.**  *To ensure high quality placements for customersand employees, Westaff uses Talent Trak® to strengthen the quality of itsselection process. This comprehensive selection process includes flexiblerecruiting methods, interviewing and reference checking. Westaff conductsadvanced skills and behavioral assessments using Talent Trak*®*, and also provides the option for bothbackground and drug testing that can be customized to meet a customer’sspecific needs. The Company maintains contracts with national drug testingand background testing service providers to help ensure high quality andconsistency in assessing its candidates.

*Time Trak®.**  *This tool provides customers with a web-basedmanagement system to assist in maximizing workforce productivity. Time Trak*®* isa flexible system allowing customers access to information to track a varietyof performance measurements such as workforce hours, labor costs, attendanceand staff performance. Time Trak*®* also includes features toautomate timecard and payroll processing.

**Markets**

The Company provides temporary staffing servicesprimarily in “secondary markets,” as well as in the downtown areas of certain “primarymarkets” in the United States and selected international markets.

The Company capitalizes on its presence in secondarymarkets and to build market share by targeting small to medium-sized customers,including divisions of Fortune 500 companies. The Company believes that in manycases, such markets are less competitive and less costly to operate in than inthe more central areas of primary markets, where a large number of staffingservices companies frequently compete for business and occupancy costs arerelatively high. In addition, the Company believes that secondary markets aremore likely to provide the opportunity to sell retail and recurring businessthat is characterized by relatively higher gross margins.

The Company augments this concentration on secondarymarkets by also focusing on national contracts with customers having a largepresence in these marketplaces. Such accounts include large clients in multiplelocations supported by a dedicated corporate-level business relationshipmanager. The Company currently has existing national accounts across manydifferent business sectors such as 

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manufacturing, government,financial services, technology and communications. The Company maintains aprofessional sales team that services and leverages existing relationships toretain and grow these accounts. In addition, the Company continues to developaggressive marketing programs to target and acquire additional clients that fitthe Westaff branch system footprint. The Company believes that its geographicalignment allows it to effectively compete for some of these nationalcontracts.

The Company markets itstemporary staffing services to local and regional customers through a networkof Company-owned and franchise agent offices, as well as through its on-siteand on-location service locations and through one licensed office. The Company’snational marketing campaigns are coordinated through its corporate headquartersin cooperation with US field offices. Marketing efforts for regional andinternational markets are conducted at the local level. New customers aredeveloped by the field offices primarily through direct sales efforts andreferrals. The Company has a robust targeted marketing program and aconsultative sales process that includes telemarketing, e-mail marketing anddirect mail campaigns.

**Recruiting**

The Company believes thata key component of its success is the ability to recruit and maintain a pool ofqualified personnel and regularly place them into desirable and appropriatepositions. The Company uses comprehensive methods to identify, assess, selectand, when appropriate, measure the skills of its temporary employees to meetthe needs of its customers. The Company believes one of its key competitiveadvantages in attracting and retaining temporary light industrial andclerical/administrative staffing personnel is its payroll system, whichprovides it with the ability to print payroll checks at virtually all of itsbranch offices within 24 hours after receipt of a timecard. Most Company-ownedoffices offer temporary employees a benefit package, including a service bonusand holiday pay. Franchise agent offices have the option to offer this benefit.All eligible temporary employees have the option to participate in the Company’s401(k) plan and discounted employee stock purchase plan.

**Operations**

The Company operates each Company-owned office as aseparate profit center and provides managers considerable operational autonomyand financial incentives. The Company also operates franchise agent offices inappropriate markets. Managers focus on business opportunities within marketsand are provided centralized support to achieve success in those markets. TheCompany believes that this structure allows it to recruit and retain highlymotivated managers who have demonstrated the ability to succeed in acompetitive environment. This structure also allows managers and staff to focuson market development while relying on centralized services for support inback-office operations, such as risk management programs and unemploymentinsurance, credit, collections, accounting, advice on legal and regulatorymatters, quality standards and marketing.

As of October 29, 2005, the Company operatedthrough a network of 239 offices in 44 states and three foreign countries. Inaddition, the Company from time to time establishes recruiting offices both forrecruiting potential temporary employees and for testing demand for itsservices in new market areas. The Company’s operations are decentralized, withbranch and market managers, regional vice presidents and franchise agentsenjoying considerable autonomy in hiring, determining business mix andadvertising.

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The following table sets forth information as to thenumber of offices in operation as of the dates indicated.

| ** **                         | ** ** | **Nov. 3,  2001** | ** ** | **Nov. 2,  2002** | ** ** | **Nov. 1,  2003** | ** ** | **Oct. 30,  2004** | ** ** | **Oct. 29,  2005** | ** ** |
|------------------------------------|------------|------------------------|------------|------------------------|------------|------------------------|------------|-------------------------|------------|-------------------------|------------|
| Number of Offices by Ownership(1): |       |                   |       |                   |       |                   |       |                    |       |                    |       |   |   |   |   |   |   |   |   |   |   |
| Company-owned                      |       |                   | 254        |                   |       |                   | 217        |                    |       |                    | 197        |   |   |   | 187 |   |   |   | 175 |   |   |
| Franchise agent                    |       |                   | 85         |                   |       |                   | 77         |                    |       |                    | 72         |   |   |   | 68 |   |   |   | 63 |   |   |
| Licensed                           |       |                   | 10         |                   |       |                   |  5    |                    |       |                    | 1          |   |   |   | 1 |   |   |   | 1 |   |   |
| Total                              |       |                   | 349        |                   |       |                   | 299        |                    |       |                    | 270        |   |   |   | 256 |   |   |   | 239 |   |   |
| Number of Offices by Location(1):  |       |                   |       |                   |       |                   |       |                    |       |                    |       |   |   |   |   |   |   |   |   |   |   |
| Domestic                           |       |                   | 291        |                   |       |                   | 246        |                    |       |                    | 221        |   |   |   | 207 |   |   |   | 193 |   |   |
| International                      |       |                   | 58         |                   |       |                   | 53         |                    |       |                    | 49         |   |   |   | 49 |   |   |   | 46 |   |   |
| Total                              |       |                   | 349        |                   |       |                   | 299        |                    |       |                    | 270        |   |   |   | 256 |   |   |   | 239 |   |   |

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(1)          ExcludesCompany-owned recruiting offices.

*Company-OwnedOffices.**  *Employees of each Company-owned office typicallyreport to a branch or market manager who is responsible for day-to-dayoperations and the profitability of a market that consists of one to severaloffices. Branch or market managers typically report to district managers orregional vice presidents. District managers report to regional vice presidentswho, in turn, report to Westaff’s Senior Vice President, Field Operations. Asof December 31, 2005, therewere nine regional vice presidents and three district managers. The Company hasa variety of incentive plans in place for its domestic and internationaloffices. One or more of these plans may be offered to branch staff as well asmarket and district managers and regional vice presidents. These plans aredesigned to motivate employees to maximize the growth and profitability oftheir office, district or region, as well as to achieve budgeted goals. TheCompany believes that its incentive-based compensation plans encourageemployees in its Company-owned offices to increase sales and profits, resultingin a creative and committed team.

*Franchise Agent Offices.**  *The Company’s franchise agents have the exclusiveright by contract to sell certain of the Company’s services and to use theCompany’s service marks, business names and systems in a specified geographicterritory.

The Company’s franchise agent agreements generallyallow franchise agents to open multiple offices within their exclusiveterritories. As of October 29, 2005, the Company’s 32 franchise agentsoperated 63 franchise agent offices. Sales generated by franchise agentoperations and related costs are included in the Company’s consolidated revenueand costs of services, respectively, and during fiscal 2003, 2004, and 2005franchise agent sales represented 27.0%, 29.0%, and 28.1% respectively, of theCompany’s revenue.

The franchise agent, as an independent contractor, isresponsible for establishing and maintaining an office and paying relatedadministrative and operating expenses, such as rent, utilities and salaries ofits branch office staff. Each franchise agent functions as a limited agent ofthe Company in recruiting job applicants, soliciting job orders, filling thoseorders and assisting and cooperating with collection matters upon request, butotherwise functions as an independent contractor. As franchisor, the Company isthe employer of the temporary employees and the owner of the customer accountsreceivable and is responsible for paying the wages of the temporary employeesand all related payroll taxes and insurance. As a result, the Company providesa substantial portion of the working capital needed for the franchise agentoperations.

Franchise agents are required to follow the Company’soperating procedures and standards in recruiting, screening, classifying andretaining temporary personnel.

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*LicensedOffices.**  *As of October 29, 2005, one licenseeoperated one licensed office. The Company is no longer offering the licenseprogram. The licensee is the employer of the temporary employees and the ownerof the customer accounts receivable. The Company finances the licensees’temporary employee payroll, payroll taxes and insurance. This indebtedness issecured by a pledge of the licensees’ accounts receivable, tangible andintangible assets, and the license agreement. Borrowings under the lines of creditbear interest at a rate equal to the reference rate of Bank of America, N.A.plus two percentage points. Interest is charged on the borrowings only if theoutstanding balance exceeds certain specified limits. Licensees are required tooperate within the framework of the Company’s policies and standards, but mustobtain their own workers’ compensation, liability, fidelity bonding and stateunemployment insurance coverage, which determines their payroll costs.

The Company’s franchise and license agreements have aninitial term of five years and are renewable for multiple five-year terms. Theagreements generally contain two-year non-competition covenants which theCompany vigorously seeks to enforce. Efforts to enforce the non-competitioncovenants have resulted in litigation brought by the Company followingtermination of certain franchise agent and license agreements. In the past fivefiscal years, the Company has commenced one action to enforce the non-competitioncovenants, which was resolved in the Company’s favor.

The Company’s sale of franchises is regulated by theFederal Trade Commission and by state business opportunity and franchise laws. TheCompany has filed registrations, been exempted from registration or filed anotice in 14 of the 15 states that require pre-sale registration or a noticefiling under franchise investment laws in order to offer the sale offranchises. The Company has not sought registration in one state since nopre-sale notice is required.

For financial informationabout operating segments for fiscal years 2003, 2004 and 2005, see Note 13 tothe consolidated financial statements included in this Annual Report.

**Seasonality**

The Company hasexperienced significant fluctuations in its operating results and anticipatesthat these fluctuations may continue. Operating results may fluctuate due to anumber of factors, including the demand for the Company’s services, the levelof competition within its markets, the Company’s ability to increase theproductivity of its existing offices, control costs and expand operations andthe availability of qualified temporary personnel. In addition, the Company’sresults of operations could be, and have in the past been, adversely affectedby severe weather conditions. The Company’s fourth fiscal quarter consists of16 or 17 weeks, while its first, second and third fiscal quarters consist of 12weeks each. Moreover, the Company’s results of operations have alsohistorically been subject to seasonal fluctuations. Demand for temporarystaffing historically has been greatest during the Company’s fourth fiscalquarter due largely to the planning cycles of many of its customers.Furthermore, sales for the first fiscal quarter are typically lower due tonational holidays as well as plant shutdowns during and after the holidayseason. These shutdowns and post-holiday season declines negatively impact joborders received by the Company, particularly in the light industrial sector.

**Customers**

The Company services smalland medium-sized companies as well as divisions of Fortune 500 companies andlocal, state and federal government agencies. As is common in the temporarystaffing industry, the Company’s engagements to provide services to itscustomers are generally of a non-exclusive, short-term nature and subject totermination by the customer with little or no notice. During fiscal 2005, nosingle customer accounted for more than 4.9% of the Company’s revenue. TheCompany’s 10 highest volume customers in fiscal 2005 accounted for an aggregateof 15.9% of the Company’s revenue.

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**Competition**

The temporary staffing industry is highly competitivewith few barriers to entry. The Company believes that the majority ofcommercial temporary staffing companies are local, full-service or specializedoperations with less than five offices. Within local markets, typically nosingle company has a dominant share of the market. The Company also competesfor qualified temporary personnel and customers with larger, nationalfull-service and specialized competitors in local, regional, national andinternational markets. The principal national competitors are Adecco SA,Spherion Corporation (commercial staffing segment), Kelly Services, Inc.(U.S. commercial staffing and international segments), Manpower Inc.,RemedyTemp, Inc. (clerical and light industrial services), ExpressPersonnel Services, Inc., and Randstad North America. Many of the Company’sprincipal competitors have greater financial, marketing and other resourcesthan the Company. In addition, there are a number of medium-sized firms whichcompete with the Company in certain markets where they may have a strongerpresence, such as regional or specialized markets.

The Company believes thatthe competitive factors in obtaining and retaining customers includeunderstanding customers’ specific job requirements, providing qualifiedtemporary personnel in a timely manner, monitoring quality of job performanceand pricing of services. Due to competitive pressures it has been difficult forthe Company to raise prices even though its costs may have increased. TheCompany believes that the primary competitive factors in obtaining qualifiedcandidates for temporary employment assignments are wages, benefits andflexibility and responsiveness of work schedules. The Company believes that withinits primary light industrial and clerical/administrative markets, timeliness ofpay is also a key competitive factor.

**Management Information Systems**

The Company’s domestic management information systemsprovide support to both branch office locations and the corporate back-office.Branch offices utilize a proprietary application designed to assist incandidate search, recruiting, customer order management, customer service,sales management and payroll entry and submission. The application alsoprovides for the sharing of information between branch offices and corporateheadquarters. Utilizing this system, field offices capture and input customer,employee, billing and payroll information. This information is electronicallycaptured on centralized servers where payroll, billing and financialinformation is processed overnight. These systems allow the Company to printchecks at its branch offices within 24 hours after receipt of the timecard.Invoices are also processed daily and distributed from the Company’scentralized corporate office. These systems also support branch officeoperations with daily, weekly, monthly and quarterly reports that provideinformation ranging from customer activity to office profitability.

Each of the Company’sinternational operations have implemented customized or third party frontoffice and/or back office operating systems that are designed to meet thespecific information technology and reporting requirements within the localjurisdiction.

**Risk Management Programs**

The Company is responsible for all employee-relatedexpenses for the temporary staff employees of its Company-owned and franchiseagent offices including workers’ compensation, unemployment insurance, socialsecurity taxes, state and local taxes and other general payroll expenses.

The Company provides workers’ compensation insurancecovering its domestic regular and temporary employees through a long-termrelationship with Travelers Property Casualty Company of America (“Travelers”).The Company is self-insured in the states of Ohio and Washington. For fiscalyears 2003 and 2005, the Company retained a $500,000 deductible per occurrencefor these policies. This retention was 

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$750,000 per claim forfiscal 2004. The Company also purchases workers’ compensation insurance coveragebased upon actual payroll classifications in the monopolistic state of NorthDakota.

The Company is contractually required to collateralizeits recorded obligations under the workers’ compensation insurance contractswith Travelers through irrevocable letters of credit, surety bonds or cash. Asof December 24, 2005, the aggregate collateral requirements have beensatisfied through $35 million of letters of credit.

The Company’s nationwiderisk management program is managed by its Risk Management Department consistingof risk management and workers’ compensation professionals as well as claimadministrators who monitor the disposition of all claims and oversee, throughan on-line system, all workers’ compensation claim activity. The departmentutilizes a variety of creative and aggressive workers’ compensation lossprevention and claim management strategies. The risk management programincludes claim strategy reviews with the carrier and third party administrator,a return-to-work modified duty program, pre-placement customer safetyevaluations and light industrial job approvals, the use of personal protectiveequipment, and the use of individual local office expense allocation formulas.

**Employees**

As of October 29,2005, the Company had approximately 26,500 temporary employees on assignmentand employed 898 regular staff. The Company’s employees are not covered by anycollective bargaining agreements. The Company believes that its relationshipswith its employees are good.

**Service Marks**

The Company has various service marks registered withthe United States Patent and Trademark Office, with the State of California andin various foreign countries, including its primary Westaff® service mark.

The Company also owns other service marks, includingthe Westaff® logo, Talent Trak®, Time Trak®, Ms. Carmen Courtesy®, andStaff for Business Jobs for People®. The Company has filed an application toregister the service mark Learning Traksm.

Federal and state servicemark registrations may be renewed indefinitely as long as the underlying markremains in use.

**Medical Services**

During fiscal 1999, the Company discontinued itsmedical business (Western Medical) principally through a sale to IntrepidU.S.A. Inc. Under the terms of the sale, the Company retained the majority ofaccounts receivable, including the trade and Medicare accounts receivablebalances.

Prior to fiscal 2003, the Company appealed WesternMedical’s 1996 Medicare cost report settlement. During the first quarter offiscal 2003, as a result of the favorable appeal settlement, the Companyrecorded $0.3 million in income from discontinued operations.

During the third quarter of fiscal 2004, the Companyresolved certain significant legal and liability claims and evaluated futurerisks associated with remaining pending claims. As a result, $0.2 million ofincome from discontinued operations was recognized and is reflected in theConsolidated Statement of Operations for the fiscal year ended October 30,2004.

As of October 29,2005, the remaining net current liabilities of the discontinued medicaloperations of $0.1 million are primarily for settled but unpaid legal claims.The Company believes it has adequately reserved for the reasonable outcome offuture events; however, should actual costs differ materially from thoseestimated by management, the Company would record additional losses (or gains)in future periods.

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**Availability of Reports**

Westaff makes its SECfilings, including financial reports on Form 10-K, 10-Q or 8-K,available free of charge on its web site at *www.westaff.com*as soon as practicable after filing. Furthermore, Westaff will provideelectronic or paper copies of filings free of charge upon written request tothe Company’s Chief Financial Officer or Investor Relations representative.

**ITEM 1A.   RISK FACTORS**

**Factors Affecting Future Operating Results**

This Form 10-Kcontains forward-looking statements concerning the Company’s future programs,products, expenses, revenue, liquidity and cash needs as well as the Company’splans and strategies. These forward-looking statements are based on currentexpectations and the Company assumes no obligation to update this information,except as required by applicable laws and regulations. Numerous factors couldcause actual results to differ significantly from the results described inthese forward-looking statements, including the following risk factors.

*Price competition in the staffing industry continues to be intense andpricing pressures from both competitors and customers may result in reduced salesand margins to the Company.*

The temporary staffingindustry is highly competitive with limited barriers to entry and continues toundergo consolidation. The Company expects the level of competition to remainhigh in the future, and competitive pricing pressures will continue to make itdifficult for the Company to raise its prices even though its costs may haveincreased, and may have an adverse effect on the Company’s market share andoperating margins. The Company competes in national, regional and local marketswith full service agencies and with specialized temporary services agencies.Many competitors are smaller than the Company but may enjoy an advantage overthe Company in discrete geographic markets because of their stronger localpresence. Other competitors have greater marketing, financial and otherresources than the Company that, among other things, could enable them toattempt to maintain or increase their market share by reducing prices.Furthermore, there has been an increase in the number of customersconsolidating their staffing services purchases with a single provider or witha small number of providers. The trend to consolidate staffing servicespurchases has in some cases made it more difficult for Westaff to obtain orretain business.

*Any significant recurrent economic downturn could result in the Company’scustomers using fewer temporary employees, which could materially adverselyaffect the Company.*

Demand for the Company’s staffing services issignificantly affected by the general level of economic activity andunemployment in the United States and the countries in which the Companyoperates. Frequently, customers use temporary staffing services to managepersonnel costs and staffing needs. When economic activity increases, temporaryemployees are often added before full-time employees are hired. However, aseconomic activity slows, many customers reduce their utilization of temporaryemployees before releasing regular full-time employees. Typically, the Companymay experience less demand for its services and more competitive pricingpressure during periods of economic downturn. The recent domestic economicrecession and resultant economic uncertainty had a material adverse effect onthe Company’s business, results of operations, cash flows and financialcondition. A recurrent recession or a significant lag in economic recoverywould likely have a further material adverse effect on the Company’s business,results of operations, cash flows or financial position.

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*Unemployment insurance premiums and workers’ compensation costs andcollateral for Westaff’s temporary employees may continue to rise and reduceWestaff’s margins and liquidity.*

Westaff is responsible for and pays unemploymentinsurance premiums and workers’ compensation costs for its regular andtemporary employees. In recent years, these costs have risen as a result ofincreased claims, general economic conditions and governmental regulations.Should these costs continue to increase in the future, there can be noassurance that Westaff will be able to increase the fees charged to itscustomers to keep pace with increased costs and if it does not, its results ofoperations, financial condition and liquidity could be adversely affected.

During the fourth quarter of fiscal 2005, the Companywas notified by the California Employment Development Department (EDD) that itsCalifornia unemployment tax rates would be increased retroactively for bothcalendar 2005 and 2004. This rate increase was based on the EDD finding thatWestaff’s wholly-owned domestic operating subsidiaries would be considered as asingle reporting entity for California unemployment tax reporting purposes. TheCompany believes that it has properly calculated its unemployment insurance taxand is in compliance with all applicable laws and regulations. The Company hastimely appealed the assessment and the rate increase and is working with itsoutside counsel to resolve this matter. The Company accrued a portion of theincreased tax during the fourth quarter of fiscal 2005. However, the Companybelieves that it has strong defenses and legal arguments with respect toapproximately $0.9 million of the assessment and accordingly has not accruedfor that portion of the assessment as of October 29, 2005. Should theCompany ultimately prove unsuccessful in its appeal, the Company would berequired to record a charge for the unaccrued portion of the assessment and payfor the taxes out of its working capital.

Westaff retains a portion of the risk under itsworkers’ compensation program (see “Business—Risk Management Programs”). Theestimated remaining deductible liability for all existing and incurred but notreported claims is accrued based upon actuarial methods using current claimsinformation, as well as prior experience, and may be subsequently revised eachquarter based on new developments related to such claims. Changes in theestimates underlying the claims reserve are charged or credited to earnings inthe period determined, and therefore large fluctuations in any given quartercould materially adversely affect earnings in that period.

The Company is contractually required to collateralizeits obligations to its insurance carrier under these workers’ compensationinsurance contracts through irrevocable letters of credit, surety bonds orcash. As of December 24, 2005, the Company’s aggregate collateralrequirements under these contracts have been satisfied through $35 million ofletters of credit; however, under certain circumstances, the Company may berequired to increase its letters of credit to $40 million.

As noted above, collateralrequirements for the Company’s workers’ compensation program are significantand place pressure on the Company’s liquidity and working capital availability.Should the Company be required to provide further collateral in addition to thefiscal 2006 payments, such additional collateral would reduce the Company’sborrowing capacity and its liquidity.

*Westaff’s success depends upon its ability to attract and retainqualified temporary personnel.*

Westaff depends upon itsability to attract and retain qualified temporary personnel who possess theskills and experience necessary to meet the staffing requirements of its customers.Westaff must continually evaluate and upgrade its base of available qualifiedpersonnel to keep pace with changing client needs and emerging technologies.Furthermore, a substantial number of the Company’s temporary employees duringany given year will terminate their employment with the Company and acceptregular staff employment with customers of the Company. Competition forindividuals with proven skills remains intense, and demand for theseindividuals is expected to remain strong for the foreseeable future. There canbe no assurance that qualified personnel will continue to be available toWestaff in sufficient numbers 

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and onterms of employment acceptable to the Company. The failure to recruit, trainand retain qualified temporary employees could materially adversely affect theCompany’s business.

*Westaff’sinformation technology systems are critical to its daily operations and theCompany initiated a process to replace these systems beginning in fiscal 2005.*

The Company’s domestic information management systems,located at a co-location facility and corporate headquarters, are critical todaily operations of the Company’s business. While backup and recovery systemsare in place, should these key systems fail it could severely impact theCompany’s business and operations, specifically its ability to timely andaccurately pay employees and bill customers.

The Company’s domesticback office payroll and billing systems are at the end of their life cycle andare no longer supported by the companies who originally supplied them. Westaffcurrently utilizes internal support to maintain and update these systems. Thisincludes the process of applying updates to remain in compliance with taxmandates and other additional regulatory requirements. This potentially createsexposure should an update not occur in a timely fashion, which could have amaterial adverse effect on the Company’s business. In fiscal 2005, the Companysuccessfully implemented two phases of its new enterprise-wide informationsystem. These phases included regular staff human resource management/payrolland core financials. In fiscal 2006, the implementation will continue and willinclude front-office, temporary payroll and billing which will result in theretirement of our existing legacy systems. This project will continue torequire significant investments in consulting fees as well as significantinternal personnel resources. While the Company anticipates a successfulimplementation, there can be no assurance that this initiative will yield theintended results. Delays in completing or an inability to successfully completethese technology initiatives could adversely affect the Company’s cash flow andoperations.

*Westaff hassignificant working capital requirements and is heavily dependent upon itsability to borrow money to meet these working capital requirements.*

The Company requires significant amounts of workingcapital to operate its business and to pay expenses relating to employment oftemporary employees. Temporary personnel are generally paid on a weekly basiswhile payments from customers are generally received 30 to 60 days afterbilling. As a result, the Company must maintain sufficient cash availability topay temporary personnel prior to receiving payment from customers.

The Company finances its operations primarily throughborrowings under its revolving credit facilities and also through cashgenerated by its operating activities. As of December 24, 2005, theCompany’s total borrowing availability was $18.2 million, with $9.2 million,$4.4 million and $4.6 million available in the US, UK and Australia,respectively.

The amount the Company is entitled to borrow under itsUS revolving credit facility is calculated each day and is dependent on thetrade accounts receivable generated from operations, which are affected byfinancial, business, economic and other factors, as well as by the daily timingof cash collections and cash outflows. If the Company experiences a significantand sustained drop in operating profits, or if there are unanticipatedreductions in cash inflows or increases in cash outlays, the Company may besubject to cash shortfalls. If such a shortfall were to occur, for even a briefperiod of time, it may have a significant adverse effect on the Company’sbusiness. Furthermore, the Company’s receivables may not be adequate to allowfor borrowings for other corporate purposes, such as capital expenditures orgrowth opportunities, and the Company would be less able to react to changes inthe market or industry conditions.

The credit facilities contain covenants which, amongother things, require the Company to maintain a minimum fixed charge coverageratio and a minimum earnings before interest, taxes, depreciation andamortization (EBITDA). The Company has, in the past, failed to comply withcertain of these covenants 

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and has been required toobtain a waiver or amendment to the credit agreement from its lenders. Anyfuture failure to comply with the covenants under the Company’s creditfacilities could result in an event of default which, if not cured or waived,could trigger prepayment obligations. If the Company were forced to refinanceborrowings under the current facilities, there can be no assurance that suchfinancing would be available or that such financing would not have a materialadverse effect on the Company’s business and financial condition. Even if suchrefinancing were available, the terms could be less favorable and the Company’sresults of operations and financial condition could be adversely affected by increasedcosts and rates.

The Company typically experiences significant seasonaland other fluctuations in its borrowings and borrowing availability,particularly in the US, and has, in the past, been required to aggressivelymanage its cash to ensure adequate funds to meet working capital requirements.Such steps included working to improve collections and adjusting the timing ofcash expenditures, reducing operating expenses where feasible and working togenerate cash from a variety of other sources.

The Company hashistorically experienced periods of negative cash flow from operations andinvestment activities, especially during seasonal peaks in revenue experiencedin the third and fourth quarters of the year. In addition, the Company isrequired to pledge amounts to secure letters of credit that collateralizecertain workers’ compensation obligations and these amounts may increase infuture periods. Any such increase in pledged amounts or sustained negative cashflows would decrease amounts available for working capital purposes and couldhave an adverse affect on the Company’s liquidity and financial condition.

*Westaff may be exposed to employment-related claims and costs that couldmaterially adversely affect its business.*

Westaff is in thebusiness of employing people and placing them in the workplace of otherbusinesses. Attendant risks of these activities include:

·       possible claims by customers of employee misconduct or negligence,

·       claims by employees of discrimination or harassment (including claimsrelating to actions of Westaff’s customers),

·       fines and costs related to the inadvertent employment of illegal aliens,

·       payment of workers’ compensation claims and other similar claims,

·       violations of wage and hour requirements,

·       errors and omissions of temporary employees, and

·       claims by customers relating to employees’ misuse of customer proprietaryinformation, misappropriation of funds, other criminal activity or torts orsimilar claims.

In addition, some or allof these claims may give rise to litigation, which could be time-consuming tothe Company’s management team as well as costly and therefore could have anegative effect on its business. In some instances, Westaff has agreed toindemnify its customers against some or all of these types of liabilities.Westaff has policies and guidelines in place to help reduce its exposure tothese risks and has purchased insurance policies against certain risks inamounts that it believes to be adequate. However, there can be no assurancethat Westaff’s insurance will be sufficient in amount or scope to cover thesetypes of risks in the future. Furthermore, there can be no assurance thatWestaff will not experience these problems in the future or that Westaff willnot incur fines or other losses or negative publicity with respect to theseproblems that could have a material adverse effect on Westaff’s business.

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*Westaff’s Founder and Chairman controls a significant amount of theCompany’s outstanding stock thus allowing him to exert significant influence onthe Company’s management and affairs.*

The Company’s Chairman andFounder, W. Robert Stover, beneficially owns directly or indirectly, or hasvoting power over, a significant amount of the Company’s outstanding stock. Asthe principal stockholder of the Company, Mr. Stover has the ability tocontrol substantially all matters submitted to the stockholders for approvaland to exert significant influence on the Company’s management and affairs. Forexample, Mr. Stover has the ability to sell his shares independently, andto control the election of the Board of Directors and the appointment ofexecutive management. He also has the ability to control any merger,consolidation, sale of substantially all of the Company’s assets or otherstrategic decisions affecting the Company or the market value of the stock.This concentration of stock and voting power could be used by Mr. Stoverto delay or prevent an acquisition of the Company or other strategic action orresult in strategic decisions that could negatively impact the value andliquidity of the outstanding stock.

*The market for Westaff’s stock may be limited and the stock price maycontinue to be extremely volatile.*

The average daily tradingvolume for Westaff’s common stock on the Nasdaq National Market was approximately39,700 shares from January 1, 2005, through December 31, 2005, andthere have been numerous days with virtually no trading in the stock.Accordingly, the market price of Westaff’s common stock is subject tosignificant fluctuations that have been, and may continue to be, exaggeratedbecause an active trading market has not developed for the stock. The Companybelieves that the common stock price has also been negatively affected by thefact that the Company’s stock is thinly traded and the absence of analystcoverage. The lack of analyst reports about the Company’s stock may make itdifficult for potential investors to make decisions about whether to purchasethe Company’s stock and may make it less likely that investors will purchasethe stock, thus further depressing the stock price. These negative factors maymake it difficult for stockholders to sell the Company’s common stock, whichmay result in losses for investors.

*Westaff’s business may suffer if it loses its key personnel.*

Westaff’s operations aredependent on the continued efforts of its executive officers and seniormanagement. Additionally, Westaff is dependent on the performance andproductivity of its local managers and field personnel. Westaff’s ability toattract and retain business is significantly affected by local relationshipsand the quality of service rendered. The loss of those key executive officersand senior management who have acquired experience in operating a staffingservice company may cause a significant disruption to Westaff’s business.Moreover, the loss of Westaff’s key local managers and field personnel mayjeopardize existing customer relationships with businesses that continue to useWestaff’s staffing services based upon past direct relationships with theselocal managers and field personnel. Either of these types of losses couldadversely affect Westaff’s operations, including Westaff’s ability to establishand maintain customer relationships.

*Westaff derives a significant portion of its revenue from franchise agentoperations.*

Franchise agent operationscomprise a significant portion of the Company’s revenue. For fiscal 2005, 28.1%of the Company’s total revenue was derived from franchise agent operations. Inaddition, the Company’s ten largest franchise agents for fiscal 2005 (based onsales volume) accounted for 17.2% of the Company’s revenue. The loss of one ormore of the Company’s franchise agents and any associated loss of customers andsales, could have a material adverse effect on the Company’s results of operations.

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*Westaff is subject to business risks associated with internationaloperations and fluctuating exchange rates.*

The Company presently hasoperations in the United Kingdom (UK), Australia and New Zealand, whichcomprised 23.2% of the Company’s revenue during fiscal 2005. Operations inforeign markets are inherently subject to certain risks, including, inparticular, different cultures and business practices, overlapping or differingtax structures, economic and political uncertainties, compliance issuesassociated with accounting and reporting requirements and changing, complex orambiguous foreign laws and regulations, particularly as they relate toemployment. All of the Company’s sales outside of the United States aredenominated in local currencies and, accordingly, the Company is subject torisks associated with fluctuations in exchange rates which could cause areduction in the Company’s profits. There can be no assurance that any of thesefactors will not have a material adverse effect on the Company’s business,results of operations, cash flows or financial condition.

*Westaff is a defendant in a variety of litigation and other actions fromtime to time, which may have a material adverse effect on the Company’sbusiness, financial condition and results of operations.*

Westaff is regularly involved in a variety oflitigation arising out of its business and, in recent years, has paidsignificant amounts as a result of adverse arbitration awards. The Company doesnot have insurance for some of these claims and there can be no assurance thatthe insurance coverage it has will cover all claims that may be assertedagainst the Company. Should the ultimate judgments or settlements not becovered by insurance or exceed its insurance coverage, they could have amaterial adverse effect on the Company’s results of operations, financialposition and cash flows. There can also be no assurance that the Company willbe able to obtain appropriate and sufficient types or levels of insurance inthe future or that adequate replacement policies will be available onacceptable terms, if at all.

*The Company is subject tothe risk of new regulations which could harm the Company’s business.*

The Company is subject tobills introduced in Congress and various state legislatures, as well as in theforeign countries in which it operates, which, if enacted, could imposeconditions that could have a negative financial impact on the Company. Suchconditions could include new or additional benefits, taxes or otherrequirements that may increase the Company’s costs of operations and reducefuture earnings.

**ITEM 1B.**   UNRESOLVEDSTAFF COMMENTS

None.

**ITEM 2.**                PROPERTIES.

The Company leases three adjacent buildings in WalnutCreek, California consisting of approximately 50,000 square feet which houseits executive and administrative offices. The lease is for a term of sevenyears commencing on January 12, 2003, with an additional five-year optionto renew.

In addition, the Companyleases space for its Company-owned offices in the United States and abroad. Themajority of the leases are for fixed terms of one to five years and containcustomary terms and conditions. The Company believes that its facilities areadequate for its current needs and does not anticipate any difficulty replacingsuch facilities or locating additional facilities, if needed.

**ITEM 3.**                LEGAL PROCEEDINGS.

In the ordinary course of its business, the Company isperiodically threatened with or named as a defendant in various lawsuits. Theprincipal risks that the Company insures against, subject to and upon the termsand conditions of its various insurance policies, are workers’ compensation,general liability, automobile liability, property damage, alternative staffingerrors and omissions, fiduciary liability and fidelity losses.

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In September 2005, Westaff’s Australiansubsidiary, together with several other entities, was named in a claim forcontribution asserted by ADI Ltd. The litigation originated in May 1998,when a fire occurred at sea on board an Australian Navy ship. The fire resultedin the death of four crewmen, and extensive damage to the ship. Aninvestigation determined that the fire was caused by the failure of fuel hosesinstalled by ADI in the ship’s engine room. The Commonwealth of Australia fileda claim against ADI which is estimated to have a value of approximately A$31million. The investigation further found that mistakes were made in theinstallation process, including those of a technical supervisor placed byWestaff with ADI. ADI alleges that if it is liable to the Commonwealth, thenWestaff is vicariously liable for the supervisor’s negligence. A defense to theclaim has been filed on behalf of Westaff. Trial is scheduled for September 2006.At this stage of the litigation, it is not possible to gauge the extent ofpotential liability of ADI and the other defendants, including Westaff, or theextent of insurance coverage that Westaff may have in the event of anunfavorable outcome.

Other than the actionlisted above, the Company is not currently a party to any material litigation.However, from time to time the Company has been threatened with, or named as adefendant in litigation brought by former franchisees or licensees, andadministrative claims and lawsuits brought by former employees. Managementbelieves the resolution of these matters will not have a material adverseeffect on the Company’s financial statements.

**ITEM 4.**                SUBMISSION OF MATTERS TO A VOTE OF SECURITYHOLDERS.

None.

**Executive Officers of theRegistrant* .**

The executive officers of the Company and theirrespective ages as of January 27, 2006, are set forth below.

| Name                 | ** ** | ** ** | ** ** | **Age**                                            | ** ** | **Position(s) Held** |
|----------------------|------------|------------|------------|----------------------------------------------------|------------|---------------------------|
| Patricia M. Newman   |       | 54         |       | President and Chief  Executive Officer             |
| Stephen  J. Russo    |       | 49         |       | Senior  Vice President, Field Operations           |
| Dirk  A. Sodestrom   |       | 48         |       | Senior  Vice President and Chief Financial Officer |
| Christa  C. Leonard  |       | 48         |       | Vice  President and Treasurer                      |
| Richard  M. Sugerman |       | 53         |       | Vice  President and Controller                     |
| Joseph  R. Coute     |       | 58         |       | Vice  President and Director of Human Resources    |
| David P. Wilson      |       | 43         |       | Vice President, Information  Services              |

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*                    Includedpursuant to Instruction 3 to Item 401(b) of Regulation S-K.

*Patricia M. Newman.**  **Ms. Newman was appointed asPresident and Chief Executive Officer of the Company effective March 16,2005. Prior to that,*Ms. Newmanheld the position of Chief Operating Officer of the Company from November 1,2004, until the appointment as President and Chief Executive Officer. Shejoined the Company as United Kingdom Managing Director in December 1998.(In November 2002, she took on the added responsibility of overseeing theCompany’s Denmark and Norway operations.) Prior to joining the Company, Ms. Newmanwas employed by Kelly Services in the UK from 1989 to 1998, most recently asCommercial Operations Director. From 1979 to 1989 she was employed by Manpowerin the UK.

*Stephen J. Russo*.   Mr. Russo joined the Company as WesternZone Manager in July 2004. On July 25, 2005, he was elected to theposition of Senior Vice President, Field Operations and is the Company’sprincipal operating officer. Prior to that, Mr. Russo was a partner at ECPGroup in Walnut Creek, California, an organizational and individual developmentconsulting partnership from October 2001 

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*to June 2004.Prior to ECP Group, Mr. Russo was Senior Vice President, ChiefAdministrative Officer and Chief Operating Officer at Gary D. Nelson Associatesfrom August 1998 to June 2001.*

*Dirk A. Sodestrom.  *Mr. Sodestrom joined the Company asController in February 1991. In December 1992, he was elected to theadditional position of Vice President. In June 1998, Mr. Sodestromwas named a Senior Vice President of the Company. Effective January 1,2001, Mr. Sodestrom was appointed as Chief Financial Officer. Mr. Sodestromwas employed from 1980 to 1991 by Price Waterhouse LLP, most recently as aSenior Audit Manager. He is a certified public accountant on inactive status.

*Christa C. Leonard.  *Ms. Leonard was hired as Vice President andTreasurer of the Company in November 2000. Ms. Leonard was previouslyemployed by USI Insurance Services Corp. as Vice President, Treasury and Tax,from 1996 to 2000. She has approximately nine years’ prior work experience inthe public accounting field, most recently from 1995 to 1996 with RobertsSchultz & Co., and also with Wallace Meyer & Co. from 1992 to1994, and KPMG Peat Marwick & Co. from 1987 to 1992. She is acertified public accountant on inactive status.

*Richard M. Sugerman.*   Mr. Sugerman was hired as Vice President andController of the Company effective February 22, 2005. Mr. Sugermanwas previously employed by DSW & Associates, Inc. as CorporateController and Secretary, from September 2002 to February 2005. From January 2001to September 2002, Mr. Sugerman was Corporate Controller andSecretary of Loquendo, Inc. Prior to that he was Vice President of Financeand Administration at Stellarnet, Inc. from March 2000 to December 2000,and Executive Vice President, Finance Director at Snyder HealthcareCommunications Worldwide from December 1998 to March 2000. Mr. Sugermanis a certified public accountant on inactive status.

*Joseph R. Coute**.**  *Mr. Coute has been employed by the Company since January 1997,as Vice President and Director of Human Resources. His previous employer wasBank of America for approximately 26 years, including 16 years in humanresources and ten years in branch operations.

*David P. Wilson**.**  *Mr. Wilson was hired in December 1997, asField Automation Manager, focusing on the field automation process. In June 1998,he was assigned the additional task of managing the customer service and helpdesk functions of the Company’s Information Services Department. Mr. Wilsonwas promoted to Vice President, Information Services in January 2001. Hehas approximately 20 years work experience in information services, mostrecently with Triad Systems Corporation as Manager, Financial and MarketingSystems, from 1991 to 1997, and Franklin Covey, Application Design Specialistfrom 1985 to 1991.

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**PART II**

**ITEM 5.**                MARKETFOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUERPURCHASES OF EQUITY SECURITIES.

*Market Information**.*   The Company’s Common Stock has been included forquotation in the Nasdaq National Market (“Nasdaq”) under the symbol “WSTF”since April 30, 1996. The following table sets forth, for the periodsindicated, the high and low closing sales prices of the Common Stock asreported on Nasdaq.

| ** **                                 | ** ** | **High** | ** ** | **Low** | ** ** |
|--------------------------------------------|------------|----------|------------|---------|------------|
| Fiscal 2004:                               |       |     |       |    |       |
| First Quarter ended January 24, 2004  |       | 2.54     |       | 1.90    |       |
| Second Quarter ended April 17, 2004   |       | 2.75     |       | 1.75    |       |
| Third Quarter ended July 10, 2004     |       | 3.58     |       | 2.16    |       |
| Fourth Quarter ended October 30, 2004 |       | 3.53     |       | 2.95    |       |
| Fiscal 2005:                               |       |     |       |    |       |
| First Quarter ended January 22, 2005  |       | 6.47     |       | 3.05    |       |
| Second Quarter ended April 16, 2005   |       | 5.59     |       | 3.21    |       |
| Third Quarter ended July 9, 2005      |       | 3.73     |       | 3.01    |       |
| Fourth Quarter ended October 29, 2005 |       | 4.71     |       | 3.41    |       |
| Fiscal 2006                                |       |     |       |    |       |
| First Quarter  ended January 21, 2006 |       | 5.20     |       | 4.45    |       |

 

On December 31, 2005, the last reported salesprice on Nasdaq for the Common Stock was $4.95 per share. As of December 31,2005, there were approximately 73 shareholders of record.

*Sales of Unregistered Securities**.  *During fiscal 2005, the Company did not sell anyunregistered securities.

*Issuer Purchases of Equity Securities**.  *None during the fourth quarter of fiscal 2005.

*Dividends**.  *The Company did not declare or pay dividends duringfiscal 2004 or fiscal 2005. Further, the Company’s current credit facilitiesprohibit payment of dividends so the Company is not currently contemplating adividend declaration.

*Securities AuthorizedUnder Equity Plans**.  *The following table sets forth securities authorizedfor issuance under equity compensation plans as of October 29, 2005. Allapplicable equity compensation plans were previously approved by securityholders.

**EQUITY COMPENSATION PLAN INFORMATION**

| **Plan Category**                                   | ** ** | ** ** | ** ** | **Number of securities to  be issued upon exercise of  outstanding options,  warrants and rights** | ** ** | **Weighted-average  exercise price of  outstanding options,  warrants and rights** | ** ** | **Number of securities  remaining available for  future issuance under  equity compensation  plans (excluding  securities reflected in  column (a))** | ** ** |
|----------------------------------------------------------|------------|------------|------------|------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------------------------------------------------------------------------------------------------|------------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|
| ** **                                               | ** ** | **(a)**    | ** ** | **(b)**                                                                                                                                              | ** ** | **(c)**                                                                                                     | ** ** |
| Equity compensation plans approved by securities holders |       |       | 640,000    |                                                                                                                                                 |       |                                                                                                        | $          | 3.69                                                                                                                                                                                                         |       |   |   | 1,482,000 |   |   |
|                                                          |            |            |            |                                                                                                                                                      |            |                                                                                                             |            |                                                                                                                                                                                                              |            |  |  |  |  |  |  |  |

 

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**ITEM6.**   SELECTED FINANCIAL DATA.

| ** **                                                                                                        | ** ** | **Fiscal Year**                                                                                                    | ** ** |
|-------------------------------------------------------------------------------------------------------------------|------------|-------------------------------------------------------------------------------------------------------------------------|------------|
| ** **                                                                                                        | ** ** | **2005**                                                                                                                | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** | **2001** | ** ** |
| ** **                                                                                                        | ** ** | **(Amounts in Thousands Except Per Share  Amounts and Number of Offices)** | ** ** |
| Revenue                                                                                                           |       | $                                                                                                                       | 612,861    |   | $ | 589,861 |   | $ | 518,738 |   | $ | 502,211 |   | $ | 553,895 |   |
| Operating income  (loss) from continuing operations                                                               |       | 6,128                                                                                                                   |       | 5,409 |   | (2,909 | ) | (3,292 | ) | (18,880 | ) |
| Income (loss)  from continuing operations before cumulative effect of change in accounting  principle (1)         |       | 20,097                                                                                                                  |       | 3,157 |   | (4,784 | ) | (1,157 | ) | (32,199 | ) |
| Earnings (loss) per  share—continuing operations before cumulative effect of change in accounting  principle |       |                                                                                                                    |       |   |   |   |   |   |   |   |   |
| Basic                                                                                                             |       | $                                                                                                                       | 1.24       |   | $ | 0.20 |   | $ | (0.30 | ) | $ | (0.07 | ) | $ | (2.03 | ) |
| Diluted                                                                                                           |       | $                                                                                                                       | 1.23       |   | $ | 0.20 |   | $ | (0.30 | ) | $ | (0.07 | ) | $ | (2.03 | ) |
| **Balance Sheet data (at end of  period):**                                                                       |       |                                                                                                                    |       |   |   |   |   |   |   |   |   |
| Working capital                                                                                                   |       | $                                                                                                                       | 40,626     |   | $ | 33,604 |   | $ | 21,237 |   | $ | 24,072 |   | $ | 16,562 |   |
| Total assets                                                                                                      |       | 138,782                                                                                                                 |       | 122,408 |   | 113,147 |   | 121,955 |   | 123,175 |   |
| Short-term debt  and capital lease  obligations                                                                   |       | 8,911                                                                                                                   |       | 16,199 |   | 25,842 |   | 25,167 |   | 30,000 |   |
| Long-term debt  and capital lease obligations (excluding current portion)                                         |       | 3,174                                                                                                                   |       | 2,125 |   | 2,590 |   | 2,000 |   |   |   |
| Stockholders’  equity                                                                                        |       | 61,621                                                                                                                  |       | 39,847 |   | 35,456 |   | 38,950 |   | 39,492 |   |
| **Other operating data:**                                                                                         |       |                                                                                                                    |       |   |   |   |   |   |   |   |   |
| Number of offices (at  end of period)                                                                             |       |                                                                                                                    |       |   |   |   |   |   |   |   |   |
| Company-owned                                                                                                     |       | 175                                                                                                                     |       | 187 |   | 197 |   | 217 |   | 254 |   |
| Franchise agent                                                                                                   |       | 63                                                                                                                      |       | 68 |   | 72 |   | 77 |   | 85 |   |
| Licensed                                                                                                          |       | 1                                                                                                                       |       | 1 |   | 1 |   | 5 |   | 10 |   |
| Total                                                                                                             |       | 239                                                                                                                     |       | 256 |   | 270 |   | 299 |   | 349 |   |

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(1)          Fiscal2005 includes the reversal of $16,681 of domestic deferred tax valuationallowance ($1.02 per diluted share). Fiscal 2001 includes the recognition of$19,249 of deferred tax asset valuation allowances ($(1.21) per diluted share).

**ITEM 7.**                MANAGEMENT’SDISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.

The following discussionis intended to assist in the understanding and assessment of significantchanges and trends related to the results of operations and financial conditionof Westaff, Inc., together with its consolidated subsidiaries. Thisdiscussion and analysis should be read in conjunction with the Company’sConsolidated Financial Statements and Notes thereto included elsewhere in thisAnnual Report on Form 10-K for the fiscal year ended October 29,2005.

**CautionaryStatement**

This notice is intended totake advantage of the “safe harbor” provided by the Private SecuritiesLitigation Reform Act of 1995 with respect to forward-looking statements.Except for the historical information contained herein, the matters discussedshould be considered forward-looking statements and readers are cautioned notto place undue reliance on those statements. The forward-looking statements inthis discussion are made based on information available as of the date hereofand are subject to a number of risks and uncertainties that could cause theCompany’s actual results and financial position to differ 

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materiallyfrom those expressed or implied in the forward-looking statements and to bebelow the expectations of public market analysts and investors. These risks anduncertainties include, but are not limited to, those discussed in “Item 1 -Business” under the heading “Factors Affecting Future Operating Results”. TheCompany undertakes no obligation to publicly release the results of anyrevisions to these forward-looking statements to reflect events orcircumstances after the date hereof or to reflect the occurrence ofunanticipated events, except as required by applicable laws and regulations.

**CriticalAccounting Policies**

The preparation of theCompany’s Consolidated Financial Statements and Notes thereto requiresmanagement to make estimates and assumptions affecting the amounts anddisclosures reported within those financial statements. These estimates areevaluated on an ongoing basis by management and generally affect revenuerecognition, collectibility of accounts receivable, workers’ compensationcosts, impairment of goodwill, income taxes, including the realizability ofdeferred tax assets, and contingencies and litigation. Management’s estimatesand assumptions are based on historical experiences and other factors believedto be reasonable under the circumstances. However, actual results undercircumstances and conditions different than those assumed could result indifferences from the estimated amounts in the financial statements.

The Company believes thefollowing critical accounting policies are those most significantly affected bymanagement’s assumptions or the use of estimates, and are important to theunderstanding of its business operations and results from operations.

*Revenue Recognition  *TheCompany follows the guidance of Emerging Issues Task Force (EITF) 99-19  “Recording Revenue Gross as a Principalversus Net as an Agent,” in its presentation of revenue and costs of services. Thisguidance requires the Company to assess whether it acts as a principal in thetransaction or as an agent acting on behalf of others. Where the Company is theprincipal in the transaction and has the risks and rewards of ownership, thetransactions are recorded gross in the statements of operations. Revenue andrelated costs of services generated by both company-owned offices and franchiseagents are included as part of the Company’s consolidated revenue and costs ofservices, respectively, since the Company has the direct contractualrelationships with the customers, holds title to the related customerreceivables and is the legal employer of the temporary employees.

The franchise agent actsas the Company’s agent and local business representative in a manner similar toa branch manager in company-owned locations. In the franchise arrangement, alladvertising, signage, invoices and correspondence with the customer are in theCompany’s name. The Company has the direct contractual relationships with itscustomers and contracts with customers are binding to the Company. The Companyis also the employer of all temporary employees in the franchise agents’operations and, as such, is obligated for the temporary employee payroll andrelated payroll taxes regardless of customer acceptance of the temporary laborservices. These factors, among others, designate the Company as a principalwith respect to its franchise agents’ operations. Franchise agents’ salesrepresented 28.1%, 29.0% and 27.0% of the Company’s total revenue for fiscal2005, 2004 and 2003, respectively. Franchise agents’ share of gross profitrepresents the net distribution earned by the franchise agent for theirservices in marketing to customers, recruiting temporary employees andservicing customer accounts.

The Company also has alicensing program in which the licensee has the direct contractual relationshipswith the customers, holds title to the related customer receivables and is thelegal employer of the temporary employees. Accordingly, revenue and costs ofservices generated by the license operation are not included in the Company’sconsolidated financial statements. The Company advances funds to licensees forpayroll, payroll taxes, insurance and other related items. Fees are paid to theCompany based either on a percentage of revenue or of gross profit generated bythe licensee and such license fees are recorded by the Company as license feesand included in revenue. As of October 29, 2005, the Company had only oneremaining licensee and is no longer offering license agreements to newprospects.

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*Collectibility of AccountsReceivable.**  *TheCompany maintains an allowance for doubtful accounts on its accounts receivablebalances for estimated losses projected to result from the inability of itscustomers to make required payments. These allowances, which were $1.0 millionand $1.1 million at October 29, 2005, and October 30, 2004,respectively, are largely determined based on customers’ financial conditions,the Company’s historical experiences, interactions with customers and industrytrends. If the financial condition of these customers were to deteriorate tothe point it would impair their ability to make the required payments,additional allowances may be required, which could materially adversely affectthe financial condition of the Company.

*Workers’ CompensationCosts.**  *TheCompany self-insures the deductible amount related to workers’ compensationclaims, which was $500,000 per claim for policy years 2003 and 2005 and$750,000 per claim for policy year 2004, and maintains accruals for theseobligations. These accruals amounted to $19.6 million and $17.1 million at October 29,2005, and October 30, 2004, respectively. The Company accrues theestimated costs of these claims based upon the expected loss rates incurredwithin the various temporary employment categories provided by the Company. Atleast annually, the Company obtains an independent actuarially determinedcalculation of the estimated costs of claims actually made to date, as well asclaims incurred but not yet reported. The resulting calculation is partiallybased on the Company’s historical loss development trends as well as overallindustry trends. As a result of updates in the actuary’s valuation, revisions aremade to recorded liabilities. Whereas management believes the recordedliabilities are adequate, there are inherent limitations in the estimationprocess whereby future actual loss rates may exceed projected loss rates, whichcould materially adversely affect the financial condition of the Company.

*Goodwill and OtherIntangible Assets.**  *Statementof Financial Accounting Standards (SFAS) No. 142 “Goodwill and OtherIntangible Assets” requires that goodwill and intangible assets that haveindefinite useful lives no longer be amortized but instead be evaluated forimpairment by applying a fair-value-based test at least annually or if eventsor circumstances change that may indicate the fair value of a reporting unit isbelow its book value. Intangible assets with finite useful lives continue to beamortized over their useful lives. The Company utilizes an independent third-partyvaluation firm to determine the fair value of its individual reporting units.The valuation methodologies considered include analyses of discounted cashflows at the reporting unit level, publicly traded companies multiples withinthe temporary staffing industry and historical control premiums paid byacquirers purchasing companies similar to Westaff. As a result of the initialimpairment tests upon adoption of SFAS No. 142, the Company recorded anon-cash charge of $0.7 million to reduce the carrying value of goodwill in itsAustralia operations. This charge is reflected as a cumulative effect of achange in accounting principle in the Company’s consolidated statement ofoperations for the fiscal year ended November 1, 2003. The Companyperforms its annual impairment tests in the fourth quarter of each fiscal year.

*Income Taxes.**  *The Company records income taxes using an asset andliability approach that requires the recognition of deferred tax assets andliabilities for the expected future tax consequences of events that have beenrecognized in the Company’s financial statements or tax returns. A valuationallowance is established when management determines it is more likely than notthat a deferred tax asset is not realizable in the foreseeable future. At October 30,2004, substantially all of the Company’s net deferred tax assets were offsetwith a valuation allowance of $18.7 million. During the fourth quarter offiscal 2005, the Company assessed the realizability of its deferred tax assets.As a result of the Company’s positive domestic earnings in fiscal 2004 and2005, the favorable projected earnings outlook, the Company’s long-term historyof profitability as well as the improvements in the Company’s financialposition, the Company determined that it is more likely than not that thedeferred tax asset will be realized. Accordingly, during the fourth quarter offiscal 2005 the Company reversed its full domestic deferred tax asset valuationallowance of $16.7 million.

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***Contingencies and Litigation.****  *In the ordinary course of its business, the Company is periodicallythreatened with or named as a defendant in various lawsuits, claims and pendingactions. The principal risks that the Company insures against are workers’ compensation,general liability, automobile liability, property damage, alternative staffingerrors and omissions, fiduciary liability and fidelity losses. If a potentialloss arising from these lawsuits, claims and actions is probable and reasonablyestimable, the Company records the estimated liability based on circumstancesand assumptions existing at the time. Whereas management believes the recordedliabilities are adequate, there are inherent limitations in the estimationprocess whereby future actual losses may exceed projected losses, which couldmaterially adversely affect the financial condition of the Company.

**Executive Overview**

We believe thatWestaff made substantial progress during fiscal 2005 towards achieving itslong-term objectives of improved growth, sustained profitability and financialstrength. The following are some of the key Westaff achievements during fiscal2005:

·       Fiscal2005 revenue increased $23.0 million or 3.9% as compared to fiscal 2004 despitea loss of sales from the divestiture of two of the Company’s significantfranchise agents in November 2004 and August 2005.

·       TheCompany launched a permanent placement growth initiative in the US duringfiscal 2005 which resulted in an increase in domestic permanent placement feesof 58.5% for fiscal 2005 as compared to fiscal 2004 and an increase in thefourth quarter 2005 permanent placement fees of 81.1% as compared to the prioryear fourth quarter.

·       Grossmargin improved to 17.3% for fiscal 2005 as compared to 16.8% in fiscal 2004primarily as a result of stabilization of workers’ compensation costs, billrate increases, changes in business mix and increased permanent placement fees.

·       TheCompany generated income from continuing operations before income taxes of $4.7million in fiscal 2005 as compared to $3.4 million in fiscal 2004, an increaseof 38.1%.

·       Asa result of increasing market demand and the Company’s improved financialperformance, the Company is in the first phase of executing its plan toreinvest in its field office staff in an effort to grow its temporary staffingand permanent placement lines of service. As of the end of fiscal 2005, fieldoffice staff had been increased by over 11% as compared to the end of fiscal2004. The Company is continuing to prudently invest in new staff as consideredappropriate to help foster top-line growth.

·       TheCompany successfully completed a restructuring during the fourth quarter offiscal 2005 which was designed to streamline and focus the organization,improve profitability and support expansion. Based on preliminary results forthe first quarter of fiscal 2006, management believes the effect of therestructure is demonstrating positive results. The Company currently expectsdomestic revenue for the first quarter of fiscal 2006 to increase between 2%and 5% as compared to the fiscal 2005 first quarter.

·       Infiscal 2005, the Company invested $8.0 million in capital expenditures,primarily relating to domestic business process management (BPM) systeminitiatives expected to result in a fully integrated, front-office toback-office system to help support future growth of the Company as well as toprovide opportunities for additional efficiencies and operating leverage. TheCompany has successfully implemented the first two phases of its BPM systemincluding its human resources system for regular Westaff employees and the corefinancial accounting and reporting systems. The final phase, which will includefully integrated front office functionality along with payroll and 

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billing for temporaryassociates, is currently scheduled to begin rollout starting late in the fourthquarter of fiscal 2006.

·       Asa result of positive cash flow from operations and the conversion of themajority of its domestic workers’ compensation cash collateral to letters ofcredit, the Company ended fiscal 2005 with total borrowings under its revolvingcredit facilities of $8.6 million as compared to $15.7 million as of the endfiscal 2004. Equally significant, the Company reduced its domestic borrowingsunder its revolving credit facilities from $11.0 million as of October 30,2004 to $2.9 million at October 29, 2005, in spite of the significantinvestment in BPM systems. As of January 21, 2006, the end of the Company’sfirst fiscal quarter, there were no borrowings outstanding under the domesticrevolving credit facility and the Company had $1.6 million of excess cash onhand.

·       Duringthe third quarter of fiscal 2005, the Company sold its Norway and Denmarksubsidiary operations. This generated a gain of $1.2 million as well as cash tothe US of $3.1 million, which includes $0.6 million of intercompany debtrepayment from Norway. We believe that this divestiture allows the Company tofocus its full efforts on its key markets of the US, UK, Australia and NewZealand.

·       Asa result of the Company’s positive domestic earnings in fiscal 2004 and 2005,the favorable projected earnings outlook, the Company’s long-term history ofprofitability as well as the improvements in the Company’s financial position,the Company has determined that it is more likely than not that its domesticdeferred tax asset will be realized. Accordingly, during the fourth quarter offiscal 2005, the Company reversed its full deferred tax asset valuationallowance of $16.7 million.

For fiscal 2006, the Company intends to focus on thefollowing key operating objectives:

·       Groworganically by prudently adding revenue-generating staff while also seekingappropriate new markets to enter through new office openings.

·       Firmlyestablish the Company’s permanent placement service line within the US andcontinue to generate significant growth and improved margins as a result ofthis business.

·       Completethe initial implementation of the Company’s new Business Process Management Systemand begin the roll-out of the fully integrated system to the field offices.

·       Carefullymonitor the Company’s financial performance against its goals by establishingspecific performance targets for each office and linking achievement of thosegoals with incentive plans. The key objective will be to continue to foster thelong-term growth of the Company while also seeking reasonable operating returnsduring fiscal 2006.

·       Launcha number of marketing campaigns during fiscal 2006 following some successfulcampaigns that we launched in the fourth quarter of fiscal 2005.

·       Continueto expand our base of regional and national account relationships.

·       Asopportunities and financing allow, carefully consider potential strategicacquisitions that would provide access to important new markets, expansionwithin existing markets and opportunities to take immediate advantage ofoperating leverage.

In recent years, theCompany has carefully managed its expenses, exercised discipline in itsmanagement of cash, implemented prudent growth and business developmentinitiatives and successfully restructured its field and corporate organization.As a result, the Company believes that is has positioned itself to takeadvantage of future opportunities within the staffing industry to grow revenueand improve its operating margins. However, the Company is also keenly aware ofmany of the business and economic risks 

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connectedwith the staffing industry and intends to continue to be prudent in itsinvestments and conservative in its use of cash.

**Discontinued Operations**

Effective June 15, 2005, the Company sold itsNorway and Denmark subsidiary operations to Personalhuset AS, a recruitment andstaffing company headquartered in Norway. Net proceeds from the sale wereapproximately $2.7 million. Additionally, as a part of the sale transaction,Westaff Norway repaid approximately $0.6 million of intercompany debt toWestaff US. Of the total proceeds, approximately $0.2 million is being held inan interest bearing escrow account as security for potential Westaff Norwaypension claims. The escrowed funds, net of any claim payments, will be remittedto the Company in June 2007. The Company recorded a net gain on the saleof $1.2 million. The Company has classified the operations as discontinuedoperations and, accordingly, has segregated the assets, liabilities, revenueand expenses of these discontinued operations in the accompanying financialstatements and notes thereto.

As required under the terms of the Company’sMulticurrency Credit Agreement, the net proceeds from the sale of the Norwayand Denmark operations were used to pay down borrowings on the Company’srevolving credit facility. Interest expense has been allocated to thesediscontinued operations in accordance with EITF 87-24.

During fiscal 1999, theCompany discontinued its medical business (Western Medical) principally througha sale to Intrepid U.S.A. Under the terms of the sale, the Company retained themajority of accounts receivable, including trade and Medicare accounts receivablebalances.

Prior to fiscal 2003, the Company appealed WesternMedical’s 1996 Medicare cost report settlement. During the first quarter offiscal 2003, as a result of the favorable appeal settlement, the Companyrecognized $0.3 million of income from discontinued operations. During thethird quarter of 2004, the Company resolved certain significant legal andliability claims and evaluated future risks associated with remaining pendingclaims and, as a result, recorded $0.2 million of income from the medicaldiscontinued operations. 

As of October 29, 2005, there are remainingcurrent liabilities of the discontinued medical operations of $0.1 million,primarily for settled but unpaid claims.

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**Results of Continuing Operations**

Thetable below sets forth, for the three most recent fiscal years, certain resultsof continuing operations data as a percentage of revenues.

| ** **                                                                                                             | ** ** | **Fiscal Year** | ** ** |
|------------------------------------------------------------------------------------------------------------------------|------------|----------------------|------------|
| ** **                                                                                                             | ** ** | **2005**             | ** ** | **2004** | ** ** | **2003** | ** ** |
| Revenue                                                                                                                |       | 100.0                | %          | 100.0 | % | 100.0 | % |
| Costs of services                                                                                                      |       | 82.7                 | %          | 83.2 | % | 83.0 | % |
| Gross profit                                                                                                           |       | 17.3                 | %          | 16.8 | % | 17.0 | % |
| Franchise agents’  share of gross profit                                                                          |       | 3.1                  | %          | 3.1 | % | 3.2 | % |
| Selling and  administrative expenses                                                                                   |       | 12.5                 | %          | 11.8 | % | 13.1 | % |
| Depreciation and  amortization                                                                                         |       | 0.7                  | %          | 0.7 | % | 1.0 | % |
| Arbitration  expenses                                                                                                  |       | 0.0                  | %          | 0.2 | % | 0.2 | % |
| Operating income  (loss) from continuing operations                                                                    |       | 1.0                  | %          | 0.9 | % | (0.6 | )% |
| Interest expense                                                                                                       |       | 0.3                  | %          | 0.4 | % | 0.3 | % |
| Interest income                                                                                                        |       | *                    |       | * |   | * |   |
| Income (loss)  from continuing operations before income taxes and cumulative effect of  change in accounting principle |       | 0.8                  | %          | 0.6 | % | (0.9 | )% |
| Income tax  provision (benefit)                                                                                        |       | (2.5                 | )%         | * |   | 0.1 | % |
| Income (loss) from  continuing operations before cumulative effect of change in accounting  principle                  |       | 3.3                  | %          | 0.5 | % | (0.9 | )% |

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*                    lessthan 0.1%

**Fiscal2005 compared to Fiscal 2004**

Revenue increased $23.0million or 3.9% for fiscal 2005 as compared to fiscal 2004. Domestic revenueincreased $0.6 million or 0.1%, while international revenue increased 18.8%over fiscal 2004.

The domestic revenueincrease is the result of a decrease in billed hours of 2.6% which was offsetby an increase in average bill rates of 2.6%. The decline in domestic billedhours reflects the effects of the November 2004 divestiture of one theCompany’s franchises, the August 2005 divestiture of another of theCompany’s franchises and a shift in business mix in an effort to increase grossmargin. The increase in average bill rates reflects the generally more positiveeconomic environment with lower national unemployment rates which allows theCompany to pass along bill rate increases to customers in certaincircumstances.

Permanent placement feesincreased from $6.1 million in fiscal 2004 to $7.1 million in fiscal 2005, anincrease of 16.1%. This increase is virtually all attributable to Westaff’sdomestic operations which grew from $1.7 million in fees in fiscal 2004 to $2.7million in fiscal 2005, an increase of 58.5%. As a percentage of revenue,permanent placement fees in the U.S were 0.6% in fiscal 2005 as compared to0.4% in fiscal 2004. The Company is continuing to invest in permanent placementconsultants and expects this revenue to increase in the US during fiscal 2006.

Of the 18.8% increase ininternational revenue noted above, 5.3% is attributable to higher currencyexchange rates. International billed hours increased 7.9% and average bill ratesincreased 5.8%. Local currency revenue from Australia increased 28.4% as aresult of strong national account sales growth. Local currency revenue in theUK declined 7.7% during fiscal 2005 primarily due to “offshoring” of certainstaffing functions by a number of Westaff’s UK customers.

The Company was beenaggressively working to increase its top-line sales growth rates in the US. Duringthe first eight weeks of fiscal 2006, domestic sales have increased over 6% ascompared to the prior 

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year. Takinginto consideration the timing of the fiscal 2006 holidays, the Companycurrently expects domestic revenue for the first quarter of fiscal 2006 toincrease 2% to 5% as compared to the fiscal 2005 quarter.

Costs of services includehourly wages of temporary employees, employer payroll taxes, state unemploymentand workers’ compensation insurance and other employee-related costs. Costs ofservices increased $16.4 million, or 3.3%, in fiscal 2005 as compared to fiscal2004. Fiscal 2005 gross profit dollars increased $6.6 million, or 6.7%, andgross margin increased to 17.3% as compared to 16.8% for fiscal 2004. Grossmargin increased primarily as a result of stabilization of workers’compensation costs as noted below, bill rate increases, changes in business mixand increased permanent placement fees as noted above, partially offset byhigher state unemployment insurance costs.

The Company’s workers’compensation costs tend to vary depending upon the mix of business betweenclerical/administrative and light industrial staffing. Unexpected adversedevelopment of open claims and increases in the Company’s incurred but notreported (IBNR) claims can also significantly affect the level of accrualsneeded to cover workers’ compensation costs. The Company reviews interim andannual actuarial estimates and monitors claim activity to ensure that accrualsremain appropriate in light of loss trends. However, unanticipated adverse lossdevelopment trends can result in a need for additional charges to be recorded. Asa percent of direct labor, domestic workers’ compensation costs decreased from5.9% in fiscal 2004 to 5.4% in fiscal 2005. The fiscal 2004 fourth quarterincluded a charge of $1.7 million to increase the Company’s domestic workers’compensation reserves as a result of unfavorable loss development trends.During fiscal 2005 the Company increased its basic accrual rates for workers’compensation which, combined with more stable loss trends, resulted in no suchcharge in fiscal 2005. The Company aggressively works to close out claims onterms that are favorable to the Company and continually monitors its costs andaccrual rates in light of actual loss trends. However, there can be noassurance that the Company’s efforts to control workers’ compensation costswill be effective or that loss development trends will not require additionalincreases in workers’ compensation accruals in future periods.

As a percent of directlabor, domestic state unemployment rates increased from 2.6% in fiscal 2004 to3.1% in fiscal 2005. This increase is largely due to an increase in theunemployment tax rate assessed in the State of California. During the fourthquarter of fiscal 2005, the Company was notified by the California EmploymentDevelopment Department (EDD) that its California unemployment tax rates wouldbe increased retroactively for both calendar years 2005 and 2004. This rateincrease was based on the EDD finding that Westaff’s wholly-owned domesticoperating subsidiaries would be considered as a single reporting entity for Californiaunemployment tax reporting purposes. The Company believes that it has properlycalculated its unemployment insurance tax and is in compliance with allapplicable laws and regulations. The Company has timely appealed the ruling bythe EDD and is working with its outside counsel to resolve this matter. TheCompany accrued a portion of the increased tax during the fourth quarter offiscal 2005. However, the Company believes that it has strong defenses andlegal arguments with respect to approximately $0.9 million of the assessmentand accordingly has not accrued for that portion of the assessment as of October 29,2005.

The Company continues tofocus its efforts on improving gross margin through development of itspermanent placement service line as well as through increases in its billingrates. Management believes that there are opportunities to continue to improvegross margin during fiscal 2006 based on higher estimated permanent placementfees, potentially lower national unemployment rates which may allow forcontinued bill rate increases and potential continued stabilization of workers’compensation costs and state unemployment insurance rates.

Franchise agents’ share ofgross profit represents the net distribution paid to franchise agents basedeither on a percentage of the sales or gross profit generated by the franchiseagents’ operations. As a percentage of consolidated revenue, franchise agents’share of gross profit was 3.1% for both fiscal 2005 

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andfiscal 2004. In November 2004 the Company sold one of its franchise agents’operations, representing four franchise offices, back to the franchise agent. Revenuefor this franchise agent comprised 3.2% of total domestic revenue for thefiscal year ended October 30, 2004. In August 2005 the Company soldone additional franchise agent operation, representing two franchise offices,back to the franchise agent. Year-to-date fiscal 2005 revenue for thisfranchise agent through the date of the sale comprised approximately 0.7% ofthe Company’s fiscal 2005 domestic revenue.

Selling and administrativeexpenses increased $6.8 million, or 9.7%, for the 2005 fiscal year as comparedto fiscal 2004 due primarily to investments in new and existing personnel alongwith associated benefits and payroll taxes. As a percentage of revenue, sellingand administrative expenses increased to 12.5% in fiscal 2005 from 11.8% infiscal 2004. The Company is continuing its investment in its field officestaff, increasing full-time equivalent positions by approximately 11% as of theend of fiscal 2005 as compared to the prior year end. These staff increaseshave been made to support the development of the Company’s domestic permanentplacement line of business along with increasing staff in selected offices tohelp support future growth and business development. Additionally, the Companyhas increased staffing to support the implementation of its new businessprocess management system. The fiscal 2005 fourth quarter included $0.5 millionof costs associated with a restructure while the fiscal 2005 second quarterincluded separation costs of $0.5 million for the Company’s former chiefexecutive officer. Selling and administrative expenses in the second quarter offiscal 2004 were reduced by a $0.7 million gain on the sale of the executiveheadquarters building in Walnut Creek, California. The fiscal 2004 fourthquarter included costs of $0.9 million associated with an unfavorablearbitration ruling.

Depreciation andamortization decreased $0.2 million or 5.0%, primarily due to assets becomingfully depreciated partially offset by higher depreciation starting in thefourth quarter associated with the portions of the Company’s BPM system thathave been placed in service. The Company expects depreciation expense toincrease in fiscal 2006 as a result of the ongoing depreciation of the new BPMsystem.

Interest expense decreased$0.5 million for fiscal 2005 as compared to fiscal 2004 primarily as a resultof lower average borrowings outstanding during the year partially offset byhigher average interest rates. Interest expense is expected to decline infiscal 2006 as a result of lower borrowings. However, the Company continues toamortize debt issuance costs associated with its credit agreement which areexpected to approximate $0.6 million during fiscal 2006. Under generallyaccepted accounting principles, these costs are charged to interest expense.

The Company records incometaxes using an asset and liability approach that requires the recognition ofdeferred tax assets and liabilities for the expected future tax consequences ofevents that have been recognized in the Company’s financial statements or taxreturns. A valuation allowance is established when management determines it ismore likely than not that a deferred tax asset is not realizable in theforeseeable future. At October 30, 2004, substantially all of the Company’snet deferred tax assets were offset with a valuation allowance of $18.7 million.During the fourth quarter of fiscal 2005, the Company assessed therealizability of its deferred tax assets. As a result of the Company’s positivedomestic earnings in fiscal 2004 and 2005, the favorable projected earningsoutlook, the Company’s long-term history of profitability as well as theimprovements in the Company’s financial position, the Company determined thatit is more likely than not that the deferred tax asset will be realized. Accordingly,during the fourth quarter of fiscal 2005 the Company reversed its full domesticdeferred tax asset valuation allowance of $16.7 million which resulted in anincrease in net income for fiscal 2005 of $16.7 million or $1.02 per dilutedshare.

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**Fiscal2004 compared to Fiscal 2003**

Revenue increased $71.1million, or 13.7%, for fiscal 2004 as compared to fiscal 2003. Domestic revenueincreased 10.1%, while international revenue from continuing operationsincreased 31.9% over fiscal 2003, with favorable currency exchange ratescontributing 16.9% of the revenue increase.

The domestic revenueincrease was the result of an increase in billed hours of 8.4% coupled with amodest increase in average bill rates of 1.5%. The growth in domestic billedhours reflects new business as well as increases in volume with variousexisting customers. International billed hours increased 11.4% andyear-over-year average bill rates increased in both the Australia and UnitedKingdom operations.

Costs of servicesincreased $60.1 million, or 14.0%, in fiscal 2004 as compared to fiscal 2003.Gross margin declined from 17.0% for fiscal 2003 to 16.8% for fiscal 2004. Themargin decline reflected the industry-wide strain on domestic margins due tocompetitive pressures as well as higher relative state unemployment and workers’compensation costs. As a percent of direct labor, the fiscal 2004 domesticstate unemployment rates increased 0.5 percentage points and domestic workers’compensation rates increased 0.3 percentage points over the fiscal 2003 rates.International gross margins increased from 20.1% for fiscal 2003 to 20.6% forfiscal 2004, with margin improvements in Australia and the United Kingdomdriven largely by increases in direct hire fees.

Workers’ compensationcosts rose to $21.6 million, or 5.0% of direct labor, for fiscal 2004, up from$18.6 million or 4.9% of direct labor for fiscal 2003. Continued upward trendsin the Company’s actuarially estimated ultimate costs for all open policy yearsresulted in an increase in the Company’s workers’ compensation accruals in bothfiscal 2004 and fiscal 2003. Based on the results of its annual actuarialvaluation, the Company recorded a charge of $1.7 million in the fourth quarterof fiscal 2004 to increase its domestic workers’ compensation reserves. Thefourth quarter of fiscal 2003 included a similar charge of $1.8 million.

Franchise agents’ share ofgross profit increased $1.9 million or 11.4% for fiscal 2004 as compared tofiscal 2003. As a percentage of consolidated revenue, franchise agents’ shareof gross profit declined slightly from 3.2% in fiscal 2003 to 3.1% in fiscal2004.

Selling and administrativeexpenses increased $1.7 million, or 2.5% for the 2004 fiscal year as comparedto fiscal 2003 primarily due to higher exchange rates used to translateinternational local currency expenses into US dollars. As a percentage ofrevenue these expenses decreased from 13.1% to 11.8% largely as a result of theCompany generating revenue increases of 13.7% in fiscal 2004 while limitingselling and administrative expenditure increases to only 2.5%. Selling andadministrative expenses for the 2004 fiscal year included a $0.7 million gainon the sale of the Company’s remaining unoccupied corporate headquarters’building.

During the fourth quarterof fiscal 2004, the Company received an unfavorable arbitration ruling relatingto a contract dispute with one of its vendors. Total costs associated with thisclaim, including the arbitration award plus related attorneys’ fees, were $1.1million for fiscal 2004. Fiscal 2003 included a charge of $1.0 million for anunfavorable California appellate court decision, which reversed a superiorcourt ruling regarding a binding arbitration award issued in January of2002.

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Depreciation and amortization decreased $1.0 millionor 18.3%, primarily due to reduced capital expenditures, assets becoming fullydepreciated and the sales of the Company’s corporate headquarters’ buildings.

Interest expenseincreased $0.5 million for fiscal 2004 as compared to fiscal 2003 primarily asa result of higher average borrowings outstanding during the year combined withhigher average interest rates. Additionally, fiscal 2004 interest expenseincludes $0.1 million of interest expense related to the unfavorablearbitration ruling discussed above.

Effective November 3,2002, the Company adopted Statement of Financial Accounting Standards (SFAS)No. 142 “Goodwill and Other Intangible Assets.” SFAS No. 142 providesthat goodwill and other intangible assets with indefinite lives are no longeramortized, but rather are evaluated for impairment by applying a fair-valuebased test. During fiscal 2003, the Company performed tests for impairment inaccordance with the new standard. In the initial test under the transitionalprovisions of SFAS No. 142, the Company determined that an impairment of$0.7 million existed in its Australia reporting unit. In accordance with SFASNo. 142, the impairment was classified as a cumulative effect of a change inaccounting principle and resulted in a restatement of the Company’s net lossfor the first fiscal quarter of 2003. The Company performed its annualimpairment valuations in the fourth quarters of fiscal 2005 and 2004. Noadditional impairments were identified.

**Liquidity and Capital Resources**

The Company requires significant amounts of workingcapital to operate its business and to pay expenses relating to employment oftemporary employees. The Company’s traditional use of cash is for financing ofaccounts receivable, particularly during periods of economic upswings andgrowth and during periods where sales are seasonally high. Temporary personnelare generally paid on a weekly basis while payments from customers aregenerally received 30 to 60 days after billing.

The Company finances its operations primarily throughcash generated by its operating activities and borrowings under its revolvingcredit facilities. Net cash provided by operating activities was $8.5 millionfor the fiscal year ended October 29, 2005, compared to $13.8 million forthe fiscal year ended October 30, 2004. Substantially all of the fiscal2005 cash provided by operating activities is the result of $21.1 million innet income reduced by the Company’s reversal of $16.7 million of domesticdeferred tax asset valuation allowance as noted above in “Results of ContinuingOperations—Fiscal 2005 compared to Fiscal 2004.”

Cash used for capital expenditures, which are primarilyfor business process management (BPM) system initiatives, other software,computers and peripherals, and office furniture and equipment, was $8.0 millionfor fiscal 2005. The Company continues to invest in enhancements and upgradesto its computer-based technologies. On August 19, 2004, the Companyentered into a license agreement for a BPM system which the Company intends toimplement in three primary phases. The initial phase, which consisted of thehuman resources system for regular Westaff employees, was successfullyimplemented in July 2005. The second phase, which includes the corefinancial accounting and reporting systems, went live as scheduled with thestart of the new fiscal year in November 2005. The final phase, which willinclude fully integrated front office functionality along with payroll andbilling for temporary associates, is currently scheduled to begin rolloutstarting late in the fourth quarter of fiscal 2006. The Company recentlydecided to convert the accounts receivable system in a separate phase which isexpected to be completed during the second fiscal quarter of 2006. Capitalexpenditures associated with this system implementation were approximately $5.3million during fiscal year 2005. The Company’s credit agreement currentlyallows up to a maximum of $6.0 million in capital expenditures for fiscal 2006.

The Company has generated cash in the past throughsales of Company-owned offices to franchise owners or sales of franchise agentand license offices back to the franchise agent or license owner. In the firstquarter of fiscal 2005, the Company sold one of its franchise agents’operations back to the franchise 

30

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agent for cash proceeds of$1.0 million. The Company has secured the franchise agents’ note payableobligation to the bank that funded the purchase, through a $1.0 million letterof credit that declines as the note obligation is paid by the franchise agent. Asof October 29, 2005, the balance on the letter of credit was $0.9 million.The $1.0 million gain on the sale of the franchise operations has beendeferred, and is being recognized as the note obligation payments are made. Duringthe fourth quarter of fiscal 2005, the Company sold an additional franchiseagent’s operations to the franchise agent for cash proceeds and a net gain of$0.5 million.

As noted above in “Discontinued Operations,” effectiveJune 15, 2005, the Company sold its Norway and Denmark subsidiaryoperations for net proceeds of approximately $2.7 million, with an additional$0.6 million repayment of intercompany debt. Of the total proceeds,approximately $0.2 million is being held in an interest bearing escrow accountas security for potential claims under Norway’s pension plans. The escrowedfunds, net of any claim payments, will be remitted to the Company in June 2007.The proceeds received were used to pay down borrowings under the Company’srevolving credit facility. The Company recorded a net gain on the sale of $1.2million.

On February 12, 2004, the Company completed thesale of its former corporate headquarters’ building for cash proceeds of $1.9million. The proceeds were used to pay down outstanding borrowings under theCompany’s revolving credit facilities. The Company has an outstanding $0.7million irrevocable standby letter of credit as a security deposit for the December 2002sale leaseback of the land and buildings housing its administrative offices.

On May 17, 2002, the Company entered intoagreements with GE Capital, as primary agent, to provide senior secured creditfacilities totaling $65.0 million, expiring in May 2007. The facilitiescomprise a five-year syndicated Multicurrency Credit Agreement consisting of a$50.0 million US Revolving Loan Commitment, a £2.7 million UK Revolving LoanCommitment (US dollar equivalent of approximately $4.0 million at the date ofthe agreement), and a $5.0 millions term loan (the Term Loan), which wasrepaid during fiscal 2003. In addition, a five-year Australian dollar facilityagreement (the A$ Facility Agreement) was executed on May 16, 2002, consistingof an A$12.0 million revolving credit facility (US dollar equivalent ofapproximately $6.0 million at the date of the agreement).

On August 19, 2005, the Multicurrency CreditAgreement was amended to allow an add-back of approximately $1.0 million to theEBITDA covenant relating to separation and restructuring costs incurred or tobe incurred during fiscal 2005. The amendment also allows the gain from thesale of the Registrant’s Norway and Denmark operations of $1.2 million to beincluded in determining compliance with the EBITDA and fixed charge covenants.Additionally, the amendment increases the maximum capital expenditures allowedfor fiscal 2005 from $6.0 million to $8.5 million and also increases the letterof credit sublimit from $35.0 million to $40.0 million.

As of October 29, 2005, the Company had $8.6million outstanding under its credit facilities consisting of $2.9 millionoutstanding from the US and $5.7 million outstanding from Australia. TheCompany had combined available borrowing capacity under its credit facilitiesof $21.1 million consisting of $10.8 million for the US, $4.7 million for the UKand $5.6 million for Australia. The Company was in compliance with allcovenants under its credit agreements as of October 29, 2005.

The Company has an unsecured subordinated promissorynote payable to its principal stockholder and Chairman of the Board ofDirectors in the amount of $2.0 million with a maturity date of August 18,2007, and an interest rate equal to an indexed rate as calculated under theCompany’s credit facilities plus seven percent, compounded monthly and payable60 calendar days after the end of each of the Company’s fiscal quarters.Payment of interest is contingent on the Company meeting minimum availabilityrequirements under its credit facilities. Additionally, payments of principalor interest are prohibited in the event of any default under the creditfacilities. The sixth amendment to the Company’s Multicurrency 

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Credit Agreement providesfor optional prepayment of the note subject to certain borrowing availabilitylimits on the US revolving loan commitment portion of the credit facilities.

On September 25, 2003, the Company executed aone-year unsecured subordinated draw down note with its principal stockholderand Chairman of the Board of Directors. The note provided for the Chairman tomake advances to the Company upon request, at his sole discretion and with noobligation to do so, in an aggregate principal amount not to exceed $1.0million outstanding at any one time. On December 23, 2003, the Chairmanmade a $1.0 million advance to the Company under the terms of the note. Theadvance plus accrued interest was repaid on August 3, 2004.

The Company works to balance its worldwide cash needsthrough dividends from and loans to its international subsidiaries. These loansand dividends are limited by the cash availability and needs of each respectivesubsidiary, restrictions imposed by the Company’s senior secured debtfacilities and, in some cases, statutory regulations of the subsidiary. The USoperations cannot directly draw on the excess borrowing availability of the UKor Australian operations; however, the Company may request dividends from theUK. During fiscal 2004, the UK utilized cash from operations and excessborrowing capacity to pay dividends to the US totaling $2.7 million. The US canalso request repayments on its intercompany loan to Australia, along withintercompany interest and royalties, although remittances from Australia may belimited by certain covenants under the terms of the Australia credit facility.Outstanding principal on the intercompany loan to Australia was $4.1 million asof October 29, 2005, and October 30, 2004.

The Company is responsible for and pays workers’compensation costs for its temporary and regular employees and is self-insuredfor the deductible amount related to workers’ compensation claims ($500,000 perclaim for fiscal years 2005 and 2003 and $750,000 per claim for fiscal 2004).  Each policy year the terms of the agreementwith the insurance carrier are renegotiated. The insurance carrier requires theCompany to collateralize its obligations through the use of irrevocable standbyletters of credit, surety bonds or cash. Effective April 20, 2005, theCompany’s insurance carrier reduced its collateral requirements for the Companythrough the cancellation of a $3.8 million surety bond thereby eliminating anyremaining outstanding surety bond. The Company does not believe that suretybonds will be available in the foreseeable future to secure workers’compensation obligations.

Under the terms of its 2005 policy year agreement, theCompany made cash payments totaling $20.6 million, paid in monthlyinstallments, which commenced on November 1, 2004. Of these payments,$15.8 million served as cash collateral to secure the Company’s fiscal 2005obligations in lieu of issuance of additional letters of credit. Cash paymentsfor 2005 policy year claims were paid out of this cash collateral fund.

During the fourth quarter of fiscal 2005, the Companyand its insurance carrier negotiated the return of $11.0 million of the fiscal2005 cash collateral and the Company issued $11.0 million of letters of creditin its place. During the first quarter of fiscal 2006, the Company issued anadditional $1.9 million of letters of credit in exchange for $1.2 million incash which represented all of the cash remaining in the 2005 collateral fund.

The Company recently completed negotiations for its2006 policy year insurance program. Total cash payments of $4.9 million will bepaid during fiscal 2006 in equal monthly installments, which commenced on November 1,2005. Cash payments for 2006 policy year claims will be paid directly by theCompany. In connection with the 2006 policy renewal and as a result of thecollateral swap noted above, as of December 24, 2005, the Company hadoutstanding $35.0 million of letters of credit to secure all outstandingobligations under its workers’ compensation program for all years except 2003,which is fully funded although subject to annual retroactive premiumadjustments based on actual claims activity. Under certain circumstances, theCompany may be required to increase its letters of credit to $40 million. TheCompany will also make ongoing cash payments for claims for all other openpolicy years (except for 2003 as noted above).

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As noted above in Results of Operations for the fiscalyear 2004, the Company received an unfavorable arbitration ruling relating to acontract dispute with one of its vendors. Payments of $0.9 million for theaward plus remaining related attorneys’ fees were paid during the first quarterof fiscal 2005.

During the first quarter of fiscal 2005, the Companyreceived $0.5 million of domestic federal income tax refunds relating to carrybackprovisions.

The Company continues toevaluate other opportunities to further strengthen its financial position.However, the Company believes that the borrowing capacity provided under theamended credit agreement, together with cash generated through its operatingperformance, will be sufficient to meet the Company’s working capital needs forthe foreseeable future.

**Off-Balance Sheet Arrangements**

None.

**Contractual Obligations**

Thefollowing summarizes the Company’s contractual cash obligations in futurefiscal years (in millions) as of October 29, 2005: 

| ** **                                   | ** ** | **Payment Due by Period(1)** | ** ** |
|----------------------------------------------|------------|---------------------------------------------|------------|
| **Contractual Obligations**             | ** ** | ** **                                  | ** ** | **Total** | ** ** | **Less than one  fiscal year** | ** ** | **1 to 3  fiscal years** | ** ** | **4 to 5  fiscal years** | ** ** | **More than 5  fiscal years** | ** ** |
| Credit facilities                            |       | $                                           | 8.6        |   |   | $ | 8.6 |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Promissory note                              |       | 2.0                                         |       |   |   |   |   |   | $ | 2.0 |   |   |   |   |   |   |   |   |   |   |
| Operating leases                             |       | 11.6                                        |       |   | 4.0 |   |   |   | 5.1 |   |   |   | $ | 2.2 |   |   |   | $ | 0.3 |   |   |
| Workers’  compensation policy year 2006 |       | 4.9                                         |       |   | 4.9 |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Capital leases—principal                |       | 1.6                                         |       |   | 0.3 |   |   |   | 0.8 |   |   |   | 0.5 |   |   |   |   |   |   |
| Capital leases—interest                 |       | 0.4                                         |       |   | 0.1 |   |   |   | 0.3 |   |   |   |   |   |   |   |   |   |   |
| Total Contractual  Obligations               |       | $                                           | 29.1       |   |   | $ | 17.9 |   |   |   | $ | 8.2 |   |   |   | $ | 2.7 |   |   |   | $ | 0.3 |   |   |
|                                              |            |                                             |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

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(1)          Thecredit agreement expires in May 2007, but the Company’s lenders couldrequire accelerated payment of amounts outstanding under the credit facilitiesin the event of default on one or more of the debt covenants contained therein.Payments under the promissory note are subject to certain restrictionsregarding borrowing capacity and compliance within the Company’s senior securedcredit facilities. Workers’ compensation obligations for policy year 2006 arebased on estimates. If actual results differ from these estimates the Companycould be required to make additional payments to, or receive refunds from, itsinsurance carrier in years subsequent to 2006.

**ITEM 7A.**   QUANTITATIVE ANDQUALITATIVE DISCLOSURES ABOUT MARKET RISK.

The Company is exposed to certain market risks fromtransactions that are entered into during the normal course of business. TheCompany’s primary market risk exposure relates to interest rate risk. At October 29,2005, the Company’s outstanding debt under variable-rate interest borrowingswas approximately $10.6 million. A change of two percentage points in theinterest rates would cause a change in interest expense of approximately $0.2million on an annual basis. The Company’s exposure to market risk for changesin interest rates is not significant with respect to interest income, as itsinvestment portfolio is not material to its consolidated balance sheet. TheCompany currently has no plans to hold an investment portfolio that includesderivative financial instruments.

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For the fiscal year ended October 29,2005, the Company’s international continuing operations comprised 23.2% of itsrevenue and, as of the end of that period, 17.2% of its total assets. TheCompany is exposed to foreign currency risk primarily due to its investments inforeign subsidiaries. The Company’s multicurrency credit facility, which allowsthe Company’s Australia and United Kingdom subsidiaries to borrow in localcurrencies, partially mitigates the exchange rate risk resulting fromfluctuations in foreign currency denominated net investments in thesesubsidiaries in relation to the US dollar. The Company does not currently holdany market risk sensitive instruments entered into for hedging transactionrisks related to foreign currencies. In addition, the Company has not enteredinto any transactions with derivative financial instruments for tradingpurposes.

**ITEM 8.**   FINANCIALSTATEMENTS AND SUPPLEMENTARY DATA.

The Financial Statementsand Supplementary Data of the Company required by this Item are set forth atthe pages indicated at Item 15(a).

**ITEM 9.**   CHANGES IN ANDDISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE.

None.

**ITEM 9A.**   CONTROLS ANDPROCEDURES.

The Company carried out anevaluation, under the supervision and with the participation of the Company’smanagement, including the Chief Executive Officer and Chief Financial Officer,of the effectiveness of the design and operation of the Company’s “disclosurecontrols and procedures” (as defined under Rules 13a–15(e) and 15d–15(e) underthe Securities Exchange Act of 1934 as amended). Based on this evaluation, theChief Executive Officer and Chief Financial Officer concluded that, as ofOctober 29, 2005 (the end of the period covered by this report) the Company’sdisclosure controls and procedures are effective in timely alerting them tomaterial information required to be included in this report. There was nochange in the Company’s internal control over financial reporting that occurredduring the fiscal period ended October 29, 2005, that has materially affected,or is reasonably likely to materially affect, the Company’s internal controlsover financial reporting.

**ITEM 9B.   OTHER INFORMATION.**

None.

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**PART III**

**ITEM 10.**   DIRECTORS ANDEXECUTIVE OFFICERS OF THE REGISTRANT.

The information requiredby this Item is incorporated herein by reference to the Company’s ProxyStatement for the 2006 Annual Meeting of Stockholders. Information required bythis item as to the executive officers of the Company is included as Item 4A ofPart I of this Annual Report on Form 10-K as permitted byInstruction 3 to Item 401(b) of Regulation S-K. The Company has adopted aCode of Ethics that applies to all the Company’s principal executive, financialand accounting officers. The Code of Ethics is posted on the Company website at*www.westaff.com*. The Company intends tosatisfy the requirements under Item 5.05 of Form 8-K regardingdisclosure of amendments to, or waivers from, provisions of its Code of Ethicsthat apply, by posting such information on the Company’s website. Copies of theCode of Ethics will be provided, free of charge, upon written request directedto Investor Relations, Westaff, Inc., P.O. Box 9280, Walnut Creek, CA94598.

**ITEM 11.**   EXECUTIVECOMPENSATION.

The information requiredby this Item is incorporated herein by reference to the Company’s ProxyStatement for the 2006 Annual Meeting of Stockholders.

**ITEM 12.**   SECURITYOWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDERMATTERS.

The information requiredby this Item is incorporated herein by reference to the Company’s ProxyStatement for the 2006 Annual Meeting of Stockholders.

**ITEM 13.**   CERTAINRELATIONSHIPS AND RELATED TRANSACTIONS.

See Note 5 of “Notes toConsolidated Financial Statements” under Item 15 of this Form 10-K.The information required by this Item is incorporated herein by reference tothe Company’s Proxy Statement for the 2006 Annual Meeting of Stockholders.

**ITEM 14.**   PRINCIPALACCOUNTANT FEES AND SERVICES.

The information requiredby this Item is incorporated herein by reference to the Company’s ProxyStatement for the 2006 Annual Meeting of Stockholders.

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**PART IV**

**ITEM 15.**   EXHIBITS ANDFINANCIAL STATEMENT SCHEDULES.

(a)           The following documents have been filed as a partof this Annual Report on Form 10-K.

| 1.     |   | Financial Statements                                                                                                                |   |   |
|--------|--------|-------------------------------------------------------------------------------------------------------------------------------------|--------|--------|
|   |   | Report of Independent Registered Public Accounting  Firm                                                                            |   | F-1    |
|   |   | Consolidated Balance Sheets—As of the Fiscal Year  Ended October 29, 2005 and the Fiscal Year Ended October 30, 2004 |   | F-2    |
|   |   | Consolidated Statements of Operations—For Each of  the Three Years in the Period Ended October 29, 2005                   |   | F-3    |
|   |   | Consolidated Statements of Stockholders’ Equity—For  Each of the Three Years in the Period Ended October 29, 2005    |   | F-4    |
|   |   | Consolidated Statements of Cash Flows—For Each of  the Three Years in the Period Ended October 29, 2005                   |   | F-5    |
|   |   | Notes to Consolidated Financial Statements                                                                                          |   | F-6    |

 

2.                 FinancialStatement Schedules.All schedules are omitted because they are not applicable or not required orbecause the required information is included in the Consolidated FinancialStatements or the Notes thereto.

3.                 Exhibits.The following exhibits are filed as part of, or incorporated by reference into,this Annual Report:

| **Exhibit   Number** | ** ** | **Description**                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         |
|----------------------|------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 3.1.2                |       | Fourth Amended and Restated Certificate of  Incorporation.(6)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           |
| 3.2.4                |       | Amended and Restated Bylaws, effective March 1,  2004.(11)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         |
| 4.1.1                |       | Form of Specimen Certificate for the Company’s  Common Stock.(2)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              |
| 10.1                 |       | Form of Indemnification Agreement between the  Company and the Officers and Key Employees of the Company.(1)                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |
| 10.2                 |       | Form of Indemnification Agreement between the  Company and the Directors of the Company.(1)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |
| 10.3.4               |       | Employment Agreement with W. Robert Stover.(2)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |
| 10.3.5               |       | Employment Contract between the Company and Dirk A.  Sodestrom.(3)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      |
| 10.3.5.1             |       | First Amendment to Employment Contract By and  Between Westaff Support, Inc. and Dirk A. Sodestrom.(8)                                                                                                                                                                                                                                                                                                                                                                                                                                                                             |
| 10.3.5.2             |       | Second Amendment to Employment Contract By and  Between Westaff Support, Inc. and Dirk A. Sodestrom.(12)                                                                                                                                                                                                                                                                                                                                                                                                                                                                      |
| 10.3.9               |       | Addendum made the 26th day of January 2005 to agreement  between Westaff (UK) Limited (“the Company”) and Patricia M. Newman (“the  Employee”) supplemental to an agreement made as of the 1st day of December 1998 between the  Company and the Employee; an addendum made as of the 4th day of February 1999 between the  Company and the Employee; a letter dated the 3rd day of April 2001 from Bob Stover to  Employee; and a memorandum dated 23rd February 2004 between the Company and the  Employee.(14) |
| 10.3.9.1             |       | Employment Agreement executed on April 7, 2005  between Westaff, Inc., Westaff Support, Inc. and Patricia M.  Newman.(20)                                                                                                                                                                                                                                                                                                                                                                                                                                                |
| 10.3.9.2             |       | Notice of Restricted Stock Award and Restricted  Stock Agreement dated April 7, 2005.(20)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |
| 10.3.9.4             |       | Notices of Grant of Stock Option dated April 7,  2005 (replaces Exhibit 10.3.9.3).(16)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |
| 10.3.9.5             |       | First Amendment to Employment Agreement between  Westaff, Inc., Westaff Support, Inc. and Patricia M. Newman                                                                                                                                                                                                                                                                                                                                                                                                                                                                  |

36

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| 10.3.10.1 |   | Third Amendment to Employment Contract by and  between the Company and Stephen Russo dated August 17, 2005, Second  Amendment to Employment Contract by and between the Company and Stephen Russo  dated July 1, 2004, First Amendment to Employment Contract by and  between the Company and Stephen Russo dated July 1, 2004, and Employment  Contract by and between the Company and Stephen Russo dated July 1,  2004. (17) |
|-----------|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.7      |   | Westaff, Inc. 1996 Stock Option/Stock Issuance  Plan, as amended and restated.(4)                                                                                                                                                                                                                                                                                                                                                              |
| 10.8.20   |   | Credit Agreement dated as of May 17, 2002.(5)                                                                                                                                                                                                                                                                                                                                                                                                  |
| 10.8.20.1 |   | First Amendment to Multicurrency Credit Agreement,  Limited Waiver and Consent of Guarantors.(7)                                                                                                                                                                                                                                                                                                                                                    |
| 10.8.20.2 |   | Second Amendment to Multicurrency Credit Agreement,  Limited Waivers and Consent of Guarantors.(8)                                                                                                                                                                                                                                                                                                                                                  |
| 10.8.20.3 |   | Third Amendment to Multicurrency Credit Agreement,  Limited Waiver and Consent of Guarantors.(9)                                                                                                                                                                                                                                                                                                                                                    |
| 10.8.20.4 |   | Fourth Amendment to Multicurrency Credit Agreement,  Limited Waivers and Consent of Guarantors.(10)                                                                                                                                                                                                                                                                                                                                                 |
| 10.8.20.5 |   | Fifth Amendment to Multicurrency Credit Agreement  and Consent of Guarantors.(12)                                                                                                                                                                                                                                                                                                                                                                   |
| 10.8.20.6 |   | Sixth Amendment to Multicurrency Credit Agreement  and Consent of Guarantors.(15)                                                                                                                                                                                                                                                                                                                                                                   |
| 10.8.20.7 |   | Seventh Amendment to Multicurrency Credit Agreement  and Consent of Guarantors.(18)                                                                                                                                                                                                                                                                                                                                                                 |
| 10.8.21   |   | Deed of Trust, Absolute Assignment of Leases and  Rents, Security Agreement and Fixture Filing effective as of May 17,  2002.(5)                                                                                                                                                                                                                                                                                                               |
| 10.8.22   |   | Pledge Agreement dated as of May 17, 2002.(5)                                                                                                                                                                                                                                                                                                                                                                                                  |
| 10.8.23   |   | Security Agreement dated as of May 17, 2002.(5)                                                                                                                                                                                                                                                                                                                                                                                                |
| 10.8.24   |   | Parent Guaranty dated as of May 17, 2002.(5)                                                                                                                                                                                                                                                                                                                                                                                                   |
| 10.8.25   |   | Subsidiary Guaranty dated as of May 17,  2002.(5)                                                                                                                                                                                                                                                                                                                                                                                              |
| 10.8.26   |   | Amended and Restated Unsecured Subordinated Note  dated May 17, 2002.(5)                                                                                                                                                                                                                                                                                                                                                                       |
| 10.8.27   |   | Unsecured Subordinated Draw Down Note dated  September 25, 2003.(9)                                                                                                                                                                                                                                                                                                                                                                            |
| 10.11     |   | Westaff, Inc. Employee Stock Purchase Plan.(4)                                                                                                                                                                                                                                                                                                                                                                                                 |
| 10.11.3   |   | International Employee Stock Purchase Plan.(4)                                                                                                                                                                                                                                                                                                                                                                                                      |
| 10.12     |   | Westaff Key Employee Transition Compensation  Plan.(13)                                                                                                                                                                                                                                                                                                                                                                                             |
| 10.13     |   | Form of Employment Contract with Certain Named  Executive Officers.(4)                                                                                                                                                                                                                                                                                                                                                                         |
| 21.1      |   | Subsidiaries of the Company.                                                                                                                                                                                                                                                                                                                                                                                                                        |
| 23.1      |   | Consent of Independent Registered Public Accounting  Firm                                                                                                                                                                                                                                                                                                                                                                                           |
| 24.1      |   | Power of Attorney (see page IV-1).                                                                                                                                                                                                                                                                                                                                                                                                             |
| 31.1      |   | Certification of the Chief Executive Officer  pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.                                                                                                                                                                                                                                                                                                                                       |
| 31.2      |   | Certification of the Chief Financial Officer  pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.                                                                                                                                                                                                                                                                                                                                       |
| 32.1      |   | Certification of the Chief Executive Officer  pursuant to 18 U.S.C. Section 1350 as Adopted Pursuant to  Section 906 of the Sarbanes-Oxley Act of 2002.                                                                                                                                                                                                                                                                                   |
| 32.2      |   | Certification of the Chief Financial Officer  pursuant to 18 U.S.C. Section 1350 as Adopted Pursuant to  Section 906 of the Sarbanes-Oxley Act of 2002.                                                                                                                                                                                                                                                                                   |

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(1)          Incorporated herein byreference to the exhibit with the same number filed with the Company’sRegistration Statement on Form S-1 (File No. 33-85536)declared effective by the Securities and Exchange Commission on April 30,1996.

(2)          Incorporated herein byreference to the exhibit with the same number filed with the Company’s AnnualReport on Form 10-K for the fiscal year ended October 31, 1998.

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(3)          Incorporated herein byreference to the exhibit with the same number filed with the Company’s AnnualReport on Form 10-K for the fiscal year ended October 28, 2000.

(4)          Incorporated herein byreference to the exhibit with the same number filed with the Company’s AnnualReport on Form 10-K for the fiscal year ended November 3, 2001.

(5)          Incorporated herein byreference to the exhibit with the same number filed with the Company’sQuarterly Report on Form 10-Q for the quarter ended April 20,2002.

(6)          Incorporated herein byreference to the exhibit with the same number filed with the Company’sQuarterly Report on Form 10-Q for the quarter ended July 13,2002.

(7)          Incorporated herein byreference to the exhibit with the same number filed with the Company’s AnnualReport on Form 10-K for the fiscal year ended November 2, 2002.

(8)          Incorporated herein byreference to the exhibit with the same number filed with the Company’sQuarterly Report on Form 10-Q for the quarter ended July 12, 2003.

(9)          Incorporated herein byreference to the exhibit with the same number filed with the Company’s AnnualReport on Form 10-K for the fiscal year ended November 1, 2003.

(10)   Incorporated herein byreference to the exhibit with the same number filed with the Company’sQuarterly Report on Form 10-Q for the quarter ended January 24,2004.

(11)   Incorporated herein byreference to the exhibit with the same number filed with the Company’s CurrentReport on Form 8-K dated March 1, 2004.

(12)   Incorporated herein byreference to the exhibit with the same number filed with the Company’sQuarterly Report on Form 10-Q for the quarter ended July 10,2004.

(13)   Incorporated herein byreference to the exhibit with the same number filed with the Company’s CurrentReport on Form 8-K dated September 20, 2004.

(14)   Incorporated herein byreference to the exhibit with the same number filed with the Company’s AnnualReport on Form 10-K for fiscal year ended October 30, 2004.

(15)   Incorporated herein byreference to the exhibit with the same number filed with the Company’s CurrentReport on Form 8-K dated January 5, 2005.

(16)   Incorporated herein byreference to the exhibit with the same number filed with the Company’sQuarterly Report on Form 10-Q for the quarter ended April 16,2005.

(17)   Incorporated herein byreference to the exhibit with the same number filed with the Company’sQuarterly Report on Form 10-Q for the quarter ended July 9,2005

(18)   Incorporated herein byreference to the exhibit with the same number filed with the Company’s CurrentReport on Form 8-K dated August 19, 2005.

38

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**REPORTOF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM**

To the Board of Directors and Stockholders of Westaff, Inc.

We have audited the accompanying consolidated balancesheets of Westaff, Inc. and subsidiaries (the Company) as of October 29,2005 and October 30, 2004, and the related consolidated statements ofoperations, stockholders’ equity, and cash flows for each of the three years inthe period ended October 29, 2005. These financial statements are theresponsibility of the Company’s management. Our responsibility is to express anopinion on these financial statements based on our audits.

We conducted our audits in accordance with thestandards of the Public Company Accounting Oversight Board (United States). Thosestandards require that we plan and perform the audit to obtain reasonableassurance about whether the financial statements are free of materialmisstatement. The Company is not required to have, nor were we engaged toperform, an audit of its internal control over financial reporting. Our auditsincluded consideration of internal control over financial reporting as a basisfor designing audit procedures that are appropriate in the circumstances, butnot for the purpose of expressing an opinion on the effectiveness of theCompany’s internal control over financial reporting. Accordingly, we express nosuch opinion. An audit also includes examining, on a test basis, evidencesupporting the amounts and disclosures in the financial statements. An auditalso includes assessing the accounting principles used and significantestimates made by management, as well as evaluating the overall financialstatement presentation. We believe that our audits provide a reasonable basisfor our opinion.

In our opinion, such consolidated financial statementspresent fairly, in all material respects, the financial position of Westaff,Inc. and subsidiaries as of  October 29,2005 and October 30, 2004, and the results of their operations and theircash flows for each of the three years in the period ended October 29,2005, in conformity with accounting principles generally accepted in the UnitedStates of America.

As discussed in Note 2,effective November 3, 2002 the Company changed its method of accounting forgoodwill and other intangibles to conform to Statement of Financial AccountingStandards No. 142, Goodwill and Other Intangible Assets.

/s/ DELOITTE & TOUCHE LLP

Oakland, CaliforniaJanuary 25, 2006

F-1

----

**Westaff, Inc.Consolidated Balance Sheets(Amounts in thousands except per share amounts)**

| ** **                                                                                                                                      | ** ** | **October 29,** | ** ** | **October 30,** | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------------------------|------------|----------------------|------------|----------------------|------------|
| ** **                                                                                                                                      | ** ** | **2005**             | ** ** | **2004**             | ** ** |
| **ASSETS**                                                                                                                                      |       |                 |       |                 |       |   |   |   |   |
| Current assets:                                                                                                                                 |       |                 |       |                 |       |   |   |   |   |
| Cash and cash equivalents                                                                                                                       |       |                 | $          | 3,014                |       |   |   | $ | 4,386 |   |   |
| Trade accounts receivable, less allowance for  doubtful accounts of $997 and $1,085                                                             |       |                 | 83,416     |                 |       |   | 83,107 |   |   |
| Income taxes receivable                                                                                                                         |       |                 | 82         |                 |       |   | 795 |   |   |
| Deferred income taxes                                                                                                                           |       |                 | 5,097      |                 |       |   | 286 |   |   |
| Prepaid expenses                                                                                                                                |       |                 | 3,847      |                 |       |   | 4,272 |   |   |
| Assets of discontinued operations                                                                                                               |       |                 |       |                 |       |   | 4,850 |   |   |
| Other current assets                                                                                                                            |       |                 | 1,337      |                 |       |   | 818 |   |   |
| Total current assets                                                                                                                            |       |                 | 96,793     |                 |       |   | 98,514 |   |   |
| Property and equipment, net                                                                                                                     |       |                 | 15,184     |                 |       |   | 10,100 |   |   |
| Deferred income taxes                                                                                                                           |       |                 | 11,951     |                 |       |   |   |   |   |
| Goodwill                                                                                                                                        |       |                 | 11,770     |                 |       |   | 11,760 |   |   |
| Other long-term assets                                                                                                                          |       |                 | 3,084      |                 |       |   | 2,034 |   |   |
|                                                                                                                                            |       |                 | $          | 138,782              |       |   |   | $ | 122,408 |   |   |
| **LIABILITIES AND STOCKHOLDERS’  EQUITY**                                                                                                  |       |                 |       |                 |       |   |   |   |   |
| Current liabilities:                                                                                                                            |       |                 |       |                 |       |   |   |   |   |
| Borrowings under revolving credit facilities                                                                                                    |       |                 | $          | 8,568                |       |   |   | $ | 15,734 |   |   |
| Current portion of capital lease obligations                                                                                                    |       |                 | 343        |                 |       |   | 465 |   |   |
| Accounts payable                                                                                                                                |       |                 | 3,755      |                 |       |   | 2,562 |   |   |
| Accrued expenses                                                                                                                                |       |                 | 42,609     |                 |       |   | 42,989 |   |   |
| Income taxes payable                                                                                                                            |       |                 | 817        |                 |       |   | 632 |   |   |
| Liabilities of discontinued operations                                                                                                          |       |                 | 75         |                 |       |   | 2,528 |   |   |
| Total current liabilities                                                                                                                       |       |                 | 56,167     |                 |       |   | 64,910 |   |   |
| Note payable to related party                                                                                                                   |       |                 | 2,000      |                 |       |   | 2,000 |   |   |
| Long-term capital lease obligations                                                                                                             |       |                 | 1,174      |                 |       |   | 125 |   |   |
| Other long-term liabilities                                                                                                                     |       |                 | 17,820     |                 |       |   | 15,526 |   |   |
| Total liabilities                                                                                                                               |       |                 | 77,161     |                 |       |   | 82,561 |   |   |
| Commitments and  contingencies (Notes 2, 12 and 14)                                                                                             |       |                 |       |                 |       |   |   |   |   |
| Stockholders’  equity:                                                                                                                     |       |                 |       |                 |       |   |   |   |   |
| Preferred stock,  $.01 par value; authorized and unissued: 1,000 shares                                                                         |       |                 |       |                 |       |   |   |   |   |
| Common stock, $.01 par value; authorized: 25,000  shares; issued: 16,378 shares at October 29, 2005 and 16,047 shares at  Ocotber 30, 2004 |       |                 | 164        |                 |       |   | 160 |   |   |
| Additional paid-in capital                                                                                                                      |       |                 | 37,803     |                 |       |   | 36,768 |   |   |
| Deferred stock compensation                                                                                                                     |       |                 | (54        | )                    |       |   |   |   |   |
| Retained earnings                                                                                                                               |       |                 | 24,151     |                 |       |   | 3,025 |   |   |
| Accumulated other comprehensive loss                                                                                                            |       |                 | (443       | )                    |       |   | (106 | ) |   |
| Total stockholders’ equity                                                                                                                 |       |                 | 61,621     |                 |       |   | 39,847 |   |   |
|                                                                                                                                            |       |                 | $          | 138,782              |       |   |   | $ | 122,408 |   |   |

 

See accompanying notes to consolidated financial statements.

F-2

----

**Westaff, Inc.Consolidated Statements of Operations(Amounts in thousands except per share amounts)**

| ** **                                                                                                             | ** ** | **Fiscal year ended** | ** ** |
|------------------------------------------------------------------------------------------------------------------------|------------|---------------------------------|------------|
| ** **                                                                                                             | ** ** | **October 29,**            | ** ** | **October 30,** | ** ** | **November 1,** | ** ** |
| ** **                                                                                                             | ** ** | **2005**                        | ** ** | **2004** | ** ** | **2003** | ** ** |
| Revenue                                                                                                                |       |                            | $          | 612,861 |   |   |   | $ | 589,861 |   |   |   | $ | 518,738 |   |   |
| Costs of services                                                                                                      |       |                            | 507,052    |   |   |   | 490,664 |   |   |   | 430,560 |   |   |
| Gross profit                                                                                                           |       |                            | 105,809    |   |   |   | 99,197 |   |   |   | 88,178 |   |   |
| Franchise agents’  share of gross profit                                                                          |       |                            | 18,884     |   |   |   | 18,494 |   |   |   | 16,599 |   |   |
| Selling and  administrative expenses                                                                                   |       |                            | 76,635     |   |   |   | 69,856 |   |   |   | 68,175 |   |   |
| Depreciation and  amortization                                                                                         |       |                            | 4,162      |   |   |   | 4,380 |   |   |   | 5,363 |   |   |
| Arbitration  expenses (Note 14)                                                                                        |       |                            |       |   |   |   | 1,058 |   |   |   | 950 |   |   |
| Operating income (loss) from continuing operations                                                                     |       |                            | 6,128      |   |   |   | 5,409 |   |   |   | (2,909 | ) |   |
| Interest expense                                                                                                       |       |                            | 1,587      |   |   |   | 2,098 |   |   |   | 1,624 |   |   |
| Interest income                                                                                                        |       |                            | (148       | ) |   |   | (85 | ) |   |   | (110 | ) |   |
| Income (loss) from  continuing operations before income taxes and cumulative effect of change in  accounting principle |       |                            | 4,689      |   |   |   | 3,396 |   |   |   | (4,423 | ) |   |
| Income tax  provision (benefit)                                                                                        |       |                            | (15,408    | ) |   |   | 239 |   |   |   | 361 |   |   |
| Income (loss) from continuing operations before cumulative  effect of change in accounting principle                   |       |                            | 20,097     |   |   |   | 3,157 |   |   |   | (4,784 | ) |   |
| Discontinued  operations:                                                                                              |       |                            |       |   |   |   |   |   |   |   |   |   |   |
| Income (loss) from discontinued operations                                                                             |       |                            | (134       | ) |   |   | 316 |   |   |   | 326 |   |   |
| Gain on sale, net of income taxes of $34                                                                               |       |                            | 1,163      |   |   |   |   |   |   |   |   |   |   |
| Total discontinued  operations, net of income taxes                                                                    |       |                            | 1,029      |   |   |   | 316 |   |   |   | 326 |   |   |
| Cumulative effect  of change in accounting principle                                                                   |       |                            |       |   |   |   |   |   |   |   | (670 | ) |   |
| Net income (loss)                                                                                                      |       |                            | $          | 21,126 |   |   |   | $ | 3,473 |   |   |   | $ | (5,128 | ) |   |
| Earnings (loss)  per share:                                                                                            |       |                            |       |   |   |   |   |   |   |   |   |   |   |
| Continuing  operations before cumulative effect

of  change in accounting principle                                    |       |                            |       |   |   |   |   |   |   |   |   |   |   |
| Basic                                                                                                                  |       |                            | $          | 1.24 |   |   |   | $ | 0.20 |   |   |   | $ | (0.30 | ) |   |
| Diluted                                                                                                                |       |                            | $          | 1.23 |   |   |   | $ | 0.20 |   |   |   | $ | (0.30 | ) |   |
| Discontinued operations—basic and diluted                                                                         |       |                            | $          | 0.06 |   |   |   | $ | 0.02 |   |   |   | $ | 0.02 |   |   |
| Cumulative effect of change in accounting principle—basic  and diluted                                            |       |                            | $          | — |   |   |   | $ | — |   |   |   | $ | (0.04 | ) |   |
| Net  income (loss)                                                                                                     |       |                            |       |   |   |   |   |   |   |   |   |   |   |
| Basic                                                                                                                  |       |                            | $          | 1.30 |   |   |   | $ | 0.22 |   |   |   | $ | (0.32 | ) |   |
| Diluted                                                                                                                |       |                            | $          | 1.29 |   |   |   | $ | 0.22 |   |   |   | $ | (0.32 | ) |   |
| Weighted average shares outstanding—basic                                                                         |       |                            | 16,271     |   |   |   | 16,033 |   |   |   | 15,996 |   |   |
| Weighted average shares  outstanding—diluted                                                                      |       |                            | 16,420     |   |   |   | 16,081 |   |   |   | 15,996 |   |   |

 

See accompanying notes to consolidated financial statements.

F-3

----

**Westaff, Inc.Consolidated Statements of Stockholders’ Equity(Amounts in thousands)**

| ** **                                  | ** ** | ** **            | ** ** | ** **  | ** ** | ** **       | ** ** | **Retained**      | ** ** | **Accumulated** | ** ** | ** **       | ** ** | ** ** | ** ** |
|---------------------------------------------|------------|-----------------------|------------|-------------|------------|------------------|------------|-------------------|------------|-----------------|------------|------------------|------------|------------|------------|
| ** **                                  | ** ** | ** **            | ** ** | ** **  | ** ** | **Additional**   | ** ** | **earnings**      | ** ** | **other**       | ** ** | **Deferred**     | ** ** | ** ** | ** ** |
| ** **                                  | ** ** | **Common stock** | ** ** | **paid-in** | ** ** | **(accumulated** | ** ** | **comprehensive** | ** ** | **stock**       | ** ** | ** **       | ** ** |
| ** **                                  | ** ** | **Shares**            | ** ** | **Amount**  | ** ** | **capital**      | ** ** | **deficit)**      | ** ** | **loss**        | ** ** | **Compensation** | ** ** | **Total**  | ** ** |
| Balance at November 2, 2002                 |       |                  | 15,972     |        |       |             | $          | 160               |       |            |       | $                | 36,627     |       |       |   | $ | 4,680 |   |   |   | $ | (2,517 | ) |   |   | $ | — |   |   | $ | 38,950 |   |
| Comprehensive  loss:                        |       |                  |       |        |       |             |       |              |       |            |       |             |       |       |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Net loss                                    |       |                  |       |        |       |             |       |              |       |            |       |             |       |       | (5,128     | ) |   |   |   |   |   |   |   |   |   |   |   |
| Currency translation adjustments       |       |                  |       |        |       |             |       |              |       |            |       |             |       |       |       |   |   |   | 1,555 |   |   |   |   |   |   |   |   |
| Total comprehensive loss                    |       |                  |       |        |       |             |       |              |       |            |       |             |       |       |       |   |   |   |   |   |   |   |   |   |   | (3,573) |   |
| Stock issued under employees' stock plans   |       |                  | 43         |        |       |             |       |              |       |            | 79         |             |       |       |       |   |   |   |   |   |   |   |   |   |   | 79 |   |
| Balance at November 1, 2003                 |       |                  | 16,015     |        |       |             | 160        |              |       |            | 36,706     |             |       |       | (448       | ) |   |   | (962 | ) |   |   | — |   |   | 35,456 |   |
| Comprehensive  income:                      |       |                  |       |        |       |             |       |              |       |            |       |             |       |       |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Net income                                  |       |                  |       |        |       |             |       |              |       |            |       |             |       |       | 3,473      |   |   |   |   |   |   |   |   |   |   |   |   |
| Currency translation adjustments       |       |                  |       |        |       |             |       |              |       |            |       |             |       |       |       |   |   |   | 856 |   |   |   |   |   |   |   |   |
| Total comprehensive income                  |       |                  |       |        |       |             |       |              |       |            |       |             |       |       |       |   |   |   |   |   |   |   |   |   |   | 4,329 |   |
| Stock issued under employees' stock plans   |       |                  | 32         |        |       |             |       |              |       |            | 62         |             |       |       |       |   |   |   |   |   |   |   |   |   |   | 62 |   |
| Balance at October 30, 2004                 |       |                  | 16,047     |        |       |             | 160        |              |       |            | 36,768     |             |       |       | 3,025      |   |   |   | (106 | ) |   |   | — |   |   | 39,847 |   |
| Comprehensive  income:                      |       |                  |       |        |       |             |       |              |       |            |       |             |       |       |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Net income                                  |       |                  |       |        |       |             |       |              |       |            |       |             |       |       | 21,126     |   |   |   |   |   |   |   |   |   |   |   |   |
| Currency translation adjustments       |       |                  |       |        |       |             |       |              |       |            |       |             |       |       |       |   |   |   | (337 | ) |   |   |   |   |   |   |   |
| Total comprehensive income                  |       |                  |       |        |       |             |       |              |       |            |       |             |       |       |       |   |   |   |   |   |   |   |   |   |   | 20,789 |   |
| Stock issued under employees' stock plans   |       |                  | 331        |        |       |             | 4          |              |       |            | 826        |             |       |       |       |   |   |   |   |   |   |   | (64 | ) |   | 766 |   |
| Tax benefits from employee  stock plans     |       |                  |       |        |       |             |       |              |       |            | 209        |             |       |       |       |   |   |   |   |   |   |   |   |   |   | 209 |   |
| Amortization of deferred stock compensation |       |                  |       |        |       |             |       |              |       |            |       |             |       |       |       |   |   |   |   |   |   |   | 10 |   |   | 10 |   |
| Balance at October  29, 2005                |       |                  | 16,378     |        |       |             | $          | 164               |       |            |       | $                | 37,803     |       |       |   | $ | 24,151 |   |   |   | $ | (443 | ) |   |   | $ | (54 | ) |   | $ | 61,621 |   |

 

See accompanying notes to consolidated financial statements.

 

F-4

----

**Westaff, Inc.Consolidated Statements of Cash Flows(Amounts in thousands)**

| ** **                                                                                       | ** ** | **Fiscal year ended** | ** ** |
|--------------------------------------------------------------------------------------------------|------------|---------------------------------|------------|
| ** **                                                                                       | ** ** | **October 29,  2005**      | ** ** | **October 30,  2004** | ** ** | **November 1,  2003** | ** ** |
| **Cash flows from operating activities**                                                         |       |                            |       |   |   |   |   |   |   |   |   |   |   |
| Net income (loss)                                                                                |       |                            | $          | 21,126 |   |   |   | $ | 3,473 |   |   |   | $ | (5,128 | ) |   |
| Adjustments to reconcile  net income (loss) to net cash provided (used) by operating activities: |       |                            |       |   |   |   |   |   |   |   |   |   |   |
| Gain on sale of  discontinued operations, net of income taxes                                    |       |                            | (1,163     | ) |   |   |   |   |   |   |   |   |   |
| Loss from  cumulative effect of change in accounting principle                                   |       |                            |       |   |   |   |   |   |   |   | 670 |   |   |
| Tax benefits from  employee stock plans                                                          |       |                            | 209        |   |   |   |   |   |   |   |   |   |   |
| Depreciation and  amortization                                                                   |       |                            | 4,190      |   |   |   | 4,474 |   |   |   | 5,500 |   |   |
| Provision for  losses on doubtful accounts                                                       |       |                            | 582        |   |   |   | 1,168 |   |   |   | 639 |   |   |
| Deferred income  taxes                                                                           |       |                            | (16,766    | ) |   |   | (278 | ) |   |   |   |   |   |
| Income from sales  of affiliate operations                                                       |       |                            | (30        | ) |   |   | (25 | ) |   |   | (128 | ) |   |
| (Gain) loss on  sale or disposal of assets                                                       |       |                            | (60        | ) |   |   | (657 | ) |   |   | 51 |   |   |
| Other                                                                                            |       |                            | (137       | ) |   |   | (198 | ) |   |   | (268 | ) |   |
| Changes in assets and  liabilities:                                                              |       |                            |       |   |   |   |   |   |   |   |   |   |   |
| Trade accounts  receivable                                                                       |       |                            | (1,511     | ) |   |   | (9,209 | ) |   |   | (3,221 | ) |   |
| Other assets                                                                                     |       |                            | (3,901     | ) |   |   | 140 |   |   |   | (4,518 | ) |   |
| Accounts payable  and accrued expenses                                                           |       |                            | 5,480      |   |   |   | 14,678 |   |   |   | 1,500 |   |   |
| Income taxes  payable                                                                            |       |                            | 151        |   |   |   | (11 | ) |   |   | (179 | ) |   |
| Other liabilities                                                                                |       |                            | (165       | ) |   |   | 268 |   |   |   | 145 |   |   |
| Net cash provided (used)  by operating activities                                                |       |                            | 8,005      |   |   |   | 13,823 |   |   |   | (4,937 | ) |   |
| **Cash flows from investing activities**                                                         |       |                            |       |   |   |   |   |   |   |   |   |   |   |
| Capital  expenditures                                                                            |       |                            | (7,544     | ) |   |   | (3,369 | ) |   |   | (2,593 | ) |   |
| Proceeds from  sales of affiliate operations                                                     |       |                            | 1,067      |   |   |   | 41 |   |   |   | 328 |   |   |
| Proceeds from  sales of assets                                                                   |       |                            |       |   |   |   | 1,945 |   |   |   | 7,386 |   |   |
| Proceeds from sale  of discontinued operations, net of cash acquired  by purchaser               |       |                            | 1,238      |   |   |   |   |   |   |   |   |   |   |
| Other, net                                                                                       |       |                            | 227        |   |   |   | (170 | ) |   |   | 48 |   |   |
| Net cash (used)  provided by investing activities                                                |       |                            | (5,012     | ) |   |   | (1,553 | ) |   |   | 5,169 |   |   |
| **Cash flows from financing activities**                                                         |       |                            |       |   |   |   |   |   |   |   |   |   |   |
| Net (repayments)  borrowings under line of credit agreements                                     |       |                            | (7,117     | ) |   |   | (9,903 | ) |   |   | 5,008 |   |   |
| Proceeds from  issuance of notes payable to related party                                        |       |                            |       |   |   |   | 1,000 |   |   |   |   |   |   |
| Payment of note  payable to related party                                                        |       |                            |       |   |   |   | (1,000 | ) |   |   | (1,000 | ) |   |
| Principal payments  on long-term debt and capital lease obligations                              |       |                            | (476       | ) |   |   | (432 | ) |   |   | (4,848 | ) |   |
| Payment of debt  issuance costs                                                                  |       |                            | (67        | ) |   |   | (178 | ) |   |   | (362 | ) |   |
| Proceeds from  issuance of common stock                                                          |       |                            | 764        |   |   |   | 63 |   |   |   | 79 |   |   |
| Net cash used by  financing activities                                                           |       |                            | (6,896     | ) |   |   | (10,450 | ) |   |   | (1,123 | ) |   |
| Effect of exchange  rate changes on cash                                                         |       |                            | (76        | ) |   |   | 414 |   |   |   | 166 |   |   |
| Net change in cash  and cash equivalents                                                         |       |                            | (3,979     | ) |   |   | 2,234 |   |   |   | (725 | ) |   |
| Cash and cash  equivalents at beginning of year                                                  |       |                            | 6,993      |   |   |   | 4,759 |   |   |   | 5,484 |   |   |
| Cash and cash  equivalents at end of year                                                        |       |                            | $          | 3,014 |   |   |   | $ | 6,993 |   |   |   | $ | 4,759 |   |   |
| **Supplemental disclosures of cash flow  information**                                           |       |                            |       |   |   |   |   |   |   |   |   |   |   |
| Cash paid during the year  for:                                                                  |       |                            |       |   |   |   |   |   |   |   |   |   |   |
| Interest                                                                                         |       |                            | $          | 1,256 |   |   |   | $ | 1,481 |   |   |   | $ | 1,252 |   |   |
| Income taxes paid  (refunded), net                                                               |       |                            | 685        |   |   |   | 786 |   |   |   | (4,220 | ) |   |
| **Supplemental schedule of noncash investing and  financing activities:**                        |       |                            |       |   |   |   |   |   |   |   |   |   |   |
| Equipment  purchased with capital leases                                                         |       |                            | $          | 1,405 |   |   |   |   |   |   |   | $ | 1,369 |   |   |

 

See accompanying notes to consolidated financial statements.

F-5

----

**Westaff, Inc.Notes to Consolidated Financial Statements(Amounts in thousands except per share amounts)**

**1.****                 Basisof Presentation**

**Basis of presentation**

Westaff, Inc. (the Parent), a Delawarecorporation, and its domestic and foreign subsidiaries (together, the Company),provide staffing services in the United States, the United Kingdom, Australiaand New Zealand. The consolidated financial statements include the accounts ofthe Parent and its domestic and foreign subsidiaries. Intercompany accounts andtransactions have been eliminated.

**Translationof foreign currencies**

The functional currency for each of the Company’sforeign operations is the applicable local currency. All assets and liabilitiesthat are denominated in foreign currencies are translated into U.S. dollars atexchange rates as of the date of the balance sheet and all revenue and expenseaccounts are translated using weighted average exchange rates for the periodspresented. Translation adjustments and gains or losses on intercompany loansthat are of a long-term investment nature are included as a separatecomponent of stockholders’ equity. Aggregate transaction gains (losses)included in determining net income (loss) were $(37), $182 and $221 for fiscalyears 2005, 2004 and 2003, respectively, and are included in selling andadministrative expenses.

**Discontinuedoperations**

InJune 2005, the Company sold its subsidiary operations in Norway andDenmark, and during fiscal year 1999, the Company sold its medical business,primarily operated through Western Medical Services, Inc. (WesternMedical), a wholly-owned subsidiary of the Company (see Note 3). As a result,the Company has classified these operations as discontinued operations and,accordingly, has segregated the assets, liabilities, revenue and expenses ofthese discontinued operations in the Consolidated Balance Sheets, Statements ofOperations and notes thereto. Cash flows pertaining to discontinued operationsare not disclosed separately in the Consolidated Statements of Cash Flows. Cashbalances of the discontinued operations of $2,607 are included in assets of discontinuedoperations on the October 30, 2004 Consolidated Balance Sheet.

**2.****                 Summaryof Significant Accounting Policies**

**Fiscalyear**

The Company’s fiscal year is a 52 or 53 week periodending the Saturday nearest the end of October. Fiscal years 2005, 2004 and2003 each include 52 weeks. For interim reporting purposes, the first threefiscal quarters comprise 12 weeks each while the fourth fiscal quarter consistsof 16 or 17 weeks.

**Accountingestimates**

The preparation of financial statements in conformitywith accounting principles generally accepted in the United States requiresmanagement to make estimates and assumptions that affect the reported amountsof assets and liabilities and disclosure of contingent assets and liabilitiesat the date of the financial statements and the reported amounts of revenue andexpenses during the reporting period. Actual results could differ from thoseestimates. Significant estimates included in the Company’s financial statementsinclude allowance for doubtful accounts, workers’ compensation liabilities andincome taxes.

F-6

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**Fairvalue of financial instruments**

The carrying amounts of cash, accounts receivable,accounts payable and all other accrued expenses approximate fair value atOctober 29, 2005 and October 30, 2004 because of the short maturityof these items. The fair value of the Company’s debt instruments approximatesthe carrying value as of October 29, 2005 and October 30, 2004 basedon current rates available to the Company for debt with similar terms.

**Cashand cash equivalents**

The Company considers all investments with maturitiesat purchase of three months or less to be cash equivalents.

**Concentrationsof credit risk**

The Company’s financial instruments that potentiallysubject the Company to concentrations of credit risk consist principally oftrade receivables. However, concentrations of credit risk are limited due tothe large number of customers comprising the Company’s customer base and theirdispersion across different business and geographic areas. Furthermore, theCompany routinely assesses the financial strength of its customers.

**Revenuerecognition**

Revenue from the sale of services is recognized at thetime the service is performed. The Company maintains an allowance for doubtfulaccounts on accounts receivable for projected estimated losses. The Company’srevenue is derived from company-owned operations and affiliate operations,which consist of franchise agent and license operations.

The Company follows the guidance of Emerging IssuesTask Force (EITF) 99-19 Recording Revenue Gross as a Principal versus Netas an Agent, for its presentation of revenue and costs of services. Thisguidance requires the Company to assess whether it acts as a principal in thetransaction or as an agent acting on behalf of others. Where the Company is theprincipal in the transaction and has the risks and rewards of ownership, thetransactions are recorded gross in the statements of operations. Revenue andrelated costs of services generated by both company-owned offices and franchiseagents are included as part of the Company’s consolidated revenue and costs ofservices, respectively, since the Company has the direct contractual relationshipswith the customers, holds title to the related customer receivables and is thelegal employer of the temporary employees.

The franchise agent acts as the Company’s agent andlocal business representative in a manner similar to a branch manager incompany-owned locations. In the franchise arrangement, all advertising,signage, invoices and correspondence with the customer are in the Company’sname. The Company has the direct contractual relationships with its customersand contracts with customers are binding to the Company. The Company is alsothe employer of all temporary employees in the franchise agents’ operationsand, as such, is obligated for the temporary employee payroll and relatedpayroll taxes regardless of customer acceptance of the temporary laborservices.   These factors, among others,designate the Company as principal with respect to its franchise agentoperations. Franchise agents’ sales represented 28.1%, 29.0% and 27.0% of theCompany’s total revenue for fiscal 2005, 2004 and 2003, respectively. Franchiseagents’ share of gross profit represents the net distribution earned by thefranchise agent for their services in marketing to customers, recruitingtemporary employees and servicing customer accounts.

The Company also has a licensing program in which thelicensee has the direct contractual relationships with the customers, holdstitle to the related customer receivables and is the legal employer of thetemporary employees. Accordingly, sales and costs of services generated by thelicense operation are not included in the Company’s consolidated financialstatements. The Company advances funds to licensees for payroll, payroll taxes,insurance and other related items. Fees are paid to the Company based either ona percentage of sales or of gross profit generated by the licensee and suchlicense fees are recorded by the Company as license fees and included inrevenue. Advances to licensees are secured by a 

F-7

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pledge of the licensee’strade receivables, tangible and intangible assets and the license agreement.Advances due from licensees bear interest at prime plus two percent but only tothe extent the aggregate advances exceed the amount of qualified tradereceivables securing the outstanding advances. Under the terms of a lockboxarrangement between the Company and its licensees, the advances are reduced asremittances are received related to licensees’ trade accounts receivable.Licensees have pledged trade receivables of $311 at October 29, 2005 and$255 at October 30, 2004 as collateral for such advances. Sales generatedby license offices (and excluded from the Company’s revenue) were $2,158,$1,562 and $4,417 for fiscal 2005, 2004 and 2003, respectively. The Companycurrently has only one remaining licensee and is no longer offering licenseagreements to new prospects.

Although the Company has the contractual right tocharge an initial franchise or license fee that encompasses start-up suppliesand material and training, the Company has not charged or collected such fees duringthe fiscal years ended 2005, 2004 and 2003, respectively, therefore there is norecorded fee income of this type included in the Consolidated Statements ofOperations for those years.

**Allowancefor doubtful accounts**

The Company records an allowance for doubtful accountsbased on historical experience. A summary of changes in the reserve for fiscalyears 2005, 2004 and 2003 is as follows:

| **Fiscal Year Ended** | ** ** | ** ** | ** ** | **Balance at  Beginning of Year** | ** ** | **Additions  Charged to  Costs and Expenses** | ** ** | **Deductions** | ** ** | **Balance at  End of Year** | ** ** |
|---------------------------------|------------|------------|------------|--------------------------------------------------|------------|--------------------------------------------------------------|------------|----------------|------------|--------------------------------------------|------------|
| October 29, 2005           |       |       | $          | 1,085                                            |       |                                                         |       | 548            |       |                                       |       | 636 |   |   |   | $ | 997 |   |   |
| October 30,  2004          |       |       | $          | 1,027                                            |       |                                                         |       | 1,046          |       |                                       |       | 988 |   |   |   | $ | 1,085 |   |   |
| November 1, 2003           |       |       | $          | 1,277                                            |       |                                                         |       | 503            |       |                                       |       | 753 |   |   |   | $ | 1,027 |   |   |

 

**Property,plant and equipment**

Property, plant and equipment are stated at cost.Depreciation is computed using the straight-line method over theestimated useful lives of the related assets, which are generally one to sevenyears for computer hardware and software, and three to ten years for furniture,equipment and fixtures. Major improvements to leased office space arecapitalized and amortized over the shorter of their useful lives or the termsof the leases, generally three to five years. The Company capitalizes internaland external costs incurred in connection with developing or obtaining internaluse software in accordance with Statement of Position (SOP) 98-1“Accounting for the Costs of Computer Software Developed or Obtained forInternal Use.”

**Goodwill**

The Company follows the provisions of Statement ofFinancial Accounting Standards (SFAS) No. 142 “Goodwill and OtherIntangible Assets”. SFAS No. 142 provides that goodwill and otherintangible assets with indefinite lives are evaluated for impairment at areporting unit level by applying a fair-value based test. The Companydetermined its reporting units as its operating segments under SFASNo. 131.

The first step in the impairment test compares the fairvalue of a reporting unit with its carrying value, including goodwill. If thecarrying value of a reporting unit exceeds its fair value, the second step ofthe goodwill impairment is performed to determine the amount of any impairmentloss by comparing the implied fair value of the reporting unit’s goodwill withthe respective carrying value.

During fiscal 2003, the Company performed tests forimpairment under the transitional provisions of SFAS No. 142 anddetermined that an impairment of $670 existed in its Australia reporting unit.In accordance with SFAS No. 142, the impairment was classified as acumulative effect of a change in accounting principle and is reflected as suchin the Consolidated Statement of Operations for the fiscal year ended November 1,2003.

F-8

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The Company performed its annual impairmentevaluations in the fourth quarters of fiscal 2005, 2004 and 2003. No additionalimpairments were identified.

The following table shows the change in goodwillduring the fiscal year ended October 29, 2005:

| ** **                                        | ** ** | **Domestic  Business Services** | ** ** | **Australia** | ** ** | **Total** | ** ** |
|---------------------------------------------------|------------|--------------------------------------|------------|---------------|------------|-----------|------------|
| Balance at October 30, 2004                  |       |                                 | $          | 10,792        |       |      |       | $ | 968 |   |   | $ | 11,760 |   |
| Effect of foreign  currency translation and other |       |                                 | 5          |          |       |      | 5          |   |   | 10 |   |
| Balance at  October 29, 2005                 |       |                                 | $          | 10,797        |       |      |       | $ | 973 |   |   | $ | 11,770 |   |

 

**Long-livedassets**

The Company accounts for its long-lived assets inaccordance with SFAS No. 144, “Accounting for the Impairment or Disposalof Long-Lived Assets”. The Company’s primary long-lived assets are property andequipment. SFAS No. 144 requires a company to assess the recoverability ofits long-lived assets whenever events and circumstances indicate the carryingvalue of an asset or asset group may not be recoverable from estimated futurecash flows expected to result from its use and eventual disposition. Additionally,the standard requires expected future operating losses from discontinuedoperations to be displayed in discontinued operations in the period(s) inwhich the losses are incurred, rather than as of the measurement date. Noimpairment charges were recorded in fiscal years 2005, 2004 or 2003.

**Workers’compensation**

The Company self-insures the deductible amountrelated to workers’ compensation claims. The deductible amount was $500 perclaim for policy year 2005, $750 per claim for policy year 2004 and $500 perclaim for policy year 2003. The Company accrues the estimated costs of workers’compensation claims based upon the expected loss rates within the varioustemporary employment categories provided by the Company. At least annually, theCompany obtains an independent actuarial valuation of the estimated costs ofclaims incurred and reported and claims incurred but not reported and adjuststhe accruals based on the results of the valuations. As of October 29,2005 and October 30, 2004, the workers’ compensation liabilities were $19,596and $17,104, respectively, of which $14,200 at October 29, 2005 and$11,900 at October 30, 2004 are included in other long-termliabilities for obligations which are not expected to be paid in the followingfiscal year.

The Company is contractually required to collateralizeits recorded obligations under the workers’ compensation insurance contractswith Travelers Indemnity Company through cash, irrevocable letters of credit orsurety bonds. As of October 29, 2005, the aggregate collateralrequirements were satisfied through $33,122 of letters of credit and $1,667cash held in deposit for policy year 2005.

**Incometaxes**

The Company records income taxes using an asset andliability approach that requires the recognition of deferred tax assets andliabilities for the expected future tax consequences of events that have beenrecognized in the Company’s financial statements or tax returns. A valuationallowance is established when it is more likely than not that a deferred taxasset is not realizable in the foreseeable future. In estimating future taxconsequences, the Company generally considers all expected future events otherthan enactments of changes in the tax law or rates.

**Accountingfor stock-based compensation**

The Company measures compensation cost for employeestock options and similar equity instruments using the intrinsic value-basedmethod of accounting prescribed by Accounting Principles Board OpinionNo. 25, “Accounting for Stock Issued to Employees”(APB 25), and followsthe disclosure-only provisions of SFAS No. 123, “Accounting forStock-Based Compensation”, as amended by SFAS No. 148, “Accounting forStock-Based Compensation—Transition and Disclosure”. Accordingly, compensationcost 

F-9

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is not recognized foroptions granted at fair market value. The following table represents pro formanet income (loss) and pro forma earnings (loss) per share had compensation costbeen determined using the fair value method:

| ** **                                                                          | ** ** | **Fiscal year ended** | ** ** |
|-------------------------------------------------------------------------------------|------------|---------------------------------|------------|
| ** **                                                                          | ** ** | **October 29,  2005**      | ** ** | **October 30,  2004** | ** ** | **November 1,  2003** | ** ** |
| Net income (loss) as reported                                                       |       |                            | $          | 21,126 |   |   |   | $ | 3,473 |   |   |   | $ | (5,128 | ) |   |
| Stock compensation  included in net income                                          |       |                            | 10         |   |   |   |   |   |   |   |   |   |   |
| Employee stock  based compensation expense determined under fair value based method |       |                            | (233       | ) |   |   | (443 | ) |   |   | (466 | ) |   |
| Pro forma net  income (loss)                                                        |       |                            | $          | 20,903 |   |   |   | $ | 3,030 |   |   |   | $ | (5,594 | ) |   |
| Earnings (loss)  per share as reported                                              |       |                            |       |   |   |   |   |   |   |   |   |   |   |
| Basic                                                                               |       |                            | $          | 1.30 |   |   |   | $ | 0.22 |   |   |   | $ | (0.32 | ) |   |
| Diluted                                                                             |       |                            | $          | 1.29 |   |   |   | $ | 0.22 |   |   |   | $ | (0.32 | ) |   |
| Pro forma  earnings (loss) per share                                                |       |                            |       |   |   |   |   |   |   |   |   |   |   |
| Basic                                                                               |       |                            | $          | 1.28 |   |   |   | $ | 0.19 |   |   |   | $ | (0.35 | ) |   |
| Diluted                                                                             |       |                            | $          | 1.27 |   |   |   | $ | 0.19 |   |   |   | $ | (0.35 | ) |   |

 

Because stock optionsgenerally become exercisable over several years and additional grants arelikely to be made in future years, the pro forma amounts for compensation costmay not be indicative of the effects on net income and earnings per share forfuture years. See Note 11 for information on the assumptions used indetermining the fair value of option grants.

**Reclassifications**

Certain amounts in thefiscal 2004 and fiscal 2003 financials have been reclassified to conform to thecurrent year presentation.

**Recentaccounting pronouncements**

In December 2004, theFinancial Accounting Standards Board (FASB) issued Statement of Financial AccountingStandards No. 123 (revised 2004) “Share-Based Payment” (SFAS 123 (R)).SFAS 123 (R) replaces FASB Statement No. 123 “Accountingfor Stock-Based Compensation”, and supersedes APB Opinion No 25 “Accounting forStock Issued to Employees”. The statement establishes standards for accountingfor share-based payment transactions. Share-based payment transactions arethose in which an entity exchanges its equity instruments for goods or servicesor in which an entity incurs liabilities in exchange for goods or services thatare based on the fair value of the entity’s equity instruments or that may besettled by the issuance of those equity instruments. SFAS 123(R) covers awide range of share-based compensation arrangements including shareoptions, restricted share plans, performance-based awards, share appreciationrights and employee share purchase plans. SFAS 123 (R) requiresa public entity to measure the cost of employee services received in exchangefor an award of equity instruments based on the fair value of the award on thegrant date (with limited exceptions). That cost will be recognized in theentity’s financial statements over the period during which the employee isrequired to provide services in exchange for the award. For public entitiesthat do not file as small business issuers, the effective date of the statementis as of the beginning of the first interim or annual reporting period thatbegins after June 15, 2005.

F-10

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TheCompany will adopt SFAS 123(R) in its first quarter of fiscal 2006utilizing the modified prospective method. The modified prospective methodrequires that compensation expense be recorded for all unvested stock optionsand restricted stock awards over the requisite service period (generally thevesting schedule).  At October 29,2005, the Company had approximately 306 unvested stock options and awardsvesting through fiscal 2009. The Company is currently in the process ofevaluating the impact of the adoption of SFAS 123 (R) on itsconsolidated results of operations or financial position.

**3.****                 DiscontinuedOperations**

In June 2005, theCompany sold its Norway and Denmark subsidiary operations to Personalhuset AS,a recruitment and staffing company headquartered in Norway, for approximately$2,700. Additionally, as a part of the sale transactions, Westaff Norway repaidapproximately $610 of intercompany debt to Westaff USA. Of the total proceeds,approximately $220 is being held in an interest bearing escrow account assecurity for potential Westaff Norway pension claims, which the Companycurrently estimates to be zero. The escrowed funds, net of any claim payments,will be remitted to the Company in June 2007. The Company recorded a netgain on the sale of $1,163.

As required by the termsof the Company’s Multicurrency Credit Agreement, the net proceeds on the saleof the Norway and Denmark operations, including the intercompany debtrepayment, were used to pay down borrowings on the Company’s revolving creditfacility. In accordance with EITF 87-24, the Company has allocatedinterest expense to the discontinued operations of $92, $111 and $118 forfiscal 2005, fiscal 2004 and fiscal 2003, respectively.

During fiscal 1999 theCompany discontinued its medical business (Western Medical) principally througha sale to Intrepid U.S.A. Under the terms of the sale, the Company retained themajority of accounts receivable, including trade and Medicare accountsreceivable balances.

Prior to fiscal 2003, theCompany appealed Western Medical’s 1996 Medicare cost report settlement. Duringthe first quarter of fiscal 2003, as a result of the favorable appealsettlement, the Company recognized $316 of income from discontinued operations.During the third quarter of 2004, the Company resolved certain significantlegal and liability claims and evaluated future risks associated with remainingpending claims and, as a result recorded $150 of income from the medicaldiscontinued operations.

Summarizedfinancial data on discontinued operations is as follows:

| ** **                                  | ** ** | **Fiscal Year Ended** | ** ** |
|---------------------------------------------|------------|---------------------------------|------------|
| ** **                                  | ** ** | **October 29,  2005**      | ** ** | **October 30,  2004** | ** ** | **Nobember 1,  2003** | ** ** |
| Revenue                                     |       |                            | $          | 7,808 |   |   |   | $ | 12,151 |   |   |   | $ | 12,639 |   |   |
| Costs and  expenses                         |       |                            | 7,942      |   |   |   | 11,835 |   |   |   | 12,313 |   |   |
| Income (loss) from  discontinued operations |       |                            | $          | (134 | ) |   |   | $ | 316 |   |   |   | $ | 326 |   |   |

 

| ** **                              | ** ** | **October 29,  2005** | ** ** | **October 30,  2004** | ** ** |
|-----------------------------------------|------------|----------------------------|------------|----------------------------|------------|
| Cash and cash  equivalents              |       |                       |       |                       |       |   | $ | 2,607 |   |   |
| Trade accounts  receivable, net         |       |                       |       |                       |       |   | 1,605 |   |   |
| Prepaid expenses                        |       |                       |       |                       |       |   | 258 |   |   |
| Property and  equipment, net            |       |                       |       |                       |       |   | 84 |   |   |
| Other assets                            |       |                       |       |                       |       |   | 296 |   |   |
| Assets of discontinued operations       |       |                       |       |                       |       |   | $ | 4,850 |   |   |
| Accounts payable                        |       |                       |       |                       |       |   | $ | 169 |   |   |
| Accrued expenses                        |       |                       | $          | 75                         |       |   |   | 2,180 |   |   |
| Other liabilities                       |       |                       |       |                       |       |   | 179 |   |   |
| Liabilities of  discontinued operations |       |                       | $          | 75                         |       |   |   | $ | 2,528 |   |   |

 

F-11

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**4.****                 Earningsper Share**

Thefollowing table sets forth the computation of basic and diluted earnings (loss)per share from continuing operations:

| ** **                                                                                                        | ** ** | **Fiscal Year Ended**      | ** ** |
|-------------------------------------------------------------------------------------------------------------------|------------|----------------------------|------------|
| ** **                                                                                                        | ** ** | **October 29,  2005** | ** ** | **October 30,  2004** | ** ** | **November 1,  2003** | ** ** |
| Income (loss)  from continuing operations before cumulative effect of change in accounting  principle             |       |                       | $          | 20,097 |   |   |   | $ | 3,157 |   |   |   | $ | (4,784 | ) |   |
| Denominator for  basic earnings per share—  weighted average shares                                          |       |                       | 16,271     |   |   |   | 16,033 |   |   |   | 15,996 |   |   |
| Effect of  dilutive securities—  Stock options and awards                                                    |       |                       | 149        |   |   |   | 48 |   |   |   | — |   |   |
| Denominator for  diluted earnings per share—  adjusted weighted average shares and assumed conversions       |       |                       | 16,420     |   |   |   | 16,081 |   |   |   | 15,996 |   |   |
| Earnings (loss) per  share from continuing operations before cumulative effect of change in accounting  principle |       |                       |       |   |   |   |   |   |   |   |   |   |   |
| Basic                                                                                                             |       |                       | $          | 1.24 |   |   |   | $ | 0.20 |   |   |   | $ | (0.30 | ) |   |
| Diluted                                                                                                           |       |                       | $          | 1.23 |   |   |   | $ | 0.20 |   |   |   | $ | (0.30 | ) |   |
| Antidilutive weighted  shares excluded from diluted  earnings per share                                           |       |                       | 85         |   |   |   | 416 |   |   |   | 1,061 |   |   |

 

**5.****                 Transactionswith Related Parties**

In 2002, the Company executed an unsecuredsubordinated promissory note payable to its principal stockholder and Chairmanof the Board of Directors in the amount of $2,000 with a maturity date of August 18,2007 and an interest rate equal to an indexed rate as calculated under theCompany’s credit facilities plus seven percent, compounded monthly and payable60 calendar days after the end of each of the Company’s fiscal quarters. Theinterest rate in effect on October 29, 2005 was 13.75%. Payment ofinterest is contingent on the Company meeting minimum availability requirementsunder its credit facilities. Additionally, payments of principal or interestare prohibited in the event of any default under the credit facilities. Interestpaid on this note during fiscal 2005, fiscal 2004 and fiscal 2003 was $246,$222 and $230, respectively.

On September 25,2003 the Company executed a one-year unsecured subordinated draw down note withits principal stockholder and Chairman of the Board of Directors. The noteprovided for the Chairman to make advances to the Company upon request, at hissole discretion and with no obligation to do so, in an aggregate principalamount not to exceed $1,000 outstanding at any one time. On December 23,2003 the Chairman made a $1,000 advance to the Company which was repaid on August 3,2004. Total interest paid on the advance during fiscal 2004 was $68.

F-12

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**6.****                 Property,Plant and Equipment**

Property,plant and equipment consists of the following:

| ** **                                      | ** ** | **October 29,** | ** ** | **October 30,** | ** ** |
|-------------------------------------------------|------------|----------------------|------------|----------------------|------------|
| ** **                                      | ** ** | **2005**             | ** ** | **2004**             | ** ** |
| Computer hardware and software                  |       |                 | $          | 30,003               |       |   |   | $ | 24,542 |   |   |
| Computer equiment  under capital lease          |       |                 | 2,774      |                 |       |   | 1,369 |   |   |
| Equipment,  furniture and fixtures              |       |                 | 19,447     |                 |       |   | 17,513 |   |   |
|                                            |       |                 | 52,224     |                 |       |   | 43,424 |   |   |
| Less accumulated  depreciation and amortization |       |                 | (37,040    | )                    |       |   | (33,324 | ) |   |
|                                            |       |                 | $          | 15,184               |       |   |   | $ | 10,100 |   |   |

 

Included in computer hardware and software isconstruction in process for information management systems of $5,734 at October 29,2005 and $2,115 at October 30, 2004.

Depreciation expense from continuing operations was$4,162, $4,380 and $5,363 for fiscal years 2005, 2004 and 2003, respectively.Amortization of capital leased equipment included in depreciation expense was$456 for fiscal 2005, $466 for fiscal 2004 and $365 for fiscal 2003.

In February 2004,the Company completed the sale of an unoccupied corporate headquarters’building for proceeds of $1,938. The $725 gain on the sale of the land and thebuilding is included in selling and administration expenses for the fiscal yearended October 30, 2004.

**7.****                 BorrowingsUnder Revolving Credit Facilities and Loans Payable**

On May 17, 2002 the Company entered intoagreements with GE Capital, as primary agent, to provide senior secured creditfacilities totaling $65,000, expiring in May 2007. The facilities comprisea five-year syndicated Multicurrency Credit Agreement consisting of a $50,000US Revolving Loan Commitment, a £2,740 UK Revolving Loan Commitment (US dollarequivalent of approximately $4,000 at the date of the agreement), and a $5,000term loan (the Term Loan), which was repaid during fiscal 2003. In addition, afive-year Australian dollar facility agreement (the A$ Facility Agreement) wasexecuted on May 16, 2002, consisting of an A$12,000 revolving creditfacility (US dollar equivalent of approximately $6,000 at the date of theagreement). Each agreement includes a letter of credit sub-facility. Letters ofcredit under the agreements expire one year from date of issuance but areautomatically renewed for one additional year unless written notice is given toor from the holder.

The US Revolving Loan Commitment provides for anaggregate $50,000 commitment subject to a borrowing base calculation oneligible domestic accounts receivable. Direct advances are also limited byoutstanding irrevocable standby letters of credit up to a maximum of $40,000. Intereston borrowings under the commitment is based either on an index rate equal tothe higher of the Federal Funds Rate plus 0.50% or the bank prime loan rate,each plus applicable margins of up to 0.50%, or on LIBOR plus margins rangingfrom 2.25% to 2.75%. Borrowings outstanding under the US Revolving LoanCommitment at October 29, 2005 were $2,883 at a weighted average interestrate of 6.78% and at October 30, 2004 were $10,974 at a weighted averageinterest rate of 4.62%.

The UK Revolving Loan Commitment is subject to aborrowing base calculation on eligible Westaff (U.K.) accounts receivable. Intereston outstanding borrowings is based on the British prime rate plus margins of upto 0.50%. Borrowings outstanding under the UK Revolving Loan Commitment wereUS$12 at October 29, 2005 with an interest rate of 4.75% and US$1,408 at October 30,2004 with an interest rate of 4.25%.

The A$ Facility Agreement is subject to a borrowingbase calculation on eligible Westaff (Australia) accounts receivable. Directadvances are limited by outstanding letters of credit up to a maximum of 

F-13

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A$500. Interest onborrowings is based on the Australian 90-day Bank Bill Swap Rate plus amargin of 2.5% to 3.5%. At October 29, 2005, borrowings of US$5,673 wereoutstanding under the A$ Facility Agreement at an interest rate of 8.69% and atOctober 30, 2004, borrowings outstanding were of US$3,352 at an interestrate of  5.47%.

The credit facilities are secured by substantially allof the assets of the Company. GE Capital, in its role as primary agent underthe credit facilities, has sole dominion and control over the Company’s primaryU.S., United Kingdom and Australia cash receipts accounts. Cash receipts intothese accounts are applied against the Company’s respective outstandingobligations under the facilities, with additional borrowings under therevolving facilities directed into the Company’s disbursement accounts.

The credit facilities expire in May 2007. TheCompany has classified all of its borrowings under the revolving creditfacilities as a current liability in accordance with Emerging Issues Task Force(EITF) 95-22 “Balance Sheet Classifications of Borrowings Outstandingunder Revolving Credit Agreements That Include Both a Subjective AccelerationClause and a Lock-Box Arrangement”, although the Company has the ability andthe intent to maintain these obligations for longer than one year.

The credit facilities contain covenants which, amongother things, require the Company to maintain a minimum fixed charge coverageratio and a minimum earnings before interest, taxes, depreciation andamortization (EBITDA). The covenants also generally restrict, limit or, incertain circumstances, prohibit the Company with respect to payment of dividends,capital expenditures, disposition of assets, incurrence of debt, mergers andacquisitions, loans to affiliates and purchases of investments.

Effective August 19, 2005, the Company and itslenders executed a seventh amendment to the Multicurrency Credit Agreementwhich allowed an add-back of approximately $1,000 to the EBITDA covenant forseparation and restructuring charges incurred during fiscal 2005. The amendmentalso allowed the gain from the sale of the Company’s Norway and Denmarkoperations of $1,163 to be included in determining compliance with the EBITDAand fixed charge covenants. Additionally, the amendment increased the maximumcapital expenditures allowed for fiscal 2005 from $6,000 to $8,500 and alsoincreased the letter of credit sublimit from $35,000 to $40,000.

At October 29,2005 the Company had $21,111 available under the credit facilities,  $34,999 in letters of credit outstanding andwas in compliance with all covenants under the credit agreement.

**8.****                 AccruedExpenses**

Accruedexpenses consist of the following:

| ** **                                          | ** ** | **October 29,** | ** ** | **October 30,** | ** ** |
|-----------------------------------------------------|------------|----------------------|------------|----------------------|------------|
| ** **                                          | ** ** | **2005**             | ** ** | **2004**             | ** ** |
| Accrued payroll and  payroll taxes                  |       |                 | $          | 15,989               |       |   |   | $ | 16,221 |   |   |
| Accrued  insurance/workers’ compensation       |       |                 | 10,474     |                 |       |   | 9,392 |   |   |
| Arbitration award and  related fees                 |       |                 |       |                 |       |   | 780 |   |   |
| Taxes other than income  taxes                      |       |                 | 3,184      |                 |       |   | 3,446 |   |   |
| Checks outstanding in  excess of book cash balances |       |                 | 6,508      |                 |       |   | 5,123 |   |   |
| Other                                               |       |                 | 6,454      |                 |       |   | 8,027 |   |   |
|                                                |       |                 | $          | 42,609               |       |   |   | $ | 42,989 |   |   |

 

**9.****                 IncomeTaxes**

During the fourth quarter of fiscal 2005, the Companyreversed $16,681 of its domestic deferred tax asset valuation allowance, as itwas determined that it is more likely than not that the deferred tax asset willbe realized.

F-14

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Theprovision (benefit) for income taxes from continuing operations consists of thefollowing:

| ** **                                                              | ** ** | **Fiscal year ended** | ** ** |
|-------------------------------------------------------------------------|------------|---------------------------------|------------|
| ** **                                                              | ** ** | **October 29,**            | ** ** | **October 30,** | ** ** | **November 1,** | ** ** |
| ** **                                                              | ** ** | **2005**                        | ** ** | **2004** | ** ** | **2003** | ** ** |
| Current:                                                                |       |                            |       |   |   |   |   |   |   |   |   |   |   |
| Federal                                                                 |       |                            | $          | 514 |   |   |   | $ | (350 | ) |   |   | $ | (211 | ) |   |
| State and local                                                         |       |                            | 330        |   |   |   | 175 |   |   |   | 52 |   |   |
| Foreign                                                                 |       |                            | 509        |   |   |   | 414 |   |   |   | 520 |   |   |
|                                                                    |       |                            | 1,353      |   |   |   | 239 |   |   |   | 361 |   |   |
| Deferred:                                                               |       |                            |       |   |   |   |   |   |   |   |   |   |   |
| Federal                                                                 |       |                            | (13,497    | ) |   |   |   |   |   |   |   |   |   |
| State and local                                                         |       |                            | (2,870     | ) |   |   |   |   |   |   |   |   |   |
| Foreign                                                                 |       |                            | (394       | ) |   |   |   |   |   |   |   |   |   |
|                                                                    |       |                            | (16,761    | ) |   |   | — |   |   |   | — |   |   |
| Total provision  (benefit) for income taxes from continuing operations: |       |                            | $          | (15,408 | ) |   |   | $ | 239 |   |   |   | $ | 361 |   |   |

 

Areconciliation of income taxes provided at the statutory federal rate (35%) andincome taxes reported in the Consolidated Statements of Operations is asfollows:

| ** **                                                          | ** ** | **Fiscal year ended** | ** ** |
|---------------------------------------------------------------------|------------|---------------------------------|------------|
| ** **                                                          | ** ** | **October 29,  2005**      | ** ** | **October 30,  2004** | ** ** | **November 1,  2003** | ** ** |
| Income tax provision  (benefit) computed at federal  statutory rate |       |                            | $          | 1,641 |   |   |   | $ | 1,247 |   |   |   | $ | (1,545 | ) |   |
| State taxes                                                         |       |                            | 286        |   |   |   | 175 |   |   |   | 52 |   |   |
| Permanent differences                                               |       |                            | 304        |   |   |   | 1,868 |   |   |   | (102 | ) |   |
| Tax credits                                                         |       |                            | (1,046     | ) |   |   | (2,706 | ) |   |   |   |   |   |
| Valuation allowances  (net of state tax effect of $1,043  for 2005) |       |                            | (16,681    | ) |   |   | (122 | ) |   |   | 1,994 |   |   |
| Other                                                               |       |                            | 88         |   |   |   | (223 | ) |   |   | (38 | ) |   |
| Income tax provision (benefit)                                      |       |                            | $          | (15,408 | ) |   |   | $ | 239 |   |   |   | $ | 361 |   |   |

 

Theapproximate tax effect of temporary differences and carryforwards that giverise to deferred tax balances are as follows:

| ** **                                                   | ** ** | **October 29,** | ** ** | **October 30,** | ** ** |
|--------------------------------------------------------------|------------|----------------------|------------|----------------------|------------|
| ** **                                                   | ** ** | **2005**             | ** ** | **2004**             | ** ** |
| Workers’ compensation                                   |       |                 | $          | 9,336                |       |   |   | $ | 8,133 |   |   |
| Accruals relating to  discontinued operations                |       |                 | 23         |                 |       |   | 86 |   |   |
| Other liabilities and  accruals                              |       |                 | 135        |                 |       |   | 1,049 |   |   |
| Federal, state and  foreign net operating loss carryforwards |       |                 | 882        |                 |       |   | 2,552 |   |   |
| Depreciation and  amortization                               |       |                 | 2,777      |                 |       |   | 3,027 |   |   |
| Sales of property                                            |       |                 | 1,653      |                 |       |   | 1,566 |   |   |
| Tax credits                                                  |       |                 | 2,242      |                 |       |   | 2,556 |   |   |
| Gross deferred tax  assets                                   |       |                 | 17,048     |                 |       |   | 18,969 |   |   |
| Valuation allowance                                          |       |                 |       |                 |       |   | (18,683 | ) |   |
| Net deferred tax asset                                       |       |                 | $          | 17,048               |       |   |   | $ | 286 |   |   |

 

F-15

----

Thedomestic and foreign components of income (loss) from continuing operationsbefore income taxes are as follows:

| ** **                                                                                                  | ** ** | **Fiscal year ended** | ** ** |
|-------------------------------------------------------------------------------------------------------------|------------|---------------------------------|------------|
| ** **                                                                                                  | ** ** | **October 29,  2005**      | ** ** | **October 30,  2004** | ** ** | **November 1,  2003** | ** ** |
| Domestic                                                                                                    |       |                            | $          | 2,535 |   |   |   | $ | 777 |   |   |   | $ | (4,923 | ) |   |
| Foreign                                                                                                     |       |                            | 2,154      |   |   |   | 2,619 |   |   |   | 500 |   |   |
| Income (loss) from continuing operations before  income taxes and cumulative change in accounting principle |       |                            | $          | 4,689 |   |   |   | $ | 3,396 |   |   |   | $ | (4,423 | ) |   |

 

At October 29, 2005, the Parent had cumulativeundistributed earnings from foreign subsidiaries of approximately $3,040. Incometaxes have not been provided on the undistributed earnings because the Companyhas deemed the earnings of its foreign subsidiaries as permanently reinvested. Theseearnings could become subject to additional tax if they were remitted asdividends, or if foreign earnings were lent to the Company. However, to theextent that these earnings were previously taxed in foreign jurisdictions, theCompany anticipates the resulting tax amount would qualify for a domestic taxcredit.

The Company’s deferred taxassets resulting from net operating loss carryforwards expire at varying futuredates, with $9 expiring during fiscal 2007, $34 expiring during fiscal 2008,$291 expiring through fiscal 2024 and $548 with no expiration dates. TheCompany’s deferred tax assets resulting from foreign tax credit carryforwardsin the amount of $49 expire in 2015. The Company’s deferred tax assetsresulting from Work Opportunity Tax Credit carryforwards in the amount of$2,193 expire through 2025.

**10.****          SavingsPlans**

The Company has anonqualified deferred savings plan for highly compensated employees and a401(k) savings plan for eligible domestic employees. Under both thedeferred and 401(k) savings plans for fiscal year 2005 and fiscal year2004, employees can elect to contribute up to 60% of their eligible annualcompensation subject to statutory limits. The Company currently is notproviding employer matching contributions.

**11.****          Stockholders’Equity**

**Treasury stock**

From time to time, theCompany repurchases shares of its common stock on the open market. Therepurchased shares may be used for reissuance under the Company’s stock optionand employee stock purchase plans. When treasury shares are reissued, anyexcess of the proceeds over the acquisition cost of the shares is credited toadditional paid-in-capital. Excess acquisition cost over the proceeds fromreissuance, determined on a first-in first-out basis, is charged to additionalpaid-in-capital to the extent of previous net “gains”, and then to retainedearnings.

**Employee stockpurchase plan**

Under the Company’s 1996Employee Stock Purchase Plan, eligible employees may authorize payrolldeductions of up to 10% of eligible compensation for the purchase of theCompany’s common stock during each semi-annual purchase period. The purchaseprice will equal the lower of 85% of the fair market value at the beginning ofthe purchase period or on the last day of the purchase period. The planprovides for the issuance of up to 750 shares of the Company’s common stock. Asof October 29, 2005, shares issued under the plan totaled 623.

F-16

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**Stock option plan**

The 1996 Stock Option/Stock Issuance Plan provides forthe granting of incentive and nonqualified stock options and stock appreciationrights. Incentive stock options may be granted at a price not less than 100% ofthe fair market value of the Company’s common stock at the date of grant.Nonqualified options may be granted at a price not less than 85% of the fairmarket value of the Company’s common stock at the date of grant. The options’vesting schedules vary subject to the participant’s period of future service orto the Company’s or the option holder’s attainment of designated performancegoals, or otherwise at the discretion of the Board of Directors. Standardvesting is over four years with 25% of the options vesting upon completion ofone year of service from the vesting commencement date, and the remainingoptions vesting in thirty-six equal monthly installments. No option may have aterm in excess of 10 years. At October 29, 2005 there were 2,424 sharesreserved for issuance under the plan. The maximum number of shares with respectto which stock options, stock appreciation rights and direct stock issuancesmay be granted to an individual in any calendar year are 1,000 shares. No stockappreciation rights have been granted under the plan.

In April 2005, the Company granted 20 restrictedshares of its common stock to its President and Chief Executive Officer underthe 1996 Stock Option/Stock Issuance Plan. 5 shares will vest at the end ofeach of the Company’s fiscal years 2006 and 2007 provided certain performancecriteria are met, with the remainder vesting in fiscal 2008. In the absence ofmeeting the performance criteria, all 20 shares will vest in fiscal 2008.

Thefollowing table summarizes the stock option transactions under the Company’splan. The fair value of each option included in the table is estimated on thedate of grant using the Black-Scholes option-pricing model with the followingweighted average assumptions for options granted in fiscal 2005, 2004 and 2003,respectively: zero dividend yield, expected volatility of 140%, 145% and 154%,expected lives of 6 years; and risk-free interest rates of 4.2%, 3.9% and 3.2%.

| ** **                                                       | ** ** | **October 29, 2005** | ** ** | **October 30, 2004** | ** ** | **November 1, 2003** | ** ** |
|------------------------------------------------------------------|------------|--------------------------------|------------|--------------------------------|------------|--------------------------------|------------|
| ** **                                                       | ** ** | ** **                     | ** ** | **Weighted**                   | ** ** | ** **                     | ** ** | **Weighted** | ** ** | ** ** | ** ** | **Weighted** | ** ** |
| ** **                                                       | ** ** | ** **                     | ** ** | **average**                    | ** ** | ** **                     | ** ** | **average** | ** ** | ** ** | ** ** | **average** | ** ** |
| ** **                                                       | ** ** | **Shares**                     | ** ** | **exercise price**        | ** ** | **Shares**                     | ** ** | **exercise price** | ** ** | **Shares** | ** ** | **exercise price** | ** ** |
| Options  outstanding, beginning of year                          |       |                           | 1,035      |                           |       |                           | $          | 3.07 |   |   |   | 1,080 |   |   |   | $ | 3.09 |   |   | $ | 1,419 |   |   | $ | 3.10 |   |   |
| Granted at market value                                          |       |                           | 219        |                           |       |                           | 3.33       |   |   |   | 44 |   |   |   | 2.53 |   |   | 52 |   |   | 2.16 |   |   |
| Exercised                                                        |       |                           | (281       | )                              |       |                           | 2.40       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Cancelled                                                        |       |                           | (333       | )                              |       |                           | 2.61       |   |   |   | (89 | ) |   |   | 3.14 |   |   | (391 | ) |   | 2.97 |   |   |
| Options  outstanding, end of year                           |       |                           | 640        |                           |       |                           | $          | 3.69 |   |   |   | 1,035 |   |   |   | $ | 3.07 |   |   | 1,080 |   |   | $ | 3.09 |   |   |
| Options exercisable, end of year                            |       |                           | 354        |                           |       |                           | $          | 4.02 |   |   |   | 562 |   |   |   | $ | 3.47 |   |   | 482 |   |   | $ | 3.64 |   |   |
| Options available for grant, end of year                         |       |                           | 1,482      |                           |       |                           |       |   |   |   | 1,389 |   |   |   |   |   |   | 1,344 |   |   |   |   |   |
| Total options  authorized                                        |       |                           | 2,424      |                           |       |                           |       |   |   |   | 2,424 |   |   |   |   |   |   | 2,424 |   |   |   |   |   |
| Weighted average  fair value of options granted during the year: |       |                           |       |                           |       |                           | $          | 3.08 |   |   |   |   |   |   |   | $ | 2.36 |   |   |   |   |   | $ | 2.04 |   |   |
|                                                                  |            |                                |            |                                |            |                                |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

F-17

----

Thefollowing table summarizes information about stock options outstanding at October 29,2005:

| ** **                              | ** ** | **Options outstanding** | ** ** | **Options exercisable**                                | ** ** |
|-----------------------------------------|------------|------------------------------|------------|-------------------------------------------------------------|------------|
| **Range of  exercise prices** | ** ** | **Shares**                   | ** ** | **Weighted average  remaining  contractual life** | ** ** | **Weighted average  exercise price** | ** ** | **Shares** | ** ** | **Weighted average  exercise price** | ** ** |
| $1.63- 2.78                        |       |                         | 82         |                                                        |       |   | 7.06 |   |   |   | $ | 2.44 |   |   |   | 65 |   |   |   | $ | 2.35 |   |   |
| $2.79- 4.00                        |       |                         | 491        |                                                        |       |   | 7.80 |   |   |   | 3.23 |   |   |   | 232 |   |   |   | 3.24 |   |   |
| $4.01- 6.33                        |       |                         | 22         |                                                        |       |   | 5.33 |   |   |   | 5.88 |   |   |   | 12 |   |   |   | 6.22 |   |   |
| $6.34- 9.58                        |       |                         | 42         |                                                        |       |   | 1.20 |   |   |   | 9.45 |   |   |   | 42 |   |   |   | 9.45 |   |   |
| $9.59-16.17                             |       |                         | 3          |                                                        |       |   | 2.41 |   |   |   | 16.17 |   |   |   | 3 |   |   |   | 16.17 |   |   |
| $1.63-16.17                             |       |                         | 640        |                                                        |       |   | 7.16 |   |   |   | $ | 3.69 |   |   |   | 354 |   |   |   | $ | 4.02 |   |   |

 

**12.****          Leases**

The Company leases real and personal property underoperating leases with terms generally ranging from one to five years. Some ofthese leases have renewal options and contain provisions for escalation basedon increases in certain costs incurred by the landlord and on Consumer PriceIndex adjustments. Rental expense from continuing operations, includingmonth-to-month rentals, amounted to $6,138 in fiscal 2005, $6,054 in fiscal2004, and $6,353 in fiscal 2003. The Company also receives rental income fromsubleases which expire on various dates. Sublease income was not material tothe Company’s results of operations for any periods presented.

In fiscal 2003, the Company entered into a sale-leasebacktransaction whereby the Company sold and leased back its administrative offices’land and buildings. The lease, which is being accounted for as an operatinglease, has a term of seven years with an option to renew  for an additional five years. The result ofthe sale was a net pre-tax gain of approximately $5,300 that the Companydeferred and is amortizing as an offset to rent expense over the seven yearlease term. In connection with the lease agreement, the Company issued a $700irrevocable standby letter of credit as a security deposit.

Futureminimum lease payments for all non-cancelable operating leases at October 29,2005 are as follows:

| ** **                    | ** ** | ** ** | ** ** | ** ** | ** ** |
|-------------------------------|------------|------------|------------|------------|------------|
| 2006                          |       | $          | 4,002      |       |
| 2007                          |       | 2,993      |       |
| 2008                          |       | 2,141      |       |
| 2009                          |       | 1,700      |       |
| 2010                          |       | 535        |       |
| Thereafter                    |       | 269        |       |
| Total minimum lease  payments |       | $          | 11,640     |       |

 

F-18

----

The following is a summary of future minimum paymentsunder capitalized leases, primarily for information technology equipment, at October 29,2005:

| ** **                                       | ** ** | **October 29,** | ** ** |
|--------------------------------------------------|------------|----------------------|------------|
| ** **                                       | ** ** | **2005**             | ** ** |
| Minimum lease  payments:                         |       |                 |       |   |   |
| Fiscal 2006                                      |       |                 | $          | 440 |   |   |
| Fiscal 2007                                      |       |                 | 551        |   |   |
| Fiscal 2008                                      |       |                 | 508        |   |   |
| Fiscal 2009                                      |       |                 | 468        |   |   |
| Fiscal 2010                                      |       |                 | 6          |   |   |
| Total minimum  lease payments                    |       |                 | 1,973      |   |   |
| Less amount representing interest                |       |                 | (456       | ) |   |
| Present value of  net minimum lease payments     |       |                 | 1,517      |   |   |
| Less current portion of capital lease obligation |       |                 | (343       | ) |   |
| Long-term capital lease  obligation              |       |                 | $          | 1,174 |   |   |

 

**13.****          OperatingSegments**

The Company has four reportable segments:  Domestic Business Services, United Kingdom,Australia and New Zealand. Domestic Business Services provides a variety oftemporary staffing and permanent placement services, primarily in clerical andlight industrial positions, through a network of company-owned and franchiseagent offices. The segment consists of nine geographically diverse companyregions under the direction of regional managers and one combined franchiseregion, each identified as an operating segment. Revenue from Domestic BusinessServices is derived wholly from the United States and its territories. Thedomestic operating segments meet the aggregation criteria specified under SFAS No. 131“Disclosures about Segments of an Enterprise and Related Information” forreporting purposes. The international operating segments comprise company-ownedoffices, primarily providing clerical and light industrial temporary staffingand permanent placement services. The Company employs a managing director whooversees operations in the United Kingdom and a managing director who overseesoperations in Australia and New Zealand. Revenue is attributed to each countrybased on the location of the respective country’s principal offices. Summarizedfinancial data for the Norway and Denmark discontinued operations is includedin Note 3.

The Company evaluates the performance of and allocatesresources to the reportable segments based on operating income. The accountingpolicies of the segments are the same as those described in Note 2. Certainoperating expenses of the Company’s corporate headquarters, which are includedin Domestic Business Services, are charged to the international entities in theform of royalties. Domestic assets relating to the generation of the royalties,primarily property, plant and equipment, have not been allocated due toimpracticality and are not considered material for purposes of assessingperformance and making operating decisions.

F-19

----

Thefollowing summarizes reporting segment data for fiscal years 2005, 2004 and2003:

| ** **                                  | ** ** | **Fiscal Year Ended October 29, 2005** | ** ** |
|---------------------------------------------|------------|-----------------------------------------------------------------|------------|
| ** **                                  | ** ** | **Domestic  Business Svcs**                                | ** ** | **United Kingdom** | ** ** | **Australia** | ** ** | **New Zealand** | ** ** | **Adjustments(1)** | ** ** | **Consolidated** | ** ** |
| Revenue                                     |       |                                                            | $          | 470,971 |   |   |   | $ | 42,582 |   |   | $ | 92,026 |   |   | $ | 7,282 |   |   |   |   |   |   |   | $ | 612,861 |   |   |
| Operating income from continuing operations |       |                                                            | $          | 3,395 |   |   |   | $ | 1,133 |   |   | $ | 1,040 |   |   | $ | 560 |   |   |   |   |   |   |   | $ | 6,128 |   |   |
| Depreciation and amortization               |       |                                                            | $          | 3,421 |   |   |   | $ | 341 |   |   | $ | 356 |   |   | $ | 44 |   |   |   |   |   |   |   | $ | 4,162 |   |   |
| Purchases of fixed assets                   |       |                                                            | $          | 7,254 |   |   |   | $ | 134 |   |   | $ | 633 |   |   | $ | 11 |   |   |   | $ | 12 |   |   |   | $ | 8,044 |   |   |
| Total long-lived assets                     |       |                                                            | $          | 24,291 |   |   |   | $ | 601 |   |   | $ | 1,987 |   |   | $ | 75 |   |   |   |   |   |   |   | $ | 26,954 |   |   |
| Total assets                                |       |                                                            | $          | 115,161 |   |   |   | $ | 8,736 |   |   | $ | 18,126 |   |   | $ | 1,358 |   |   |   | $ | (4,599 | ) |   |   | $ | 138,782 |   |   |

 

| ** **                                  | ** ** | **Fiscal Year Ended October 30, 2004** | ** ** |
|---------------------------------------------|------------|-----------------------------------------------------------------|------------|
| ** **                                  | ** ** | **Domestic  Business Svcs**                                | ** ** | **United Kingdom** | ** ** | **Australia** | ** ** | **New Zealand** | ** ** | **Adjustments(1)** | ** ** | **Consolidated** | ** ** |
| Revenue                                     |       |                                                            | $          | 470,414 |   |   |   | $ | 45,088 |   |   | $ | 67,708 |   |   | $ | 6,651 |   |   |   |   |   |   |   | $ | 589,861 |   |   |
| Operating income from continuing operations |       |                                                            | $          | 2,317 |   |   |   | $ | 2,172 |   |   | $ | 722 |   |   | $ | 198 |   |   |   |   |   |   |   | $ | 5,409 |   |   |
| Depreciation and amortization               |       |                                                            | $          | 3,561 |   |   |   | $ | 361 |   |   | $ | 394 |   |   | $ | 64 |   |   |   |   |   |   |   | $ | 4,380 |   |   |
| Purchases of fixed assets                   |       |                                                            | $          | 2,827 |   |   |   | $ | 374 |   |   | $ | 128 |   |   | $ | 11 |   |   |   | $ | 29 |   |   |   | $ | 3,369 |   |   |
| Total long-lived assets                     |       |                                                            | $          | 19,184 |   |   |   | $ | 868 |   |   | $ | 1,710 |   |   | $ | 98 |   |   |   |   |   |   |   | $ | 21,860 |   |   |
| Total assets                                |       |                                                            | $          | 94,031 |   |   |   | $ | 10,433 |   |   | $ | 13,604 |   |   | $ | 1,613 |   |   |   | $ | 2,727 |   |   |   | $ | 122,408 |   |   |

 

| ** **                                         | ** ** | **Fiscal Year Ended October 30, 2003** | ** ** |
|----------------------------------------------------|------------|-----------------------------------------------------------------|------------|
| ** **                                         | ** ** | **Domestic  Business Svcs**                                | ** ** | **United Kingdom** | ** ** | **Australia** | ** ** | **New Zealand** | ** ** | **Adjustments(1)** | ** ** | **Consolidated** | ** ** |
| Revenue                                            |       |                                                            | $          | 428,174 |   |   |   | $ | 33,409 |   |   | $ | 52,340 |   |   | $ | 4,815 |   |   |   |   |   |   |   | $ | 518,738 |   |   |
| Operating income (loss) from continuing operations |       |                                                            | $          | (3,818 | ) |   |   | $ | 1,316 |   |   | $ | (156 | ) |   | $ | (251 | ) |   |   |   |   |   |   | $ | (2,909 | ) |   |
| Depreciation and amortization                      |       |                                                            | $          | 4,594 |   |   |   | $ | 290 |   |   | $ | 399 |   |   | $ | 80 |   |   |   |   |   |   |   | $ | 5,363 |   |   |
| Purchases of  fixed assets                         |       |                                                            | $          | 1,816 |   |   |   | $ | 369 |   |   | $ | 284 |   |   | $ | 65 |   |   |   | $ | 59 |   |   |   | $ | 2,593 |   |   |
|                                                    |            |                                                                 |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

----

(1)          Adjustments reflectassets related to discontinued operations and elimination of domesticinvestments in international subsidiaries.

F-20

----

**14.****          Commitmentsand Contingencies**

In the ordinary course of its business, the Company isperiodically threatened with or named as a defendant in various lawsuits. Theprincipal risks that the Company insures against are workers’ compensation,general liability, automobile liability, property damage, alternative staffingerrors and omissions, fiduciary liability and fidelity losses.

On October 28, 2003, Bond International Software, Inc.(“Bond”) filed a demand for arbitration with the American Arbitration Association(“AAA”). Bond sought compensation for the Company’s alleged breach of a 2001software agreement. The Company filed a counterclaim, seeking the return ofmonies previously paid to Bond. The arbitration hearing was held in September 2004.The arbitrator issued an Interim Award onOctober 25,2004, agreeing that the Company had the right to terminate the agreement, butgranting Bond “termination charges” in the amount of $423 plusinterest fromJanuary 2002. The arbitrator denied Bond’s claim for damages for breach ofthe implied covenant of good faith and fair dealing, and denied the Company’scounterclaim. In the Final Award issued December 4, 2004, the arbitratorordered the Company to pay Bond $291 in attorneys’ fees and costs, and to paythe AAA administrative fees and arbitrator compensation totaling $44. As aresult of the arbitration, the Company recorded a charge of $1,058 in fiscal2004 for the award and related legal fees.

On March 9, 2000, SynergyStaffing, Inc. (“claimant”) filed a complaint against the Companyalleging, among other things, that the Company fraudulently induced the claimantto sell the assets of The Personnel Connection, Inc. On January 9,2002, an arbitration panel rendered an interim award in favor of the claimantfor compensatory damages of $2,224 plus interest, as well as reasonableattorneys’ fees and other costs incurred in the proceeding. During the fourthquarter of fiscal 2001, the Company recorded an accrued liability and relatedpretax charge of $3,600 for the estimated costs of the award. On February 11,2002, the arbitration panel issued an Order Modifying Interim Award, creditingthe Company for $800 previously paid under a price protection clause in theasset purchase agreement and thereby reducing the principal amount of the awardto $1,424. As a result of the interim award, the Company determined that $693of the initial estimated liabilities were no longer required, and recorded thereduction in its fourth fiscal quarter of 2002. The claimant asked the SuperiorCourt to correct and confirm the interim award. On September 25, 2002, theCourt denied the claimant’s motion. The claimant then filed an appeal of thedenial with the appellate court.  On October 21,2003 the appellate court reversed the Superior Court’s denial of the claimant’smotion. The Company filed a petition for rehearing, which was denied. In December 2003,the claimants agreed to a settlement of $930. Accordingly, the Company recordeda $950 charge to earnings in fiscal 2003 for the cost of the settlement plusrelated attorneys’ fees.

In September 2005, Westaff’s Australiansubsidiary, together with several other entities, was named in a claim forcontributions asserted by ADI Ltd. The litigation originated in May 1998,when a fire occurred at sea on board an Australian Navy ship. The fire resultedin the death of four crewmen, and extensive damage to the ship. Aninvestigation determined that the fire was caused by the failure of fuel hosesinstalled by ADI in the ship’s engine room. The Commonwealth of Australia fileda claim against ADI which is estimated to have a value of approximately A$31,000.The investigation further found that mistakes were made in the installationprocess, including those of a technical supervisor placed by Westaff with ADI. ADIalleges that if it is liable to the Commonwealth, then Westaff is vicariouslyliable for the supervisor’s negligence. A defense to the claim has been filedon behalf of Westaff. Trial is scheduled for September 2006. At this stageof the litigation, it is premature to gauge the extent of potential liabilityof ADI and the other defendants, including Westaff, or the extent of insurancecoverage that Westaff may have in the event of an unfavorable outcome.

During the fourth quarter of fiscal 2005, the Companywas notified by the California Employment Development Department (EDD) that itsCalifornia unemployment tax rates would be increased retroactively for bothcalendar years 2005 and 2004. This rate increase was based on the EDD findingthat 

F-21

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Westaff’s wholly-owneddomestic operating subsidiaries would be considered as a single reportingentity for California unemployment tax reporting purposes. The Company believesit has properly calculated its unemployment insurance tax and is in compliancewith applicable laws and regulations. The Company has timely appealed theassessment and the rate increase and is working with its outside counsel toresolve this matter. The Company accrued a portion of the increased tax duringthe fourth quarter of fiscal 2005. However, the Company believes that it hasstrong defenses and legal arguments with respect to approximately $900 of theassessment and, accordingly, has not accrued for that portion of the assessmentas of October 29, 2005.

From time to time theCompany has been threatened with, or named as a defendant in, lawsuits,including countersuits brought by former franchise agents or licensees, andadministrative claims and lawsuits brought by employees or former employees. TheCompany does not believe the outcome of any proceedings on these actions wouldhave a material adverse effect on its financial position, results of operationsor cash flows. The Company is not currently a party to any material litigation,except as disclosed above.

F-22

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**15.****          QuarterlyFinancial Information (Unaudited)**

Thefollowing is a summary of the unaudited quarterly financial information for thefiscal years ended October 29, 2005 and October 30, 2004.

| ** **                                                    | ** ** | **First  Quarter** | ** ** | **Second  Quarter** | ** ** | **Third  Quarter** | ** ** | **Fourth  Quarter(1)** | ** ** |
|---------------------------------------------------------------|------------|--------------------|------------|---------------------|------------|--------------------|------------|------------------------|------------|
| **Fiscal  year ended October 29, 2005**                       |       |               |       |                |       |               |       |                   |       |   |   |
| Revenue                                                       |       | $                  | 135,305    |                | $          | 135,521            |       | $                      | 141,053    |   |   | $ | 200,982 |   |   |
| Gross profit                                                  |       | $                  | 22,857     |                | $          | 23,153             |       | $                      | 24,628     |   |   | $ | 35,171 |   |   |
| Income (loss) from continuing operations                      |       | $                  | 568        |                | $          | (328               | )          | $                      | 1,079      |   |   | $ | 18,778 |   |   |
| Income from  discontinued operations                          |       | (62                | )          | (43                 | )          | (29                | )          |                   |       |   |   |
| Gain on sale of  discontinued operations, net of income taxes |       |               |       |                |       | 1,163              |       |                   |       |   |   |
| Net income (loss)                                             |       | $                  | 506        |                | $          | (371               | )          | $                      | 2,213      |   |   | $ | 18,778 |   |   |
| Earnings (loss) per share                                     |       |               |       |                |       |               |       |                   |       |   |   |
| Income (loss) from continuing operations                      |       |               |       |                |       |               |       |                   |       |   |   |
| Basic                                                         |       | $                  | 0.04       |                | $          | (0.02              | )          | $                      | 0.07       |   |   | $ | 1.15 |   |   |
| Diluted                                                       |       | $                  | 0.03       |                | $          | (0.02              | )          | $                      | 0.07       |   |   | $ | 1.14 |   |   |
| Discontinued operations—basic and diluted                |       | $                  | *          |                | $          | *                  |       | $                      | 0.07       |   |   | $ | — |   |   |
| Net income (loss)                                             |       |               |       |                |       |               |       |                   |       |   |   |
| Basic                                                         |       | $                  | 0.03       |                | $          | (0.02              | )          | $                      | 0.14       |   |   | $ | 1.15 |   |   |
| Diluted                                                       |       | $                  | 0.03       |                | $          | (0.02              | )          | $                      | 0.14       |   |   | $ | 1.14 |   |   |
| **Fiscal year ended October 30, 2004**                        |       |               |       |                |       |               |       |                   |       |   |   |
| Revenue                                                       |       | $                  | 120,122    |                | $          | 128,811            |       | $                      | 139,345    |   |   | $ | 201,583 |   |   |
| Gross profit                                                  |       | $                  | 20,112     |                | $          | 21,504             |       | $                      | 23,931     |   |   | $ | 33,650 |   |   |
| Income (loss) from continuing operations                      |       | $                  | (808       | )                   | $          | 256                |       | $                      | 1,520      |   |   | $ | 2,188 |   |   |
| Income (loss)  from discontinued operations                   |       | (98                | )          | (88                 | )          | 235                |       |                   | 267        |   |   |
| Net income (loss)                                             |       | $                  | (906       | )                   | $          | 168                |       | $                      | 1,755      |   |   | $ | 2,455 |   |   |
| Basic and diluted earnings (loss) per share                   |       |               |       |                |       |               |       |                   |       |   |   |
| Income (loss) from continuing operations                      |       | $                  | (0.05      | )                   | $          | 0.02               |       | $                      | 0.09       |   |   | $ | 0.13 |   |   |
| Discontinued operations                                       |       | $                  | (0.01      | )                   | $          | (0.01              | )          | $                      | 0.20       |   |   | $ | 0.02 |   |   |
| Net income (loss)                                             |       | $                  | (0.06      | )                   | $          | 0.01               |       | $                      | 0.29       |   |   | $ | 0.15 |   |   |

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*                    Less than$(0.01)

(1)          Net income for thefourth quarter of fiscal 2005 includes the reversal of $16,681, or $1.01 perdiluted share, of domestic deferred tax valuation allowances. The results forthe fourth quarter of fiscal 2004 include a $1,655 charge for increased workers’compensation costs due primarily to adverse loss development of historicalclaims and a $1,058 charge related to an adverse arbitration award (Note 14).

F-23

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**SIGNATURES**

Pursuant to the requirements of Section 13 or 15(d) ofthe Securities Exchange Act of 1934, the Registrant has duly caused this reportto be signed on behalf of the undersigned, thereunto duly authorized.

|          |   | WESTAFF, INC. |
|----------|--------|--------------------|
|     |   | By:                | /s/  PATRICIA M. NEWMAN |
|     |   |               | Patricia M. Newman |
| * * |   | * *           | *President and Chief Executive  Officer* |
|     |   |               | Date: January 27, 2006 |

 

**POWER OF ATTORNEY**

KNOW ALL PERSONS BY THESE PRESENTS:

That the undersigned officers and directors of Westaff, Inc.,a Delaware corporation, do hereby constitute and appoint Patricia M. Newman andDirk A. Sodestrom the lawful attorney-in-fact, each with full power ofsubstitution, for him in any and all capacities, to sign any amendments to thisreport on Form 10-K and to file the same, with exhibits thereto andother documents in connection therewith, with the Securities and ExchangeCommission, hereby ratifying and confirming all that each of saidattorney-in-fact or his substitute or substitutes may do or cause to be done byvirtue hereof.

IN WITNESS WHEREOF, each of the undersigned hasexecuted this Power of Attorney as of the date indicated.

Pursuantto the requirements of the Securities Exchange Act of 1934, this report hasbeen signed below by the following persons on behalf of the Registrant and inthe capacities and on the dates indicated.

|                                                  | **Signature** | ** **                                         | ** ** |                        | **Title** | ** ** | ** ** |  | **Date** | ** ** |
|--------------------------------------------------|---------------|----------------------------------------------------|------------|------------------------|-----------|------------|------------|--|----------|------------|
| /s/ W. ROBERT STOVER                             |          | Chairman  of the Board                             |       | January 27, 2006  |
|       W. Robert  Stover |          |                                               |       |                   |
| /s/ PATRICIA M. NEWMAN                           |          | President and Chief Executive Officer and Director |       | January 27, 2006  |
| Patricia M. Newman                               |          | (Principal  Executive Officer)                     |       |                   |
| /s/ DIRK A. SODESTROM                            |          | Senior  Vice President and Chief Financial Officer |       | January 27,  2006 |
|      Dirk A. Sodestrom       |          | (Principal  Financial Officer)                     |       |                   |
| /s/ JACK D. SAMUELSON                            |          | Director                                           |       | January 27,  2006 |
|      Jack D.  Samuelson      |          |                                               |       |                   |
| /s/ RONALD D. STEVENS                            |          | Director                                           |       | January 27,  2006 |
|      Ronald D.  Stevens      |          |                                               |       |                   |
| /s/ JANET M. BRADY                               |          | Director                                           |       | January 27,  2006 |
|     Janet M. Brady                |          |                                               |       |                   |

 

| *By:   | /s/      | DIRK A. SODESTROM  |
|--------|----------|--------------------|
|   |     | Dirk A. Sodestrom  |
|   | * * | *Attorney-in-Fact* |

 

IV-1

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