##### **UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**Washington, D. C. 20549**

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

| **x**      | ** ** | **QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)  OF THE SECURITIES EXCHANGE ACT OF 1934.**                                                                                                                                                                                                         |
|------------|------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| ** ** | ** ** | ** **                                                                                                                                                                                                                                                                                            |
| ** ** |       | **For the quarterly period ended July 8, 2006**                                                                                                                                                                                                                                                       |
| ** ** |       | ** **                                                                                                                                                                                                                                                                                            |
| **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      |   | (I.R.S. employer        |
| of incorporation  or organization) |   | identification  number) |

#####  

**298 NorthWiget LaneWalnut Creek, California  94598-2453**

(Address of registrant’s principal executive offices)

**(925) 930-5300**

(Registrant’s telephonenumber)

Indicate by checkmark whether the registrant (1) has filed all reports required to be filed bySection 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding12 months (or for such shorter period that the registrant was required to filesuch reports), and (2) has been subject to such filing requirements for thepast 90 days.  Yes  x   Noo

Indicate by checkmark whether the registrant is a large accelerated filer, an accelerated filer,or a non-accelerated filer. See definition of accelerated filer and largeaccelerated filer in Rule 12b-2 of the Exchange Act.  (Check One):

Large acceleratedfile  o   Acceleratedfiler  o   Non-acceleratedfiler  x

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

Indicate thenumber of shares outstanding of each of the issuer’s classes of common stock,as of the latest practicable date:

| **Class**                      | ** ** | **Outstanding  at August 18, 2006** |
|--------------------------------|------------|-------------------------------------|
|                           |       |                                |
| Common Stock,  $0.01 par value |       | 16,531,170 shares                   |

 

 

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

**INDEX**
|              | ** ** | ** **                                                                                              | ** ** | **PAGE**   |
|--------------|------------|---------------------------------------------------------------------------------------------------------|------------|------------|
|         |       |                                                                                                    |       |       |
| **Part I.**  | ** ** | **Financial Information**                                                                               |       |       |
|         |       |                                                                                                    |       |       |
| Item 1.      |       | Financial Statements  (Unaudited)                                                                       |       |       |
|         |       |                                                                                                    |       |       |
|         |       | Condensed  Consolidated Balance Sheets - July 8, 2006 and October 29, 2005                              |       | 3          |
|         |       |                                                                                                    |       |       |
|         |       | Condensed  Consolidated Statements of Operations - 12 and 36 weeks ended July 8, 2006  and July 9, 2005 |       | 4          |
|         |       |                                                                                                    |       |       |
|         |       | Condensed  Consolidated Statements of Cash Flows - 36 weeks ended July 8, 2006 and July  9, 2005        |       | 5          |
|         |       |                                                                                                    |       |       |
|         |       | Notes to  Condensed Consolidated Financial Statements                                                   |       | 6          |
|         |       |                                                                                                    |       |       |
| Item 2.      |       | Management’s  Discussion and Analysis of Financial Condition and Results of Operations             |       | 15         |
|         |       |                                                                                                    |       |       |
| Item 3.      |       | Quantitative  and Qualitative Disclosures About Market Risk                                             |       | 32         |
|         |       |                                                                                                    |       |       |
| Item 4.      |       | Controls and  Procedures                                                                                |       | 33         |
|         |       |                                                                                                    |       |       |
| **Part II.** | ** ** | **Other Information**                                                                                   | ** ** | ** ** |
|         |       |                                                                                                    |       |       |
| Item 1.      |       | Legal Proceedings                                                                                       |       | 34         |
|         |       |                                                                                                    |       |       |
| Item  1A.    |       | Risk  Factors                                                                                           |       | 34         |
|         |       |                                                                                                    |       |       |
| Item 2.      |       | Unregistered  Sales of Equity Securities and Use of Proceeds                                            |       | 34         |
|         |       |                                                                                                    |       |       |
| Item 3.      |       | Defaults Upon  Senior Securities                                                                        |       | 34         |
|         |       |                                                                                                    |       |       |
| Item 4.      |       | Submission of  Matters to a Vote of Security Holders                                                    |       | 34         |
|         |       |                                                                                                    |       |       |
| Item 5.      |       | Other Information                                                                                       |       | 35         |
|         |       |                                                                                                    |       |       |
| Item  6.     |       | Exhibits                                                                                                |       | 35         |
|         |       |                                                                                                    |       |       |
| Signatures   |       |                                                                                                    |       | 36         |

 

2

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**Partl.  Financial Information**

**Item1.  Financial Statements**

**Westaff, Inc.**

**CondensedConsolidated Balance Sheets (Unaudited)**
| ** **                                                                                                                                        | ** ** | **July 8,**                                                      | ** ** | **October 29,** | ** ** |
|---------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------------------------------------------------------|------------|----------------------|------------|
| ** **                                                                                                                                        | ** ** | **2006**                                                              | ** ** | **2005**             | ** ** |
| ** **                                                                                                                                        | ** ** | **(In thousands, except per share amounts)** | ** ** |
| **ASSETS**                                                                                                                                        | ** ** | ** **                                                            | ** ** | ** **           | ** ** |
| Current assets:                                                                                                                                   |       |                                                                  |       |                 |       |
| Cash and cash  equivalents                                                                                                                        |       | $                                                                     | 8,933      |                 | $          | 3,014 |   |
| Trade accounts  receivable, less allowance for doubtful accounts of $1,067 and $997                                                               |       | 69,899                                                                |       | 83,416               |       |
| Income taxes receivable                                                                                                                           |       | 59                                                                    |       | 82                   |       |
| Deferred income taxes                                                                                                                             |       | 5,334                                                                 |       | 5,097                |       |
| Prepaid expenses                                                                                                                                  |       | 3,288                                                                 |       | 3,847                |       |
| Other current assets                                                                                                                              |       | 3,171                                                                 |       | 1,337                |       |
| Total current assets                                                                                                                              |       | 90,684                                                                |       | 96,793               |       |
|                                                                                                                                              |       |                                                                  |       |                 |       |
| Property and equipment,  net                                                                                                                      |       | 14,713                                                                |       | 15,184               |       |
| Deferred income taxes                                                                                                                             |       | 12,143                                                                |       | 11,951               |       |
| Goodwill                                                                                                                                          |       | 11,995                                                                |       | 11,770               |       |
| Other long-term assets                                                                                                                            |       | 2,740                                                                 |       | 3,084                |       |
| Total Assets                                                                                                                                      |       | $                                                                     | 132,275    |                 | $          | 138,782 |   |
|                                                                                                                                              |       |                                                                  |       |                 |       |
| **LIABILITIES AND STOCKHOLDERS’  EQUITY**                                                                                                    | ** ** | ** **                                                            | ** ** | ** **           | ** ** |
| Current liabilities:                                                                                                                              |       |                                                                  |       |                 |       |
| Borrowing under  revolving credit facilities                                                                                                      |       | $                                                                     | 2,286      |                 | $          | 8,568 |   |
| Current portion of  capital lease obligations                                                                                                     |       | 319                                                                   |       | 343                  |       |
| Accounts payable                                                                                                                                  |       | 2,825                                                                 |       | 3,755                |       |
| Accrued expenses                                                                                                                                  |       | 43,477                                                                |       | 42,684               |       |
| Income taxes payable                                                                                                                              |       | 309                                                                   |       | 817                  |       |
| Total current  liabilities                                                                                                                        |       | 49,216                                                                |       | 56,167               |       |
|                                                                                                                                              |       |                                                                  |       |                 |       |
| Note payable to related  party                                                                                                                    |       | 2,000                                                                 |       | 2,000                |       |
| Long-term capital lease  obligations                                                                                                              |       | 975                                                                   |       | 1,174                |       |
| Other long-term  liabilities                                                                                                                      |       | 17,232                                                                |       | 17,820               |       |
| Total liabilities                                                                                                                                 |       | 69,423                                                                |       | 77,161               |       |
|                                                                                                                                              |       |                                                                  |       |                 |       |
| Commitments and  contingencies                                                                                                                    |       |                                                                  |       |                 |       |
|                                                                                                                                              |       |                                                                  |       |                 |       |
| Stockholders’ equity:                                                                                                                        |       |                                                                  |       |                 |       |
| Preferred stock, $0.01  par value; authorized and unissued: 1,000 shares                                                                          |       |                                                                  |       |                 |       |
| Common stock, $0.01 par  value; authorized: 25,000 shares; issued and outstanding: 16,508 shares at  July 8, 2006, and 16,378 at October 29, 2005 |       | 165                                                                   |       | 164                  |       |
| Additional paid-in  capital                                                                                                                       |       | 38,349                                                                |       | 37,803               |       |
| Deferred stock  compensation                                                                                                                      |       | —                                                                |       | (54                  | )          |
| Retained earnings                                                                                                                                 |       | 24,671                                                                |       | 24,151               |       |
| Accumulated other  comprehensive loss                                                                                                             |       | (333                                                                  | )          | (443                 | )          |
| Total stockholders’  equity                                                                                                                  |       | 62,852                                                                |       | 61,621               |       |
| Total Liabilities and Stockholders’ Equity                                                                                                   |       | $                                                                     | 132,275    |                 | $          | 138,782 |   |

 

See accompanyingnotes to condensed consolidated financial statements.

3

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**Westaff, Inc.**

**CondensedConsolidated Statements of Operations (Unaudited)**
| ** **                                             | ** ** | **12 Weeks Ended**                                          | ** ** | **36 Weeks Ended** | ** ** |
|--------------------------------------------------------|------------|-----------------------------------------------------------------------|------------|------------------------------|------------|
| ** **                                             | ** ** | **July 8,**                                                      | ** ** | **July 9,**             | ** ** | **July 8,** | ** ** | **July 9,** | ** ** |
| ** **                                             | ** ** | **2006**                                                              | ** ** | **2005**                     | ** ** | **2006** | ** ** | **2005** | ** ** |
| ** **                                             | ** ** | **(In thousands, except per share amounts)** | ** ** |
|                                                   |       |                                                                  |       |                         |       |   |   |   |   |
| Revenue                                                |       | $                                                                     | 140,859    |                         | $          | 141,053 |   | $ | 418,095 |   | $ | 411,879 |   |
|                                                   |       |                                                                  |       |                         |       |   |   |   |   |
| Costs of  services                                     |       | 115,420                                                               |       | 116,425                      |       | 345,342 |   | 341,240 |   |
|                                                   |       |                                                                  |       |                         |       |   |   |   |   |
| Gross profit                                           |       | 25,439                                                                |       | 24,628                       |       | 72,753 |   | 70,639 |   |
|                                                   |       |                                                                  |       |                         |       |   |   |   |   |
| Franchise  agents’ share of gross profit          |       | 4,111                                                                 |       | 4,391                        |       | 12,451 |   | 12,422 |   |
| Selling and  administrative expenses                   |       | 18,715                                                                |       | 17,595                       |       | 55,714 |   | 52,569 |   |
| Depreciation and  amortization                         |       | 1,148                                                                 |       | 934                          |       | 3,492 |   | 2,849 |   |
|                                                   |       |                                                                  |       |                         |       |   |   |   |   |
| Operating income  from continuing operations           |       | 1,465                                                                 |       | 1,708                        |       | 1,096 |   | 2,799 |   |
|                                                   |       |                                                                  |       |                         |       |   |   |   |   |
| Interest expense                                       |       | 292                                                                   |       | 343                          |       | 850 |   | 1,021 |   |
| Interest income                                        |       | (26                                                                   | )          | (28                          | )          | (76 | ) | (71 | ) |
|                                                   |       |                                                                  |       |                         |       |   |   |   |   |
| Income from  continuing operations before income taxes |       | 1,199                                                                 |       | 1,393                        |       | 322 |   | 1,849 |   |
| Provision  (benefit) for income taxes                  |       | 17                                                                    |       | 314                          |       | (198 | ) | 530 |   |
|                                                   |       |                                                                  |       |                         |       |   |   |   |   |
| Income from  continuing operations                     |       | 1,182                                                                 |       | 1,079                        |       | 520 |   | 1,319 |   |
|                                                   |       |                                                                  |       |                         |       |   |   |   |   |
| Discontinued  operations:                              |       |                                                                  |       |                         |       |   |   |   |   |
| Loss from  discontinued operations                     |       | —                                                                |       | (29                          | )          | — |   | (134 | ) |
| Gain on sale,  net of income taxes of $34              |       | —                                                                |       | 1,163                        |       | — |   | 1,163 |   |
| Total  discontinued operations, net of income taxes    |       | —                                                                |       | 1,134                        |       | — |   | 1,029 |   |
|                                                   |       |                                                                  |       |                         |       |   |   |   |   |
| Net income                                             |       | $                                                                     | 1,182      |                         | $          | 2,213 |   | $ | 520 |   | $ | 2,348 |   |
|                                                   |       |                                                                  |       |                         |       |   |   |   |   |
| Earnings per  share - basic and diluted:               |       |                                                                  |       |                         |       |   |   |   |   |
| Continuing  operations                                 |       | $                                                                     | 0.07       |                         | $          | 0.07 |   | $ | 0.03 |   | $ | 0.08 |   |
|                                                   |       |                                                                  |       |                         |       |   |   |   |   |
| Discontinued  operations                               |       | $                                                                     | —     |                         | $          | 0.07 |   | $ | — |   | $ | 0.06 |   |
|                                                   |       |                                                                  |       |                         |       |   |   |   |   |
| Net income                                             |       | $                                                                     | 0.07       |                         | $          | 0.14 |   | $ | 0.03 |   | $ | 0.14 |   |
|                                                   |       |                                                                  |       |                         |       |   |   |   |   |
| Weighted average  shares outstanding - basic           |       | 16,483                                                                |       | 16,339                       |       | 16,419 |   | 16,229 |   |
| Weighted average shares  outstanding - diluted         |       | 16,557                                                                |       | 16,391                       |       | 16,502 |   | 16,384 |   |

 

See accompanyingnotes to condensed consolidated financial statements.

4

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**Westaff, Inc.**

**CondensedConsolidated Statements of Cash Flows (Unaudited)**
| ** **                                                                         | ** ** | **36 Weeks Ended** | ** ** |
|------------------------------------------------------------------------------------|------------|------------------------------|------------|
| ** **                                                                         | ** ** | **July 8,**             | ** ** | **July 9,** | ** ** |
| ** **                                                                         | ** ** | **2006**                     | ** ** | **2005** | ** ** |
| ** **                                                                         | ** ** | **(In thousands)**      | ** ** |
| **Cash  flows from operating activities**                                          |       |                         |       |   |   |
| Net income                                                                         |       | $                            | 520        |   | $ | 2,348 |   |
| Adjustments to reconcile net income to net cash provided  by operating activities: |       |                         |       |   |   |
| Gain on sale of discontinued operations, net of  income taxes                      |       | —                       |       | (1,163 | ) |
| Stock-based compensation                                                           |       | 204                          |       | — |   |
| Depreciation and amortization                                                      |       | 3,492                        |       | 2,877 |   |
| Provision for losses on doubtful accounts                                          |       | 317                          |       | 364 |   |
| Deferred income taxes                                                              |       | (424                         | )          | — |   |
| Income from sales of affiliate operations                                          |       | (145                         | )          | (95 | ) |
| Other                                                                              |       | (248                         | )          | (45 | ) |
| Changes in assets and liabilities:                                                 |       |                         |       |   |   |
| Trade accounts receivable                                                          |       | 13,279                       |       | 6,874 |   |
| Other assets                                                                       |       | 881                          |       | (7,571 | ) |
| Accounts payable and accrued expenses                                              |       | 184                          |       | (584 | ) |
| Income taxes payable                                                               |       | (509                         | )          | (28 | ) |
| Other liabilities                                                                  |       | 29                           |       | (67 | ) |
|                                                                               |       |                         |       |   |   |
| Net cash  provided by operating activities                                         |       | 17,580                       |       | 2,910 |   |
|                                                                               |       |                         |       |   |   |
| **Cash  flows from investing activities**                                          |       |                         |       |   |   |
| Capital expenditures                                                               |       | (3,763                       | )          | (5,161 | ) |
| Proceeds from sales of affiliate operations                                        |       | 35                           |       | 1,062 |   |
| Payment for purchase of affiliate operations                                       |       | (1,593                       | )          | (7 | ) |
| Proceeds from sale of discontinued operations, net  of cash acquired by purchaser  |       | —                       |       | 1,238 |   |
| Other, net                                                                         |       | (317                         | )          | 162 |   |
|                                                                               |       |                         |       |   |   |
| Net cash used by  investing activities                                             |       | (5,638                       | )          | (2,706 | ) |
|                                                                               |       |                         |       |   |   |
| **Cash  flows from financing activities**                                          |       |                         |       |   |   |
| Net repayments under line of credit agreements                                     |       | (6,244                       | )          | (3,706 | ) |
| Principal payments on capital lease obligations                                    |       | (224                         | )          | (353 | ) |
| Issuance of common stock                                                           |       | 399                          |       | 646 |   |
| Other                                                                              |       | (19                          | )          | (11 | ) |
|                                                                               |       |                         |       |   |   |
| Net cash used by  financing activities                                             |       | (6,088                       | )          | (3,424 | ) |
|                                                                               |       |                         |       |   |   |
| Effect of  exchange rate changes on cash                                           |       | 65                           |       | (146 | ) |
|                                                                               |       |                         |       |   |   |
| Net change in  cash and cash equivalents                                           |       | 5,919                        |       | (3,366 | ) |
| Cash and cash  equivalents at beginning of period                                  |       | 3,014                        |       | 6,993 |   |
| Cash and cash  equivalents at end of period                                        |       | $                            | 8,933      |   | $ | 3,627 |   |

 

See accompanyingnotes to condensed consolidated financial statements.

5

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**Westaff, Inc.**

**Notes toCondensed Consolidated Financial Statements (Unaudited)**

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

The accompanying condensed consolidated financial statementsof Westaff, Inc. and its domestic and foreign subsidiaries (together, theCompany), as of July 8, 2006 and for the 12 and 36-week periods ended July 8,2006 and July 9, 2005 are unaudited.

The condensed consolidated financial statements, inthe opinion of management, reflect all adjustments, which are of a normalrecurring nature, necessary for a fair presentation of the financial position,results of operations and cash flows for the periods presented. The condensedconsolidated balance sheet as of October 29, 2005 presented herein, has beenderived from the audited balance sheet included in the Company’s Annual Reporton Form 10-K for the fiscal year ended October 29, 2005.

Certain financial information normally included in annual financialstatements prepared in accordance with accounting principles generally acceptedin the United States that 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-K for thefiscal year ended October 29, 2005.

The Company’s fiscal year is a 52 or 53-week period ending the Saturdaynearest the end of October. For interim reporting purposes, the first threefiscal quarters comprise 12 weeks each, while the fourth fiscal quarterconsists of 16 or 17 weeks. The results of operations for the 12 and 36-weekperiod ended July 8, 2006 are not necessarily indicative of the results to beexpected for the full fiscal year or for any future period.

In June 2005, the Company sold its subsidiaryoperations in Norway and Denmark. As a result, the Company has classified theseoperations as discontinued operations and, accordingly, has segregated theassets, liabilities, revenue and expenses of these discontinued operations inthe accompanying condensed consolidated financial statements and notes thereto.Cash flows pertaining to discontinued operations are not disclosed separatelyin the condensed consolidated statements of cash flows.

**2.**              Stock-Based Compensation

The Company’s 1996 Stock Option/StockIssuance Plan terminated on April 30, 2006. At the annual meeting ofstockholders held on April 19, 2006, the stockholders approved the 2006 StockIncentive Plan. The 2006 Stock Incentive Plan provides for the granting ofincentive and nonqualified stock options, restricted stock awards and stockappreciation rights. Incentive stock options may be granted at a price not lessthan 100% of the fair market value of the Company’s common stock at the date ofgrant. Although nonqualified options may be granted at a price not less than85% of the fair market value of the Company’s common stock at the date ofgrant, the Company has historically issued option grants with exercise pricesequal to fair market value on the date of grant. The options’ vesting schedulesvary subject to the participant’s period of future service or to the Company’sor the option holder’s attainment of designated performance goals, or otherwiseat the discretion of the Board of Directors. Standard vesting is over fouryears with 25% of the options vesting upon completion of one year of servicefrom the vesting commencement date, and the remaining options vesting in 36equal monthly installments. No option may have a term in excess of 10 years. Asof July 8, 2006, no options were outstanding under this plan.

6

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On July 26, 2006, the Board of Directors adopted and approved anamendment and restatement of the Company’s 1996 Employee Stock Purchase Plan to(i) bifurcate the Purchase Plan into the Company’s Employee Stock Purchase Planand the Company’s International Employee Stock Purchase Plan, (together the“Purchase Plans”), (ii) extend the term of the Purchase Plans to the lastbusiness day of January 2017, (iii) expand the actions that we can take inconnection with a “Corporate Transaction” and (iv) modify the participatingsubsidiaries to these Purchase Plans to cover the employees of certain of oursubsidiaries. In addition, effective for purchase periods commencing on andafter August 1, 2006, the purchase price for shares purchased under thePurchase Plans will equal 90% of the lower of (i) the fair market value at thebeginning of the purchase period or (ii) the fair market value on the last dayof the purchase period. Under the Purchase Plans, eligible employees mayauthorize payroll deductions of up to 10% of eligible compensation for thepurchase of the Company’s common stock during each semiannual purchase period.The Purchase Plans provide for the issuance of up to 750,000 shares of theCompany’s common stock. As of July 8, 2006, shares issued under the PurchasePlans totaled 641,000.

Effective October 30, 2005,the Company adopted Statement of Financial Accounting Standards No. 123(revised 2004) “Share-Based Payment” (SFAS 123(R)) using the modifiedprospective method of adoption, which does not require restatement of priorperiods. SFAS 123(R) requires the Company to recognize compensation expense forits stock options, restricted stock awards and employee stock purchase sharesoutstanding, but not yet vested, as of the date of adoption and for futurestock option and award grants and employee stock purchase shares.

Activity in the Company’sstock option plans for the 36 weeks ended July 8, 2006 was as follows:
|                                          | ** ** | ** **          | ** ** | ** **                | ** ** | **Weighted average**      | ** ** | **Aggregate**       | ** ** |
|------------------------------------------|------------|---------------------|------------|---------------------------|------------|--------------------------------|------------|---------------------|------------|
| ** **                               | ** ** | ** **          | ** ** | **Weighted average** | ** ** | **remaining contractual** | ** ** | **intrinsic**       | ** ** |
| ** **                               | ** ** | **Shares**          | ** ** | **exercise price**   | ** ** | **term (years)**               | ** ** | **value**           | ** ** |
| ** **                               | ** ** | **(in '000s)** | ** ** | ** **                | ** ** | ** **                     | ** ** | **(in '000s)** | ** ** |
|                                     |       |                |       |                      |       |                           |       |                |       |
| Options  outstanding at October 29, 2005 |       | 640                 |       | $                         | 3.69       |                           |       |                |       |   |
| Granted                                  |       | 9                   |       | 4.05                      |       |                           |       |                |       |
| Exercised                                |       | (113                | )          | 3.01                      |       |                           |       | $                   | 123        |   |
| Cancelled                                |       | (81                 | )          | 6.17                      |       |                           |       |                |       |
| Options  outstanding at July 8, 2006     |       | 455                 |       | $                         | 3.42       |                           | 7.21       |                | $          | 410 |   |
|                                     |       |                |       |                      |       |                           |       |                |       |
| Exercisable at July 8,  2006             |       | 273                 |       | $                         | 3.47       |                           | 6.21       |                | $          | 257 |   |

 

Intrinsic value is definedas the difference between the current market value and the grant price. At July8, 2006, the Company had 20,000 restricted stock shares outstanding with anintrinsic value of $18,000 and recorded liabilities for payroll withholdings of$77,000 under its employee stock purchase plan to be used to purchase shares ata weighted average exercise price of $3.39 with an estimated aggregateintrinsic value of $7,000.

7

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For the 12 weeks ended July8, 2006, the Company recorded stock-based compensation of $67,000 ($54,000 netof related income tax benefit), and for the 36 weeks ended July 8, 2006, theCompany recorded stock-based compensation of $204,000 ($162,000 net of relatedincome tax benefit). Stock-based compensation expense is included in sellingand administrative expenses. The total deferred compensation cost related tononvested stock options and awards not yet recognized is approximately $290,000,which will be recognized over the next two fiscal years.

Prior to the adoption ofSFAS 123(R), the Company measured compensation cost for employee stock optionsand similar equity instruments using the intrinsic value-based method ofaccounting prescribed by Accounting Principles Board Opinion No. 25,“Accounting for Stock Issued to Employees” (APB 25), and followed thedisclosure-only provisions of SFAS No. 123, “Accounting for Stock-BasedCompensation,” as amended by SFAS No. 148, “Accounting for Stock-BasedCompensation - Transition and Disclosure.” Accordingly, compensation cost wasnot recognized for options granted at fair market value. The following tablerepresents pro forma net income and pro forma earnings per share for the fiscalquarter ended July 9, 2005 as if compensation cost had been determined usingthe fair value method:
|                                                                  | ** ** | **12 Weeks Ended**                                       | ** ** | **36 Weeks Ended** | ** ** |
|------------------------------------------------------------------|------------|--------------------------------------------------------------------|------------|------------------------------|------------|
| ** **                                                       | ** ** | **July 9,**                                                   | ** ** | **July 9,**             | ** ** |
| ** **                                                       | ** ** | **2005**                                                           | ** ** | **2005**                     | ** ** |
| ** **                                                       | ** ** | **(In thousands, except per share data)** | ** ** |
|                                                             |       |                                                               |       |                         |       |
| Net income as  reported                                          |       | $                                                                  | 2,213      |                         | $          | 2,348 |   |
| Stock-based  compensation determined under the fair value method |       | (80                                                                | )          | (113                         | )          |
|                                                             |       |                                                               |       |                         |       |
| Pro forma net  income                                            |       | $                                                                  | 2,133      |                         | $          | 2,235 |   |
|                                                             |       |                                                               |       |                         |       |
| Income per  common share:                                        |       |                                                               |       |                         |       |
| Basic and diluted - as reported                                  |       | $                                                                  | 0.14       |                         | $          | 0.14 |   |
| Basic and  diluted - pro forma                                   |       | $                                                                  | 0.13       |                         | $          | 0.14 |   |

 

The fair value of eachoption grant was estimated on the date of grant using the Black-Scholesvaluation model, with a six year expected life and the assumption of a zerodividend rate. Volatility is based on the Company’s historical volatilitythrough the date of grant. The risk-free interest rate used is based on theU.S. Treasury constant maturities at the time of grant having a term thatapproximates the expected life of the option.

 

**3.****              Goodwill**

**Thefollowing summarizes the change in goodwill during the 36 weeks ended July 8,2006:**

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|                                         | ** ** | **Domestic**               | ** ** | ** **    | ** ** | ** ** | ** ** |
|-----------------------------------------|------------|----------------------------|------------|---------------|------------|------------|------------|
| ** **                              | ** ** | **Business Services** | ** ** | **Australia** | ** ** | **Total**  | ** ** |
| ** **                              | ** ** | **(In thousands)**    | ** ** |
|                                    |       |                       |       |          |       |       |       |
| Balance at  October 29, 2005            |       | $                          | 10,797     |          | $          | 973        |       | $ | 11,770 |   |
| Effect of  foreign currency translation |       | —                     |       | (3            | )          | (3         | )          |
| Acquisitions of  affiliate operations   |       | 228                        |       | —        |       | 228        |       |
|                                    |       |                       |       |          |       |       |       |
| Balance at July 8, 2006                 |       | $                          | 11,025     |          | $          | 970        |       | $ | 11,995 |   |

 

**TheCompany performs its annual impairment evaluation in the fourth quarter of eachfiscal year.**

**4.**              Discontinued Operations

In June 2005, the Company sold its Norway and Denmarksubsidiary operations to Personalhuset AS, a recruitment and staffing companyheadquartered in Norway, for approximately $2.7 million. Of the total proceeds,approximately $228,000 is being held in an interest bearing escrow account assecurity for potential Westaff Norway pension claims, which the Companycurrently estimates to be zero. The escrowed funds, net of any claim payments,are scheduled to be remitted to the Company in June 2007. The Company recordeda net gain on the sale of $1.2 million.

As required by the terms of the Company’sMulticurrency Credit Agreement, the net proceeds on the sale of the Norway andDenmark operations, including the intercompany debt repayment, were used to paydown borrowings on the Company’s revolving credit facility. In accordance withEITF 87-24, the Company has allocated interest expense to the discontinuedoperations of $34,000 and $92,000 for the 12 weeks and 36 weeks ended July 9,2005, respectively.

Summarized information on the Norway and Denmarkdiscontinued operations is as follows:
|                                    | ** ** | **12 Weeks Ended** | ** ** | **36 Weeks Ended** | ** ** |
|------------------------------------|------------|------------------------------|------------|------------------------------|------------|
| ** **                         | ** ** | **July 9,**             | ** ** | **July 9,**             | ** ** |
| ** **                         | ** ** | **2005**                     | ** ** | **2005**                     | ** ** |
| ** **                         | ** ** | **(In thousands)**      | ** ** |
|                               |       |                         |       |                         |       |
| Revenue                            |       | $                            | 2,067      |                         | $          | 7,808 |   |
|                               |       |                         |       |                         |       |
| Costs and  expenses                |       | 2,096                        |       | 7,942                        |       |
|                               |       |                         |       |                         |       |
| Loss from discontinued  operations |       | $                            | (29        | )                            | $          | (134 | ) |

 

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

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 2006 andfiscal 2005). The Company accrues the estimated costs of workers’ compensationclaims based upon the expected loss rates within the various temporaryemployment categories provided by the Company. At least annually, the Companyobtains an independent actuarial valuation of the estimated costs of claimsreported but not settled, and claims

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incurredbut not reported, and adjusts the accruals based on the results of thevaluations. As of July 8, 2006 and October 29, 2005, workers’ compensationliabilities were approximately $21.6 million and $19.6 million respectively, ofwhich $14.2 million is included in other long-term liabilities on each of the respectivebalance sheets for obligations that are not expected to be paid within one yearof the balance sheet date.

Periodically, 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 July 8, 2006, the Company had $35.3million of letters of credit securing its domestic workers’ compensationobligations.

**6.**              Earnings Per Share

The following table sets forth the computation ofbasic and diluted earnings per share from continuing operations:
|                                                                                                         | ** ** | **12 Weeks Ended**                                          | ** ** | **36 Weeks Ended** | ** ** |
|---------------------------------------------------------------------------------------------------------|------------|-----------------------------------------------------------------------|------------|------------------------------|------------|
| ** **                                                                                              | ** ** | **July 8,**                                                      | ** ** | **July 9,**             | ** ** | **July 8,** | ** ** | **July 9,** | ** ** |
| ** **                                                                                              | ** ** | **2006**                                                              | ** ** | **2005**                     | ** ** | **2006** | ** ** | **2005** | ** ** |
| ** **                                                                                              | ** ** | **(In thousands, except per share amounts)** | ** ** |
|                                                                                                    |       |                                                                  |       |                         |       |   |   |   |   |
| Income from  continuing operations                                                                      |       | $                                                                     | 1,182      |                         | $          | 1,079 |   | $ | 520 |   | $ | 1,319 |   |
|                                                                                                    |       |                                                                  |       |                         |       |   |   |   |   |
| Denominator for  basic earnings per share - weighted average shares                                     |       | 16,483                                                                |       | 16,339                       |       | 16,419 |   | 16,229 |   |
|                                                                                                    |       |                                                                  |       |                         |       |   |   |   |   |
| Effect of  dilutive securities: stock options and awards                                                |       | 74                                                                    |       | 52                           |       | 83 |   | 155 |   |
| Denominator for  diluted earnings per share - adjusted weighted average shares and assumed  conversions |       | 16,557                                                                |       | 16,391                       |       | 16,502 |   | 16,384 |   |
|                                                                                                    |       |                                                                  |       |                         |       |   |   |   |   |
| Earnings per  share from continuing operations                                                          |       |                                                                  |       |                         |       |   |   |   |   |
| Basic                                                                                                   |       | $                                                                     | 0.07       |                         | $          | 0.07 |   | $ | 0.03 |   | $ | 0.08 |   |
| Diluted                                                                                                 |       | $                                                                     | 0.07       |                         | $          | 0.07 |   | $ | 0.03 |   | $ | 0.08 |   |
|                                                                                                    |       |                                                                  |       |                         |       |   |   |   |   |
| Anti-dilutive weighted  shares excluded from diluted earnings per share                                 |       | 251                                                                   |       | 104                          |       | 273 |   | 84 |   |

 

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**7.****              ComprehensiveIncome**

Comprehensive income consists of the following:
|                                   | ** ** | **12 Weeks Ended** | ** ** | **36 Weeks Ended** | ** ** |
|-----------------------------------|------------|------------------------------|------------|------------------------------|------------|
| ** **                        | ** ** | **July 8,**             | ** ** | **July 9,**             | ** ** | **July 8,** | ** ** | **July 9,** | ** ** |
| ** **                        | ** ** | **2006**                     | ** ** | **2005**                     | ** ** | **2006** | ** ** | **2005** | ** ** |
| ** **                        | ** ** | **(In thousands)**      | ** ** |
|                              |       |                         |       |                         |       |   |   |   |   |
| Net income                        |       | $                            | 1,182      |                         | $          | 2,213 |   | $ | 520 |   | $ | 2,348 |   |
| Currency  translation adjustments |       | 393                          |       | (5                           | )          | 111 |   | 263 |   |
|                              |       |                         |       |                         |       |   |   |   |   |
| Comprehensive income              |       | $                            | 1,575      |                         | $          | 2,208 |   | $ | 631 |   | $ | 2,611 |   |

 

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

On May 17, 2002, theCompany entered into agreements with GE Capital, as primary agent, to providesenior secured credit facilities totaling $65.0 million expiring in May 2007.The facilities comprise a five-year syndicated Multicurrency Credit Agreementconsisting of a $50.0 million U.S. Revolving Loan Commitment, a £2,740,000 U.K.Revolving Loan Commitment (U.S. dollar equivalent of approximately $4.0 millionat the date of the agreement), and a $5.0 million term loan (the “Term Loan”),which was repaid during fiscal 2003. In addition, a five-year Australian dollarfacility agreement (the A$ Facility Agreement) was executed on May 16, 2002,consisting of an A$12.0 million revolving credit facility (U.S. dollarequivalent of approximately $6.0 million at the date of the agreement). Eachagreement includes a letter of credit sub-facility. Letters of credit under theagreements expire one year from date of issuance, but are automatically renewedfor one additional year unless written notice is given to or from the holder.

Effective March 1, 2006, theCompany and its lenders executed an eighth amendment to the MulticurrencyCredit Agreement. Among other things, the amendment reset minimum earningsbefore interest, taxes, depreciation and amortization (“EBITDA”) covenants forfiscal 2006 and beyond, adjusted the fixed charge coverage ratio for theCompany’s second quarter of fiscal 2006, extended the credit facility for oneadditional year to May 2008 and added an additional pricing grid that willallow the Company to benefit from reduced interest rates and letter of creditfees upon achieving certain minimum EBITDA targets. Additionally, the amendmentincreased the maximum amount of the U.S. Revolving Loan Commitment by $5.0million to $55.0 million and increased the letter of credit sublimit from $40.0million to $45.0 million. The Company was not in compliance with its minimumEBITDA covenant as of the end of the first quarter of fiscal 2006, and theamendment included a waiver of this covenant violation.

On July 25, 2006, theCompany and its lenders executed a ninth amendment to the Multicurrency CreditAgreement solely for the purpose of determining the financial covenants. Theamendment allows for a one-time add-back adjustment of approximately $448,000to EBITDA commencing the fiscal quarter ending April 15, 2006, for theseparation and transition charges related to the termination of employment fortwo former executives of the Company.

**9.****              Related PartyTransactions**

The Company has anunsecured subordinated promissory note payable to its principal stockholder andChairman of the Board of Directors dated May 17, 2002 in the amount of $2.0million. The note has a maturity date of August 18, 2007 and an interest rateequal to an indexed rate as calculated

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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 July 8, 2006 was 15.25%. Payment of interest iscontingent on the Company meeting minimum availability requirements under itscredit facilities. Additionally, payments of principal or interest areprohibited in the event of any default under the credit facilities.

**10.****       OperatingSegments**

As discussed in Note 4 above, the Company sold its Norway and Denmarkoperations in June 2005, and has classified these as discontinued operations.

The following table summarizes reporting segment data with the 12 and36 weeks ended July 9, 2005 restated to exclude the Norway and Denmarkoperations:
| ** **                                          | ** ** | **Domestic**            | ** ** | **United**  | ** ** | ** **    | ** ** | **New**     | ** ** | **Continuing** | ** ** |
|-----------------------------------------------------|------------|-------------------------|------------|-------------|------------|---------------|------------|-------------|------------|----------------|------------|
| ** **                                          | ** ** | **Business Svcs.** | ** ** | **Kingdom** | ** ** | **Australia** | ** ** | **Zealand** | ** ** | **Operations** | ** ** |
| ** **                                          | ** ** | **(In thousands)** | ** ** |
| 12 Weeks Ended  July 8, 2006                        |       |                    |       |        |       |          |       |        |       |           |       |
|                                                |       |                    |       |        |       |          |       |        |       |           |       |
| Revenue                                             |       | $                       | 111,438    |        | $          | 9,513         |       | $           | 18,734     |           | $          | 1,174 |   | $ | 140,859 |   |
| Operating income  (loss) from continuing operations |       | $                       | 1,570      |        | $          | 45            |       | $           | (189       | )              | $          | 39 |   | $ | 1,465 |   |
|                                                |       |                    |       |        |       |          |       |        |       |           |       |
| 12 Weeks Ended  July 9, 2005                        |       |                    |       |        |       |          |       |        |       |           |       |
|                                                |       |                    |       |        |       |          |       |        |       |           |       |
| Revenue                                             |       | $                       | 107,958    |        | $          | 9,412         |       | $           | 22,045     |           | $          | 1,638 |   | $ | 141,053 |   |
| Operating income  from continuing operations        |       | $                       | 1,127      |        | $          | 164           |       | $           | 301        |           | $          | 116 |   | $ | 1,708 |   |
|                                                |       |                    |       |        |       |          |       |        |       |           |       |
| 36 Weeks Ended  July 8, 2006                        |       |                    |       |        |       |          |       |        |       |           |       |
|                                                |       |                    |       |        |       |          |       |        |       |           |       |
| Revenue                                             |       | $                       | 328,107    |        | $          | 27,432        |       | $           | 58,604     |           | $          | 3,952 |   | $ | 418,095 |   |
| Operating income  (loss) from continuing operations |       | $                       | 945        |        | $          | 371           |       | $           | (346       | )              | $          | 126 |   | $ | 1,096 |   |
|                                                |       |                    |       |        |       |          |       |        |       |           |       |
| 36 Weeks Ended  July 9, 2005                        |       |                    |       |        |       |          |       |        |       |           |       |
|                                                |       |                    |       |        |       |          |       |        |       |           |       |
| Revenue                                             |       | $                       | 313,706    |        | $          | 29,184        |       | $           | 63,514     |           | $          | 5,475 |   | $ | 411,879 |   |
| Operating income from  continuing operations        |       | $                       | 1,078      |        | $          | 635           |       | $           | 793        |           | $          | 293 |   | $ | 2,799 |   |

 

**11.**       Commitments and Contingencies

In the ordinary course of its business, the Company is periodicallythreatened 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.

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Duringthe fourth quarter of fiscal 2005, the Company was notified by the CaliforniaEmployment Development Department (“EDD”) that Westaff’s domestic operatingsubsidiaries unemployment tax rates would be increased retroactively for bothcalendar 2005 and 2004, which would result in additional unemployment taxes ofapproximately $900,000. The Company believes that it has properly calculatedits unemployment insurance tax and is in compliance with all applicable lawsand regulations. The Company has timely appealed the ruling by the EDD and isworking with its outside counsel to resolve this matter. The Company believesthat it has strong defenses and legal arguments with respect to the unaccruedassessment and, accordingly, has not accrued for that portion of the assessmentas of July 8, 2006.

Otherthan the action listed 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, litigation brought by former franchisees orlicensees, and administrative claims and lawsuits brought by employees orformer employees. Management believes the resolution of these matters will nothave a material adverse effect on the Company’s financial statements.

**12.**       Acquisition

EffectiveJanuary 23, 2006, the Company acquired certain assets of Peggy FruhwirthEnterprises, Inc., previously a Westaff franchise located in Houston, Texas.The Company paid $1.5 million in cash for the assets and the sellingshareholders’ noncompete agreements. Furthermore, the Company agreed to pay acontingent earn-out based on the level of financial performance achieved by thebusiness through September 30, 2006. The Company believes the terms andconditions of the preexisting relationship were consistent with otherrelationships the Company has with other franchisees, and accordingly has notrecorded a settlement gain or loss. The transaction resulted in the Companyrecording $1.5 million of intangible assets and $21,000 of fixed assets.

Thepurchase agreement was amended on August 1, 2006, to accelerate the earn-outperiod gross profit computation from an end date of September 30, 2006, to anactual gross profit computation through July 8, 2006, plus an estimatedcomputation through September 30, 2006. Consequently, the resulting earn-outpayment of $2.3 million was paid on August 11, 2006. In the fourth quarter, theCompany expects to record an additional $1.5 million of identified intangibleassets and $779,000 of goodwill.

**13.**       Income Taxes

**Income tax expense (benefit) for the interim periods isbased upon an estimated annual effective tax rate. The effective rate issubstantially lower than the statutory rate due primarily to domesticemployment tax credits, foreign tax credits and a capital loss associated withthe sale of foreign subsidiary stock.**

**14.**       RecentAccounting Pronouncement

**In June 2006, the Financial Accounting Standards Board (“FASB”)issued FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes –an interpretation of FASB Statement No. 109”**

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**(“FIN 48”). FIN 48 prescribes a recognition threshold andmeasurement process for recording in the financial statements uncertain taxpositions taken or expected to be taken in a tax return in accordance with SFASNo. 109, “Accounting for Income Taxes.” Tax positions must meet amore-likely-than-not recognition threshold at the effective date to berecognized upon the adoption of FIN 48 and in subsequent periods. Theaccounting provisions of FIN 48 will be effective for the Company beginning infiscal year 2008. The Company has not yet completed its evaluation of theimpact of adoption on the Company’s financial position or results ofoperations.**

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

### **Cautionary Statement**

This Form 10-Q containsforward-looking statements within the meaning of the Private SecuritiesLitigation Reform Act of 1995. Except for the historical information containedherein, the matters discussed should be considered forward-looking statementsand readers are cautioned not to place undue reliance on those statements. Thesestatements are only predictions, and actual events or results may differmaterially. The forward-looking statements give our current expectations orforecasts of future events. You can identify these statements by the fact thatthey do not relate strictly to current facts. They use words such as “will,” “anticipate,”“estimate,” “expect,” “project,” “intend,” “plan,” “believe,” “target,” “forecast,”and other words and terms of similar meaning in connection with any discussionof future operating or financial performance. These forward-looking statementsare made based on information available as of the date of this report and aresubject to a number of risks and uncertainties that could cause the Company’sactual results and financial position to differ materially from those expressedor implied in the forward-looking statements and to be below the expectationsof public market analysts and investors. Investors should bear this in mind asthey consider forward-looking statements.

These risks and uncertaintiesinclude, but are not limited to, those discussed in the section titled “RiskFactors” included below and in the Company’s Annual Report on Form 10-K for thefiscal year ended October 29, 2005. You should understand that it is notpossible to predict or identify all such factors. Consequently, you should notconsider any such list to be a complete set of all potential risks oruncertainties faced by us.

The Company undertakes noobligation to publicly release the results of any revisions to these forward-lookingstatements to reflect events or circumstances after the date hereof or toreflect the occurrence of unanticipated events, except as required byapplicable laws and regulations.

The following discussion isintended to assist in the understanding and assessment of significant changesand trends related to the results of operations and financial condition ofWestaff, Inc., together with its consolidated subsidiaries. Thisdiscussion and analysis should be read in conjunction with the Company’s ConsolidatedFinancial Statements and Notes included elsewhere in this Form 10-Q and in theCompany’s Annual Report on Form 10-K for the fiscal year ended October 29,2005.

**CompanyOverview**

We provide staffing servicesprimarily in suburban and rural markets through a network of Company-owned,franchise agent and licensed offices in the United States, United Kingdom,Australia and New Zealand. We offer a wide range of staffing solutions,including permanent placement, replacement and temporary staffing, primarilyfocused on recruiting and placing light industrial and clerical/administrativepersonnel. The Company has over 55 years of experience in the staffing industryand annually puts more than 125,000 people to work through 240 field offices.Our corporate headquarters provides support services to the field offices inareas such as marketing, human resources, risk management, legal, nationalsales, accounting, and information technology.

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To complement our serviceofferings, which include temporary staffing, permanent placement, temp-to-hireservices, payroll services and on-location programs, we utilize a number oftools focused on increasing our pool of qualified candidates. Additionally, weemploy a robust, targeted marketing program as well as a consultative salesprocess, and both of these tools assist in our sales efforts to new andexisting customers. Management believes all of these tools enhance ourcompetitive edge and position us to effectively pursue high growth marketniches.

The staffing industry ishighly competitive with generally few barriers to entry, which contributes tosignificant price competition and lower margins as competitors attempt tomaintain or gain market share. While the pressure on gross margins continues in2006, particularly in the United Kingdom and Australian marketplaces, we havenoted margin improvements in the United States and New Zealand. On aprospective basis, we believe our focus on increasing permanent placementservices, improving results from underperforming field offices and prudentlymanaging costs will allow us to improve our operating margins.

It is important to note that our business tends to be seasonal withsales for the first fiscal quarter typically lower than other fiscal quartersdue to national holidays as well as plant shutdowns during and after theholiday season. These shutdowns and post-holiday season declines negativelyimpact customer orders received by us, particularly in the light industrialsector. Demand for staffing services has historically tended to grow during thesecond and third fiscal quarters and has been greatest during the fourth fiscalquarter due largely to the planning cycles of many of our customers.Furthermore, our fourth fiscal quarter consists of 16 or 17 weeks, while thefirst, second and third fiscal quarters consist of 12 weeks each.

Domestically, payroll taxes and related benefits fluctuate with thelevel of payroll costs, but tend to represent a smaller percentage of revenueand payroll costs later in our fiscal year as federal and state statutory wagelimits for unemployment and social security taxes are exceeded on a peremployee basis.  Workers’ compensationexpense varies with both the frequency and severity of workplace injury claimsreported during a quarter and the estimated future costs of such claims.Adverse and positive loss development of prior period claims during asubsequent quarter may also contribute to the volatility in our estimatedworkers’ compensation expense.

Our operating results may fluctuate due to a number of factors such as:

·                  seasonality, especially in our lightindustrial business,

·                  wage limits on statutory payroll taxes,

·                  claims experience for workers’ compensation,

·                  demand and competition for our services, and

·                  the effects of acquisitions.

In addition, our operating results have also historically tended tofollow seasonal sales trends with the bulk of annual operating profits fallingwithin the third and fourth fiscal quarters.

Management believes that, as a result of the typical sales cycle withinthe staffing industry, it is critical to invest in field office staff andgrowth initiatives during the first and second fiscal quarters in order tobenefit from these investments during the third and fourth quarters of thefiscal year.

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### **Summary of Critical Accounting Policies**

Management’s Discussion and Analysis of Financial Condition and Resultsof Operations discusses our consolidated financial statements, which have beenprepared in conformity with generally accepted accounting principles in theUnited States of America. The preparation of these financial statementsrequires management to make estimates and assumptions that affect the amountsand disclosures reported within those financial statements. On an on-goingbasis, management evaluates its estimates, including those related to revenuerecognition, workers’ compensation costs, collectibility of accountsreceivable, goodwill and intangible assets, contingencies, litigation, andincome taxes. Management bases its estimates and judgments on historicalexperiences and on various other factors that are believed to be reasonableunder the circumstances. Actual results under circumstances and conditionsdifferent than those assumed could result in differences from the estimatedamounts in the financial statements.

Management believes the following critical accounting policies reflectthe more significant judgments and estimates used in the preparation of ourconsolidated financial statements. There have been no material changes to thesepolicies during fiscal 2006.

For more information on these policies, please see Note 1 of Notes toConsolidated Financial Statements, located in Item 8 of Part II of our Form10-K for the fiscal year ended October 29, 2005.

*Revenue Recognition* - We record revenue from the sale of temporary staffing, permanentplacement fees, and temp-to-hire fees by our Company-owned and franchisedoperations. Temporary staffing revenue and the related labor costs and payrolltaxes are recorded in the period in which the services are performed.Temp-to-hire fees are generally recorded when the temporary employee is hireddirectly by the customer. Permanent placement fees are recognized when thecandidate commences full-time employment and, if necessary, sales allowancesare established to estimate losses due to placed candidates not remainingemployed for the permanent placement guarantee period, which is typically fourweeks.

We account for our revenue and the related direct costs of ourfranchise arrangements in accordance with Emerging Issues Task Force (“EITF”)99-19, *Recording Revenue Gross as a Principal versus Netas an Agent*. We first assess whether we act as a principal in ourtransactions or as an agent acting on the behalf of others. When we are theprincipal in a transaction and have the risks and rewards of ownership, werecord the transaction gross in our income statement. Where we act merely as anagent, only the net fees earned are recorded in the income statement. Under ourtraditional franchise agreement, we have the direct contractual arrangementswith our customers and the contracts are binding on us. We are also theemployer of all temporary employees in the franchise agents operations and, assuch, are obligated for the temporary employee payroll, related payroll taxesand the risk of loss for accounts receivable collection. As we retain the risksand rewards of ownership, the revenue and direct expenses of our franchiseagents are included in our Results of Operations. Each accounting period, weremit to each franchisee either a portion of the gross margin or a portion ofthe sales generated by its office(s), based on what the relevant franchiseagreement dictates.

*Workers’ Compensation Reserves* - We self-insure the deductible amount related to workers’compensation claims, which was $500,000 per claim for policy years 2006 and2005 and $750,000 per claim for policy year 2004. We maintain reserves forworkers’ compensation costs based upon actuarial methods utilized to estimatethe remaining undiscounted liability for the deductible portion of all claims,

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including those incurred but not reported. This process includesestablishing loss development factors, based on the historical claimsexperience of the Company and the staffing industry, and applying those factorsto current claims information to derive an estimate of our ultimate claimsliability. The calculated ultimate liability is calculated for each policy yearand is then reduced by the cumulative claims payments to determine the requiredreserves. We evaluate the reserve and the underlying assumptions regularlythroughout the year and make adjustments accordingly. If the actual cost ofsuch claims and related expenses exceeds the amounts estimated, additionalreserves may be required. While we believe that the recorded reserves areadequate, there can be no assurances that future, unfavorable changes toestimates relied upon in the determination of these reserves will not occur.

*Collectibility of Accounts Receivable* - We provide an allowance for doubtfulaccounts on accounts receivable based on an estimation of losses which couldoccur if customers are unable to make required payments. We evaluate thisallowance on a regular basis throughout the year and make adjustments as theevaluation warrants. If the financial condition of our customers were todeteriorate, resulting in an impairment of their ability to make payments,additional allowances could be required. Our estimates are influenced bynumerous factors including our large, diverse customer base, which is disbursedacross a wide geographical area. No single customer accounted for more than 10%of revenue or 10% of accounts receivable for the 36 weeks ended July 8, 2006.

*Goodwill and Intangible Assets* - Statement of Financial Accounting Standards (“SFAS”) No. 142, *Goodwill and Other Intangible Assets*(“SFAS No. 142”)requires that goodwill and certain intangible assets with indefinite usefullives no longer be amortized but instead be subject to an impairment testperformed on an annual basis or whenever events or circumstances indicate thatimpairment may have occurred. Intangible assets with finite lives continue tobe amortized over their estimated useful lives.

*Income Taxes*- We account for income taxes by utilizing an asset and liability approach thatrequires recording deferred tax assets and liabilities for the future yearconsequences of events that have been recognized in our financial statements ortax returns. As required under SFAS No. 109, *Accountingfor Income Taxes*, we measure these expected future tax consequencesbased upon provisions of tax law as currently enacted. The effects of futurechanges in tax laws are not anticipated. Variations in the actual outcome ofthese future tax consequences could materially impact our financial position orour results of operations. We also provide a reserve for tax contingencies whenwe believe a probable and estimatable exposure exists.

*Reserves for Legal and Regulatory Liabilities* - There are various claims,lawsuits and pending actions against us incident to our operations for which wehave recorded liabilities that we believe are appropriate. We evaluate thisreserve regularly throughout the year and make adjustments as needed. If theactual outcome of these matters is different than expected, an adjustment is chargedor credited to expense in the period the outcome occurs or the period in which the estimate changes.

**Accounting Changes**

Effective October 30, 2005, we adoptedSFAS No. 123(R) (revised 2004)*Share-Based Payment*using the modified prospective transition method of adoption, which does notrequire restatement of prior periods. This requires us to recognizecompensation expense for stock options granted, restricted stock awards andemployee stock purchase shares outstanding but not yet vested on the date ofadoption and for future stock option and award grants and employee stockpurchase shares. See Note 2, Stock-based Compensation,in the accompanying notes to the condensed consolidated financial statementsfor further information.

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For the 12 weeks ended July 8, 2006, we recorded stock-basedcompensation expense of $67,000 ($54,000net of related income tax benefit), and for the 36 weeks ended July 8, 2006 werecorded $204,000 ($162,000 net of related income tax benefit). The totalcompensation cost related to non-vested stock options and awards not yetrecognized is currently estimated at $290,000 over the next two fiscal years.

### **Results of Operations - 12 weeks ended July 8, 2006and July 9, 2005**

*Revenue*

Total revenue for the 12 weeks ended July 8, 2006 was $140.9 million, adecrease of 0.1% or $194,000 over the same period in the prior year. Domesticrevenue increased by 3.2% or $3.5 million driven largely by a 73.9% increase inpermanent placement revenue and a 2.9% increase in the average bill rate. Our domesticrevenue growth is attributable to the investments we continue to make in ourfield operations, including an increase in our staff assigned to our fieldoffices. Some of these individuals are permanent placement consultants, whichaccount for the significant growth in our permanent placement revenue.Offsetting the domestic revenue growth was a decrease in international revenueof 11.1% or $3.7 million. This decrease was caused by a 12.5% decrease intemporary billed hours partially offset by a 13.3% increase in permanentplacement revenue. The decrease in billable hours is primarily due to thecompetitive pressures faced in Australia, which recognized a $3.3 milliondecrease, and the United Kingdom. The increase in permanent placement revenueis primarily due to a 42.0% increase in Australia, attributable to an increasein staff focused on the permanent placement business. We have implemented aplan in Australia to improve operating results, which includes closure ofunprofitable offices, reductions in headcount and aggressively pursuing newrevenue opportunities.

*Costs ofServices*

Costs of services includehourly wages of temporary employees, employer payroll taxes, stateunemployment, workers’ compensation insurance and other employee-relatedcosts. Costs of services as a percentage of revenue decreased slightly from82.5% in the third quarter of fiscal 2005 to 81.9% in fiscal 2006, primarily asa result of increased permanent placement revenue, which include comparativelyfew direct costs. Grossprofit increased by 3.3% or $811,000 over the third quarter of fiscal 2005,while the gross profit margin increased from 17.5% in 2005 to 18.1% over thesame period. Domestic gross profit increased$1.5 million, with gross margin increasing from 17.2% in the fiscal 2005quarter to 18.0% in fiscal 2006, due largely to increased permanent placementrevenue and increased bill rates. Further, there was no corresponding increasein average pay rates, state unemployment rates and workers’ compensation costs,which compose the bulk of costs of services for sales of temporary services.Offsetting a portion of this increase was a $734,000 decrease in internationalgross profit due to a $424,000 decrease in Australian gross profit, a $170,000decrease in the United Kingdom gross profit, and a $140,000 decrease in the NewZealand gross profit. Competitive pressures noted in the three countries causedrevenue declines, although the gross margin percentages increased in two ofthese three markets. We have initiatives in place within all our markets toimprove the gross margins, which include increasing permanent placementrevenue, improving the results of underperforming offices and closely managingcosts.

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*Franchiseagents’ share of gross profit*

Franchise agents’ share ofgross profit represents the net distribution paid to franchise agents basedeither on a percentage of revenue or gross profit generated by the franchiseagents’ operations. As a percentage of consolidated revenue, franchise agents’share of gross profit decreased slightly from 3.1% of revenue in the 2005fiscal quarter to 2.9% in the 2006 fiscal quarter. During the second fiscalquarter of 2006, we acquired our Houston, Texas, franchised operations, whichis a primary cause of the decrease as a percentage of revenue. Additionally atthe beginning of our third fiscal quarter, we acquired our Raleigh, NorthCarolina, franchised operation, which also resulted in a decrease in thispercentage.

*Selling and administrativeexpenses*

Selling and administrative expenses increased $1.1million, or 6.4% for the2006 fiscal quarter as compared to the 2005 quarter. As a percentage ofrevenue, selling and administrative expenses were 13.3% for the fiscal 2006quarter and 12.5% for the fiscal 2005 quarter. The increase is primarily due toincreased domestic salaries and related expenses resulting from additionalstaff in our field offices. We deliberately increased the number of thesepersonnel as a means to drive more sales and enhance our service, and thisinvestment has resulted in the increased domestic revenue previously noted. Asof the end of the third quarter of fiscal 2006 compared to the end of the thirdquarter of fiscal 2005, we had increased the domestic field staff by 10%. Overhalf of these field staff additions were in support of our permanent placementservice line of business with the remainder focused on developing the temporarystaffing business line. Subsequent to the end of the third fiscal quarter of2006, we announced a number of organizational restructuring changes, primarilyaffecting our domestic field operations and corporate support operations. Thesechanges represent the elimination of 30 positions, 17 of which resulted inexisting employees being terminated. We expect to incur severance costs associatedwith these terminations of $113,000 in the fourth fiscal quarter of 2006.Further and as previously reported at the beginning of the third fiscalquarter, we implemented reductions in our selling, general and administrativecosts, principally by reducing our headcount in support functions at ourcorporate headquarters. Those reductions, coupled with the actions implementedafter the end of the third quarter, are projected to yield in excess of $3.2million of cost savings on an annualized basis.

*Depreciation and amortization*

Depreciation and amortization increased $214,000 primarily as a resultof depreciation and amortization related to the new, domestic business processmanagement system, some modules of which have been placed into service. This newsystem has replaced our former systems for regular staff payroll, humanresources, general ledger, purchasing, accounts receivable, and accountspayable. We are still developing the portion of the system that will replaceour existing billing, temporary payroll and front office systems. Additionally,we plan to make additional investments in business process management systemsand infrastructure in our international operations.

*Interest expense*

Interest expense decreased $51,000 or 14.9% primarily as a result ofdecreased average borrowings both domestically and internationally during thefiscal 2006 quarter, partially offset by higher average interest rates. We hadno domestic borrowings under our line of credit at July 8, 2006.Internationally, Australia had $2.3 million of short-term borrowings at July 8,2006, and the United Kingdom had minimal borrowings at July 8, 2006.

*Provision(benefit) for income taxes*

Income tax(benefit) expense for the interim periods is based upon an estimated annualeffective tax rate. In addition to the amount of tax resulting from applyingthe projected annual effective tax rate to pre-tax income, we include certainitems treated as tax benefits or additional liabilities to arrive at theestimated overall tax amount. For the 12 weeks ended July 8, 2006, werecognized an income tax provision of $17,000 derived primarily from domesticfederal and state taxes partially offset by foreign tax benefits.

The estimatedannual tax rate for fiscal 2006 is approximately 22%. This rate differs fromthe 35% federal statutory corporate tax rate due to the expected utilization ofvarious tax benefits, including domestic employment credits and foreign taxcredits, partially offset by state and foreign income taxes.

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*Income from continuing operations*

Income from continuing operations for the fiscal quarter increased to$1.2 million from $1.1 million in the same fiscal quarter of fiscal 2005, withdiluted income per share of $0.07 on a comparative third quarter basis.

*Net income*

Net income for the fiscal quarter decreased to $1.2 million from $2.2million in the same quarter of fiscal 2005, due to the $1.2 million gain onsale of the Norway and Denmark subsidiaries in the 2005 fiscal quarter. No suchsale or gain occurred in the third quarter of fiscal 2006. Diluted income pershare decreased from $0.14 in the third fiscal quarter 2005 to $0.07 in the2006 third fiscal quarter.

### **Results of Operations - 36 weeks ended July 8, 2006and July 9, 2005**

*Revenue*

Total revenue was $418.1 million during the first 36 weeks of fiscal2006, an increase of 1.5% or $6.2 million from the same period in 2005.Domestic revenue increased by 4.6% or $14.4 million driven largely by a 101.5%increase in permanent placement revenue, a 1.6% increase in the average bill rate,and a 2.3% increase in temporary billed hours. Our domestic revenue growth isattributable to an increase in our staff assigned to our field offices. Some ofthese individuals are permanent placement consultants, which account for thesignificant growth in our permanent placement revenue. Offsetting a portion ofthe domestic revenue growth was a decrease in international revenue of 8.3% or$8.2 million.  This decrease was causedby an 8.6% decrease in temporary billed hours partially offset by a 10.8% increasein permanent placement revenue. The decrease in billable hours is primarily dueto the competitive pressures faced in all three international countries. Theincrease in permanent placement revenue is primarily due to a 43.0% increasenoted in Australia, attributable to an increase in staff focused on thepermanent placement business.

*Costs ofservices*

Costs of services includehourly wages of temporary employees, employer payroll taxes, state unemploymentand workers’ compensation insurance and other employee-related costs.Costs of services as a percentage of revenue decreased marginally to 82.6%during the first 36 weeks of fiscal 2006 from 82.8% from the same period in2005. Gross profit increased marginally to 17.4% during the first 36 weeks offiscal 2006 from 17.2% from the same period in 2005. Domestic gross profitincreased by 9.0% or $4.7 million over the first 36 weeks of fiscal 2005, whilethe gross profit margin increased from 16.6% in fiscal 2005 to 17.3% in fiscal2006, due largely to increased permanent placement revenue. Further, there wasno corresponding increase in average pay rates, state unemployment rates andworkers’ compensation costs, which comprise the bulk of costs of services forsales of temporary services. Offsetting a portion of the domestic gross profitincrease was a $2.6 million decrease in international gross profit, dueprimarily to a $1.2 million decrease in Australian gross profit as well as a$963,000 decrease in the United Kingdom gross profit. Competitive pressures inboth countries caused revenue declines, and the revenue that was maintainedgenerally produced lower margins. We have initiatives in place within all ourmarkets to improve gross margins, which include increasing permanent placementrevenue, improving the results of underperforming offices and more closelymanaging costs.

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*Franchiseagents’ share of gross profit*

Franchise agents’ share ofgross profit represents the net distribution paid to franchise agents basedeither on a percentage of the sales or gross profit generated by the franchiseagents’ operations. As a percentage of consolidated revenue, franchise agents’share of gross profit remained stable at 3.0% of revenue for the first 36 weeksof fiscal 2006 compared to fiscal 2006 year-to-date.

*Selling andadministrative expenses*

Selling and administrativeexpenses increased $3.1 million, or 6.0% for the first 36 weeks of fiscal 2006 ascompared to the same period in 2005. As a percentage of revenue, selling andadministrative expenses were 13.3% for the first 36 weeks of fiscal 2006 and12.8% for the corresponding period in fiscal 2005. The increase is primarilydue to increased domestic salaries and related expenses resulting fromadditional staff in our field offices. We deliberately increased the number ofthese personnel as a means to drive more sales and enhance our service, andthis investment has resulted in the increased domestic revenue previouslynoted. Subsequent to the end of the third fiscal quarter of 2006, we announceda number of organizational restructuring changes, primarily affecting ourdomestic field operations and corporate support operations. These changesrepresent the elimination of 30 positions, 17 of which resulted in existingemployees being terminated. We expect to incur severance costs associated withthese terminations of $113,000 in the fourth fiscal quarter of 2006. Subsequentto the end of the second fiscal quarter, we implemented reductions in ourselling, general and administrative costs, principally by reducing ourheadcount in support functions at our corporate headquarters. These reductionsin costs are projected to yield in excess of $3.2 million of cost savings on anannualized basis.

*Depreciation and amortization*

Depreciation and amortization increased $643,000 or 22.6% primarily asa result of depreciation and amortization related to the new, domestic businessprocess management system, some modules of which have been placed in service.This new system has replaced our former systems for regular staff payroll,human resources, general ledger, purchasing, accounts receivable, and accountspayable. We are still developing the portion of the system that will replaceour existing billing, temporary payroll and front office systems. Additionally,we plan to make additional investments in business process management systemsand infrastructure in our international operations.

*Interest expense*

Interest expense decreased $171,000 or 16.7% primarily as a result ofdecreased average borrowings both domestically and internationally duringfiscal 2006 partially offset by higher average interest rates. We had nodomestic borrowings under our line of credit at July 8, 2006. Internationally,Australia had $2.3 million of short-term borrowing at the close of the thirdfiscal quarter of 2006, and the United Kingdom had minimal short-termborrowings.

*Provision(benefit) for income taxes*

Income tax(benefit) expense for the interim periods is based upon an estimated annualeffective tax rate. In addition to the amount of tax resulting from applyingthe projected annual effective tax rate to pre-tax income, we include certainitems treated as tax benefits or additional liabilities to arrive at theestimated overall tax amount. For the 36 weeks ended July 8, 2006, we recognizedan income tax benefit of $198,000 derived primarily from domestic employmenttax credits and a capital loss associated with the sale of foreign subsidiarystock.

The estimatedannual tax rate for fiscal 2006 is approximately 22%. This rate differs fromthe 35% federal statutory corporate tax rate due to the expected utilization ofvarious tax benefits, including domestic employment credits and foreign taxcredits, partially offset by state and foreign income taxes.

*Net income*

Net income was $520,000 for the first 36 weeks of fiscal 2006 comparedto net income of $2.3 million for the first 36 weeks of fiscal 2005. Thisdecrease is primarily due to the gain on sale of the Norway and Denmarksubsidiaries of $1.2 million in fiscal 2005 with no such gain recorded infiscal 2006. The tax benefit for the 36 weeks ended July 8, 2006 of $198,000 isthe result of income tax benefits on pre-tax losses both domestically and inAustralia partially offset by estimated income taxes on income in the UnitedKingdom and New Zealand. For the first 36 weeks of fiscal 2006, there werediluted earnings per share of $0.03 compared to diluted earnings of $0.14 forthe same fiscal period of 2005.

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**Liquidityand Capital Resources**

**CashFlows from Operating Activities**

Werequire significant amounts of working capital to operate our business and topay expenses relating to employment of our temporary associates. Ourtraditional use of cash is for financing our accounts receivable, particularlyduring periods where sales are seasonally high such as the fourth fiscalquarter. Our temporary associates are generally paid on a weekly basis; and wetypically bill our customers on a daily, weekly or monthly basis while paymentsfrom customers are generally received between 30 and 60 days after billing.Consequently, from time to time we may experience negative cash flow fromoperations.

Ourcash position of $8.9 million at July 8, 2006, increased by $5.9 million ascompared to our most recent fiscal year end of October 29, 2005. The increasein cash is due primarily to net cash provided by operating activities of $17.6 million,partially offset by repayments under our line of credit agreements, capitalexpenditures, and payments for the purchase of affiliate operations.

Netcash provided by operating activities was $17.6 million for the 36 weeks endedJuly 8, 2006. Enhanced collections of accounts receivable coupled with reducedcash outflows for the fiscal 2006 workers’ compensation program contributed tothis generation of cash.

Duringthe 36 weeks ended July 8, 2006, cash used for capital expenditures wasprimarily for the business process management system implementation, additionalcomputer software and hardware and office furniture and equipment. Theseexpenditures aggregated to $3.8 million during that period. Currently, weanticipate total capital expenditures to be approximately $6.0 million forfiscal year 2006.

OnJanuary 23, 2006, we acquired our Houston franchise operation, consisting oftwo branch offices. The purchase price was $1.5 million in cash plus acontingent earn-out payment based on the gross profit of the operations. Thepurchase agreement was amended on August 1, 2006 to accelerate the earn-outperiod gross profit computation from an end date of September 30, 2006 to anactual gross profit computation through July 8, 2006 plus an estimatedcomputation through September 30, 2006. Consequently, the resulting earn-out payment of $2.3 million was paid onAugust 11, 2006.

**CapitalResources**

In May 2002, we entered intoagreements with GE Capital, as primary agent, to provide senior secured creditfacilities totaling $65.0 million, expiring in May 2007. The facilitiescomprise a five-year syndicated Multicurrency Credit Agreement consisting of a$50.0 million U.S. Revolving Loan Commitment, a £2.7 million U.K. RevolvingLoan Commitment (U.S. dollar equivalent of approximately $4.0 million at thedate of the agreement), and a $5.0 million term loan (the “Term Loan”), whichwas repaid during fiscal 2003. In addition, a five-year Australian dollarfacility agreement (the “A$ Facility Agreement”) was executed on May 16, 2002,consisting of an A$12.0 million revolving credit facility (U.S. dollar equivalentof approximately $6.0 million at the date of the agreement). Each agreementincludes a letter of credit sub-facility. Letters of credit under theagreements expire one year from date of issuance, but are automatically renewedfor one additional year unless written notice is given to or from the holder.

The credit facilities aresecured by substantially all our assets. GE Capital, in its role as primaryagent under the credit facilities, has sole dominion and control over ourprimary domestic, United Kingdom and Australian cash receipts accounts. Cashreceipts into these accounts are applied against our respective outstandingobligations under the facilities, with additional borrowings under therevolving facilities directed into our disbursement accounts.

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Effective March 1, 2006, we executed an eighthamendment to the Multicurrency Credit Agreement. Among other things, theamendment reset minimum earnings before interest, taxes, depreciation andamortization (“EBITDA”) covenants for fiscal 2006 and beyond, adjusted thefixed charge coverage ratio for the second quarter of fiscal 2006, extended thecredit facility for one additional year and added an additional pricing gridthat will allow us to benefit from reduced interest rates and letter of credit feesupon achieving certain minimum EBITDA targets. Additionally, the amendmentincreased the maximum amount of the facility by $5.0 million to $55.0 millionand increased the letter of credit sub-facility limit from $40.0 million to$45.0 million. We had not been in compliance with the minimum EBITDA covenantas of the end of the first quarter of fiscal 2006, and this amendment includeda waiver of this covenant violation. We are currently in compliance with allcovenants related to the Multicurrency Credit Agreement.

On July 25, 2006, we and ourlenders executed a ninth amendment to the Multicurrency Credit Agreement solelyfor the purpose of determining the financial covenants. The amendment allowsfor a one-time add-back adjustment of approximately $448,000 to EBITDAcommencing the fiscal quarter ending April 15, 2006, for the separation andtransition charges related to the termination of employment for two of ourformer executives.

As of July 8, 2006, we had $2.3million outstanding under our Multicurrency Credit Agreement, substantially allof which was attributable to borrowings under the Australian revolving creditfacility. We had consolidated available borrowing capacity of $16.3 millionconsisting of $7.3 million for the domestic operations, $4.3 million for theUnited Kingdom operations and $4.7 million for the Australian operations.

We have an unsecuredsubordinated promissory note payable to our principal stockholder and Chairmanof the Board of Directors in the amount of $2.0 million with a maturity date ofAugust 18, 2007, and an interest rate equal to an indexed rate as calculatedunder our credit agreement plus seven percent, compounded monthly and payable60 calendar days after the end of each of the fiscal quarters. The interestrate in effect on July 8, 2006 was 15.25%. Payment of interest is contingent onour meeting minimum availability requirements as stated in the creditagreement. Additionally, payments of principal or interest are prohibited inthe event of any default under the credit agreement.

Our current ratio increased to1.8 from 1.7 when comparing the July 8, 2006 balance sheet to the October 29,2005 balance sheet, primarily a reflection of higher cash and cash equivalentscoupled with lower short-term borrowings.

We work to balance ourworldwide cash needs through dividends from and loans to our internationalsubsidiaries. These loans and dividends are limited by the immediate futurecash availability and needs of each respective subsidiary, restrictions imposedby the senior secured debt facilities and, in some cases, statutory regulationsapplicable to the subsidiary. The domestic operations cannot directly draw onthe excess borrowing availability of the United Kingdom or Australianoperations; however, we may request dividends from our United Kingdomsubsidiary. We can also request repayments on intercompany balances due fromour international subsidiaries, subject to their cash flow needs and regulatoryrestrictions. During the third fiscal quarter, $138,000 was paid to us by ourinternational operations in the form of intercompany interest and royalties.

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We are responsible for paying workers’ compensationcosts for our temporary and regular employees and are self-insured for thedeductible amount related to workers’ compensation claims ($500,000 per claimfor fiscal years 2005 and 2006). We are required by our insurance carriers tocollateralize our potential workers’ compensation liabilities through the useof irrevocable standby letters of credit, surety bonds or cash.

As of July 8, 2006, we hadoutstanding $35.3 million of letters of credit to secure all outstandingobligations under our workers’ compensation program for all years except 2003,which has been fully funded subject to annual retroactive premium adjustmentsbased on actual claims activity. Under certain circumstances, we may berequired to increase our letters of credit to $40.0 million. In addition, wemay be required to make ongoing cash payments for claims originally resultingin other open policy years.

Under the terms of our fiscal2006 policy year insurance program, we are required to make total cash paymentsof $4.9 million during fiscal 2006 in equal monthly installments, whichcommenced on November 1, 2005.

From time to time, we havegenerated cash through the sales of our company-owned offices to franchiseowners or sales of territorial rights to a franchisee.

We have no material, unrecordedcommitments, losses, contingencies or guarantees associated with any relatedparties or unconsolidated entities.

Managementbelieves that current liquid assets, the funds anticipated to be generated fromoperations and borrowing capacity available under our credit agreement will besufficient to meet our working capital needs for the foreseeable future.

**OperatingActivities**

Our working capital position was $41.5 million at the end of the thirdfiscal quarter of 2006, compared to $40.6 million at October 29, 2005.

DaysSales Outstanding (“DSO,” a measure of how quickly accounts receivable arecollected) decreased domestically to 41.7 days as compared to 44.7 days as ofOctober 29, 2005. Internationally, DSO decreased to 41.8 days as compared to55.0 days as of October 29, 2005. Consolidated accounts receivable decreased by$13.5 million or 16.2% net of the allowance for doubtful accounts, reflectingthe seasonality of our business coupled with the impact of lower DSO.

**DiscontinuedOperations**

OnJune 15, 2005, we sold our Norway and Denmark subsidiary operations toPersonalhuset AS, a recruitment and staffing company headquartered in Norway.Net proceeds from the sale were approximately $2.7 million. Of the totalproceeds, approximately $228,000 is being held in an interest bearing escrowaccount as security for potential Westaff Norway pension claims. The escrowedfunds, 

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netof any claim payments, will be remitted in June 2007. We recorded a net gain onthe sale of $1.2 million. We have classified the operations as discontinuedoperations and, accordingly, have segregated the assets, liabilities, revenueand expenses of these discontinued operations in the accompanying financialstatements and notes thereto. Cash flows pertaining to discontinued operationsare not disclosed separately in the condensed consolidated statements of cashflows.

Asrequired under the terms of the Multicurrency Credit Agreement, the netproceeds from the sale of the Norway and Denmark operations were used to paydown borrowings on our revolving credit facility. Interest expense has beenallocated to these discontinued operations in accordance with EITF 87-24.

**RiskFactors**

Investingin our securities involves risk. The following risk factors, issues anduncertainties should be considered when evaluating our future prospects. Inparticular, please consider these risk factors when reading “forward-looking”statements which appear throughout this report. Forward-looking statementsrelate to our expectations for future events and time periods. Generally, wordssuch as “expect,” “intend,” “anticipate” and similar expressions identifyforward-looking statements. Each of these forward-looking statements involvesrisks and uncertainties, and future events and circumstances could differsignificantly from those anticipated in the forward-looking statements. Any oneof the following risks could harm our operating results or financial conditionand could result in a significant decline in value of an investment in us.Further, additional risks and uncertainties that have not yet been identifiedor which we currently believe are immaterial may also harm our operatingresults and financial condition.

**Pricecompetition in the staffing industry continues to be intense, and pricingpressures from both competitors and customers could adversely impact ourfinancial results.**

Thestaffing industry is highly competitive with limited barriers to entry andcontinues to undergo consolidation. We compete in regional and local marketswith large full service agencies, specialized temporary and permanent placementservices agencies and small local companies. While some competitors are smallerthan us, they may enjoy an advantage in discrete geographic markets because ofa stronger local presence. Other competitors have greater marketing, financialand other resources than us that, among other things, could enable them toattempt to maintain or increase their market share by reducing prices.Furthermore, in past years there has been an increase in the number ofcustomers consolidating their staffing services purchases with a singleprovider or with a small number of providers. The trend to consolidate staffingservices purchases has in some cases made it more difficult for us to obtain orretain business.

Weexpect the level of competition to remain high in the future, and competitivepricing pressures will continue to make it difficult for us to raise our pricesto immediately and fully offset increased costs of doing business, includingincreased labor costs, costs for workers’ compensation and state unemploymentinsurance. If we are not able to effectively compete in our targeted markets,our operating margins and other financial results will be harmed and the priceof our securities could decline.

**Theamount of collateral that we are required to maintain to support our workers’compensation obligations could increase, reducing the amount of capital that wehave available to support and grow our field operations.**

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We are contractually obligated to collateralize our workers’compensation obligations under our workers’ compensation program throughirrevocable letters of credit, surety bonds or cash. As of July 8, 2006, ouraggregate collateral requirements under these contracts have been securedthrough $35.3 million of letters of credit; however under certaincircumstances, such as an inability to maintain minimum borrowing availability,we could be required to increase our letters of credit to $40 million. Further,our workers’ compensation program expires November 1, 2007, and as part of therenewal, could be subject to an increase in collateral. These collateralrequirements are significant and place pressure on our liquidity and workingcapital capacity. We believe that our current sources of liquidity are adequateto satisfy our immediate needs for these obligations; however, our availablesources of capital are limited. Depending on future changes in collateralrequirements, we could be required to seek additional sources of capital in thefuture, which may not be available on commercially reasonable terms.

 

**Ourreserves for workers’ compensation claims may be inadequate to cover our ultimateliability, and we may incur additional charges if the actual amounts exceed thereserved amounts.**

Wemaintain reserves to cover our estimated liabilities for workers’ compensationclaims based upon actuarial estimates of the future cost of claims and relatedexpenses which have been reported but not settled, and that have been incurredbut not yet reported. The determination of these reserves is based on a numberof factors, including current and historical claims activity, medical costtrends and developments in existing claims. Reserves do not represent an exactcalculation of liability and are affected by both internal and external events,such as adverse development on existing claims, changes in medical costs,claims handling procedures, administrative costs, inflation, legal trends andlegislative changes. Reserves are adjusted as necessary to reflect new claimsand existing claims development, and such adjustments are reflected in theresults of the periods in which the reserves are adjusted. While we believe ourjudgments and estimates are adequate, if our reserves are insufficient to coverour actual losses, an adjustment could be charged to expense that may bematerial to our earnings.

**We havesignificant working capital requirements and are heavily dependent upon ourability to borrow money to meet these working capital requirements.**

Werequire significant amounts of working capital to operate our business and topay expenses relating to employment of temporary employees. Temporary personnelare generally paid on a weekly basis while payments from customers aregenerally received 30 to 60 days after billing. As a result, we must maintainsufficient cash availability to pay temporary personnel prior to receivingpayment from customers.

Wefinance our operations primarily through borrowings under our revolving creditfacilities and also through cash generated by our operating activities. As of July 8, 2006, our total borrowing capacitywas $16.3 million consisting of $7.3 million for the domestic operations, $4.3million for the United Kingdom operations and $4.7 million for the Australianoperations.

Theamount we are entitled to borrow under our revolving credit facilities iscalculated daily and is dependent on eligible trade accounts receivablegenerated from operations, which are affected by financial, business, economicand other factors, as well as by the daily timing of cash collections and cashoutflows. If we experience a significant and sustained drop in operatingprofits, or if there are unanticipated reductions in cash inflows or increasesin cash outlays, we may be subject to cash shortfalls. If such a shortfall wereto occur for even a brief period of time, it may have a significant adverseeffect on our business. Furthermore, our receivables may not be adequate toallow for borrowings for other corporate purposes, such as capital expendituresor growth opportunities, and we would be less able to react to changes in themarket or industry conditions.

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Thecredit facilities contain covenants which, among other things, require us tomaintain a minimum fixed charge coverage ratio and minimum EBITDA. At the end offiscal 2006, the minimum EBITDA covenant increases to $13.0 million on atrailing thirteen period basis. We have, in the past, failed to comply withcertain of these covenants and have been required to obtain a waiver or anamendment to the credit agreement from our lenders. Any future failure tocomply with the covenants under our credit facilities could result in an eventof default which, if not cured or waived, could trigger prepayment obligations.If we were forced to refinance borrowings under the current facilities, therecan be no assurance that such financing would be available or that suchfinancing would not have a material adverse effect on our business andfinancial condition. Even if such refinancing were available, the terms couldbe less favorable and our results of operations and financial condition couldbe adversely affected by increased costs and rates.

Wetypically experience significant seasonal and other fluctuations in ourborrowings and borrowing availability, particularly in the United States, andhave, in the past, been required to aggressively manage our cash to ensureadequate funds to meet working capital requirements. Such steps includedworking to improve collections and adjusting the timing of cash expenditures,reducing operating expenses where feasible and working to generate cash from avariety of other sources.

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

**Workers’compensation costs for temporary employees may continue to rise and reducemargins and require more liquidity.**

Inthe United States, we are responsible for and pay workers’ compensation costsfor our regular and temporary employees. In recent years, these costs haverisen substantially as a result of increased claims, general economicconditions and governmental regulations. To date in fiscal 2006, the increasein the volume of claims has fallen despite an increase in our domestic revenue,yet the increases in cost per claim have continued. Under our workers’compensation insurance program, we maintain “per occurrence” insurance, whichonly covers claims for a particular event above a $500,000 deductible. Ourworkers’ compensation insurance expires November 1, 2007, and we cannotguarantee that we will be able to successfully renew such policy. Further,there are covenants associated with the continuation of the policy and therecan be no guarantee that we will continue to meet those covenants goingforward. Should our workers’ compensation premium costs continue to increase inthe future, there can be no assurance that we will be able to increase the feescharged to our customers to keep pace with increased costs or if we were unableto obtain insurance on reasonable terms or forced to significantly increase ourdeductible per claim, our results of operations, financial condition andliquidity could be adversely affected.

**Weassume the obligation to make wage, tax, and regulatory payments to ourtemporary employees and are then exposed to accounts receivable risks from ourcustomers.**

Wegenerally assume responsibility for and manage the risks associated with ourpayroll obligations, including liability for payment of salaries and wages,payroll taxes as well as group health insurance. These obligations are fixedand become a liability of ours, whether or not the associated client wherethese employees have been assigned makes payments required by our serviceagreement, which exposes us to credit risks. We attempt to mitigate this riskby billing on a frequent basis, which typically occurs 

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dailyor weekly. In addition, we establish an allowance for doubtful accounts forestimated losses resulting from the inability of our customers to make requiredand timely payments. Further, we carefully monitor the timeliness of ourcustomers’ payments and impose strict credit standards. Finally, the majorityof our accounts receivable is used to secure our revolving credit facilities,which we rely on for liquidity. If we fail to adequately manage our creditrisks associated with accounts receivable, our financial position could beadversely impacted.

**Anysignificant economic downturn could result in our customers using fewerstaffing services, which could materially adversely affect our business.**

Demandfor staffing services is significantly affected by the general level ofeconomic activity. As economic activity slows, many customers reduce theirutilization of temporary employees before undertaking layoffs of their regularfull-time employees. Further, demand for permanent placement services alsoslows as the labor pool directly available to our customers increases, makingit easier for them to identify new employees directly. Typically, we mayexperience increased pricing pressures from other staffing companies duringperiods of economic downturn, which could have a material adverse effect on ourfinancial condition. The domestic economic recession of 2001 and 2002 did havea material adverse effect on our business. Additionally, in geographic areaswhere we derive a significant amount of business, a regional or localizedeconomic downturn could adversely affect our operating results and financialposition.

**Thecost of unemployment insurance for temporary employees may rise and reduce ourmargins.**

Inthe United States, we are responsible for and pay unemployment insurancepremiums for our temporary and regular employees. In recent years, these costshave risen as a result of increased claims, general economic conditions andgovernment regulations. Should these costs continue to increase, there can beno assurance that we will be able to increase the fees charged to our customersin the future to keep pace with the increased costs, and if we do not, ourresults of operations and liquidity could be adversely affected.

**Wederive a significant portion of our revenue from franchise agent operations.**

Franchiseagent operations comprise a significant portion of our revenue. For the first36 weeks of 2006, 28.4% of our total revenue was derived from franchise agentoperations. In addition, our ten largest franchise agents for the first 36weeks of fiscal 2006 (based on sales volume) accounted for 17.6% of ourrevenue. There can be no assurances that we will be able to attract newfranchisees or that we will be able to retain our existing franchisees. Theloss of one or more of our franchise agents and any associated loss ofcustomers and sales could have a material adverse effect on our results ofoperations.

**We aresubject to business risks associated with international operations andfluctuating exchange rates.**

Wepresently have operations in the United Kingdom, Australia and New Zealand,which comprised 21.5% of our revenue during the first 36 weeks of fiscal 2006.Operations in foreign markets are inherently subject to certain risks,including in particular:

·                  differentcultures and business practices,

·                  overlapping ordiffering tax structures,

·                  economic andpolitical uncertainties,

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·                  complianceissues associated with accounting and reporting requirements, and

·                  changing,complex or ambiguous foreign laws and regulations, particularly as they relateto employment.

Allof our sales outside of the United States are denominated in local currenciesand, accordingly, we are subject to risks associated with fluctuations inexchange rates, which could cause a reduction in our profits. There can be noassurance that any of these factors will not have a material adverse effect onour business, results of operations, cash flows or financial condition.

**The loss of any of our key personnel could harm our business.**

Ourfuture financial performance is significantly impacted by our ability toattract, motivate and retain key management personnel including our ChiefExecutive Officer and other members of the senior management team. Competitionfor qualified management personnel is very competitive and in the event that weexperience further turnover in senior management positions, we cannot assureyou that we will be able to recruit suitable replacements on a timely basis. Wemust also successfully integrate all new management and other key positionswithin our organization to achieve our operating objectives. Even if we aresuccessful, turnover in key management positions could temporarily harm ourfinancial performance and results of operations until the new managementbecomes familiar with our business.

**Oursuccess is impacted by our ability to attract and retain qualified temporaryand permanent personnel.**

Wecompete with other staffing services to meet our customers’ needs, and we mustcontinuously attract reliable candidates to meet the staffing requirements ofour customers. Consequently, we must continuously evaluate and upgrade our baseof available qualified personnel to keep pace with changing customer needs andemerging technologies. Furthermore, a substantial number of our temporaryemployees during any given year will terminate their employment with us andaccept regular staff employment with our customers. Competition for individualswith proven skills remains intense, and demand for these individuals isexpected to remain strong for the foreseeable future. There can be no assurancethat qualified personnel will continue to be available to us in sufficientnumbers and on acceptable terms to us. The failure to identify, recruit, trainand place candidates as well as retain qualified temporary employees over along period of time could materially adversely affect our business.

**Our service agreements may be terminated on short notice,leaving us vulnerable to loss of a significant amount of customers in a shortperiod of time.**

Ourservice agreements are generally cancellable on 30-days notice by the customerto us. As a result, our customers can terminate their agreement with us at anytime, making us particularly vulnerable to a significant decrease in revenuewithin a short period of time that could be difficult to quickly replace.

**Our information technology systems are critical to theoperations of our business.**

Ourdomestic information management systems are essential for data exchange andoperational communications with branches spread throughout the United States.We have replaced key component hardware and software including backup systemswithin the past twelve months and are currently working towards replacingfurther key components over the next twelve to eighteen months. Anyinterruption, impairment or loss of data integrity or malfunction of thesesystems could severely impact 

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ourbusiness; especially our ability to timely and accurately pay employees andbill customers. Further, any significant delay in our plans to replace theremaining key components could adversely affect the business. Issues witheither require that we commit significant additional capital as well asmanagement resources in order to resolve the interruption or delay.

**We may be exposed to employment-related claims and costs thatcould materially adversely affect our business.**

Weare in the business of employing people and placing them in the workplace ofother businesses on either a temporary or permanent basis. As a result, we aresubject to a large number of laws and regulations relating to employment. Therisks related to engaging in such business include but are not limited to:

·                  potential claims of discrimination andharassment,

·                  violations of health and safety, wage andhour laws,

·                  immigration related claims,

·                  criminal activity, and

·                  claims relating to actions by customersincluding misuse of proprietary information and misappropriation of assets.

Inaddition, some or all of these claims may give rise to litigation, which couldbe time-consuming to our management team, and therefore, could have a negativeeffect on our business. In some instances, we have agreed to indemnify ourcustomers against some or all of these types of liabilities. We have policiesand guidelines in place to help reduce our exposure to these risks and havepurchased insurance policies against certain risks in amounts that we currentlybelieve to be adequate. However, there can be no assurance that our insurancewill be sufficient in amount or scope to cover these types of liabilities orthat we will be able to secure insurance coverage for such risks on affordableterms. Furthermore, there can be no assurance that we will not experience theseissues in the future or that they could have a material adverse effect on ourbusiness.

**OurFounder and Chairman controls a significant amount of our outstanding stockthus allowing him to exert significant influence on our management and affairs.**

OurChairman and Founder, W. Robert Stover, beneficially owns directly orindirectly, or has voting power over, in excess of 38% of our outstandingstock. As the principal stockholder of Westaff, Mr. Stover has the abilityto materially influence all matters submitted to the stockholders for approvaland to exert significant influence on our management and affairs. For example,Mr. Stover has the ability to sell his shares independently and to stronglyinfluence the election of the Board of Directors and the appointment ofexecutive management. He also has the ability to strongly influence any merger,consolidation, sale of substantially all of our assets or other strategicdecisions affecting us or the market value of the stock. This concentration ofstock and voting power could be used by Mr. Stover to delay or prevent anacquisition of Westaff or other strategic action or result in strategicdecisions that could negatively impact the value and liquidity of ouroutstanding stock.

**Themarket for our stock may be limited, and the stock price may continue to beextremely volatile.**

Theaverage daily trading volume for our common stock on the Nasdaq Global Marketwas approximately 38,000 shares from January 1, 2006, through July 8,2006. Accordingly, the market price of our common stock is subject tosignificant fluctuations that have been, and may continue to be, 

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exaggeratedbecause an active trading market has not developed for the stock. We believethat the common stock price has also been negatively affected by the fact thatour stock is thinly traded and also due to the absence of analyst coverage. Thelack of analyst reports about our stock may make it difficult for potentialinvestors to make decisions about whether to purchase our stock and may make itless likely that investors will purchase the stock, thus further depressing thestock price. These negative factors may make it difficult for stockholders tosell our common stock, which may result in losses for investors.

**Thecompliance costs associated with Section 404 of the Sarbanes-Oxley Actregarding internal control over financial reporting could be substantial, whilefailure to achieve and maintain compliance could have an adverse effect on ourstock price.**

Pursuantto Section 404 of the Sarbanes-Oxley Act of 2002 and current Securities andExchange Commission (“SEC”) regulations and proposed rules, beginning with ourAnnual Report for the fiscal year ended November 1, 2008, we expect to be requiredto furnish a report by our management on our internal control over financialreporting. Further, we expect that our external auditors will be required toaudit our internal control over financial reporting report and include theirattestation on that report in our annual report on Form 10-K starting from ourannual report for the 2009 fiscal year. The process of fully documenting andtesting our internal control procedures in order to satisfy these requirementswill result in increased general and administrative expenses and may shiftmanagement time and attention from profit-generating activities to complianceactivities. Furthermore, during the course of our internal control testing, wemay identify deficiencies which we may not be able to remediate in time to meetthe reporting deadline under Section 404. Failure to achieve and maintain aneffective internal control environment or complete our Section 404certifications could have a material adverse effect on our stock price.

**We area defendant in a variety of litigation and other actions from time to time,which may have a material adverse effect on our business, financial conditionand results of operations.**

Weare regularly involved in a variety of litigation arising out of our businessand, in recent years, have paid significant amounts as a result of adversearbitration awards. We do not have insurance for some of these claims, andthere can be no assurance that the insurance coverage we have will cover allclaims that may be asserted against us. Should the ultimate judgments orsettlements not be covered by insurance or exceed our insurance coverage, theycould have a material adverse effect on our results of operations, financialposition and cash flows. There can also be no assurance that we will be able toobtain appropriate and sufficient types or levels of insurance in the future orthat adequate replacement policies will be available on acceptable terms, if atall.

**Item3.  Quantitative and QualitativeDisclosures About Market Risk**

We are exposed to certainmarket risks from transactions that are entered into during the normal courseof business. Our primary market risk exposure relates to interest rate risk. AtJuly 8, 2006, our outstanding debt under variable-rate interest borrowings was approximately$4.3 million. A change of two percentage points in the interest rates wouldcause a change in interest expense of approximately $86,000 on an annual basis.Our exposure to market risk for changes in interest rates is not significantwith respect to interest income, as our investment portfolio is not material toour consolidated balance sheet. We currently have no plans to hold aninvestment portfolio that includes derivative financial instruments.

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For the 36 weeks endedJuly 8, 2006, our international operations comprised 21.5% of our revenue and,as of the end of that period, 18.6% of our total assets. We are exposed toforeign currency risk primarily due to our investments in foreign subsidiaries.Our multicurrency credit facility, which allows our Australian and UnitedKingdom subsidiaries to borrow in local currencies, partially mitigates theexchange rate risk resulting from fluctuations in foreign currency denominatednet investments in these subsidiaries in relation to the U.S. dollar. We do notcurrently hold any market risk sensitive instruments entered into for hedgingtransaction risks related to foreign currencies. In addition, we have notentered into any transactions with derivative financial instruments for tradingpurposes.

### **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 andoperations of the Company’s “disclosure controls and procedures” (as definedunder Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934,as amended). Based on this evaluation, the Chief Executive Officer and ChiefFinancial Officer concluded that, as of July 8, 2006 (the end of the periodcovered by this report) the Company’s disclosure controls and procedures areeffective in timely alerting them to material information required to bepublicly reported. There was no change in the Company’s internal control overfinancial reporting that occurred during the fiscal period ended July 8, 2006,that has materially affected, or is reasonably likely to materially affect, theCompany’s internal controls over financial reporting.

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**Part II.****          OtherInformation**

### **Item1.****                       LegalProceedings**

In the ordinary course ofour business, we are periodically threatened with or named as a defendant invarious lawsuits. The principal risks that we insure against are workers’compensation, general liability, automobile liability, property damage,alternative staffing errors and omissions, fiduciary liability and fidelitylosses.

We are not currently a partyto any material litigation. However, from time to time we have been threatenedwith, or named as a defendant in litigation brought by former franchisees orlicensees, and administrative claims and lawsuits brought by former employees.Management believes the resolution of these matters will not have a materialadverse effect on our financial statements.

### **Item1A.****              RiskFactors**

The disclosure in the section above titled “RiskFactors” in Part I Item 2 “Management’s Discussion and Analysis of FinancialCondition and Results of Operations” is hereby incorporated by reference.

### **Item2.****                       UnregisteredSales of Equity Securities and Use of Proceeds**

Not applicable.

### **Item3.****                    DefaultsUpon Senior Securities**

Not applicable.

### **Item4.****                       Submissionof Matters to a Vote of Security Holders**

Our Annual Meeting ofStockholders was held on April 19, 2006. The results of the matters voted uponat the meeting were:

(a)                      Eachof the nominees to the Board of Directors was elected as Class I director toserve for a three-year term until their successor is elected and qualified. Thenominees were:

Ronald D. Stevens:                                          15,318,578common shares for and 510,413 withheld;

Jack D. Samuelson:                                          15,564,409common shares for and 264,582 withheld.

The terms of W. Robert Stover and Janet M. Brady as Class III directorswill continue until the Company’s 2008 annual meeting of stockholders. The termof Patricia M. Newman as Class II director will continue until the Company’s2007 annual meeting of stockholders.

(b)                     Thestockholders approved the adoption of the 2006 Stock Incentive Plan. The 2006Stock Incentive Plan is intended as the successor to, and a continuation of,our 1996 Stock Option/Stock Issuance Plan:

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9,841,489 common shares for; 2,014,344 against;367,500 abstaining and 3,605,658 broker non-votes.

### **Item5.****                       OtherInformation**

On July 26, 2006, our Board of Directors adopted and approved anamendment and restatement of the 1996 Employee Stock Purchase Plan to (i)bifurcate the Purchase Plan into the Westaff, Inc. Employee Stock Purchase Planand the Westaff, Inc. International Employee Stock Purchase Plan (together the “PurchasePlans”), (ii) extend the term of the Purchase Plans to the last business day ofJanuary 2017, (iii) expand the actions that we can take in connection with a “CorporateTransaction” and (iv) modify the participating subsidiaries to these PurchasePlans to cover the employees of certain of our subsidiaries. In addition,effective for purchase periods commencing on and after August 1, 2006, thepurchase price for shares purchased under the Purchase Plans will equal 90% ofthe lower of (i) the fair market value at the beginning of the purchase periodor (ii) the fair market value on the last day of the purchase period. TheWestaff, Inc. Employee Stock Purchase Plan, amended and restated on July 26,2006 and the Westaff, Inc. International Employee Stock Purchase Plan, amendedand restated on July 26, 2006 are filed as exhibits to this report.

**Item6.   Exhibits**

Set forth below is a list of the exhibits included as part of thisQuarterly Report:

10.1                                       Westaff,Inc. Employee Stock Purchase Plan, amended and restated on July 26, 2006.

10.2                                       Westaff,Inc. International Employee Stock Purchase Plan, amended and restated on July26, 2006.

31.1                                       Certificationof the Chief Executive Officer pursuant to Section 302 of the Sarbanes-OxleyAct of 2002.

31.2                                       Certificationof the Chief Financial Officer pursuant to Section 302 of the Sarbanes-OxleyAct of 2002.

32.1                                       Certificationof the Chief Executive Officer pursuant to 18 U.S.C. Section 1350 as AdoptedPursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

32.2                                       Certificationof the Chief Financial Officer pursuant to 18 U.S.C. Section 1350 as AdoptedPursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

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**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.                                     |
|-----------------|---------------------------------------------------|
|            |                                              |
|            |                                              |
| August 22, 2006 |                                              |   /s/ John P. Sanders |   |
| Date            |                                              |     John P. Sanders |
|            | Senior Vice President and Chief Financial Officer |
|                 |                                                   |  |  |  |

 

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**EXHIBIT INDEX**

 
| Exhibit No. | ** ** | **Description of Document**                                                                                                                             |
|-------------|------------|---------------------------------------------------------------------------------------------------------------------------------------------------------|
|        |       |                                                                                                                                                    |
| 10.1        |       | Westaff, Inc. Employee Stock Purchase Plan, amended  and restated on July 26, 2006.                                                                     |
|        |       |                                                                                                                                                    |
| 10.2        |       | Westaff, Inc. International Employee Stock Purchase  Plan, amended and restated on July 26, 2006.                                                       |
|        |       |                                                                                                                                                    |
| 31.1        |       | Certification of the Chief Executive Officer  pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.                                                |
|        |       |                                                                                                                                                    |
| 31.2        |       | Certification of the Chief Financial Officer  pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.                                                |
|        |       |                                                                                                                                                    |
| 32.1        |       | Certification of the Chief Executive Officer  pursuant to 18 U.S.C. Section 1350 as Adopted Pursuant to Section 906 of the  Sarbanes-Oxley Act of 2002. |
|        |       |                                                                                                                                                    |
| 32.2        |       | Certification of the Chief Financial Officer  pursuant to 18 U.S.C. Section 1350 as Adopted Pursuant to Section 906 of the  Sarbanes-Oxley Act of 2002. |

 

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