**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**Washington, D. C. 20549**

 

##### **FORM 10-Q**

 
| **ý** | **QUARTERLY  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE  ACT OF 1934.**                                                                                                                                                                                                                                  |
|------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|       |                                                                                                                                                                                                                                                                                                                                      |
|       | **For the  quarterly period ended**  **January 22, 2005**                                                                                                                                                                                                                                                                       |
|       |                                                                                                                                                                                                                                                                                                                                      |
| **o**      | **TRANSITION  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE  ACT OF 1934**                                                                                                                                                                                                                                  |
|       |                                                                                                                                                                                                                                                                                                                                      |
|       | **For the  transition period from                           to                         ** |

 

**Commission file number 0-24990**

 

**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 number) |

##### ** **

##### **298 North Wiget Lane**

**Walnut Creek, California 94598-2453**

(Address of registrant’s principal executive offices)

 

**(925) 930-5300**

(Registrant’s telephonenumber)

 

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  ýNo  o

 

Indicate by check markwhether the registrant is an accelerated filer (as defined in Rule 12b-2of the Exchange Act).    Yes  oNo  ý

 

Indicate the number ofshares outstanding of each of the issuer’s classes of common stock, as of thelatest practicable date:

 

| **Class**                    | ** ** | **Outstanding at March 7,  2005** |
|------------------------------|------------|----------------------------------------|
| ** **                   | ** ** | ** **                             |
| Common Stock, $.01 par value |       | 16,318,785 shares                      |

 

 

----

 

##### **WESTAFF, INC. AND SUBSIDIARIES**

 

**INDEX**

 
| ** **        | ** **                                                                                                         | ** ** | **Page**   |
|-------------------|--------------------------------------------------------------------------------------------------------------------|------------|------------|
| **Part I.**  | **Financial  Information**                                                                                         | ** ** | ** ** |
|              |                                                                                                               |       |       |
| Item 1.           | Financial Statements  (Unaudited)                                                                                  |       |       |
|              |                                                                                                               |       |       |
|              | Condensed  Consolidated Balance Sheets -  January 22, 2005 and October 30, 2004                          |       | 3          |
|              |                                                                                                               |       |       |
|              | Condensed  Consolidated Statements of Operations -  12 weeks ended January 22, 2005 and January 24, 2004 |       | 4          |
|              |                                                                                                               |       |       |
|              | Condensed  Consolidated Statements of Cash Flows -  12 weeks ended January 22, 2005 and January 24, 2004 |       | 5          |
|              |                                                                                                               |       |       |
|              | Notes  to Condensed Consolidated Financial Statements                                                              |       | 6          |
|              |                                                                                                               |       |       |
| Item  2.          | Management’s  Discussion and Analysis of Financial Condition and Results of Operations                        |       | 11         |
|              |                                                                                                               |       |       |
| Item  3.          | Quantitative  and Qualitative Disclosures About Market Risk                                                        |       | 15         |
|              |                                                                                                               |       |       |
| Item 4.           | Controls  and Procedures                                                                                           |       | 16         |
|              |                                                                                                               |       |       |
| **Part II.** | **Other Information**                                                                                              | ** ** | ** ** |
| ** **        | ** **                                                                                                         | ** ** | ** ** |
| Item 1.           | Legal Proceedings                                                                                                  |       | 17         |
|              |                                                                                                               |       |       |
| Item  2.          | Unregistered  Sales of Equity Securities and Use of Proceeds                                                       |       | 17         |
|              |                                                                                                               |       |       |
| Item 3.           | Defaults Upon  Senior Securities                                                                                   |       | 17         |
|              |                                                                                                               |       |       |
| Item  4.          | Submission  of Matters to a Vote of Security Holders                                                               |       | 17         |
|              |                                                                                                               |       |       |
| Item 5.           | Other Information                                                                                                  |       | 17         |
|              |                                                                                                               |       |       |
| Item 6.           | Exhibits                                                                                                           |       | 17         |
|              |                                                                                                               |       |       |
| Signatures        |                                                                                                               | 18         |

 

----

** **

**Part l.Financial Information**

** **

**Item1. Financial Statements**

** **

**Westaff, Inc.**

** **

**Condensed Consolidated Balance Sheets(Unaudited)**

**(Inthousands except per share amounts)**

 
| ** **                                                                                                                                                           | ** ** | **January 22,  2005** | ** ** | **October 30,  2004** | ** ** |
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|----------------------------|------------|----------------------------|------------|
| **ASSETS**                                                                                                                                                           |       |                       |       |                       |       |
| Current assets:                                                                                                                                                      |       |                       |       |                       |       |
| Cash and cash equivalents                                                                                                                                            |       | $                          | 4,406      |                       | $          | 6,993 |   |
| Trade accounts receivable, less allowance for  doubtful accounts of $1,106 and $1,124                                                                                |       | 74,647                     |       | 84,712                     |       |
| Income taxes receivable                                                                                                                                              |       | 286                        |       | 847                        |       |
| Deferred income taxes                                                                                                                                                |       | 294                        |       | 286                        |       |
| Prepaid expenses                                                                                                                                                     |       | 3,484                      |       | 4,530                      |       |
| Other current assets                                                                                                                                                 |       | 1,196                      |       | 877                        |       |
| Total current assets                                                                                                                                                 |       | 84,313                     |       | 98,245                     |       |
|                                                                                                                                                                 |       |                       |       |                       |       |
| Property and equipment, net                                                                                                                                          |       | 10,468                     |       | 10,184                     |       |
| Goodwill                                                                                                                                                             |       | 11,806                     |       | 11,760                     |       |
| Other long-term assets                                                                                                                                               |       | 8,085                      |       | 2,219                      |       |
| Total Assets                                                                                                                                                         |       | $                          | 114,672    |                       | $          | 122,408 |   |
|                                                                                                                                                                 |       |                       |       |                       |       |
| **LIABILITIES AND STOCKHOLDERS’ EQUITY**                                                                                                                        |       |                       |       |                       |       |
| Current liabilities:                                                                                                                                                 |       |                       |       |                       |       |
| Borrowing under revolving credit facilities                                                                                                                          |       | $                          | 12,315     |                       | $          | 15,734 |   |
| Current portion of capital lease obligations                                                                                                                         |       | 463                        |       | 465                        |       |
| Accounts payable                                                                                                                                                     |       | 2,632                      |       | 2,731                      |       |
| Accrued expenses                                                                                                                                                     |       | 39,368                     |       | 44,944                     |       |
| Income taxes payable                                                                                                                                                 |       | 635                        |       | 632                        |       |
| Net liabilities of discontinued operations                                                                                                                           |       | 153                        |       | 225                        |       |
| Total current liabilities                                                                                                                                            |       | 55,566                     |       | 64,731                     |       |
|                                                                                                                                                                 |       |                       |       |                       |       |
| Note payable to related party                                                                                                                                        |       | 2,000                      |       | 2,000                      |       |
| Long-term capital lease obligations                                                                                                                                  |       | 12                         |       | 125                        |       |
| Other long-term liabilities                                                                                                                                          |       | 16,461                     |       | 15,705                     |       |
| Total liabilities                                                                                                                                                    |       | 74,039                     |       | 82,561                     |       |
|                                                                                                                                                                 |       |                       |       |                       |       |
| Commitments and contingencies                                                                                                                                        |       |                       |       |                       |       |
|                                                                                                                                                                 |       |                       |       |                       |       |
| Stockholders’ equity:                                                                                                                                           |       |                       |       |                       |       |
| Preferred stock, $.01 par value; authorized and  unissued: 1,000 shares                                                                                              |       |                       |       |                       |       |
| Common stock, $.01 par value; authorized: 25,000  shares; issued and outstanding: 16,051 shares at January 22, 2005 and  16,047 shares at October 30, 2004 |       | 161                        |       | 160                        |       |
| Additional paid-in capital                                                                                                                                           |       | 36,779                     |       | 36,768                     |       |
| Retained earnings                                                                                                                                                    |       | 3,531                      |       | 3,025                      |       |
| Accumulated other comprehensive income (loss)                                                                                                                        |       | 162                        |       | (106                       | )          |
| Total stockholders’ equity                                                                                                                                      |       | 40,633                     |       | 39,847                     |       |
| Total Liabilities and Stockholders’ Equity                                                                                                                      |       | $                          | 114,672    |                       | $          | 122,408 |   |

 

See accompanying notes to condensed consolidated financial statements.

 

3

----

 

**Westaff, Inc.**

** **

**Condensed Consolidated Statements of Operations (Unaudited)**

**(Inthousands except per share amounts)**

 
| ** **                                      | ** ** | **12 Weeks Ended**         | ** ** |
|-------------------------------------------------|------------|----------------------------|------------|
| ** **                                      | ** ** | **January 22,  2005** | ** ** | **January 24,  2004** | ** ** |
| ** **                                      | ** ** | ** **                 | ** ** | ** ** | ** ** |
| Revenue                                         |       | $                          | 138,261    |   | $ | 122,578 |   |
|                                            |       |                       |       |   |   |
| Costs of services                               |       | 114,659                    |       | 101,837 |   |
|                                            |       |                       |       |   |   |
| Gross profit                                    |       | 23,602                     |       | 20,741 |   |
|                                            |       |                       |       |   |   |
| Franchise agents’ share of gross profit    |       | 3,974                      |       | 3,802 |   |
| Selling and administrative expenses             |       | 17,559                     |       | 16,186 |   |
| Depreciation and amortization                   |       | 970                        |       | 1,103 |   |
|                                            |       |                       |       |   |   |
| Operating income (loss)                         |       | 1,099                      |       | (350 | ) |
|                                            |       |                       |       |   |   |
| Interest expense                                |       | 423                        |       | 473 |   |
| Interest income                                 |       | (26                        | )          | (20 | ) |
|                                            |       |                       |       |   |   |
| Income (loss) before provision for income taxes |       | 702                        |       | (803 | ) |
| Provision for income taxes                      |       | 196                        |       | 103 |   |
|                                            |       |                       |       |   |   |
| Net income (loss)                               |       | $                          | 506        |   | $ | (906 | ) |
|                                            |       |                       |       |   |   |
| Earnings (loss) per share - basic and diluted:  |       | $                          | 0.03       |   | $ | (0.06 | ) |
|                                            |       |                       |       |   |   |
| Weighted average shares outstanding - basic     |       | 16,048                     |       | 16,015 |   |
| Weigthed average shares outstanding - diluted   |       | 16,262                     |       | 16,015 |   |

 

See accompanying notes to condensed consolidated financial statements.

 

4

----

 

**Westaff, Inc.**

** **

**Condensed Consolidated Statements of Cash Flows(Unaudited)**

**(Inthousands)**

 
| ** **                                                                                | ** ** | **12 Weeks Ended**         | ** ** |
|-------------------------------------------------------------------------------------------|------------|----------------------------|------------|
| ** **                                                                                | ** ** | **January 22,  2005** | ** ** | **January 24,  2004** | ** ** |
| **Cash flows from operating activities**                                                  |       |                       |       |   |   |
| Net income (loss)                                                                         |       | $                          | 506        |   | $ | (906 | ) |
| Adjustments to reconcile net income (loss) to net  cash provided by operating activities: |       |                       |       |   |   |
| Depreciation and amortization                                                             |       | 970                        |       | 1,103 |   |
| Provision for losses on doubtful accounts                                                 |       | 183                        |       | 138 |   |
| (Gain) loss on sale or disposal of assets                                                 |       | (5                         | )          | 52 |   |
| Income from sales of affiliate operations                                                 |       | (18                        | )          | (4 | ) |
| Other                                                                                     |       | (81                        | )          | 304 |   |
| Changes in assets and liabilities:                                                        |       |                       |       |   |   |
| Trade accounts receivable                                                                 |       | 10,346                     |       | 9,052 |   |
| Other assets                                                                              |       | (4,859                     | )          | (3,088 | ) |
| Accounts payable and accrued expenses                                                     |       | (6,053                     | )          | (5,037 | ) |
| Income taxes payable                                                                      |       | (9                         | )          | (144 | ) |
| Other liabilities                                                                         |       | (13                        | )          | (259 | ) |
|                                                                                      |       |                       |       |   |   |
| Net cash provided by continuing operations                                                |       | 967                        |       | 1,211 |   |
| Net cash used by discontinued operations                                                  |       | (72                        | )          | (178 | ) |
|                                                                                      |       |                       |       |   |   |
| Net cash provided by operating activities                                                 |       | 895                        |       | 1,033 |   |
|                                                                                      |       |                       |       |   |   |
| **Cash flows from investing activities**                                                  |       |                       |       |   |   |
| Capital expenditures                                                                      |       | (1,182                     | )          | (262 | ) |
| Proceeds from sales of affiliate operations                                               |       | 1,045                      |       | 7 |   |
| Other, net                                                                                |       | 193                        |       | 22 |   |
|                                                                                      |       |                       |       |   |   |
| Net cash provided (used) by investing activities                                          |       | 56                         |       | (233 | ) |
|                                                                                      |       |                       |       |   |   |
| **Cash flows from financing activities**                                                  |       |                       |       |   |   |
| Net repayments under line of credit agreements                                            |       | (3,542                     | )          | (4,870 | ) |
| Principal payments on capital lease obligations                                           |       | (115                       | )          | (96 | ) |
| Proceeds from notes payable to related parties                                            |       |                       |       | 1,000 |   |
| Issuance of common stock                                                                  |       | 11                         |       |   |   |
| Other                                                                                     |       | (6                         | )          |   |   |
|                                                                                      |       |                       |       |   |   |
| Net cash used by financing activities                                                     |       | (3,652                     | )          | (3,966 | ) |
|                                                                                      |       |                       |       |   |   |
| Effect of exchange rate changes on cash                                                   |       | 114                        |       | 39 |   |
|                                                                                      |       |                       |       |   |   |
| Net change in cash and cash equivalents                                                   |       | (2,587                     | )          | (3,127 | ) |
| Cash and cash equivalents at beginning of period                                          |       | 6,993                      |       | 4,759 |   |
| Cash and cash equivalents at end of period                                                |       | $                          | 4,406      |   | $ | 1,632 |   |

 

See accompanying notes to condensed consolidated financial statements.

 

5

----

 

**Westaff, Inc.**

** **

**Notes to Condensed Consolidated FinancialStatements (Unaudited)**

**(Inthousands except per share amounts)**

 

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

 

The accompanying condensed consolidated financial statements of Westaff, Inc.and its domestic and foreign subsidiaries (together, the Company), as of January 22,2005 and for the 12 week periods ended January 22, 2005 and January 24,2004 are unaudited.

 

The condensed consolidated financial statements, in the opinion ofmanagement, reflect all adjustments, which are of a normal recurring nature,necessary for a fair presentation of the financial position, results ofoperations and cash flows for the periods presented. The condensed consolidatedbalance sheet as of October 30, 2004 presented herein, has been derivedfrom the audited balance sheet included in the Company’s Annual Report on Form 10-Kfor the fiscal year ended October 30, 2004.

 

                        Certainfinancial information which is normally included in annual financial statementsprepared in accordance with accounting principles generally accepted in theUnited States, but which is not required for interim reporting purposes, hasbeen condensed or omitted. The accompanying condensed consolidated financialstatements should be read in conjunction with the financial statements andnotes thereto included in the Company’s Annual Report on Form 10-Kfor the fiscal year ended October 30, 2004.

 

                        TheCompany’s fiscal year is a 52 or 53 week period ending the Saturday nearest theend of October. For interim reporting purposes, the first three fiscal quarterscomprise 12 weeks each, while the fourth fiscal quarter consists of 16 or 17weeks. The results of operations for the 12 weeks ended January 22, 2005are not necessarily indicative of the results to be expected for the fullfiscal year or for any future period.

 

During fiscal year 1999, the Company sold its medical business,primarily operated through Western Medical Services, Inc., a wholly ownedsubsidiary of the Company (see Note 4). As a result, the Company has classifiedits medical operations as discontinued operations in these condensedconsolidated financial statements and notes thereto.

 

Certain amounts in the January 24, 2004 financial statements havebeen reclassified to conform to the January 22, 2005 presentation.

 

**2.**              Stock-basedCompensation

 

TheCompany measures compensation cost for employee stock options and similarequity instruments using the intrinsic value-based method of accountingprescribed by Accounting Principles Board Opinion No. 25, “Accounting forStock Issued to Employees”(APB 25), and follows the disclosure-only provisionsof SFAS No. 123, “Accounting for Stock-Based Compensation”, as amended bySFAS No. 148, “Accounting for Stock-Based Compensation — Transition andDisclosure”. As all options have been granted at fair value, no compensation costhas been recognized in the financial statements. The following table representspro forma net income (loss) and pro forma income (loss) per share hadcompensation cost been determined using the fair value method:

 

6

----

 
| ** **                                                       | ** ** | **12 Weeks Ended**         | ** ** |
|------------------------------------------------------------------|------------|----------------------------|------------|
| ** **                                                       | ** ** | **January 22,  2005** | ** ** | **January 24,  2004** | ** ** |
|                                                             |       |                       |       |   |   |
| Net income (loss) as reported                                    |       | $                          |  506  |   | $ | (906 | ) |
| Stock based compensation determined under the fair  value method |       | (99                        | )          | (107 | ) |
|                                                             |       |                       |       |   |   |
| Pro forma net income (loss)                                      |       | $                          |  407  |   | $ | (1,013 | ) |
|                                                             |       |                       |       |   |   |
| Income (loss) per common share:                                  |       |                       |       |   |   |
| Basic and diluted - as reported                                  |       | $                          |  0.03 |   | $ | (0.06 | ) |
| Basic and diluted - pro forma                                    |       | $                          |  0.03 |   | $ | (0.06 | ) |

 

Becausestock options generally become exercisable over several years and additional grantsare likely to be made in future periods, the pro forma amounts for compensationcost may not be indicative of the effects on net income and earnings per sharefor future periods.

 

**3.****              Goodwill**

 

Thechange in the carrying amount of goodwill for the 12 weeks ended January 22,2005 is due to the effect of changes in foreign currency translation rates. TheCompany performs its annual impairment evaluation in the fourth quarter of eachfiscal year.

 

**4.****              DiscontinuedOperations**

 

Duringfiscal 1999, the Company sold certain of its franchise agent and Company-ownedmedical offices and entered into a termination agreement with one of itsmedical licensees. During the fourth quarter of fiscal 1999, the Companycompleted the sale of the remaining medical business to Intrepid U.S.A. Inc.under an asset purchase agreement.

 

As of January 22, 2005, the remaining currentliabilities of the discontinued medical operations of $153 are for settled butunpaid claims of $125 and other costs of $28.

 

**5.****              Workers’Compensation**

 

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 ($750 perclaim for fiscal year 2004 and $500 per claim for fiscal 2005.) The Companyaccrues the estimated costs of workers’ compensation claims based upon theexpected loss rates within the various temporary employment categories providedby the Company. At least annually, the Company obtains an independent actuarialvaluation of the estimated costs of claims reported but not settled, and claimsincurred but not reported, and may adjust the accruals based on the results ofthe valuations. As of January 22, 2005 and October 30, 2004, workers’compensation liabilities were $16,629 and $16,382, 

 

7

----

 

respectively, of which $11,900 is included in otherlong-term liabilities on each of the respective balance sheets for obligationswhich are not expected to be paid in the following fiscal year.

 

Each policy year the terms of the agreement with theinsurance carrier are renegotiated. The insurance carrier requires the Companyto collateralize its recorded obligations through the use of irrevocableletters of credit, surety bonds or cash. At January 22, 2005, the Companyhad $22,375 of letters of credit and a $3,843 surety bond securing its domesticworkers’ compensation obligations. In addition to premium and claim payments,the Company is cash collaterizing its fiscal 2005 policy year through paymentstotaling $15,775, of which $6,152 has been paid as of January 22, 2005 andis reflected in other long-term assets in the consolidated balance sheet.

 

**6.  Earnings (Loss) Per Share**

 

The following table sets forth the computation of basic and dilutedearnings (loss) per share:

 
| ** **                                                                                             | ** ** | **12 Weeks Ended**         | ** ** |
|--------------------------------------------------------------------------------------------------------|------------|----------------------------|------------|
| ** **                                                                                             | ** ** | **January 22,  2005** | ** ** | **January 24,  2004** | ** ** |
| ** **                                                                                             | ** ** | ** **                 | ** ** | ** ** | ** ** |
| Net income (loss)                                                                                      |       | $                          | 506        |   | $ | (906 | ) |
|                                                                                                   |       |                       |       |   |   |
| Denominator for basic earnings per share - weighted  average shares                                    |       | 16,048                     |       | 16,015 |   |
|                                                                                                   |       |                       |       |   |   |
| Effect of dilutive securities: stock options                                                           |       | 214                        |       | — |   |
| Denominator for diluted earnings per share -  adjusted weighted average shares and assumed conversions |       | 16,262                     |       | 16,015 |   |
|                                                                                                   |       |                       |       |   |   |
| Basic and diluted earnings (loss) per share                                                            |       | $                          |  0.03 |   | $ |  (0.06 | ) |
|                                                                                                   |       |                       |       |   |   |
| Anti-dilutive weighted shares excluded from diluted  earnings (loss) per share                         |       | 94                         |       | 1,020 |   |

 

**7.****              Comprehensive Income(Loss)**

 

Comprehensiveincome (loss) consists of the following:

 
| ** **                       | ** ** | **12 Weeks Ended**   | ** ** |
|----------------------------------|------------|----------------------|------------|
| ** **                       | ** ** | **January 22,** | ** ** | **January 24,** | ** ** |
| ** **                       | ** ** | **2005**             | ** ** | **2004** | ** ** |
| ** **                       | ** ** | ** **           | ** ** | ** ** | ** ** |
| Net income (loss)                |       | $                    | 506        |   | $ | (906 | ) |
| Currency translation adjustments |       | 268                  |       | 875 |   |
|                             |       |                 |       |   |   |
| Comprehensive income (loss)      |       | $                    | 774        |   | $ | (31 | ) |

 

8

----

 

**8.****              Credit Agreement**

 

On May 17,2002, the Company entered into agreements with GE Capital, as primary agent, toprovide senior secured credit facilities totaling $65,000, expiring in May 2007.The facilities comprise a five-year syndicated Multicurrency Credit Agreementconsisting of a $50,000 US Revolving Loan Commitment, a £2,740 UK RevolvingLoan Commitment (US dollar equivalent of approximately $4,000 at the date ofthe agreement), and a $5,000 term loan (the Term Loan), which was repaid duringfiscal 2003. In addition, a five-year Australian dollar facility agreement (theA$Facility Agreement) was executed on May 16, 2002, consisting of anA$12,000 revolving credit facility (US dollar equivalent of approximately$6,000 at the date of the agreement). Each agreement includes a letter ofcredit sub-facility. Letters of credit under the agreements expire one yearfrom date of issuance but are automatically renewed for one additional yearunless written notice is given to or from the holder.

 

On January 5, 2005, a sixth amendment to theMulticurrency Credit Agreement was executed. The amendment, among other things,allows a $1,400 add-back adjustment to the rolling 13-period earningsbefore interest, taxes, depreciation and amortization (EBITDA) covenant at October 30,2004 for additional workers’ compensation charges the Company incurred duringthe fourth quarter of fiscal 2004 relating to adverse loss development onhistorical claims.

 

**9.****              RelatedParty Transactions**

 

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 under the terms of thenote. The advance plus accrued interest was repaid on August 3, 2004.

 

The Company alsohas an unsecured subordinated promissory note payable to its principalstockholder and Chairman of the Board of Directors dated May 17, 2002 inthe amount of $2,000. The note has a maturity date of August 18, 2007 andan interest rate equal to an indexed rate as calculated under the Company’scredit facilities plus seven percent, compounded monthly and payable 60calendar days after the end of each of the Company’s fiscal quarters. Theinterest rate in effect on January 22, 2005 was 12.25%. 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.

 

**10.****       Operating Segments**

 

The following tablesummarizes reporting segment data:

 

9

----

 
| ** **                               | ** ** | **Domestic  Business Svcs.** | ** ** | **United Kingdom** | ** ** | **Australia** | ** ** | **Other  International** | ** ** | **Consolidated** | ** ** |
|------------------------------------------|------------|------------------------------|------------|--------------------|------------|---------------|------------|--------------------------|------------|------------------|------------|
| ** **                               | ** ** | ** **                   | ** ** | ** **         | ** ** | ** **    | ** ** | ** **               | ** ** | ** **       | ** ** |
| **12 Weeks Ended January 22, 2005** |       |                         |       |               |       |          |       |                     |       |             |       |
|                                     |       |                         |       |               |       |          |       |                     |       |             |       |
| Revenue                                  |       | $                            | 103,081    |               | $          | 9,820         |       | $                        | 20,381     |             | $          | 4,979 |   | $ | 138,261 |   |
|                                     |       |                         |       |               |       |          |       |                     |       |             |       |
| Operating income                         |       | $                            | 586        |               | $          | 347           |       | $                        | 155        |             | $          | 11 |   | $ | 1,099 |   |
|                                     |       |                         |       |               |       |          |       |                     |       |             |       |
| **12 Weeks Ended January 24, 2004** |       |                         |       |               |       |          |       |                     |       |             |       |
|                                     |       |                         |       |               |       |          |       |                     |       |             |       |
| Revenue                                  |       | $                            | 94,533     |               | $          | 8,559         |       | $                        | 15,394     |             | $          | 4,092 |   | $ | 122,578 |   |
|                                     |       |                         |       |               |       |          |       |                     |       |             |       |
| Operating income (loss)                  |       | $                            | (677       | )                  | $          | 283           |       | $                        | 144        |             | $          | (100 | ) | $ | (350 | ) |

 

**11.****       Commitmentsand Contingencies**

 

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

 

**12.****           Recent AccountingPronouncements**

 

In December 2004, the Financial AccountingStandards Board (FASB) issued Statement of Financial Accounting Standards No. 123(revised 2004) “Share-Based Payment” (SFAS 123 (R)). SFAS 123 (R) replaces FASBStatement No. 123 “Accounting for Stock-Based Compensation”, andsupersedes APB Opinion No 25 “Accounting for Stock Issued to Employees”. Thestatement establishes standards for accounting for share-based paymenttransactions. Share-based payment transactions are those in which an entityexchanges its equity instruments for goods or services or in which an entityincurs liabilities in exchange for goods or services that are based on the fairvalue of the entity’s equity instruments or that may be settled by the issuanceof those equity instruments. SFAS 123(R) covers a wide range of share-basedcompensation arrangements including share options, restricted share plans,performance-based awards, share appreciation rights and employee share purchaseplans. SFAS 123(R) requires a public entity to measure the cost of employeeservices received in exchange for an award of equity instruments based on thefair value of the award on the grant date (with limited exceptions). That costwill be recognized in the entity’s financial statements over the period duringwhich the employee is required to provide services in exchange for the award. TheCompany is required to adopt SFAS 123(R) in the fourth quarter of fiscal 2005,and has not currently evaluated the impact of adoption on its overall resultsof operations or financial position.

 

10

----

 

**Westaff, Inc.**

 

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

 

### **CautionaryStatement**

 

Thisnotice is intended to take advantage of the “safe harbor” provided by thePrivate Securities Litigation Reform Act of 1995 with respect to forward-lookingstatements. Except for the historical information contained herein, the mattersdiscussed should be considered forward-looking statements and readers arecautioned not to place undue reliance on those statements. The forward-lookingstatements in this discussion are made based on information available as of thedate hereof and are subject to a number of risks and uncertainties that couldcause the Company’s actual results and financial position to differ 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 “FactorsAffecting Future Operating Results” and elsewhere in the Company’s AnnualReport on Form 10-K for the fiscal year ended October 30, 2004.The Company 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.

 

Thefollowing discussion is intended to assist in the understanding and assessmentof significant changes and trends related to the results of operations andfinancial condition of Westaff, Inc., together with its consolidatedsubsidiaries. This discussion and analysis should be read in conjunction withthe Company’s Consolidated Financial Statements and Notes thereto included elsewherein this Form 10-Q and in the Company’s Annual Report on Form 10-Kfor the fiscal year ended October 30, 2004.

### ** **

### **Critical Accounting Policies**

 

Thepreparation of the Company’s financial statements in conformity with generallyaccepted accounting principles in the United States of America 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, income taxes 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.

 

TheCompany’s critical accounting policies are described in Item 7 “Management’sDiscussion and Analysis of Financial Condition and Results of Operations” andin the notes to the consolidated financial statements in the Company’spreviously filed Annual Report on Form 10-K for the fiscal yearended October 30, 2004. There were no changes to these policies during the12 week period ended January 22, 2005.

 

### **Executive Overview**

 

The Company’srevenue growth, both domestic and international, has continued into the firstquarter of fiscal 2005, though as anticipated, the rate of growth has moderatedover what was experienced in the last half of fiscal 2004.  Currently, moderate revenue growth in the midto high single digits is anticipated for the second quarter of fiscal 2005 withcontinued quarter-over-quarter growth through the

 

11

----

 

end of the fiscalyear. Economic indications of sustainable job growth in the staffing industryare supported in recent surveys by the American Staffing Association. February 2005marked the 20th consecutive month of year-over-year growth for the industry asmeasured and reported by the U.S. Bureau of Labor Statistics.

 

While there hasbeen no real alleviation of the strain on gross margins within the staffingindustry, the Company was able to generate a slight increase in its grossmargin rate to 17.1% for the 2005 quarter despite increases in 2005 stateunemployment insurance rates, as well as continued increases in domesticworkers’ compensation accrual rates. The Company is continuing its focus onincreasing bill rates where feasible and on growing direct hire revenue in aneffort to address the competitive pressures on gross margins.

 

The Company’sliquidity remains strong, with $10.4 million excess borrowing capacity in theU.S. and approximately $3 million for each of the United Kingdom and Australiaoperations. The Company is also focusing on implementation of a new and fullyintegrated enterprise-wide management information system. The new system willprovide expanded operational productivity and enhanced reporting capabilitiesthat will place the Company in an excellent position to take advantage ofcontinued growth in global economies.

 

**Results of Operations**

 

**Fiscal Quarter Ended January 22, 2005compared to Fiscal Quarter Ended January 24, 2004**

 

Revenueincreased $15.7 million or 12.8% for the first fiscal quarter of 2005 ascompared to the fiscal 2004 quarter. Domestic revenue increased 9.0%, whileinternational revenue increased 25.4%, assisted by the effect of favorableexchange rates.

 

Thedomestic revenue increase is largely the result of an increase in billed hoursof 5.6%, with increases reported in the majority of the Company’sgeographically dispersed regions. Excluding the effect of exchange ratefluctuations, international revenue increased 17.2%, with an increase of 16.2%in billed hours. The increase reflects revenue increases in each of the fiveforeign countries the Company operates in, with the largest increase, 25.6% ona constant currency basis, reported for the Company’s Australia operations.

 

Costsof services include hourly wages of temporary employees, employer payrolltaxes, state unemployment and workers’ compensation insurance and otheremployee-related costs. Costs of services increased $12.8 million, or 12.6%, inthe 2005 fiscal quarter as compared to 2004. Gross margin was 17.1% for thefiscal 2005 quarter and 16.9% for the fiscal 2004 quarter. Increases in averagebill rates outpaced increased average pay rates for the fiscal 2005 quarter,helping margins stabilize despite a 20.4% increase in domestic stateunemployment rates and a 6.8% increase in domestic workers’ compensationaccrual rates.

 

Overall,unemployment insurance rates in many states have been adversely impacted by thehigh levels of unemployment since early 2001. Many states have seen consecutiveyears of declines in their trust funds and some states have been forced toborrow money from the federal government to continue paying benefits. Currently,industry expectations are that state unemployment rates will remain high atleast through 2006 and possibly beyond.

 

TheCompany’s workers’ compensation costs tend to vary depending upon the mix ofbusiness between clerical/administrative and light industrial staffing. Workers’compensation accrual rates were 4.8% of 

 

12

----

 

directlabor for the fiscal 2005 quarter and 4.5% for the fiscal 2004 quarter. Unexpectedadverse development of claims reported but not yet settled, and increases inthe Company’s claims incurred but not yet reported, can also significantlyaffect the level of accruals needed to cover workers’ compensation costs. TheCompany reviews interim and annual actuarial estimates and monitors claimactivity to ensure that accruals remain appropriate in light of loss trends. However,unanticipated adverse loss development trends could result in the need foradditional charges to be recorded, increasing accrual rates beyond thosecurrently reported.

 

Franchiseagents’ share of gross profit represents the net distribution paid to franchiseagents based either on a percentage of the sales or gross profit generated bythe franchise agents’ operations. As a percentage of consolidated revenue,franchise agents’ share of gross profit was 2.9% for the fiscal 2005 quarterand 3.1% for the fiscal 2004 quarter. The percentage decrease is partially dueto the November 2004 divestiture of one of the Company’s franchiseoperations.

 

Sellingand administrative expenses increased $1.4 million, or 8.5% for the 2005 quarteras compared to the 2004 quarter, primarily due to higher exchange rates used totranslate international local currency expenses into U.S. dollars.  As a percentage of revenue, selling andadministrative expenses decreased from 13.2% to 12.7% as a result of theCompany’s generating higher revenue in the current quarter while continuing toclosely monitor expenditure levels.

 

Depreciationand amortization decreased $0.1 million or 12.1%, primarily due to a decreasedbase of depreciating assets.

 

Net interest expensedecreased $0.1 million or 12.4% primarily as a result of decreased averageborrowings during the fiscal 2005 quarter.

 

**Liquidityand Capital Resources**

 

TheCompany requires significant amounts of working capital to operate its businessand to pay expenses relating to employment of temporary employees. The Company’straditional use of cash is for financing of accounts receivable, particularlyduring periods of economic upswings and growth and during periods where salesare seasonally high. Temporary personnel are generally paid on a weekly basiswhile payments from customers are generally received 30 to 60 days afterbilling.

 

TheCompany finances its operations primarily through cash generated by itsoperating activities and borrowings under its revolving credit facilities. Netcash provided by operating activities was $0.9 million for the 12 weeks ended January 22,2005 compared to $1.0 million for the 12 weeks ended January 24, 2004. Netincome for the fiscal 2005 quarter, and increased collections on accountsreceivable as compared to the prior year quarter, were substantially offset bycash payments of $6.2 million as collateral for the Company’s 2005 workers’compensation obligations (see further discussion below), and decreases inaccounts payable and accrued expenses.

 

Cashused for capital expenditures, which are primarily for management informationsystems initiatives, other software, computers and peripherals, and officefurniture and equipment, totaled $1.2 million for the 12 weeks ended January 22,2005 as compared to $0.3 million for the same period in fiscal 2004. Theincrease in capital expenditures during the fiscal 2005 quarter is primarilydue to the Company’s recent start of an implementation of new managementinformation systems. The Company currently anticipates capital expenditureswill be approximately $6.0 million for the fiscal 2005 year.

 

13

----

 

Fromtime to time, the Company has generated cash through sales of Company-ownedoffices to franchise owners or sales of franchise agent and license officesback to the franchise agent or license owner. During the first quarter offiscal 2005, the Company sold one of its franchise agents’ operations back tothe franchise agent for cash proceeds of $1.0 million. The Company has securedthe franchise agents’ note payable obligation to the bank that funded thepurchase through a $1.0 million letter of credit that will decline as the noteobligation is paid by the franchise agent. The $1.0 million gain on the sale ofthe franchise operations has been deferred, and will be recognized as the noteobligation payments are made.

 

In May 2002, the Company entered into agreements with GE Capital,as primary agent, to provide senior secured credit facilities totaling $65.0million, expiring in May 2007. The facilities comprise a five-yearsyndicated Multicurrency Credit Agreement consisting of a $50.0 million USRevolving Loan Commitment, a £2.7 million UK Revolving Loan Commitment (USdollar equivalent of approximately $4.0 million at the date of the agreement),and a $5.0 million term loan (the Term Loan), which was repaid during fiscal2003. In addition, a five-year Australian dollar facility agreement (the A$FacilityAgreement) was executed on May 16, 2002, consisting of an A$12.0 millionrevolving credit facility (US dollar equivalent of approximately $6.0 millionat the date of the agreement). Each agreement includes a letter of creditsub-facility. Letters of credit under the agreements expire one year from dateof issuance but are automatically renewed for one additional year unlesswritten notice is given to or from the holder.

 

On January 5, 2005, a sixth amendment to theMulticurrency Credit Agreement was executed. The amendment, among other things,allows a $1.4 million add-back adjustment to the rolling 13-periodearnings before interest, taxes, depreciation and amortization (EBITDA)covenant at October 30, 2004 for additional workers’ compensation chargesthe Company incurred during the fourth quarter of fiscal 2004 relating toadverse loss development on historical claims. The add-back will assist theCompany in maintaining its minimum EBITDA and fixed charge covenants throughoutfiscal 2005.

 

As ofJanuary 22, 2005, the Company had $12.3 million outstanding under itscredit facilities with available borrowing capacity of $16.5 million consistingof $10.4 million for the U.S. operations, $3.1 million for the U.K. operationsand $3.0 million for the Australia operations.

 

TheCompany has an unsecured subordinated promissory note payable to its principalstockholder and Chairman of the Board of Directors in the amount of$2.0 million with a maturity date of August 18, 2007, and an interestrate equal to an indexed rate as calculated under the Company’s creditfacilities plus seven percent, compounded monthly and payable 60 calendar daysafter the end of each of the Company’s fiscal quarters. The interest rate ineffect on January 22, 2005 was 12.25%. Payment of interest is contingenton the Company meeting minimum availability requirements under its creditfacilities. Additionally, payments of principal or interest are prohibited inthe event of any default under the credit facilities.

 

On September 25, 2003 the Company executed a one-year unsecuredsubordinated draw down note with its principal stockholder and Chairman of theBoard of Directors. The note provided for the Chairman to make advances to theCompany upon request, at his sole discretion and with no obligation to do so,in an aggregate principal amount not to exceed $1.0 million outstanding at anyone time. On December 23, 2003 the Chairman made a $1.0 million advance tothe Company under the terms of the note. The advance plus accrued interest wasrepaid 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 immediate future cash availability and needsof each respective subsidiary, restrictions imposed by the Company’s seniorsecured debt facilities and, in some cases, statutory regulations of thesubsidiary. The US operations 

 

14

----

 

cannot directly draw on the excess borrowingavailability of the UK or Australian operations; however, the Company mayrequest dividends from the UK. The US can also request repayments onintercompany balances due from its international subsidiaries, subject to theircash flow needs and regulatory restrictions. The level of repayments from Australiaare currently restricted under the terms of the Australia credit facility;however, as a result of positive operating performance in Australia in fiscal2003 and fiscal 2004, the Company was notified by its Australian lender thatthese restrictions will be reduced or eliminated during fiscal 2005.

 

TheCompany is responsible for and pays workers’ compensation costs for itstemporary and regular employees and is self-insured for the deductible amountrelated to workers’ compensation claims ($500,000 per claim for fiscal 2005 and$750,000 per claim for fiscal 2004.) Each policy year the terms of theagreement with the insurance carrier are renegotiated. The insurance carrierrequires the Company to collateralize its obligations through the use of irrevocablestandby letters of credit, surety bonds or cash. At January 22, 2005 theCompany had $22.4 million of outstanding letters of credit and a $3.8 millionsurety bond securing its domestic workers compensation obligations for policyyears 2004 and earlier.

 

Underthe terms of its 2005 policy year agreement, the Company will make cashpayments totaling $20.6 million to be paid in monthly installments, whichcommenced on November 1, 2004 in the amounts of $2.7 million for the firstthree installments and $1.4 million for the remaining nine installments. Ofthese payments, $15.8 million will serve to cash collateralize the Company’sfiscal 2005 obligations in lieu of issuance of additional letters of credit. Cashpayments for 2005 policy year claims will be paid out of this cash collateralfund. The Company will also make ongoing cash payments for claims for all otheropen policy years except 2003, which is fully funded although subject to annualretroactive premium adjustments based on actual claims activity.

 

Duringthe fourth quarter of fiscal 2004, the Company received an unfavorablearbitration ruling relating to a contract dispute with one of its vendors. Totalcosts associated with the claim, including the arbitration award plus relatedattorneys’ fees were $1.1 million. Payments of $0.9 million for the award plusremaining related attorneys’ fees were paid during the first quarter of fiscal2005.

 

Duringthe first quarter of fiscal 2005, the Company received $0.5 million of domesticfederal income tax refunds relating to carryback provisions.

 

The Company believes thatthe current borrowing capacity provided under its credit facilities, togetherwith cash generated through its improved operating performance, will besufficient to meet the Company’s working capital needs for the foreseeablefuture.

 

**Item 3. Quantitative****and Qualitative Disclosures About Market Risk**

 

The Company isexposed to certain market risks from transactions that are entered into duringthe normal course of business. The Company’s primary market risk exposurerelates to interest rate risk. At January 22, 2005, the Company’soutstanding debt under variable-rate interest borrowings was approximately$14.3 million. A change of 2% in the interest rates would cause a change ininterest expense of approximately $0.3 million on an annual basis. The Company’sexposure to market risk for changes in interest rates is not significant withrespect to interest income, as its investment portfolio is not material to itsconsolidated balance sheet. The Company currently has no plans to hold aninvestment portfolio that includes derivative financial instruments.

 

15

----

 

For the 12 weeks ended January 22, 2005, theCompany’s international operations comprised 25.4% of its revenue and, as ofthe end of that period, 25.6% of its total assets. The Company is exposed toforeign currency risk primarily due to its investments in foreign subsidiaries.The Company’s multicurrency credit facility, which allows the Company’sAustralia and United Kingdom subsidiaries to borrow in local currencies,partially mitigates the exchange rate risk resulting from fluctuations inforeign currency denominated net investments in these subsidiaries in relationto the U.S. dollar. The Company does not currently hold any market risksensitive instruments entered into for hedging transaction risks related toforeign currencies. In addition, the Company has not entered into anytransactions with derivative financial instruments for trading purposes.

 

### **Item 4. Controls**and Procedures

 

The Company carried out an evaluation, under the supervisionand with the participation of the Company’s management, including the ChiefExecutive Officer and Chief Financial Officer, of the effectiveness of thedesign and operations of the Company’s “disclosure controls and procedures” (asdefined 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 of January 22,2005 (the end of the period covered by this report) the Company’s disclosurecontrols and procedures are effective in timely alerting them to materialinformation required to be included in this report. There was no change in theCompany’s internal control over financial reporting that occurred during thefiscal period ended January 22, 2005, that has materially affected, or isreasonably likely to materially affect, the Company’s internal controls overfinancial reporting.

 

16

----

 

### **Item 1. Legal Proceedings**

 

TheCompany is not currently a party to any material litigation. However, from timeto time the Company has been threatened with or named as a defendant inlawsuits, including countersuits brought by former franchise agents orlicensees, and administrative claims and lawsuits brought by employees orformer employees.

 

### **Item 2. Unregistered Sales of Equity Securities andUse of Proceeds**

 

None.

 

### **Item 3. Defaults Upon Senior Securities**

 

Notapplicable.

 

### **Item 4. Submission of Matters to a Vote of SecurityHolders**

 

None.

 

### **Item 5. Other Information**

 

Noevents.

 

**Item 6. Exhibits**

 

Setforth below is a list of the exhibits included as part of this QuarterlyReport:

 
| 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. |

 

17

----

 

**SIGNATURES**

 

Pursuant to therequirements of the Securities Exchange Act of 1934, the Registrant has dulycaused this report to be signed on its behalf by the undersigned thereunto dulyauthorized.

 

 
|                | WESTAFF, INC.                                     |
|---------------------|---------------------------------------------------|
|                |
|                |
| March 8,  2005 | /s/ Dirk A. Sodestrom                             |   |
| Date                |                                              | Dirk A. Sodestrom |
|                | Senior Vice President and Chief Financial Officer |
|                     |                                                   |  |  |  |

 

 

18

----