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

**Washington, D. C. 20549**

 

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

 

**ý****                                ****QUARTERLYREPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACTOF 1934.**

 

**For thequarterly period ended April 16, 2005**

 

**o****                                ****TRANSITIONREPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACTOF 1934**

 

**For thetransition period from                        to                        **

 

**Commission file number 0-24990**

 

**WESTAFF, INC.**

(Exact name of registrant as specified in its charter)

 

| **Delaware**                                                        | ** ** | **94-1266151**                          |
|---------------------------------------------------------------------|------------|-----------------------------------------|
| (State or other jurisdiction  of incorporation or organization)     |       | (I.R.S.employer  identification number) |
|                                                                |
| **298 North Wiget Lane  Walnut Creek, California  94598-2453** |
| (Address of registrant’s principal executive  offices)         |
|                                                                |
| **(925)  930-5300**                                            |
| (Registrant’s telephone  number)                               |

 

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

 

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

 

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

 

| **Class**                    | ** ** | **Outstanding at May 30,  2005** |
|------------------------------|------------|---------------------------------------|
|                         |       |                                  |
| Common Stock, $.01 par value |       | 16,338,785 shares                     |

 

 

----

 

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

##### ** **

**INDEX**

 
|              |                                                                                                                   | **Page**   |
|-------------------|------------------------------------------------------------------------------------------------------------------------|------------|
| **Part I.**  | **Financial Information**                                                                                              | ** ** |
| ** **        | ** **                                                                                                             | ** ** |
| Item 1.           | Financial Statements (Unaudited)                                                                                       |       |
|              |                                                                                                                   |       |
|              | Condensed  Consolidated Balance Sheets -   April 16, 2005 and October 30, 2004                               | 3          |
|              |                                                                                                                   |       |
|              | Condensed  Consolidated Statements of Operations -   12 and 24 weeks ended April 16, 2005 and April 17, 2004 | 4          |
|              |                                                                                                                   |       |
|              | Condensed  Consolidated Statements of Cash Flows -   24 weeks ended April 16, 2005 and April 17, 2004        | 5          |
|              |                                                                                                                   |       |
|              | Notes  to Condensed Consolidated Financial Statements                                                                  | 6          |
|              |                                                                                                                   |       |
| Item  2.          | Management’s  Discussion and Analysis of Financial Condition and Results of Operations                            | 12         |
|              |                                                                                                                   |       |
| Item  3.          | Quantitative  and Qualitative Disclosures About Market Risk                                                            | 17         |
|              |                                                                                                                   |       |
| Item 4.           | Controls and Procedures                                                                                                | 18         |
|              |                                                                                                                   |       |
| **Part II.** | **Other Information**                                                                                                  | ** ** |
| ** **        | ** **                                                                                                             | ** ** |
| Item 1.           | Legal Proceedings                                                                                                      | 19         |
|              |                                                                                                                   |       |
| Item  2.          | Unregistered  Sales of Equity Securities and Use of Proceeds                                                           | 19         |
|              |                                                                                                                   |       |
| Item 3.           | Defaults Upon  Senior Securities                                                                                       | 19         |
|              |                                                                                                                   |       |
| Item  4.          | Submission  of Matters to a Vote of Security Holders                                                                   | 19         |
|              |                                                                                                                   |       |
| Item 5.           | Other Information                                                                                                      | 19         |
|              |                                                                                                                   |       |
| Item 6.           | Exhibits                                                                                                               | 19         |
|              |                                                                                                                   |       |
| Signatures        | 20                                                                                                                     |

 

----

 

**Part l.  Financial Information**

 

**Item 1.  Financial Statements**

 

**Westaff, Inc.**

 

**Condensed Consolidated BalanceSheets (Unaudited)**

**(Inthousands except per share amounts)**

 
| ** **                                                                            | ** ** | **April 16,** | ** ** | **October 30,** | ** ** |
|---------------------------------------------------------------------------------------|------------|--------------------|------------|----------------------|------------|
| ** **                                                                            | ** ** | **2005**           | ** ** | **2004**             | ** ** |
| **ASSETS**                                                                            |       |               |       |                 |       |
| Current assets:                                                                       |       |               |       |                 |       |
| Cash and cash equivalents                                                             |       | $                  | 4,042      |                 | $          | 6,993 |   |
| Trade accounts receivable, less allowance for  doubtful accounts of $1,161 and $1,124 |       | 73,907             |       | 84,712               |       |
| Income taxes receivable                                                               |       | 267                |       | 847                  |       |
| Deferred income taxes                                                                 |       | 294                |       | 286                  |       |
| Prepaid expenses                                                                      |       | 3,711              |       | 4,530                |       |
| Other current assets                                                                  |       | 1,598              |       | 877                  |       |
| Total current assets                                                                  |       | 83,819             |       | 98,245               |       |
|                                                                                  |       |               |       |                 |       |
| Property and equipment, net                                                           |       | 10,991             |       | 10,184               |       |
| Goodwill                                                                              |       | 11,801             |       | 11,760               |       |
| Other long-term assets                                                                |       | 11,157             |       | 2,219                |       |
| Total Assets                                                                          |       | $                  | 117,768    |                 | $          | 122,408 |   |
|                                                                                  |       |               |       |                 |       |
| **LIABILITIES AND STOCKHOLDERS’ EQUITY**                                         |       |               |       |                 |       |
| Current liabilities:                                                                  |       |               |       |                 |       |
| Borrowing under revolving credit facilities                                           |       | $                  | 10,378     |                 | $          | 15,734 |   |
| Current portion of capital lease obligations                                          |       | 371                |       | 465                  |       |
| Accounts payable                                                                      |       | 3,732              |       | 2,731                |       |
| Accrued expenses                                                                      |       | 43,530             |       | 44,944               |       |
| Income taxes payable                                                                  |       | 413                |       | 632                  |       |
| Net liabilities of discontinued operations                                            |       | 127                |       | 225                  |       |
| Total current liabilities                                                             |       | 58,551             |       | 64,731               |       |
|                                                                                  |       |               |       |                 |       |
| Note payable to related party                                                         |       | 2,000              |       | 2,000                |       |
| Long-term capital lease obligations                                                   |       | 59                 |       | 125                  |       |
| Other long-term liabilities                                                           |       | 16,267             |       | 15,705               |       |
| Total liabilities                                                                     |       | 76,877             |       | 82,561               |       |
|                                                                                  |       |               |       |                 |       |
| Commitments and contingencies                                                         |       |               |       |                 |       |
|                                                                                  |       |               |       |                 |       |
| Stockholders’ equity:                                                            |       |               |       |                 |       |
| Preferred stock, $.01 par value; authorized and  unissued: 1,000 shares               |       |               |       |                 |       |
| Common stock, $.01 par value; authorized: 25,000  shares; issued and outstanding:     |       |               |       |                 |       |
| 16,339 shares at April 16, 2005 and 16,047  shares at October 30, 2004      |       | 163                |       | 160                  |       |
| Additional paid-in capital                                                            |       | 37,476             |       | 36,768               |       |
| Deferred stock compensation                                                           |       | (64                | )          |                 |       |
| Retained earnings                                                                     |       | 3,160              |       | 3,025                |       |
| Accumulated other comprehensive income (loss)                                         |       | 156                |       | (106                 | )          |
| Total stockholders’ equity                                                       |       | 40,891             |       | 39,847               |       |
| Total Liabilities and Stockholders’ Equity                                       |       | $                  | 117,768    |                 | $          | 122,408 |   |

 

See accompanying notes to condensed consolidated financial statements.

 

3

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**Westaff, Inc.**

 

**Condensed Consolidated Statementsof Operations (Unaudited)**

**(Inthousands except per share amounts)**

 
| ** **                                     | ** ** | **12 Weeks Ended** | ** ** | **24 Weeks Ended** | ** ** |
|------------------------------------------------|------------|--------------------|------------|--------------------|------------|
| ** **                                     | ** ** | **April 16,** | ** ** | **April 17,** | ** ** | **April 16,** | ** ** | **April 17,** | ** ** |
| ** **                                     | ** ** | **2005**           | ** ** | **2004**           | ** ** | **2005** | ** ** | **2004** | ** ** |
|                                           |       |               |       |               |       |   |   |   |   |
| Revenue                                        |       | $                  | 138,324    |               | $          | 131,318 |   | $ | 276,566 |   | $ | 253,904 |   |
|                                           |       |               |       |               |       |   |   |   |   |
| Costs of services                              |       | 114,449            |       | 109,187            |       | 229,107 |   | 211,024 |   |
|                                           |       |               |       |               |       |   |   |   |   |
| Gross profit                                   |       | 23,875             |       | 22,131             |       | 47,459 |   | 42,880 |   |
|                                           |       |               |       |               |       |   |   |   |   |
| Franchise agents’ share of gross profit   |       | 4,056              |       | 3,985              |       | 8,030 |   | 7,787 |   |
| Selling and administrative expenses            |       | 18,923             |       | 16,374             |       | 36,463 |   | 32,568 |   |
| Depreciation and amortization                  |       | 966                |       | 1,071              |       | 1,937 |   | 2,174 |   |
|                                           |       |               |       |               |       |   |   |   |   |
| Operating income (loss)                        |       | (70                | )          | 701                |       | 1,029 |   | 351 |   |
|                                           |       |               |       |               |       |   |   |   |   |
| Interest expense                               |       | 313                |       | 442                |       | 736 |   | 914 |   |
| Interest income                                |       | (32                | )          | (14                | )          | (58 | ) | (34 | ) |
|                                           |       |               |       |               |       |   |   |   |   |
| Income (loss) before income taxes              |       | (351               | )          | 273                |       | 351 |   | (529 | ) |
| Provision for income taxes                     |       | 20                 |       | 105                |       | 216 |   | 208 |   |
|                                           |       |               |       |               |       |   |   |   |   |
| Net income (loss)                              |       | $                  | (371       | )                  | $          | 168 |   | $ | 135 |   | $ | (737 | ) |
|                                           |       |               |       |               |       |   |   |   |   |
| Earnings (loss) per share - basic and diluted: |       | $                  | (0.02      | )                  | $          | 0.01 |   | $ | 0.01 |   | $ | (0.05 | ) |
|                                           |       |               |       |               |       |   |   |   |   |
| Weighted average shares outstanding - basic    |       | 16,302             |       | 16,032             |       | 16,175 |   | 16,024 |   |
| Weigthed average shares outstanding - diluted  |       | 16,302             |       | 16,036             |       | 16,378 |   | 16,024 |   |

 

See accompanying notes to condensed consolidated financial statements.

 

4

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**Westaff, Inc.**

 

**Condensed Consolidated Statementsof Cash Flows (Unaudited)**

**(Inthousands)**

 
| ** **                                                                                | ** ** | **24 Weeks Ended** | ** ** |
|-------------------------------------------------------------------------------------------|------------|--------------------|------------|
| ** **                                                                                | ** ** | **April 16,** | ** ** | **April 17,** | ** ** |
| ** **                                                                                | ** ** | **2005**           | ** ** | **2004** | ** ** |
| **Cash flows from operating activities**                                                  |       |               |       |   |   |
| Net income (loss)                                                                         |       | $                  | 135        |   | $ | (737 | ) |
| Adjustments to reconcile net income (loss) to net  cash provided by operating activities: |       |               |       |   |   |
| Depreciation and amortization                                                             |       | 1,937              |       | 2,174 |   |
| Provision for losses on doubtful accounts                                                 |       | 269                |       | 480 |   |
| Gain on sale or disposal of assets                                                        |       | (35                | )          | (667 | ) |
| Income from sales of affiliate operations                                                 |       | (12                | )          | (9 | ) |
| Other                                                                                     |       | (72                | )          | (106 | ) |
| Changes in assets and liabilities:                                                        |       |               |       |   |   |
| Trade accounts receivable                                                                 |       | 10,973             |       | 3,603 |   |
| Other assets                                                                              |       | (8,629             | )          | (4,019 | ) |
| Accounts payable and accrued expenses                                                     |       | (691               | )          | 719 |   |
| Income taxes payable                                                                      |       | (232               | )          | (258 | ) |
| Other liabilities                                                                         |       | (73                | )          | 221 |   |
|                                                                                      |       |               |       |   |   |
| Net cash provided by continuing operations                                                |       | 3,570              |       | 1,401 |   |
| Net cash used by discontinued operations                                                  |       | (98                | )          | (192 | ) |
|                                                                                      |       |               |       |   |   |
| Net cash provided by operating activities                                                 |       | 3,472              |       | 1,209 |   |
|                                                                                      |       |               |       |   |   |
| **Cash flows from investing activities**                                                  |       |               |       |   |   |
| Capital expenditures                                                                      |       | (2,682             | )          | (792 | ) |
| Proceeds from sales of affiliate operations                                               |       | 1,054              |       | 16 |   |
| Proceeds from sales of assets                                                             |       |               |       | 1,937 |   |
| Other, net                                                                                |       | 187                |       | (10 | ) |
|                                                                                      |       |               |       |   |   |
| Net cash provided (used) by investing activities                                          |       | (1,441             | )          | 1,151 |   |
|                                                                                      |       |               |       |   |   |
| **Cash flows from financing activities**                                                  |       |               |       |   |   |
| Net repayments under line of credit agreements                                            |       | (5,498             | )          | (6,302 | ) |
| Principal payments on capital lease obligations                                           |       | (232               | )          | (196 | ) |
| Proceeds from notes payable to related parties                                            |       |               |       | 1,000 |   |
| Issuance of common stock                                                                  |       | 646                |       | 32 |   |
| Other                                                                                     |       | (8                 | )          | (67 | ) |
|                                                                                      |       |               |       |   |   |
| Net cash used by financing activities                                                     |       | (5,092             | )          | (5,533 | ) |
|                                                                                      |       |               |       |   |   |
| Effect of exchange rate changes on cash                                                   |       | 110                |       | 223 |   |
|                                                                                      |       |               |       |   |   |
| Net change in cash and cash equivalents                                                   |       | (2,951             | )          | (2,950 | ) |
| Cash and cash equivalents at beginning of period                                          |       | 6,993              |       | 4,759 |   |
| Cash and cash equivalents at end of period                                                |       | $                  | 4,042      |   | $ | 1,809 |   |

 

See accompanying notes to condensed consolidated financial statements.

 

5

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**Westaff, Inc.**

 

**Notes to Condensed ConsolidatedFinancial Statements (Unaudited)**

**(In thousandsexcept per share amounts)**

 

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

 

The accompanying condensed consolidated financial statements of Westaff, Inc.and its domestic and foreign subsidiaries (together, the Company), as of April 16,2005 and for the 12 and 24 week periods ended April 16, 2005 and April 17,2004 are unaudited.

 

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

 

Certainfinancial information which is normally included in annual financial statementsprepared in accordance with accounting principles generally accepted in theUnited States, but which is not required for interim reporting purposes, hasbeen condensed or omitted.  Theaccompanying condensed consolidated financial statements should be read inconjunction with the financial statements and notes thereto included in the Company’sAnnual Report on Form 10-K for the fiscal year ended October 30,2004.

 

TheCompany’s fiscal year is a 52 or 53 week period ending the Saturday nearest theend of October.  For interim reportingpurposes, the first three fiscal quarters comprise 12 weeks each, while thefourth fiscal quarter consists of 16 or 17 weeks.  The results of operations for the 12 and 24week periods ended April 16, 2005 are not necessarily indicative of theresults to be expected for the full fiscal year or for any future period.

 

During fiscal year 1999, the Company sold its medical business,primarily operated through Western Medical Services, Inc., a wholly ownedsubsidiary of the Company (see Note 4). As a result, the Company has classified its medical operations asdiscontinued operations in these condensed consolidated financial statementsand notes thereto.

 

Certain amounts in the April 17, 2004 financial statements havebeen reclassified to conform to the April 16, 2005 presentation.

 

**2.**              Stock-basedCompensation

 

The Company measures compensation cost for employeestock options and similar equity instruments using the intrinsic value-basedmethod of accounting prescribed by Accounting Principles Board Opinion No. 25,“Accounting for Stock Issued to Employees”(APB 25), and follows thedisclosure-only provisions of SFAS No. 123, “Accounting for Stock-BasedCompensation”, as amended by SFAS No. 148, “Accounting for Stock-BasedCompensation – Transition and Disclosure”. As all options have been granted at fair value, no compensation cost hasbeen recognized in the financial statements. The following table represents pro forma net income (loss) and pro formaincome (loss) per share had compensation cost been determined using the fairvalue method:

 

6

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| ** **                                                       | ** ** | **12 Weeks Ended** | ** ** | **24 Weeks Ended** | ** ** |
|------------------------------------------------------------------|------------|--------------------|------------|--------------------|------------|
| ** **                                                       | ** ** | **April 16,** | ** ** | **April 17,** | ** ** | **April 16,** | ** ** | **April 17,** | ** ** |
| ** **                                                       | ** ** | **2005**           | ** ** | **2004**           | ** ** | **2005** | ** ** | **2004** | ** ** |
|                                                             |       |               |       |               |       |   |   |   |   |
| Net income (loss) as reported                                    |       | $                  | (371       | )                  | $          | 168 |   | $ | 135 |   | $ | (737 | ) |
| Stock based compensation determined under the fair  value method |       | 65                 |       | (101               | )          | (33 | ) | (207 | ) |
|                                                             |       |               |       |               |       |   |   |   |   |
| Pro forma net income (loss)                                      |       | $                  | (306       | )                  | $          | 67 |   | $ | 102 |   | $ | (944 | ) |
|                                                             |       |               |       |               |       |   |   |   |   |
| Income (loss) per common share:                                  |       |               |       |               |       |   |   |   |   |
| Basic and diluted - as reported                                  |       | $                  | (0.02      | )                  | $          | 0.01 |   | $ | 0.01 |   | $ | (0.05 | ) |
| Basic and diluted - pro forma                                    |       | $                  | (0.02      | )                  | $          | 0.00 |   | $ | 0.01 |   | $ | (0.06 | ) |
|                                                                  |            |                    |            |                    |            |  |  |  |  |  |  |  |  |  |  |  |

 

Because stock options generally become exercisableover several years and additional grants are likely to be made in futureperiods, the pro forma amounts for compensation cost may not be indicative ofthe effects on net income and earnings per share for future periods.

 

**3.****              Goodwill**

 

Thechange in the carrying amount of goodwill for the 24 weeks ended April 16,2005 is due to the effect of changes in foreign currency translation rates. TheCompany performs its annual impairment evaluation in the fourth quarter of eachfiscal year.

 

**4.****              DiscontinuedOperations**

 

During fiscal 1999, the Company sold certain of itsfranchise agent and Company-owned medical offices and entered into atermination agreement with one of its medical licensees. During the fourthquarter of fiscal 1999, the Company completed the sale of the remaining medicalbusiness to Intrepid U.S.A. Inc. under an asset purchase agreement.

 

As of April 16,2005, the remaining current liabilities of the discontinued medical operationsof $127 are for settled but unpaid claims of $100 and other costs of $27.

 

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

 

The Company isresponsible for and pays workers’ compensation costs for its temporary andregular employees and is self-insured for the deductible amount related toworkers’ compensation claims ($500 per claim for fiscal 2005 and $750 per claimfor fiscal year 2004.)  The Companyaccrues the estimated costs of workers’ compensation claims based upon theexpected loss rates within the various temporary employment categories providedby the Company.  At least annually, theCompany obtains an 

 

7

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independentactuarial valuation of the estimated costs of claims reported but not settled,and claims incurred but not reported, and adjusts the accruals based on theresults of the valuations.  As of April 16,2005 and October 30, 2004, workers’ compensation liabilities were $17,901and $16,382, respectively, of which $11,900 is included in other long-termliabilities on each of the respective balance sheets for obligations which arenot expected to be paid in the following fiscal year.

 

Eachpolicy year the terms of the agreement with the insurance carrier arerenegotiated.  The insurance carrierrequires the Company to collateralize its recorded obligations through the useof irrevocable letters of credit, surety bonds or cash.  At April 16, 2005, the Company had$22,375 of letters of credit and a $3,843 surety bond securing its domesticworkers’ compensation obligations.  Inaddition to premium and claim payments, the Company is cash collaterizing itsfiscal 2005 policy year through payments totaling $15,775, of which $9,360 hasbeen paid as of April 16, 2005 and is reflected in other long-term assets inthe consolidated balance sheet.  Effective April 20, 2005, the Company’s insurance carrier reducedits collateral requirements through the cancellation of the $3,843 surety bond.

 

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

 

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

 
| ** **                                                                                             | ** ** | **12 Weeks Ended** | ** ** | **24 Weeks Ended** | ** ** |
|--------------------------------------------------------------------------------------------------------|------------|--------------------|------------|--------------------|------------|
| ** **                                                                                             | ** ** | **April 16,** | ** ** | **April 17**  | ** ** | **April 16,** | ** ** | **April 17** | ** ** |
| ** **                                                                                             | ** ** | **2005**           | ** ** | **2004**           | ** ** | **2005** | ** ** | **2004** | ** ** |
|                                                                                                   |       |               |       |               |       |   |   |   |   |
| Net income (loss)                                                                                      |       | $                  | (371       | )                  | $          | 168 |   | $ | 135 |   | $ | (737 | ) |
|                                                                                                   |       |               |       |               |       |   |   |   |   |
| Denominator for basic earnings per share - weighted  average shares                                    |       | 16,302             |       | 16,032             |       | 16,175 |   | 16,024 |   |
|                                                                                                   |       |               |       |               |       |   |   |   |   |
| Effect of dilutive securities: stock options and  awards                                               |       |               |       | 4                  |       | 203 |   |   |   |
| Denominator for diluted earnings per share -  adjusted weighted average shares and assumed conversions |       | 16,302             |       | 16,036             |       | 16,378 |   | 16,024 |   |
|                                                                                                   |       |               |       |               |       |   |   |   |   |
| Basic and diluted earnings (loss) per share                                                            |       | $                  | (0.02      | )                  | $          | 0.01 |   | $ | 0.01 |   | $ | (0.05 | ) |
|                                                                                                   |       |               |       |               |       |   |   |   |   |
| Anti-dilutive weighted shares excluded from diluted  earnings (loss) per share                         |       | 252                |       | 1,003              |       | 79 |   | 1,009 |   |
|                                                                                                        |            |                    |            |                    |            |  |  |  |  |  |  |  |  |  |

 

8

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**7.****              ComprehensiveIncome (Loss)**

 

Comprehensive income (loss) consists of the following:

 
| ** **                       | ** ** | **12 Weeks Ended** | ** ** | **24 Weeks Ended** | ** ** |
|----------------------------------|------------|--------------------|------------|--------------------|------------|
| ** **                       | ** ** | **April 16,** | ** ** | **April 17,** | ** ** | **April 16,** | ** ** | **April 17,** | ** ** |
| ** **                       | ** ** | **2005**           | ** ** | **2004**           | ** ** | **2005** | ** ** | **2004** | ** ** |
|                             |       |               |       |               |       |   |   |   |   |
| Net income (loss)                |       | $                  | (371       | )                  | $          | 168 |   | $ | 135 |   | $ | (737 | ) |
| Currency translation adjustments |       | (5                 | )          | (234               | )          | 262 |   | 640 |   |
|                             |       |               |       |               |       |   |   |   |   |
| Comprehensive income (loss)      |       | $                  | (376       | )                  | $          | (66 | ) | $ | 397 |   | $ | (97 | ) |

 

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

 

On May 17,2002, the Company entered into agreements with GE Capital, as primary agent, toprovide senior secured credit facilities totaling $65,000, expiring in May 2007.  The facilities comprise a five-yearsyndicated Multicurrency Credit Agreement consisting of a $50,000 US RevolvingLoan Commitment, a £2,740 UK Revolving Loan Commitment (US dollar equivalent ofapproximately $4,000 at the date of the agreement), and a $5,000 term loan (theTerm Loan), which was repaid during fiscal 2003.  In addition, a five-year Australian dollarfacility agreement (the A$ Facility Agreement) was executed on May 16,2002, consisting of an A$12,000 revolving credit facility (US dollar equivalentof approximately $6,000 at the date of the agreement).  Each agreement includes a letter of creditsub-facility.  Letters of credit underthe agreements expire one year from date of issuance but are automaticallyrenewed for one additional year unless written notice is given to or from theholder.

 

On January 5, 2005, a sixth amendment to theMulticurrency Credit Agreement was executed. The amendment, among other things, allows a $1,400 add-back adjustmentto the rolling 13-period earnings before interest, taxes, depreciation andamortization (EBITDA) covenant at October 30, 2004 for additional workers’compensation charges the Company incurred during the fourth quarter of fiscal2004 relating to adverse loss development on historical claims.

 

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

 

On September 25,2003 the Company executed a one-year unsecured subordinated draw down note withits principal stockholder and Chairman of the Board of Directors.  The note provided for the Chairman to makeadvances to the Company upon request, at his sole discretion and with noobligation to do so, in an aggregate principal amount not to exceed $1,000outstanding at any one time.  On December 23,2003 the Chairman made a $1,000 advance to the Company under the terms of thenote.  The advance plus accrued interestwas repaid on August 3, 2004.

 

The Company alsohas an unsecured subordinated promissory note payable to its principalstockholder and Chairman of the Board of Directors dated May 17, 2002 inthe amount of $2,000.  The note has amaturity date of August 18, 2007 and an interest rate equal to an indexedrate as calculated under the Company’s credit facilities plus seven percent,compounded monthly and payable 60 calendar days after the end of each of theCompany’s fiscal quarters.  The interestrate in effect on April 16, 2005 was 12.75%.  Payment of interest is contingent on theCompany meeting minimum availability requirements under its credit facilities.Additionally, payments of principal or interest are prohibited in the event ofany default under the credit facilities.

 

9

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**10.****       OperatingSegments**

 

Thefollowing table summarizes reporting segment data:

 
| ** **                         | ** ** | **Domestic**            | ** ** | ** **              | ** ** | ** **    | ** ** | **Other**         | ** ** | ** **       | ** ** |
|------------------------------------|------------|-------------------------|------------|-------------------------|------------|---------------|------------|-------------------|------------|------------------|------------|
| ** **                         | ** ** | **Business Svcs.** | ** ** | **United Kingdom** | ** ** | **Australia** | ** ** | **International** | ** ** | **Consolidated** | ** ** |
|                               |       |                    |       |                    |       |          |       |              |       |             |       |
| 12 Weeks Ended April 16, 2005 |       |                    |       |                    |       |          |       |              |       |             |       |
|                               |       |                    |       |                    |       |          |       |              |       |             |       |
| Revenue                            |       | $                       | 102,687    |                    | $          | 9,951         |       | $                 | 21,088     |             | $          | 4,598 |   | $ | 138,324 |   |
| Operating income (loss)            |       | $                       | (577       | )                       | $          | 124           |       | $                 | 336        |             | $          | 47 |   | $ | (70 | ) |
|                               |       |                    |       |                    |       |          |       |              |       |             |       |
| 12 Weeks Ended April 17, 2004 |       |                    |       |                    |       |          |       |              |       |             |       |
|                               |       |                    |       |                    |       |          |       |              |       |             |       |
| Revenue                            |       | $                       | 102,261    |                    | $          | 9,727         |       | $                 | 15,282     |             | $          | 4,048 |   | $ | 131,318 |   |
| Operating income (loss)            |       | $                       | 339        |                    | $          | 312           |       | $                 | 122        |             | $          | (72 | ) | $ | 701 |   |
|                               |       |                    |       |                    |       |          |       |              |       |             |       |
| 24 Weeks Ended April 16, 2005 |       |                    |       |                    |       |          |       |              |       |             |       |
|                               |       |                    |       |                    |       |          |       |              |       |             |       |
| Revenue                            |       | $                       | 205,749    |                    | $          | 19,771        |       | $                 | 41,469     |             | $          | 9,577 |   | $ | 276,566 |   |
| Operating income                   |       | $                       | 8          |                    | $          | 471           |       | $                 | 492        |             | $          | 58 |   | $ | 1,029 |   |
|                               |       |                    |       |                    |       |          |       |              |       |             |       |
| 24 Weeks Ended April 17, 2004 |       |                    |       |                    |       |          |       |              |       |             |       |
|                               |       |                    |       |                    |       |          |       |              |       |             |       |
| Revenue                            |       | $                       | 196,801    |                    | $          | 18,287        |       | $                 | 30,676     |             | $          | 8,140 |   | $ | 253,904 |   |
| Operating income (loss)            |       | $                       | (339       | )                       | $          | 595           |       | $                 | 266        |             | $          | (171 | ) | $ | 351 |   |

 

**11.**       Commitmentsand Contingencies

 

In the ordinary course of its business, the Company is periodicallythreatened with or named as a defendant in various lawsuits.  The principal risks that the Company insuresagainst are workers’ compensation, general liability, automobile liability,property damage, alternative staffing errors and omissions, fiduciary liabilityand fidelity losses.  From time to timethe Company has been threatened with, or named as a defendant in, lawsuits,including countersuits brought by former franchise agents or licensees, andadministrative claims and lawsuits brought by employees or formeremployees.  The Company does not believethe outcome of any proceedings on these actions would have a material adverse effecton its financial position, results of operations or cash flows.

 

**12.****       RecentAccounting Pronouncements**

 

In December 2004, the Financial AccountingStandards Board (FASB) issued Statement of Financial Accounting Standards No. 123(revised 2004) “Share-Based Payment” (SFAS 123 (R)).  SFAS 123 (R)

 

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replaces FASB Statement No. 123 “Accounting forStock-Based Compensation”, and supersedes APB Opinion No 25 “Accounting forStock Issued to Employees”. The statement establishes standards for accountingfor share-based payment transactions. Share-based payment transactions are those in which an entity exchangesits equity instruments for goods or services or in which an entity incursliabilities in exchange for goods or services that are based on the fair valueof the entity’s equity instruments or that may be settled by the issuance ofthose equity instruments.  SFAS 123(R)covers a wide range of share-based compensation arrangements including shareoptions, restricted share plans, performance-based awards, share appreciationrights and employee share purchase plans. SFAS 123(R) requires a public entity to measure the cost of employeeservices received in exchange for an award of equity instruments based on thefair value of the award on the grant date (with limited exceptions).  That cost will be recognized in the entity’sfinancial statements over the period during which the employee is required toprovide services in exchange for the award. The Company is required to adopt SFAS 123(R) in the first quarter offiscal 2006, and has not currently evaluated the impact of adoption on itsoverall results of operations or financial position.

 

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**Westaff, Inc.**

 

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

 

### **Cautionary Statement**

 

This notice is intendedto take advantage of the “safe harbor” provided by the Private SecuritiesLitigation Reform Act of 1995 with respect to forward-looking statements.Except for the historical information contained herein, the matters discussedshould be considered forward-looking statements and readers are cautioned notto place undue reliance on those statements. Any forward-looking statements inthis discussion are made based on information available as of the date hereofand are subject to a number of risks and uncertainties that could cause theCompany’s actual results and financial position to differ materially from thoseexpressed or implied in the forward-looking statements and to be below theexpectations of public market analysts and investors. These risks anduncertainties include, but are not limited to, those discussed in Item 1 “FactorsAffecting Future Operating Results” and elsewhere in the Company’s AnnualReport on Form 10-K for the fiscal year ended October 30, 2004.  The Company undertakes no obligation topublicly 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 discussionis intended to assist in the understanding and assessment of significantchanges and trends related to the results of operations and financial conditionof Westaff, Inc., together with its consolidated subsidiaries. Thisdiscussion and analysis should be read in conjunction with the Company’sConsolidated Financial Statements and Notes thereto included elsewhere in this Form 10-Qand in the Company’s Annual Report on Form 10-K for the fiscal year ended October 30,2004.

 

### **Critical AccountingPolicies**

### ** **

Thepreparation of the Company’s financial statements in conformity with generallyaccepted accounting principles in the United States of America requiresmanagement to make estimates and assumptions affecting the amounts anddisclosures reported within those financial statements.  These estimates are evaluated on an ongoingbasis by management and generally affect revenue recognition, collectibility ofaccounts receivable, workers’ compensation costs,  income taxes and contingencies andlitigation.  Management’s estimates andassumptions are based on historical experiences and other factors believed tobe reasonable under the circumstances. However, actual results under circumstances and conditions differentthan those assumed could result in differences from the estimated amounts inthe financial statements.

 

TheCompany’s critical accounting policies are described in Item 7 “Management’sDiscussion and Analysis of Financial Condition and Results of Operations” andin the notes to the consolidated financial statements in the Company’spreviously filed Annual Report on Form 10-K for the fiscal year ended October 30,2004.  There were no changes to thesepolicies during the 24 week period ended April 16, 2005.

 

### **Executive Overview**

### ** **

Continuedbut moderate revenue growth in the second quarter of fiscal 2005 resulted intotal revenue growth of 8.9% for the first half of fiscal 2005 over the firsthalf of fiscal 2004.  The effect offoreign exchange rates on reported growth is moderating and, on a constantcurrency basis, revenue growth for this fiscal 2005 period was 7.6% over the sameperiod of fiscal 2004.  The Company hasinstituted new programs aimed at energizing its sales force and continues itsfocus on increasing direct hire revenue.

 

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Therising workers compensation costs the Company has experienced during the pastfew years have begun to stabilize, assisting gross margin in increasing to17.3% in the second quarter of fiscal 2005 from 16.9% in the same quarter offiscal 2004.  Interim claims valuationsprepared by the Company’s independent actuaries during the second quarter offiscal 2005 provide early indications that this stabilization may continuethroughout the remainder of the fiscal year. The operating loss for the fiscal 2005 quarter reflects, among otherthings, unanticipated severance costs and lost revenue due to the divestitureof one of the Company’s franchise operations.

 

TheCompany’s liquidity remains strong with $19.7 million aggregate availableborrowing capacity as of April 16, 2005. As of this date, the constraints the Company was experiencing in meetingits credit facility covenants during much of fiscal 2004 are not inevidence.  The Company is moving forwardwith its implementation of a new and fully integrated business processmanagement software platform that it believes will provide expanded operationalproductivity and enhance the services it can provide to its customers.

 

**Resultsof Operations**

 

**FiscalQuarter Ended April 16, 2005 compared to Fiscal Quarter Ended April 17,2004**

 

Revenue increased $7.0million or 5.3% for the second fiscal quarter of 2005 as compared to the fiscal2004 quarter.  Domestic revenue increased0.4%, while international revenue increased 22.6%, assisted by the effect offavorable exchange rates.

 

Domestic billed hoursdecreased 1.3%, offset by an increase in average bill rates of 1.3%.  The decrease in billed hours is partially theresult of decreased sales from some higher volume, lower margin business as theCompany continues its focus on servicing higher margin accounts.  Domestic revenue was also negatively impactedby the November 2004 divestiture of one of the Company’s franchiseoperations.

 

Excluding the effect ofexchange rate fluctuations, international revenue increased 17.7% for thefiscal 2005 quarter, with an increase of 14.3% in billed hours.  Substantially all of the internationalrevenue increase is attributable to the Company’s Australia operations thatachieved a 32.9% increase in billed hours over the fiscal 2004 quarter as aresult of both new business and increases in existing business.

 

Costs of services includehourly wages of temporary employees, employer payroll taxes, state unemploymentand workers’ compensation insurance and other employee-related costs.  Costs of services increased $5.3 million, or4.8%, in the 2005 fiscal quarter as compared to 2004.  Gross margin was 17.3% for the fiscal 2005quarter and 16.9% for the fiscal 2004 quarter. During the second quarter of fiscal 2004, the Company recorded a chargeto adjust its workers compensation accruals to actuarially determined levels.  As a result of favorable claims developmenttrends in the current fiscal year, the Company was able to reduce its workerscompensation accruals during the second quarter of fiscal 2005.

 

Franchise agents’ shareof gross profit represents the net distribution paid to franchise agents basedeither on a percentage of the sales or gross profit generated by the franchiseagents’ operations. As a percentage of consolidated revenue, franchise agents’share of gross profit was 2.9% for the fiscal 2005 quarter and 3.0% for thefiscal 2004 quarter.  The percentagedecrease is partially due to the November 2004 divestiture of one of theCompany’s franchise operations as noted above.

 

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Selling andadministrative expenses increased $2.5 million, or 15.6% for the 2005 quarteras compared to the 2004 quarter.  As apercentage of revenue, selling and administrative expenses were 13.7% for thefiscal 2005 quarter and 12.5% for the fiscal 2004 quarter.  Subsequent to the second quarter of fiscal2004, in light of positive economic indicators for the U.S. economy’s growth,the Company loosened its restrictions on hiring and wage increases for itsfull-time employees and reinstated full salaries for certain managementemployees whose salaries were reduced during fiscal 2003.  Additionally, the fiscal 2005 quarterincludes severance related costs of $0.5 million.  Selling and administrative expenses for the12 weeks ended April 17, 2004 were reduced by a $0.7 million gain on the saleof the former executive headquarters building in Walnut Creek, California.

 

Depreciation andamortization decreased $0.1 million or 9.8%, primarily due to a decreased baseof depreciating assets.

 

Net interest expensedecreased $0.1 million primarily as a result of decreased average borrowingsduring the fiscal 2005 quarter somewhat offset by higher average interestrates.

 

The decrease in theprovision for income taxes for the fiscal 2005 quarter was primarily due tolower pre-tax income generated in the Company’s United Kingdom operations.

 

**24 WeeksEnded April 16, 2005 compared to 24 Weeks Ended April 17, 2004**

 

On a constant currencybasis, revenue growth for the 24 weeks ended April 16, 2005 was 7.6% overthe same 24 week period in fiscal 2004, with domestic and international growthof 4.5% and 17.4%, respectively.  Therevenue growth was attributable to an increase in billed hours of 2.1% fordomestic operations and 15.3%  for theinternational operations, with average bill rate increases of 2.4% for each.

 

Gross margin for the 24week period in fiscal 2005 was 17.2% as compared to 16.9% for the fiscal 2004period.  Both domestic and internationalaverage bill rate increases outpaced increases in pay rates when compared tothe 24 week period in fiscal 2004.  Theincrease in gross margin was also aided by increases in direct hire revenuethat slightly more than offset increases in domestic state unemployment rates,as well as the workers’ compensation adjustments noted in the fiscal quarterdiscussion above.

 

The Company’s workerscompensation costs tend to vary depending upon the mix of business betweenclerical/administrative and light industrial staffing.  In the past several years, unexpected adversedevelopment of claims reported but not yet settled, and increases in claimsincurred but not yet reported, have resulted in the need for additional chargesto be recorded to increase its accrual levels. Based on the Company’s interim actuarial valuation for fiscal 2005, theCompany believes there is evidence that workers compensation costs may bestabilizing.

 

As a percentage ofconsolidated revenue, franchise agents’ share of gross profit was 2.9% for the24 week period of fiscal 2005 and 3.1% for the comparable period of fiscal2004.   As noted above in the discussionof the fiscal quarter results, the November 2004 divestiture of one of theCompany’s franchise operations contributed to the percentage decrease.

 

Selling andadministrative expenses increased $3.9 million, or 12.0%, for the fiscal 2005period as compared to the fiscal 2004 period. The increase is attributable to the same factors discussed in the fiscalquarter results above, as well as to higher average exchange rates used totranslate international local currency expenses into U.S. dollars.

 

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For the 24 week period offiscal 2005 as compared to the fiscal 2004 period, depreciation expense and netinterest expense each decreased $0.2 million. The provision for income taxes, which is primarily attributable to theCompany’s international operations, was $0.2 million in each of the fiscal 2005and 2004 periods.

 

**Liquidityand Capital Resources**

 

The Company requiressignificant amounts of working capital to operate its business and to pay expensesrelating to employment of temporary employees. The Company’s traditional use ofcash is for financing of accounts receivable, particularly during periods ofeconomic upswings and growth and during periods where sales are seasonallyhigh. Temporary personnel are generally paid on a weekly basis while paymentsfrom customers are generally received 30 to 60 days after billing.

 

The Company finances itsoperations primarily through cash generated by its operating activities andborrowings under its revolving credit facilities. Net cash provided byoperating activities was $3.4 million for the 24 weeks ended April 16,2005 compared to $1.2  million for the 24weeks ended April 17, 2004.  Netincome for the fiscal 2005 period, and increased collections on accountsreceivable as compared to the prior year period, were substantially offset bycash payments of $9.4 million as collateral for the Company’s 2005 workers’compensation obligations (see further discussion below), and decreases inaccounts payable and accrued expenses.

 

Cash used for capitalexpenditures, which are primarily for business process management (BPM) systeminitiatives, other software, computers and peripherals, and office furnitureand equipment, totaled $2.7 million for the 24 weeks ended April 16, 2005as compared to $0.8 million for the same period in fiscal 2004. The increase incapital expenditures during fiscal 2005 is primarily due to work in process onthe implementation of a new BPM system that the Company began in late fiscal2004.  The Company currently anticipatescapital expenditures will be approximately $6.0 million for the fiscal 2005year.

 

From time to time, theCompany has generated cash through sales of Company-owned offices to franchiseowners or sales of franchise agent and license offices back to the franchiseagent or license owner.  During the firstquarter of fiscal 2005, the Company sold one of its franchise operations backto the franchise agent for cash proceeds of $1.0 million.  The Company secured the franchise agents’note payable obligation to the bank that funded the purchase through a $1.0million letter of credit that will decline as the note obligation is paid bythe franchise agent.  The $1.0 milliongain on the sale of the franchise operations has been deferred, and will berecognized as the note obligation payments are made.

 

In February 2004,the Company sold its remaining unoccupied corporate headquarters’ for cashproceeds of $1.9 million.  The $0.7million gain on the sale is included in selling and administrative expenses forthe 24 week period ended April 17, 2004.

 

In May 2002, the Company entered into agreements with GE Capital,as primary agent, to provide senior secured credit facilities totaling $65.0million, expiring in May 2007.  Thefacilities comprise a five-year syndicated Multicurrency Credit Agreementconsisting of a $50.0 million US Revolving Loan Commitment, a £2.7 million UKRevolving Loan Commitment (US dollar equivalent of approximately $4.0 millionat the date of the agreement), and a $5.0 million term loan (the Term Loan),which was repaid during fiscal 2003.  Inaddition, a five-year Australian dollar facility agreement (the A$ FacilityAgreement) was executed on May 16, 2002, consisting of an A$12.0 millionrevolving credit facility (US dollar equivalent of approximately $6.0 millionat the date of the agreement).  Eachagreement includes a 

 

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letter of credit sub-facility. Letters of credit under the agreements expire one year from date ofissuance but are automatically renewed for one additional year unless writtennotice is given to or from the holder.

 

The credit facilities are secured by substantially all of the assets ofthe Company. GE Capital, in its role as primary agent under the creditfacilities, has sole dominion and control over the Company’s primary U.S.,United Kingdom and Australia cash receipts accounts.  Cash receipts into these accounts are appliedagainst the Company’s respective outstanding obligations under the facilities,with additional borrowings under the revolving facilities directed into theCompany’s disbursement accounts.

 

On January 5, 2005, a sixth amendment to theMulticurrency Credit Agreement was executed. The amendment, among other things, allows a $1.4 million add-backadjustment to the rolling 13-period earnings before interest, taxes,depreciation and amortization (EBITDA) covenant at October 30, 2004 foradditional workers’ compensation charges the Company incurred during the fourthquarter of fiscal 2004 relating to adverse loss development on historicalclaims.  The add-back will assist theCompany in maintaining its minimum EBITDA and fixed charge covenants throughoutfiscal 2005.

 

As of April 16,2005, the Company had $10.4 million outstanding under its credit facilitieswith available borrowing capacity of $19.7 million consisting of $10.1 millionfor the U.S. operations, $3.7 million for the U.K. operations and $5.9 millionfor the Australia operations.

 

The Company has anunsecured subordinated promissory note payable to its principal stockholder andChairman of the Board of Directors in the amount of $2.0 million with amaturity date of August 18, 2007, and an interest rate equal to an indexedrate as calculated under the Company’s credit facilities plus seven percent,compounded monthly and payable 60 calendar days after the end of each of theCompany’s fiscal quarters.  The interestrate in effect on April 16, 2005 was 12.75%.  Payment of interest is contingent on theCompany meeting minimum availability requirements under its creditfacilities.  Additionally, payments ofprincipal or interest are prohibited in the event of any default under thecredit facilities.

 

On September 25, 2003 the Company executed a one-year unsecuredsubordinated draw down note with its principal stockholder and Chairman of theBoard of Directors.  The note providedfor the Chairman to make advances to the Company upon request, at his solediscretion and with no obligation to do so, in an aggregate principal amountnot to exceed $1.0 million outstanding at any one time.  On December 23, 2003 the Chairman made a$1.0 million advance to the Company under the terms of the note. The advanceplus accrued interest was repaid on August 3, 2004.

 

The Company works to balance its worldwide cash needsthrough dividends from and loans to its international subsidiaries.  These loans and dividends are limited by theimmediate future cash availability and needs of each respective subsidiary,restrictions imposed by the Company’s senior secured debt facilities and, insome cases, statutory regulations of the subsidiary.  The US operations cannot directly draw on theexcess borrowing availability of the UK or Australian operations; however, theCompany may request dividends from the UK. The US can also request repayments on intercompany balances due from itsinternational subsidiaries, subject to their cash flow needs and regulatoryrestrictions.  As a result of positiveoperating performance in Australia in fiscal 2003 and fiscal 2004,  during the second quarter of fiscal 2005 theCompany’s Australian lender substantially reduced restrictions on repayments ofits intercompany balances.

 

The Company isresponsible for and pays workers’ compensation costs for its temporary andregular employees and is self-insured for the deductible amount related toworkers’ compensation claims ($500,000 per claim for fiscal 2005 and $750,000per claim for fiscal 2004.)  Each policyyear the terms of the 

 

16

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agreement with theinsurance carrier are renegotiated.  Theinsurance carrier requires the Company to collateralize its obligations throughthe use of irrevocable standby letters of credit, surety bonds or cash.  At April 16, 2005 the Company had $22.4million of outstanding letters of credit and a $3.8 million surety bondsecuring its domestic workers compensation obligations for policy years 2004and earlier.  Effective April 20,2005, the insurance carrier reduced its collateral requirements for the Companythrough the cancellation of the $3.8 million surety bond.

 

Under the terms of its2005 policy year agreement, the Company will make cash payments totaling $20.6million to be paid in monthly installments, which commenced on November 1,2004 in the amounts of $2.7 million for the first three installments and $1.4million for the remaining nine installments. Of these payments, $15.8 million will serve to cash collateralize theCompany’s fiscal 2005 obligations in lieu of issuance of additional letters ofcredit.  Cash payments for 2005 policyyear claims will be paid out of this cash collateral fund.  The Company will also make ongoing cashpayments for claims for all other open policy years except 2003, which wasfully funded although subject to annual retroactive premium adjustments basedon actual claims activity.

 

During the fourth quarterof fiscal 2004, the Company received an unfavorable arbitration ruling relatingto a contract dispute with one of its vendors. Total costs associated with the claim, including the arbitration awardplus related attorneys’ fees were $1.1 million. Payments of $0.9 million for the award plus remaining related attorneys’fees were paid during the first quarter of fiscal 2005.

 

During the first quarterof fiscal 2005, the Company received $0.5 million of domestic federal incometax refunds relating to carryback provisions.

 

The Company has a stockoption/stock issuance plan that provides for the granting of stock options,awards and appreciation rights to certain key employees at the discretion ofits Board of Directors.   The Companyalso has an employee stock purchase plan whereby eligible employees mayauthorize payroll deductions for semi-annual purchases of the Company’s stockat a discount.  During the 24 weeks endedApril 16, 2005,  cash proceeds of$0.6 million were received for purchases of 271,618 shares of the Company’scommon stock under these plans.

 

The Company believes thatthe current borrowing capacity provided under its credit facilities, togetherwith cash generated through operations, will be sufficient to meet the Company’sworking capital needs for the foreseeable future.

 

**Item 3.  Quantitative and Qualitative DisclosuresAbout Market Risk**

 

TheCompany is exposed to certain market risks from transactions that are enteredinto during the normal course of business. The Company’s primary market risk exposure relates to interest raterisk.  At April 16, 2005, theCompany’s outstanding debt under variable-rate interest borrowings wasapproximately $12.4 million.  A change of2% in the interest rates would cause a change in interest expense ofapproximately $0.2 million on an annual basis. The Company’s exposure to market risk for changes in interest rates isnot significant with respect to interest income, as its investment portfolio isnot material to its consolidated balance sheet. The Company currently has no plans to hold an investment portfolio thatincludes derivative financial instruments.

 

For the 24 weeks ended April 16,2005, the Company’s international operations comprised 25.6% of its revenueand, as of the end of that period, 25.8% of its total assets.  The Company is exposed to foreign currencyrisk primarily due to its investments in foreign subsidiaries.  The Company’s multicurrency 

 

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credit facility, whichallows the Company’s Australia and United Kingdom subsidiaries to borrow inlocal currencies, partially mitigates the exchange rate risk resulting fromfluctuations in foreign currency denominated net investments in thesesubsidiaries in relation to the U.S. dollar. The Company does not currently hold any market risk sensitiveinstruments entered into for hedging transaction risks related to foreigncurrencies.  In addition, the Company hasnot entered into any transactions with derivative financial instruments fortrading purposes.

 

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

### ** **

The Company carried out an evaluation, under the supervisionand with the participation of the Company’s management, including the ChiefExecutive Officer and Chief Financial Officer, of the effectiveness of thedesign and operations of the Company’s “disclosure controls and procedures” (asdefined under Rules 13a-15(e) and 15d-15(e) under the SecuritiesExchange Act of 1934, as amended).  Basedon this evaluation, the Chief Executive Officer and Chief Financial Officerconcluded that, as of April 16, 2005 (the end of the period covered bythis report) the Company’s disclosure controls and procedures are effective intimely alerting them to material information required to be included in thisreport.  There was no change in theCompany’s internal control over financial reporting that occurred during thefiscal period ended April 16, 2005, that has materially affected, or is reasonablylikely to materially affect, the Company’s internal controls over financialreporting.

 

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### **Item 1.  LegalProceedings**

### ** **

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

 

### **Item 2.  UnregisteredSales of Equity Securities and Use of Proceeds**

### ** **

None.

 

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

### ** **

Notapplicable.

 

### **Item 4. Submission of Matters to a Vote of Security Holders**

### ** **

None.

 

### **Item 5.  OtherInformation**

### ** **

Noevents.

 

**Item 6. Exhibits**

 

Set forthbelow is a list of the exhibits included as part of this Quarterly Report:

 
| 10.3.9.4 |   | Notices of Grant  of Stock Option dated April 7, 2005 (replaces Exhibit 10.3.9.3)                                                                                 |
|----------|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 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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**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.                                     |              |
|------------------------|---------------------------------------------------|-------------------|
|                   |                                              |              |
|                   |                                              |              |
| May 31, 2005 |                                              |              | /s/ Dirk A. Sodestrom |   |   |
| Date                   |                                              | Dirk A. Sodestrom |   |
|                   | Senior Vice President and Chief Financial Officer |              |
|                        |                                                   |                   |  |  |  |

 

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