##### **UNITED STATES**

**SECURITIESAND EXCHANGE COMMISSION**

**Washington,D. C.  20549**

 

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

 

|       | **(MARK ONE)** |                                                                                                                                                                                                                                                               |
|------------|----------------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|       |           |                                                                                                                                                                                                                                                               |
| **ý** |           | **QUARTERLY  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**                                                                                                                                                                       |
|       |           |                                                                                                                                                                                                                                                               |
|       |           | **For the quarterly period ended****January  24, 2004**                                                                                                                                                                                                            |
|       |           |                                                                                                                                                                                                                                                               |
| **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 itscharter)

 

| **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 telephone  number)                           |

 

Indicate by check mark whether the registrant (1) has filed all reportsrequired to be filed by Section 13 or 15(d) of the Securities Exchange Act of1934 during the preceding 12 months (or for such shorter period that theregistrant was required to file such reports), and (2) has been subject to suchfiling requirements for the past 90 days. Yes ý  No o

 

Indicate by check mark whether the registrant is an accelerated filer(as defined in Rule 12b-2 of the Exchange Act).   Yes o  No ý

 

Indicate the number of shares outstanding of each of the issuer’sclasses of common stock, as of the latest practicable date:

 

| **Class**                    |   | **Outstanding  at March 8, 2004** |
|------------------------------|--------|-----------------------------------|
|                         |   |                              |
| Common Stock, $.01 par value |   | 16,033,229 shares                 |

 

 

----

 

**WESTAFF, INC. AND SUBSIDIARIES**

 

**INDEX**

 
| **Part I.**  | **Financial Information**                                                                                |   |
|--------------|----------------------------------------------------------------------------------------------------------|--------|
|         |                                                                                                     |   |
| Item 1.      | Financial Statements (Unaudited)                                                                         |   |
|         |                                                                                                     |   |
|         | Condensed Consolidated Balance Sheets -  January 24, 2004 and November 1, 2003                           |   |
|         |                                                                                                     |   |
|         | Condensed Consolidated Statements of  Operations -  12 weeks ended January 24, 2004 and January 25, 2003 |   |
|         |                                                                                                     |   |
|         | Condensed Consolidated Statements of Cash  Flows -  12 weeks ended January 24, 2004 and January 25, 2003 |   |
|         |                                                                                                     |   |
|         | Notes to Condensed Consolidated Financial  Statements                                                    |   |
|         |                                                                                                     |   |
| Item  2.     | Management’s  Discussion and Analysis of Financial Condition and Results of Operations              |   |
|         |                                                                                                     |   |
| Item  3.     | Quantitative  and Qualitative Disclosures About Market Risk                                              |   |
|         |                                                                                                     |   |
| Item 4.      | Controls and  Procedures                                                                                 |   |
|         |                                                                                                     |   |
| **Part II.** | **Other Information**                                                                                    |   |
|         |                                                                                                     |   |
| Item 1.      | Legal Proceedings                                                                                        |   |
|         |                                                                                                     |   |
| Item  2.     | Changes  in Securities and Use of Proceeds                                                               |   |
|         |                                                                                                     |   |
| Item 3.      | Defaults Upon  Senior Securities                                                                         |   |
|         |                                                                                                     |   |
| Item  4.     | Submission  of Matters to a Vote of Security Holders                                                     |   |
|         |                                                                                                     |   |
| Item 5.      | Other Information                                                                                        |   |
|         |                                                                                                     |   |
| Item 6.      | Exhibits and  Reports on Form 8-K                                                                        |   |
|         |                                                                                                     |   |
| Signatures   |                                                                                                     |

 

2

----

 

**PartI.  Financial Information**

 

**Item1.  Financial Statements**

** **

**Westaff, Inc.**

** **

**Condensed Consolidated Balance Sheets(Unaudited)**

**(In thousands except per share amounts)**
|                                                                                                                                      |   | **January  24,  2004** |    | **November  1,  2003** |   |
|-------------------------------------------------------------------------------------------------------------------------------------------|--------|------------------------|---------|------------------------|--------|
| **ASSETS**                                                                                                                                |   |                   |    |                   |   |
| Current assets:                                                                                                                           |   |                   |    |                   |   |
| Cash and cash equivalents                                                                                                                 |   | $                      | 1,632   |                   | $      | 4,759 |   |
| Trade accounts receivable, less allowance  for doubtful accounts of $764 and $1,067                                                       |   | 66,797                 |    | 74,564                 |   |
| Income taxes receivable                                                                                                                   |   | 536                    |    | 536                    |   |
| Prepaid expenses                                                                                                                          |   | 2,659                  |    | 2,833                  |   |
| Other current assets                                                                                                                      |   | 1,725                  |    | 1,741                  |   |
| Total current assets                                                                                                                      |   | 73,349                 |    | 84,433                 |   |
|                                                                                                                                      |   |                   |    |                   |   |
| Property and equipment, net                                                                                                               |   | 11,851                 |    | 12,569                 |   |
| Goodwill, net                                                                                                                             |   | 11,807                 |    | 11,687                 |   |
| Other long-term assets                                                                                                                    |   | 8,275                  |    | 4,458                  |   |
| Total Assets                                                                                                                              |   | $                      | 105,282 |                   | $      | 113,147 |   |
|                                                                                                                                      |   |                   |    |                   |   |
| **LIABILITIES AND STOCKHOLDERS’ EQUITY**                                                                                             |   |                   |    |                   |   |
| Current liabilities:                                                                                                                      |   |                   |    |                   |   |
| Borrowing under revolving credit facilities                                                                                               |   | $                      | 20,887  |                   | $      | 25,410 |   |
| Current portion of capital lease  obligations                                                                                             |   | 439                    |    | 432                    |   |
| Note payable to related party                                                                                                             |   | 1,000                  |    |                   |   |
| Accounts payable                                                                                                                          |   | 1,213                  |    | 2,013                  |   |
| Accrued expenses                                                                                                                          |   | 31,041                 |    | 34,086                 |   |
| Income taxes payable                                                                                                                      |   | 498                    |    | 626                    |   |
| Net liabilities of discontinued operations                                                                                                |   | 451                    |    | 629                    |   |
| Total current liabilities                                                                                                                 |   | 55,529                 |    | 63,196                 |   |
|                                                                                                                                      |   |                   |    |                   |   |
| Note payable to related party                                                                                                             |   | 2,000                  |    | 2,000                  |   |
| Long-term capital lease obligations                                                                                                       |   | 486                    |    | 590                    |   |
| Other long-term liabilities                                                                                                               |   | 11,842                 |    | 11,905                 |   |
| Total liabilities                                                                                                                         |   | 69,857                 |    | 77,691                 |   |
|                                                                                                                                      |   |                   |    |                   |   |
| 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: 16,015 shares at January 24, 2004 and  November 1, 2003 |   | 160                    |    | 160                    |   |
| Additional paid-in capital                                                                                                                |   | 36,706                 |    | 36,706                 |   |
| Accumulated retained deficit                                                                                                              |   | (1,354                 | )       | (448                   | )      |
| Accumulated other comprehensive loss                                                                                                      |   | (87                    | )       | (962                   | )      |
| Total stockholders’ equity                                                                                                           |   | 35,425                 |    | 35,456                 |   |
| Total Liabilities and Stockholders’ Equity                                                                                           |   | $                      | 105,282 |                   | $      | 113,147 |   |

 

See accompanying notes to condensedconsolidated financial statements.

 

3

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**Westaff, Inc.**

 

**Condensed Consolidated Statements ofOperations (Unaudited)**

**(In thousands except per share amounts)**

 
|                                                                                                         |   | **12 Weeks  Ended**    |    |
|--------------------------------------------------------------------------------------------------------------|--------|------------------------|---------|
|                                                                                                         |   | **January  24,  2004** |    | **January  25,  2003** |   |
|                                                                                                         |   |                   |    |   |   |
| Revenues                                                                                                     |   | $                      | 122,483 |   | $ | 117,834 |   |
|                                                                                                         |   |                   |    |   |   |
| Costs of services                                                                                            |   | 101,837                |    | 97,463 |   |
|                                                                                                         |   |                   |    |   |   |
| Gross profit                                                                                                 |   | 20,646                 |    | 20,371 |   |
|                                                                                                         |   |                   |    |   |   |
| Franchise agents’ share of gross profit                                                                 |   | 3,802                  |    | 3,412 |   |
| Selling and administrative expenses                                                                          |   | 16,091                 |    | 15,888 |   |
| Depreciation and amortization                                                                                |   | 1,103                  |    | 1,281 |   |
|                                                                                                         |   |                   |    |   |   |
| Operating loss from continuing operations                                                                    |   | (350                   | )       | (210 | ) |
|                                                                                                         |   |                   |    |   |   |
| Interest expense                                                                                             |   | 473                    |    | 465 |   |
| Interest income                                                                                              |   | (20                    | )       | (52 | ) |
|                                                                                                         |   |                   |    |   |   |
| Loss from continuing operations before  income taxes and cumulative effect of change in accounting principle |   | (803                   | )       | (623 | ) |
| Provision for income taxes                                                                                   |   | 103                    |    | 41 |   |
|                                                                                                         |   |                   |    |   |   |
| Loss from continuing operations before  cumulative effect of change in accounting principle                  |   | (906                   | )       | (664 | ) |
|                                                                                                         |   |                   |    |   |   |
| Income from discontinued operations                                                                          |   |                   |    | 316 |   |
| Cumulative effect of change in accounting  principle                                                         |   |                   |    | (670 | ) |
|                                                                                                         |   |                   |    |   |   |
| Net loss                                                                                                     |   | $                      | (906    | ) | $ | (1,018 | ) |
|                                                                                                         |   |                   |    |   |   |
| Earnings (loss) per share - basic and  diluted:                                                              |   |                   |    |   |   |
|                                                                                                         |   |                   |    |   |   |
| Continuing operations before cumulative  effect of change in accounting principle                            |   | $                      | (0.06   | ) | $ | (0.04 | ) |
|                                                                                                         |   |                   |    |   |   |
| Discontinued operations                                                                                      |   | $                      | —  |   | $ | 0.02 |   |
|                                                                                                         |   |                   |    |   |   |
| Cumulative effect of change in accounting  principle                                                         |   | $                      | —  |   | $ | (0.04 | ) |
|                                                                                                         |   |                   |    |   |   |
| Net loss                                                                                                     |   | $                      | (0.06   | ) | $ | (0.06 | ) |
|                                                                                                         |   |                   |    |   |   |
| Weighted average shares outstanding - basic  and diluted                                                     |   | 16,015                 |    | 15,972 |   |

 

See accompanying notes to condensedconsolidated financial statements.

 

4

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**Westaff, Inc.**

** **

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

**(In thousands)**

 
|                                                                             |   | **12 Weeks  Ended**    |   |
|----------------------------------------------------------------------------------|--------|------------------------|--------|
|                                                                             |   | **January  24,  2004** |   | **January  25,  2003** |   |
| **Cash flows from operating activities**                                         |   |                   |   |   |   |
| Net loss                                                                         |   | $                      | (906   | ) | $ | (1,018 | ) |
| Adjustments to reconcile net loss to net  cash provided by operating activities: |   |                   |   |   |   |
| Income from discontinued operations                                              |   |                   |   | (316 | ) |
| Loss from cumulative effect of change in  accounting principle                   |   |                   |   | 670 |   |
| Depreciation and amortization                                                    |   | 1,103                  |   | 1,281 |   |
| Provision for losses on doubtful accounts                                        |   | 138                    |   | (75 | ) |
| Loss (gain) on sale or disposal of assets                                        |   | 52                     |   | (4 | ) |
| Other                                                                            |   | 300                    |   | (97 | ) |
| Changes in assets and liabilities:                                               |   |                   |   |   |   |
| Trade accounts receivable                                                        |   | 9,052                  |   | 10,335 |   |
| Other assets                                                                     |   | (3,088                 | )      | (79 | ) |
| Accounts payable and accrued expenses                                            |   | (5,037                 | )      | (8,283 | ) |
| Income taxes payable                                                             |   | (144                   | )      | (261 | ) |
| Other liabilities                                                                |   | (259                   | )      | 7 |   |
|                                                                             |   |                   |   |   |   |
| Net cash provided by continuing operations                                       |   | 1,211                  |   | 2,160 |   |
| Net cash (used) provided by discontinued  operations                             |   | (178                   | )      | 475 |   |
|                                                                             |   |                   |   |   |   |
| Net cash provided by operating activities                                        |   | 1,033                  |   | 2,635 |   |
|                                                                             |   |                   |   |   |   |
| **Cash flows from investing activities**                                         |   |                   |   |   |   |
| Capital expenditures                                                             |   | (262                   | )      | (625 | ) |
| Proceeds from sales of affiliate operations                                      |   | 7                      |   | 170 |   |
| Proceeds from sales of assets                                                    |   |                   |   | 7,386 |   |
| Other, net                                                                       |   | 22                     |   | (14 | ) |
|                                                                             |   |                   |   |   |   |
| Net cash (used) provided by investing  activities                                |   | (233                   | )      | 6,917 |   |
|                                                                             |   |                   |   |   |   |
| **Cash flows from financing activities**                                         |   |                   |   |   |   |
| Net repayments under line of credit  agreements                                  |   | (4,870                 | )      | (5,211 | ) |
| Principal payments on long-term debt and  capital lease obligations              |   | (96                    | )      | (4,500 | ) |
| Proceeds from notes payable to related  parties                                  |   | 1,000                  |   |   |   |
| Payment of note payable to related party                                         |   |                   |   | (1,000 | ) |
|                                                                             |   |                   |   |   |   |
| Net cash used by financing activities                                            |   | (3,966                 | )      | (10,711 | ) |
|                                                                             |   |                   |   |   |   |
| Effect of exchange rate changes on cash                                          |   | 39                     |   | 76 |   |
|                                                                             |   |                   |   |   |   |
| Net change in cash and cash equivalents                                          |   | (3,127                 | )      | (1,083 | ) |
| Cash and cash equivalents at beginning of  period                                |   | 4,759                  |   | 5,484 |   |
| Cash and cash equivalents at end of period                                       |   | $                      | 1,632  |   | $ | 4,401 |   |

 

See accompanying notes to condensedconsolidated financial statements.

 

5

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**Westaff, Inc.**

** **

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

**(In thousands except per share amounts)**

** **

**1.****              Basis ofPresentation**

 

The accompanying condensed consolidatedfinancial statements of Westaff, Inc. and its domestic and foreign subsidiaries(together, the Company), as of January 24, 2004 and for the 12 week periodsended January 24, 2004 and January 25, 2003 are unaudited.

 

The condensed consolidated financialstatements, in the opinion of management, reflect all adjustments, which are ofa normal recurring nature, necessary for a fair presentation of the financialposition, results of operations and cash flows for the periods presented.  The condensed consolidated balance sheet asof November 1, 2003 presented herein, has been derived from the audited balancesheet included in the Company’s Annual Report on Form 10-K for the fiscal yearended November 1, 2003.

 

Certain financial information which isnormally included in annual financial statements prepared in accordance withaccounting principles generally accepted in the United States, but which is notrequired for interim reporting purposes, has been condensed or omitted.  The accompanying condensed consolidatedfinancial statements should be read in conjunction with the financialstatements and notes thereto included in the Company’s Annual Report on Form10-K for the fiscal year ended November 1, 2003.

 

The Company’s fiscal year is a 52 or 53 weekperiod ending the Saturday nearest the end of October.  For interim reporting purposes, the firstthree fiscal quarters comprise 12 weeks each, while the fourth fiscal quarterconsists of 16 or 17 weeks.  The resultsof operations for the 12 week period ended January 24, 2004 are not necessarilyindicative of the results to be expected for the full fiscal year or for anyfuture period.

 

During fiscal year 1999, the Company sold itsmedical business, primarily operated through Western Medical Services, Inc.(Western Medical), a wholly owned subsidiary of the Company (see Note 4).  As a result, the Company has classified itsmedical operations as discontinued operations in these condensed consolidatedfinancial statements and notes thereto.

 

**2.****              Stock-basedCompensation**

 

The Companymeasures compensation cost for employee stock options and similar equityinstruments using the intrinsic value-based method of accounting prescribed byAccounting Principles Board Opinion No. 25, “Accounting for Stock Issued toEmployees”(APB 25), and follows the disclosure-only provisions of SFAS No. 123,“Accounting for Stock-Based Compensation”, as amended by SFAS No. 148,“Accounting for Stock-Based Compensation – Transition and Disclosure”.  As all options have been granted at fairvalue, no compensation cost has been recognized in the financial statements.  The following table represents pro forma netloss and pro forma loss per share had compensation cost been determined usingthe fair value method:

 

6

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|                                                             |   | **12 Weeks  Ended**    |   |
|------------------------------------------------------------------|--------|------------------------|--------|
|                                                             |   | **January  24,  2004** |   | **January  25,  2003** |   |
|                                                             |   |                   |   |   |   |
| Net loss as reported                                             |   | $                      | (906   | ) | $ | (1,018 | ) |
| Stock based compensation determined under  the fair value method |   | (107                   | )      | (116 | ) |
|                                                             |   |                   |   |   |   |
| Pro forma net loss                                               |   | $                      | (1,013 | ) | $ | (1,134 | ) |
|                                                             |   |                   |   |   |   |
| Loss per common share:                                           |   |                   |   |   |   |
| Basic and diluted - as reported                                  |   | $                      | (0.06  | ) | $ | (0.06 | ) |
| Basic and diluted - pro forma                                    |   | $                      | (0.06  | ) | $ | (0.07 | ) |

 

Because stockoptions 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**

 

Effective November3, 2002, the Company adopted Statement of Financial Accounting Standards (SFAS)No. 142 “Goodwill and Other Intangible Assets”.  SFAS No. 142 provides that goodwill and other intangible assetswith indefinite lives are no longer amortized, but rather are evaluated forimpairment by applying a fair-value based test. The impairment test is comprisedof two parts.  The first step comparesthe fair value of a reporting unit with its carrying value, includinggoodwill.  If the carrying value of areporting unit exceeds its fair value, the second step of the goodwillimpairment test must be performed.  Thesecond step compares the implied fair value of the reporting units’ goodwillwith the respective carrying value in order to determine the amount ofimpairment loss, if any.

 

During fiscal2003, the Company performed tests for impairment in accordance with the newstandard.   In the initial test underthe transitional provisions of SFAS No. 142, the Company determined that animpairment of $670 existed in its Australia reporting unit. In accordance withSFAS No. 142, the impairment was classified as a cumulative effect of a changein accounting principle and resulted in a restatement of the Company’s net lossfor the fiscal quarter ended January 25, 2003.

 

The Companyperforms its annual impairment evaluation in the fourth quarter of each fiscalyear. No additional impairment was identified in the Company’s annualimpairment evaluation for fiscal 2003.

 

7

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**The change in the carrying amount of goodwill for the 12weeks ended January 24, 2004 is due to the effect of changes in foreigncurrency translation rates.**

** **

**In accordance with SFAS No. 142, no amortization ofgoodwill was recorded in the 12 week periods ended January 24, 2004 and January25, 2003.**

** **

**4.****              DiscontinuedOperations**

 

During fiscal1999, the Company sold certain of its franchise agent and Company-owned medicaloffices and entered into a termination agreement with one of its medicallicensees. During the fourth quarter of fiscal 1999, the Company completed thesale of the remaining medical business to Intrepid U.S.A. Inc. (Intrepid) underan asset purchase agreement. Under the terms of the sale, the Company retainedthe majority of accounts receivable, including trade and Medicare accountsreceivable balances.

 

Prior to fiscal2003, the Company appealed Western Medical’s 1996 Medicare cost reportsettlement.  During the first quarter offiscal 2003, the appeal was settled and Western Medical received additionalcost reimbursements.  As a result of thefavorable appeal settlement, the Company recognized $316 of income fromdiscontinued operations in the fiscal quarter ended January 25, 2003.

 

As of January 24, 2004, the remaining currentliabilities of the discontinued medical operations are for estimated pendinglegal claims of $300, malpractice/liability claims of  $150 and other costs of $3.

 
|                                       |   | **January  24,  2004** |   | **November  1,  2003** |   |
|--------------------------------------------|--------|------------------------|--------|------------------------|--------|
|                                       |   |                   |   |                   |   |
| Current assets (primarily receivables)     |   | $                      | 2      |                   | 15     |   |
| Current liabilities                        |   | (453                   | )      | (644                   | )      |
|                                       |   |                   |   |                   |   |
| Net liabilities of discontinued operations |   | $                      | (451   | )                      | $      | (629 | ) |
|                                            |        |                        |        |                        |        |  |  |

 

**5.****              Earnings (Loss) PerShare**

 

Basic earnings per share and diluted earningsper share are the same for all periods when the Company has a net loss fromcontinuing operations.  The followingtable sets forth the computation of basic and diluted loss per share:

 

8

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|                                                                                                                     |   | **12 Weeks  Ended**    |   |
|--------------------------------------------------------------------------------------------------------------------------|--------|------------------------|--------|
|                                                                                                                     |   | **January  24,  2004** |   | **January  25,  2003** |   |
|                                                                                                                     |   |                   |   |   |   |
| Loss from continuing operations before  cumulative effect of change in accounting principle                              |   | $                      | (906   | ) | $ | (664 | ) |
|                                                                                                                     |   |                   |   |   |   |
| Denominator for basic and diluted earnings  per share                                                                    |   | 16,015                 |   | 15,972 |   |
|                                                                                                                     |   |                   |   |   |   |
| Basic and diluted loss per share from  continuing operations before cumulative effect of change in accounting  principle |   | $                      | (0.06  | ) | $ | (0.04 | ) |
|                                                                                                                     |   |                   |   |   |   |
| Anti-dilutive weighted shares excluded from  diluted loss per share                                                      |   | 1,020                  |   | 1,100 |   |

 

**6.****              ComprehensiveIncome (Loss)**

 

Comprehensiveincome (loss) consists of the following:

 
|                             |   | **12 Weeks  Ended**    |   |
|----------------------------------|--------|------------------------|--------|
|                             |   | **January  24,  2004** |   | **January  25,  2003** |   |
|                             |   |                   |   |   |   |
| Net loss                         |   | $                      | (906   | ) | $ | (1,018 | ) |
| Currency translation adjustments |   | 875                    |   | 509 |   |
| Comprehensive loss               |   | $                      | (31    | ) | $ | (509 | ) |

 

**7.****             ****Credit Agreement**

 

At November 1, 2003 and through January 24, 2004, the Company was outof compliance with certain financial covenants under its Multicurrency CreditAgreement, including a minimum earnings before interest, taxes, depreciationand amortization (EBITDA) covenant.  OnFebruary 20, 2004, the Company and its lending agents executed a fourthamendment to the agreement.  Theamendment allows certain one-time add-backs to EBITDA for the fiscal periodended November 1, 2003, which eliminates the covenant defaults and resets theEBITDA and certain other covenants going forward.  The amendment also requires a separate EBITDA covenantcalculation for the Company’s domestic operations on a stand-alone basis.  In addition, the amendment resets thereserves which effect the Company’s borrowing capacity, redefines eligibletrade accounts receivable for purposes of calculating the US and UK borrowingbase, increases the applicable margins on outstanding irrevocable letters of creditby 1.0% and reduces maximum capital expenditures allowed for fiscal 2004 by$1,000.

 

9

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**8.****              RelatedParty Transactions**

 

On September 25, 2003 theCompany executed a one-year unsecured subordinated draw down note with itsprincipal stockholder and Chairman of the Board of Directors.  The note provides for the Chairman to makeadvances to the Company upon request, at his sole discretion and with noobligation to do so, in an aggregate principal amount not to exceed $1,000outstanding at any one time.  Principaland interest on advances are due and payable on the earlier of twenty-twobusiness days from the date of the advance or the final maturity date of thedraw down note (September 25, 2004), subject to certain restrictions regardingborrowing capacity and compliance with certain covenants in the Company’ssenior secured credit facilities.  Theinterest rate on outstanding advances is equal to an indexed rate as calculatedunder the Company’s credit facilities plus seven percent, compounded monthly.On December 23, 2003 the Chairman made a $1,000 advance to the Company underthe terms of the note.

 

**9.****              OperatingSegments**

 

The following table summarizes reportingsegment data:

 
|                                                                                                           |   | **Domestic  Business Svcs.** |   | **United  Kingdom  Operations** |   | **Other  International** |   | **Total  Continuing  Operations** |   |
|----------------------------------------------------------------------------------------------------------------|--------|------------------------------|--------|---------------------------------|--------|--------------------------|--------|-----------------------------------|--------|
|                                                                                                           |   |                         |   |                            |   |                     |   |                              |   |
| **12 Weeks Ended January 24, 2004**                                                                            |   |                         |   |                            |   |                     |   |                              |   |
|                                                                                                           |   |                         |   |                            |   |                     |   |                              |   |
| Revenues                                                                                                       |   | $                            | 94,438 |                            | $      | 8,559                    |   | $                                 | 19,486 |   | $ | 122,483 |   |
| Operating income (loss) from continuing  operations before cumulative effect of change in accounting principle |   | $                            | (677   | )                               | $      | 283                      |   | $                                 | 44     |   | $ | (350 | ) |
|                                                                                                           |   |                         |   |                            |   |                     |   |                              |   |
| **12 Weeks Ended January 25, 2003**                                                                            |   |                         |   |                            |   |                     |   |                              |   |
|                                                                                                           |   |                         |   |                            |   |                     |   |                              |   |
| Revenues                                                                                                       |   | $                            | 96,495 |                            | $      | 6,480                    |   | $                                 | 14,859 |   | $ | 117,834 |   |
| Operating income (loss) from continuing  operations before cumulative effect of change in accounting principle |   | $                            | (98    | )                               | $      | 104                      |   | $                                 | (216   | ) | $ | (210 | ) |

 

**10.****       Commitments andContingencies**

 

In the ordinary course ofits business, the Company is periodically threatened with or named as a defendantin 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.

 

OnMarch 9, 2000, Synergy Staffing, Inc. (“claimant”) filed a complaint in the Los Angeles County Superior Courtof the State of California against the Company, all members of its Board ofDirectors and one of the executive officers. The complaint alleged, among otherthings, that the defendants fraudulently induced the claimant to sell theassets of The Personnel Connection, Inc. The Company’s petition for an ordercompelling arbitration was granted and the Superior

 

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Courtlawsuit was stayed.  The arbitrationproceeded under the auspices of the American Arbitration Association. OnJanuary 9, 2002, the arbitration panel rendered an interim award in favor ofthe claimant for compensatory damages of $2,224, plus interest from the date ofthe award, as well as reasonable attorneys’ fees and other costs incurred inthe proceeding.  During the fourthquarter of fiscal 2001, the Company recorded an accrued liability and related pretaxcharge of $3,600 for the estimated costs of the award.  On February 11, 2002, the arbitration panelissued an Order Modifying Interim Award, crediting the Company for $800previously paid under a price protection clause in the asset purchase agreementand thereby reducing the principal amount of the award to $1,424.  As a result of the interim award, theCompany determined that $693 of the initial estimated liabilities were nolonger required, and recorded the reduction in its fourth fiscal quarter of2002. The claimant asked the Superior Court to correct and confirm the interimaward.  On September 25, 2002, the Courtdenied the claimant’s motion.  Theclaimant then filed an appeal of the denial with the appellate court.   On October 21, 2003 the appellate courtreversed the Superior Court’s denial of the claimant’s motion.  The Company filed a petition for rehearing,which was denied.  In December 2003, theclaimants agreed to a settlement of $930 and the Company  recorded a charge to earnings in its fiscal2003 Statement of Operations of $950 for the cost of the settlement plusrelated attorneys’ fees.  The settlementamount and related fees were paid in the first quarter of fiscal 2004.

 

From time to time the Company has been threatened with, or named as adefendant in, lawsuits, including countersuits brought by former franchiseagents or licensees, and administrative claims and lawsuits brought byemployees 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

 

**11.****          ****Recent Accounting Pronouncements**

 

In January 2003,the Financial Accounting Standards Board (FASB) issued FASB Interpretation No.46, “Consolidation of Variable Interest Entities, an Interpretation ofAccounting Research Bulletin No. 51” (FIN 46). FIN 46 provides guidance on identifying variable interest entities andassessing whether or not they should be consolidated.  The provisions of FIN 46 are to be applied immediately tovariable interest entities created after January 31, 2003 to the firstreporting period ending after December 15, 2003.  For all variable interest entities created prior to February 1,2003, public companies will be required to apply the provisions of FIN 46 atthe end of the first interim or annual reporting period ending after March 15,2004.  The Company currently does notbelieve adoption of the interpretation will have a material impact on itsconsolidated results of operations or financial position.

 

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**Item2.  Management’s Discussion and Analysisof Financial Condition and Results of Operations**

 

### **Cautionary Statement**

 

The following discussion is intended to assist in the understanding andassessment of significant changes and trends related to the results ofoperations and financial condition of Westaff, Inc., together with itsconsolidated subsidiaries. This discussion and analysis should be read inconjunction with the Company’s Consolidated Financial Statements and Notesthereto included in the Company’s Annual Report on Form 10-K for the fiscalyear ended November 1, 2003.

 

In addition to historical information, this discussion and analysisincludes certain forward-looking statements regarding events and financialtrends that may affect the Company’s future operating results and financialposition. This notice is intended to take advantage of the “safe harbor”provided by the Private Securities Litigation Reform Act of 1995 with respectto such forward-looking statements. These forward-lookingstatements include, but are not limited to, statements regarding liquidity andfinancing, credit facilities, workers’ compensation and unemployment insurancecosts, sales, gross margin, selling and administrative expenses, capitalexpenditures, capital resources and medical operations. Readers are cautionednot to place undue reliance on these forward-looking statements, whichare made based on information available as of the date hereof; actual resultsmay differ materially. The Company undertakes no obligation to publicly releasethe results of any revisions to these forward-looking statements toreflect events or circumstances after the date hereof or to reflect theoccurrence of unanticipated events, except as required by applicable laws andregulations.

 

The forward-looking statements included herein are also subjectto a number of other risks and uncertainties that could cause the Company’sactual results and financial position to differ materially from those anticipatedin the forward-looking statements. Such risks and uncertainties include,but are not limited to: the ability to raise additional capital and the abilityto continue as a going concern, credit facilities and compliance with debtcovenants, possible adverse effects of fluctuations in the general economy,variability of employee-related costs including workers’ compensationliabilities, a highly competitive market, control by a significant shareholder,the volatility of the Company’s stock price, reliance on management informationsystems, reliance on executive management, risks related to internationaloperations, risks associated with customers, variability of operating resultsand the seasonality of the business cycle, ability to attract and retain the servicesof qualified temporary personnel, reliance on field management, employerliability risks and risks related to franchise agent and licensedoperations.  Due to the foregoingfactors, it is possible that in some future period the Company’s results of operationsmay be below the expectations of public market analysts and investors.  In addition, the Company’s results ofoperations have historically been subject to quarterly and seasonalfluctuations.  These and other risks anduncertainties related to the Company’s business are described in detail in Item1, “Factors Affecting Future Operating Results” in the Company’s Annual Reporton Form 10-K for the fiscal year ended November 1, 2003.

 

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### **Liquidity**

### ** **

### **On February 20, 2004, the Companyand its lending group executed a fourth amendment to the Company’sMulticurrency Credit Agreement.  Theamendment, among other things, allows certain one-time add-backs to the minimumearnings before interest, taxes, depreciation and amortization (EBITDA)covenant for the fiscal period ended November 1, 2003, which eliminates thecovenant defaults existing on that date as disclosed in the Company’s AnnualReport on Form 10-K for the fiscal year ended November 1, 2003.**

 

The Company continues to face significant challenges with respect toliquidity and financing. Based on current forecasts and expectations regardingfiscal 2004, the Company believes that it will continue to face periods of lowcash availability and will be required to carefully manage its cash positionthroughout the year. Furthermore, if the Company is unable to achieve itsoperating forecasts for the year, or if there are unexpected reductions in cashinflows or increases in cash outlays, the Company may be faced with a cashshortfall which could have a material adverse effect on the Company’s businessand financial condition. Please see “Liquidity and Capital Resources” for amore complete discussion of the credit agreement amendment, the Company’sfinancing issues, cash positions, sources and uses of cash, including potentialadditional sources of cash, borrowing arrangements and other risks anduncertainties surrounding the Company’s liquidity.

 

### **CriticalAccounting 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 are evaluated on an ongoingbasis by management and generally affect revenue recognition, collectibility ofaccounts receivable, workers’ compensation costs,  income taxes and contingencies and litigation.  Management’s estimates and assumptions arebased on historical experiences and other factors believed to be reasonableunder the circumstances.  However,actual results under circumstances and conditions different than those assumedcould result in differences from the estimated amounts in the financialstatements.

 

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’s previouslyfiled Annual Report on Form 10-K for the fiscal year ended November 1,2003.  There were no changes to thesepolicies for the 12 week period ended January 24, 2004.

 

**DiscontinuedOperations**

 

During fiscal 1999, theCompany discontinued its medical operations (Western Medical), principallythrough a sale to Intrepid U.S.A. (Intrepid). Under the terms of the sale, theCompany retained the majority of accounts receivable, including trade andMedicare accounts receivable balances. Prior to fiscal 2003, the Company appealed Western Medical’s 1996Medicare cost report settlement.  Duringthe first quarter of fiscal 2003, the appeal was settled and Western

 

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Medical receivedadditional cost reimbursements.  As aresult of the favorable appeal settlement, the Company recognized $316,000 ofincome from discontinued operations in the first quarter of fiscal 2003.  Currently, the Company believes it hasadequate reserves for remaining estimated liabilities related to the medicalbusiness of $0.5 million, which primarily relate to pending legal ormalpractice liability claims.  However,if actual resolution costs differ materially from those estimated bymanagement, the Company would record additional losses (or gains) in futureperiods.

 

**Resultsof Continuing Operations**

 

**FiscalQuarter Ended January 24, 2004 compared to Fiscal Quarter Ended January 25,2003**

 

*Revenues.* Total revenues increased $4.6 million or 3.9% for the fiscal quarter of2004 as compared to the fiscal 2003 quarter, primarily due to the effect offavorable exchange rates on international revenues.  Domestic revenues decreased 2.1%, while international revenuesincreased 31.4%.

 

The decrease in domestic revenues is primarily the result of a decreasein billed hours of 2.8%.  In the secondquarter of fiscal 2003, the domestic operations had a reduction in sales forsome high volume, low-margin government business which has not been fullyreplaced by new business as of the end of the current fiscal quarter.  Domestic operations continue to encountersubstantial competitive pricing pressures. Average bill rates increased a marginal 0.6% for the fiscal quarterended January 24, 2004 as compared to the quarter ended January 25, 2003.

 

Excluding the effect of exchange rate fluctuations, internationalrevenues increased 9.1%, primarily due to an increase in billed hours of8.4%.  Quarter over quarter increases inrevenues were reported for the Australia, New Zealand and United Kingdomoperations, partially offset by revenue declines in Denmark and Norway.

 

*Costs of Services*.  Costs of services include hourly wages of temporary employees,employer payroll taxes, state unemployment and workers’ compensation insuranceand other employee-related costs. Costs of services increased $4.4 million, or 4.5%, in the 2004fiscal quarter as compared to 2003. Gross margin declined from 17.3% for the first quarter of fiscal 2003 to16.9% for the first quarter of fiscal 2004. The margin decline is primarily due to a combination of decreases in theaverage markup of bill rates over pay rates as a result of the highlycompetitive environment within the staffing industry,  increases in the costs for workers’ compensation, and increasesin state unemployment insurance costs as compared to the fiscal 2003 quarter.

 

Domestic workers’ compensation costs were 5.1% of direct labor for thefirst quarter of fiscal 2004 as compared to 4.5% for the fiscal 2003quarter.  Unexpected adverse developmentof open claims and increases in the Company’s actuarily determined incurred butnot reported claims can significantly affect the level of accruals needed tocover workers’ compensation costs. Based on current projections, the Company estimates that accrual ratesfor workers’ compensation costs for the remainder of fiscal 2004 will be in therange of 5.2% to 5.6% of direct labor for its domestic operations.  There can be no assurance that the Company’sefforts to control workers’ compensation costs will be effective or that lossdevelopment trends will not require even higher

 

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accrual rates than those currently estimated, which could have amaterial adverse effect on the Company’s results of operations.

 

*Franchise Agents’ Share of Gross Profit.*  Franchise agents’ share of gross profitrepresents the net distribution paid to franchise agents based either on apercentage of the sales or gross profit generated by the franchise agents’operations.  Franchise agents’ share ofgross profit increased $0.4 million, or 11.4%, for the first quarter offiscal 2004 as compared to the first quarter of fiscal 2003, primarily due toincreased revenues from these operations. As a percentage of consolidated revenues, franchise agents’ share ofgross profit was 3.1% for the fiscal 2004 quarter and 2.9% for the fiscal 2003quarter.

 

*Selling and Administrative Expenses. *Selling and administrative expenses increased$0.2 million, or 1.3% for the fiscal quarter ended January 24, 2004 ascompared to the fiscal quarter ended January 25, 2003.  The increase is the result of higherexchange rates used in the translation of local currencies to US dollars forthe Company’s international operations. As a percentage of revenues, consolidatedselling and administrative expenses decreased from 13.5% in the fiscal 2003quarter to 13.1% in the current fiscal quarter.

 

The Company currently expects to continue its company-wide policieslimiting domestic full-time employee hiring and wage increases, and willcontinue to monitor and reduce its operating expenses where feasible throughthe remainder of fiscal 2004 unless changes in economic circumstances warrantotherwise.

 

*Depreciation and amortization. *Depreciationand amortization decreased $0.2 million or 13.9%, primarily due to reducedcapital expenditures and assets reaching fully depreciated useful lives.

 

*Cumulative effect of change inaccounting principle**.***** **Effective November 3, 2002, the Company adoptedStatement of Financial Accounting Standards (SFAS) No. 142 “Goodwill and OtherIntangible Assets”.  SFAS No. 142provides that goodwill and other intangible assets with indefinite lives are nolonger amortized, but rather are evaluated for impairment by applying afair-value based test.  During fiscal2003, the Company performed tests for impairment in accordance with the newstandard.   In the initial test underthe transitional provisions of SFAS No. 142, the Company determined that animpairment of $670,000 existed in its Australia reporting unit.  In accordance with SFAS No. 142, theimpairment was classified as a cumulative effect of a change in accountingprinciple and resulted in a restatement of the Company’s net loss for thefiscal quarter ended January 25, 2003 .

 

**Liquidity and CapitalResources**

 

### **Overview of LiquidityRisks**

 

AtNovember 1, 2003 and through January 24, 2004, the Company was out ofcompliance with certain financial covenants under its Multicurrency CreditAgreement, including a minimum earnings before interest, taxes, depreciationand amortization (EBITDA) covenant.  OnFebruary 20, 2004, the Company and its lending group executed a fourthamendment to the agreement.

 

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Theamendment allows certain one-time addbacks to EBITDA for the fiscal periodended November 1, 2003, which eliminates the covenant defaults and resets theEBITDA and certain other covenants going forward.  The amendment also requires a separate EBITDA covenantcalculation for the Company’s domestic operations on a stand-alone basis.  In addition, the amendment resets thereserves which affect the Company’s borrowing capacity, redefines eligibletrade accounts receivable for purposes of calculating the US and UK borrowingbase, increases the applicable margins on outstanding irrevocable letters ofcredit by 1.0% and reduces maximum capital expenditures allowed for fiscal 2004by $1.0 million.

 

The Company requires significant amounts of working capital to operateits business and to pay expenses relating to employment of temporary employees.  Based on the terms of the amendment andmanagement’s current operating and cash flow forecasts, management estimatesthat it may be reasonably possible that the Company may not be able to meet itsworking capital requirements in three to six months without increases in itsborrowing capacity under the current credit facilities through reductions inits outstanding irrevocable letters of credit, or from additional sources ofdebt or equity.  The Company further estimatesthat if additional capital is required, the Company would seek a minimum of$3.0 million to $5.0 million to meet working capital requirements through atleast the end of fiscal 2004. Additional capital may be required in fiscal 2005.

 

As of February 21, 2004, total borrowing availability was $6.3 million,with $1.0 million, $3.5 million and $1.8 million available in the US, UK andAustralia, respectively.  Under theterms of the amendment, reserves against the US borrowing availability werereset from a reserve of $2.0 million prior to the amendment to a graduatingreserve of $0 as of the amendment date to $2.5 million at October 15, 2004 andthereafter.  The amendment increasedborrowing availability in the UK  byapproximately $2.3 million.  The UKutilized  a portion of this increase intheir borrowing capacity to pay a dividend of $1.5 million to the US onFebruary 25, 2004.  The amount theCompany is entitled to borrow under its amended US revolving credit facility iscalculated each day and is dependent on the trade accounts receivable generatedfrom operations, which are affected by financial, business, economic and otherfactors, as well as by the daily timing of cash collections and cashoutflows.  As a result, the Company maybe subject to cash shortfalls.  If sucha shortfall were to occur, for even a brief period of time, it may have asignificant adverse effect on the Company’s business.

 

The Company is aggressively seeking alternative financing and isworking with a financial advisor to explore this and other strategic alternativesto increase its available capital.  TheCompany is currently involved in several discussions regarding suchalternatives.  However, there can be noassurance that the Company will be able to increase its available capital orobtain adequate alternative financing. If increases in capital are achieved through equity issues, dilution toexisting shareholders holdings would be likely.  If alternative financing is obtained, there can be no assurancethat the cost of such financing would not have a material adverse effect on theCompany’s  results of operations andfinancial condition.

 

The Company is managingits cash availability by aggressively working to collect cash and by adjustingthe timing of cash outflows to help mitigate potential cash shortfalls.  The Company

 

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also works with keyvendors to spread out the timing of certain commitments throughout the year tobalance its cash needs.   Finally, theCompany has worked aggressively to reduce operating costs where possible andwill continue to identify potential cash savings in the coming year.  In particular, the Company is focusing onthe very high costs associated with operating as a public company and is evaluatingopportunities to reduce such costs.

 

In addition to managing the cash inflow and outlays, the Company canalso work to balance its worldwide cash needs through loans and dividends toand from its international subsidiaries. These loans and dividends are limited by the immediate and future cashavailability and needs of each respective subsidiary, restrictions imposed bythe Company’s senior secured debt facilities and, in some cases, statutoryregulations of the subsidiary.

 

The Company has also generated cash in the past through sales andsale/leasebacks of property and equipment. In February 2004, the Company completed the sale of its remaining unoccupied corporate headquarters’building for cash proceeds of $1.9 million. The Company believes that there are no further similar asset sales orsale/leasebacks opportunities that would generate significant amounts of cash.

 

The Company has also generated cash in prior years through the sale ofCompany-owned offices to franchise owners or through the sale offranchise agent and license offices back to the franchise agent or licenseowner.  During fiscal 2003, 2002 and2001, the Company generated cash proceeds of $328,000, $1.2 million and$0.7 million, respectively, from these types of transaction. The Companycurrently has no specific Company-owned, franchise or license officesales pending or planned.

 

The Company’s Founder  andChairman of the Board has in the past loaned funds to the Company to provideworking capital.  As noted below, inDecember 2003 the Company’s Founder loaned $1.0 million to theCompany.  Currently, the Company doesnot anticipate any additional loans from the Company’s Founder.

 

The Company has in the past worked with its insurance carrier to modifythe amount and type of collateral required in support of the Company’s workers’compensation obligations.  In somecases, the Company’s insurance carrier has agreed to reduce letter of creditobligations rather than reduce surety bonds to help support the Company’s cashposition.  Reductions to letters ofcredit increase the Company’s borrowing availability dollar for dollar whilereductions to the surety bond do not. The Company’s insurance carrier has, inthe past, agreed to review collateral requirements mid-year to determine if areduction in the collateral requirements is feasible.  Under the terms of the Company’s current insurance policyagreement, effective January 31, 2004 outstanding surety bonds of $9.8 millionwere reduced to $5.8 million. Additionally, effective February 29, 2004 the Company’s insurancecarrier agreed to reduce the outstanding letters of credit by$1.0 million. Furthermore, the Company’s insurance carrier has agreed toreevaluate collateral requirements in May 2004, which may result infurther reduction to the surety bond or letters of credit.  However, in the event of a future potentialcash shortfall, there can be no assurance that the Company would be successfulin obtaining further reductions to its collateral or letters of creditrequirements.

 

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As noted above, in addition to its borrowings under debt facilities,the Company’s liquidity is dependent upon a variety of factors including itsoperating performance, accounts receivable, the timing of cash inflow andoutlays and other economic factors, many of which are outside the control ofmanagement.  There can be no assurancethat the Company will not face potential cash shortfalls, which, even if for ashort period of time, could have a material adverse effect on the Company’sbusiness and financial condition.  Ifthe Company were to experience significant or prolonged cash shortfalls, theCompany would need to pursue additional debt or equity financing; however therecan be no assurance that such alternatives could be obtained.

 

**GeneralDiscussion of Liquidity and Capital Resources**

 

The Company’s traditional use of cash is for financing of accountsreceivable, particularly during periods of economic upswings and growth andduring periods where sales are seasonally high . Temporary personnel are generallypaid on a weekly basis while payments from customers are generally received 30to 60 days after billing. Historically, the Company has financed its operations primarily throughcash generated by operating activities and through various forms of debt andequity financing; however, the Company has also generated cash through othermeans as discussed above.

 

Net cash provided by operating activities was $1.0 million for the 12weeks ended January 24, 2004, and $2.6 million for the 12 weeks ended January25, 2003.  The higher level of net cashprovided by operating activities in the prior year quarter was primarily due toincreases in trade accounts receivable collections exceeding new receivablesgenerated through sales of services.

 

Cash used for capital expenditures, which are primarily for managementinformation systems initiatives, other software, computers and peripherals, andoffice furniture and equipment, totaled $0.3 million for the 12 weeks endedJanuary 24, 2004 as compared to $0.6 million for the same period in fiscal2003.  The Company continues to investin enhancements and upgrades to its computer-based technologies; however,capital expenditures are limited under the terms of its recently amended seniorsecured debt facilities and cannot exceed $2.5 million for fiscal 2004.

 

In December 2002, the Company entered into a sale-leaseback transactionwhereby the Company sold and leased back the land and buildings housing itsadministrative offices.  The result ofthe sale was a net pre-tax gain of approximately $5.0 million that theCompany deferred and is amortizing as an offset to rent expense over theseven-year lease term.  A portion of thenet proceeds from the sale of $6.9 million was used to repay theoutstanding principal and interest under a term loan of $4.5 million.  Additionally, the Company paid theoutstanding principal and accrued interest of $1.0 million on a promissorynote payable to the Company’s President and Chief Executive Officer.

 

The Company has an unsecured subordinated promissory note payable toits principal stockholder and Chairman of the Board of Directors in the amountof $2.0 million with a maturity date of August 18, 2007, and aninterest rate 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 in effect on January 24,2004 was 11.0%.  Payment of interest iscontingent on the Company meeting minimum availability requirements

 

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under its credit facilities. Additionally, payments of principal or interest are prohibited in theevent of any default under the credit facilities.

 

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 note provides for the Chairman to makeadvances to the Company upon request, at his sole discretion and with no obligationto do so, in an aggregate principal amount not to exceed $1.0 millionoutstanding at any one time.  Principaland interest on advances are due and payable on the earlier of twenty-twobusiness days from the date of the advance or the final maturity date of thedraw down note (September 25, 2004), subject to certain restrictions regardingborrowing capacity and compliance with certain covenants in the Company’ssenior secured credit facilities.  Theinterest rate on outstanding advances is equal to an indexed rate as calculatedunder the Company’s credit facilities plus seven percent, compoundedmonthly.  On December 23, 2003 theChairman made a $1.0 million advance to the Company under the terms of the note.

 

On February 12, 2004 theCompany completed the sale of its remaining unoccupied corporate headquarters’for cash proceeds of $1.9 million.  Theproceeds were used to pay down outstanding borrowings under the Company’srevolving credit facilities.

 

The Company is responsible for and pays workers’ compensation costs forits temporary and regular employees and is self-insured for the deductibleamount related to workers’ compensation claims ($500,000 per claim for fiscalyear 2003 and increasing to $750,000 per claim for fiscal 2004.)  Each policy year the terms of the agreementwith the insurance carrier are renegotiated. The Company is contractually required to collateralize its recordedobligations through the use of irrevocable letters of credit, surety bonds orcash.  The Company is cash collateralizingits fiscal 2004 policy year through payments totaling $13.8 million, withadditional payments of $4.1 million for insurance premiums and expenses..  As of March 8, 2004 the Company has madepayments of $8.1 million.  Eightadditional monthly payments of $1.2 million are due through the end of fiscal2004.  All other open policy years arecollaterized with $14.3 million of the Company’s outstanding irrevocableletters of credit and the $5.8 million surety bond discussed above.  The Company will also make ongoing cashpayments for claims for all open policy years except 2003, which is fullyfunded (but subject to annual adjustments based on actual losses).

 

As noted above, the Company and its lending agents executed a fourthamendment to the Company’s Multicurrency Credit Agreement which, among otherthings, eliminated events of default on an EBITDA covenant as of November 1,2003 and  through January 24, 2004.  In the event the Company is out ofcompliance with one or more covenants in the future, there can be no assurancethat its lenders would grant a waiver or amendment with respect to thosecovenants, which could have a significant adverse effect on the Company’sfinancial condition and operations.

 

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

 

The Company is exposed tocertain market risks from transactions that are entered into during the normalcourse of business.  The Company’sprimary market risk exposure relates to interest rate risk.  At January 24, 2004, the Company’soutstanding debt under variable-rate interest

 

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borrowings wasapproximately $23.9 million.  A changeof 2% in the interest rates would cause a change in interest expense ofapproximately $0.5 million on an annual basis. The Company’s exposure to market risk for changes in interest rates isnot significant with respect to interest income, as its investment portfolio isnot material to its consolidated balance sheet.  The Company currently has no plans to hold an investmentportfolio that includes derivative financial instruments.

 

For the 12 weeks ended January 24, 2004, theCompany’s international operations comprised 22.9% of its revenues and, as ofthe end of that period, 22.9% of its total assets.  The Company is exposed to foreign currency risk primarily due toits investments in foreign subsidiaries. The Company’s multicurrency credit facility, which allows the Company’sAustralia and United Kingdom subsidiaries to borrow in local currencies, partiallymitigates the exchange rate risk resulting from fluctuations in foreigncurrency denominated net investments in these subsidiaries in relation to theU.S. dollar.  The Company does notcurrently hold any market risk sensitive instruments entered into for hedgingtransaction risks related to foreign currencies.  In addition, the Company has not entered into any transactionswith derivative financial instruments for trading purposes.

 

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

 

TheCompany carried out an evaluation, under the supervision and with theparticipation of the Company’s management, including the Chief ExecutiveOfficer and Chief Financial Officer, of the effectiveness of the design andoperation of the Company’s disclosure controls and procedures.  Based on this evaluation, the ChiefExecutive Officer and Chief Financial Officer concluded that, as of January 24,2004 (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 the Company’s internal control overfinancial reporting that occurred during the fiscal quarter ended January 24,2004, that has materially affected, or is reasonably likely to materiallyaffect, the Company’s internal controls over financial reporting.

 

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**PartII  Other Information**

 

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

 

As previouslyreported in the Company’s Annual Report on Form 10-K for the fiscal year endedNovember 1, 2003, Synergy Staffing, Inc. (“claimant”) filed a complaint againstthe Company on March 9, 2000, alleging, among other things, that they werefraudulently induced to sell the assets of The Personnel Connection, Inc.  During the Company’s fiscal year 2002, anarbitration panel awarded the claimant $1.4 million for compensatory damages,attorneys’ fees and other related costs. During the fourth quarter of fiscal 2001, the Company recorded anaccrued liability and related pretax charge of $3.6 million for the estimatedcost of the arbitration award, attorney’s fees and related expenses.  OnFebruary 11, 2002, the arbitration panel issued an Order Modifying InterimAward, crediting the Company for $800,000 previously paid under a priceprotection clause in the asset purchase agreement and thereby reducing theprincipal amount of the award to $1.4 million. As a result of the interim award, the Company determined that $693,000of the initial estimated liabilities were no longer required, and recorded thereduction in its fourth fiscal quarter of 2002.

 

The claimant asked the Superior Court to correct and confirm the interimaward.  On September 25, 2002, the Courtdenied the claimant’s motion.  Theclaimant then filed an appeal of the denial with the appellate court.   On October 21, 2003 the appellate courtreversed the Superior Court’s denial of the claimant’s motion.  The Company filed a petition for rehearing,which was denied.  In December 2003, theclaimant agreed to a settlement of $930,000 and the Company recorded a chargeto earnings in its fiscal 2003 Statement of Operations of $950,000 for the costof the settlement plus related attorneys’ fees.  The settlement and related fees were paid in the first quarter offiscal 2004.

 

Except as disclosed above, the Company is not currently a party to anymaterial litigation. However, from time to time the Company has been threatenedwith, or named as a defendant in, lawsuits, including countersuits brought byformer franchise agents or licensees, and administrative claims and lawsuitsbrought by employees or former employees.

 

### **Item2.  Changes in Securities and Use ofProceeds**

 

Not applicable.

 

### **Item3.  Defaults Upon Senior Securities**

 

Not applicable.

 

### **Item4.  Submission of Matters to a Vote ofSecurity Holders**

 

Not applicable.

 

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

 

Not applicable.

 

**Item 6. Exhibits and Reports on Form 8-K**

 

(a)                                  Exhibits

 
| 10.8.20.4 |   | Fourth Amendment to Multicurrency Credit Agreement, Limited Waivers  and Consent of Guarantors.                                                         |
|-----------|--------|---------------------------------------------------------------------------------------------------------------------------------------------------------|
| 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. |

 

(b)                                 Reportson Form 8-K

 

Current Report on Form 8-K (Items 7 and 12) dated January 7, 2004 filedwith the Securities and Exchange Commission on January 8, 2004.

 

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**SIGNATURES**

 

Pursuant to the requirements of the Securities Exchange Act of 1934,the Registrant has duly caused this report to be signed on its behalf by theundersigned thereunto duly authorized.

 

 
|          |   | WESTAFF, INC.                                     |   |
|---------------|--------|---------------------------------------------------|--------|
|          |   |                                              |
|          |   |                                              |
| March 9, 2004 |   |   /s/  Dirk A.  Sodestrom          |   |
| Date          |   | Dirk A. Sodestrom                                 |   |
|          |   | Senior Vice President and Chief Financial Officer |
|               |        |                                                   |        |  |  |

 

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