**UNITEDSTATESSECURITIES AND EXCHANGE COMMISSIONWashington, D. C.  20549**

#### ** **

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

 

| **(MARK  ONE)** |
|-----------------|
|            |   |   |
| **ý**      |   | **QUARTERLY REPORT PURSUANT TO  SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934.** |
|            |   |   |
|            |   | **For the quarterly period ended****January  25, 2003** |
|            |   |   |
| **o**           |   | **TRANSITION REPORT PURSUANT TO  SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934** |
|            |   |   |
|            |   | **For the transition period from                  to                ** |

 

**Commissionfile 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 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  ý    No  o

 

Indicate by check markwhether the registrant is an accelerated filer (as defined in Rule 12b-2 of theExchange 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 March 11, 2003** |
|-------------------------------|--------|-----------------------------------|
|                          |   |                              |
| Common Stock,  $.01 par value |   | 15,995,375  shares                |

 

 

----

 

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

 

**INDEX**

 

 
| PART I.  FINANCIAL INFORMATION |
|-------------------------------------|
|                                |   |
| Item  1.                            | Financial  Statements (Unaudited) |
|                                |   |
|                                | Condensed  Consolidated Balance Sheets -  January 25, 2003 and November 2, 2002 |
|                                |   |
|                                | Condensed  Consolidated Statements of Operations -  12 weeks ended January 25, 2003 and January 26, 2002 |
|                                |   |
|                                | Condensed Consolidated  Statements of Cash Flows -  12 weeks ended January 25, 2003 and January 26, 2002 |
|                                |   |
|                                | Notes to Condensed  Consolidated Financial Statements |
|                                |   |
| Item 2.                             | Management’s Discussion and Analysis of  Financial Condition and Results of Operations |
|                                |   |
| Item 3.                             | Quantitative and Qualitative Disclosures About  Market Risk |
|                                |   |
| Item 4.                             | Controls and Procedures |
|                                |   |
| PART II.   OTHER INFORMATION   |
|                                |   |
| Item 1.                             | Legal  Proceedings |
|                                |   |
| Item  2.                            | Changes  in Securities |
|                                |   |
| Item 3.                             | Defaults upon Senior  Securities |
|                                |   |
| Item  4.                            | Submission  of Matters to a Vote of Security Holders |
|                                |   |
| Item 5.                             | Other  Information |
|                                |   |
| Item 6.                             | Exhibits and Reports  on Form 8-K |
|                                |   |
| SIGNATURES                          |
|                                |   |
| CERTIFICATIONS                      |

 

2

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**PART 1.  FINANCIAL INFORMATION**

 

**Item 1. Financial Statements**

 

**Westaff,Inc.**

** **

**CondensedConsolidated Balance Sheets (Unaudited)**

**(Inthousands except per share amounts)**

** **
|                                                                                                                                      |   | **January 25,  2003** |    | **November 2,  2002** |   |
|-------------------------------------------------------------------------------------------------------------------------------------------|--------|-----------------------|---------|-----------------------|--------|
| **ASSETS**                                                                                                                                |   |                  |    |                  |   |
| Current  assets:                                                                                                                          |   |                  |    |                  |   |
| Cash  and cash equivalents                                                                                                                |   | $                     | 4,401   |                  | $      | 5,484 |   |
| Trade  accounts receivable, less allowance for doubtful accounts of $1,242 and  $1,316                                                    |   | 61,876                |    | 70,861                |   |
| Income  taxes receivable                                                                                                                  |   | 5,227                 |    | 5,227                 |   |
| Prepaid  expenses                                                                                                                         |   | 5,452                 |    | 5,373                 |   |
| Other  current assets                                                                                                                     |   | 4,068                 |    | 4,500                 |   |
| Total  current assets                                                                                                                     |   | 81,024                |    | 91,445                |   |
|                                                                                                                                      |   |                  |    |                  |   |
| Property  and equipment, net                                                                                                              |   | 14,731                |    | 15,778                |   |
| Goodwill,  net                                                                                                                            |   | 12,131                |    | 12,034                |   |
| Other  long-term assets                                                                                                                   |   | 2,717                 |    | 2,698                 |   |
| Total  Assets                                                                                                                             |   | $                     | 110,603 |                  | $      | 121,955 |   |
|                                                                                                                                      |   |                  |    |                  |   |
| **LIABILITIES AND STOCKHOLDERS’ EQUITY**                                                                                             |   |                  |    |                  |   |
| Current  liabilities:                                                                                                                     |   |                  |    |                  |   |
| Short-term  borrowings                                                                                                                    |   | $                     | 4,593   |                  | $      | 9,667 |   |
| Current  portion of long-term debt and capital lease obligations                                                                          |   | 402                   |    | 4,500                 |   |
| Note  payable to related party                                                                                                            |   |                  |    | 1,000                 |   |
| Accounts  payable                                                                                                                         |   | 1,412                 |    | 2,657                 |   |
| Accrued  expenses                                                                                                                         |   | 32,810                |    | 38,165                |   |
| Income  taxes payable                                                                                                                     |   | 526                   |    | 779                   |   |
| Net  liabilities of discontinued operations                                                                                               |   | 763                   |    | 605                   |   |
| Total  current liabilities                                                                                                                |   | 40,506                |    | 57,373                |   |
|                                                                                                                                      |   |                  |    |                  |   |
| Note  payable to related party                                                                                                            |   | 2,000                 |    | 2,000                 |   |
| Long-term  debt and capital lease obligations                                                                                             |   | 10,841                |    | 10,000                |   |
| Other  long-term liabilities                                                                                                              |   | 18,145                |    | 13,632                |   |
| Total  liabilities                                                                                                                        |   | 71,492                |    | 83,005                |   |
|                                                                                                                                      |   |                  |    |                  |   |
| 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:  15,972 shares at January 25, 2003 and November 2, 2002 |   | 160                   |    | 160                   |   |
| Additional  paid-in capital                                                                                                               |   | 36,627                |    | 36,627                |   |
| Retained  earnings                                                                                                                        |   | 4,332                 |    | 4,680                 |   |
| Accumulated  other comprehensive loss                                                                                                     |   | (2,008                | )       | (2,517                | )      |
| Total  stockholders’ equity                                                                                                          |   | 39,111                |    | 38,950                |   |
| Total  Liabilities and Stockholders’ Equity                                                                                          |   | $                     | 110,603 |                  | $      | 121,955 |   |

 

See accompanyingnotes to condensed consolidated financial statements.

 

3

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**Westaff,Inc.**

 

**CondensedConsolidated Statements of Operations(Unaudited)**

**(Inthousands except per share amounts)**

 
|                                                     |   | **12 Weeks  Ended**    |    |
|----------------------------------------------------------|--------|------------------------|---------|
|                                                     |   | **January  25,  2003** |    | **January  26,  2002** |   |
|                                                     |   |                   |    |   |   |
| Revenues                                                 |   | $                      | 117,834 |   | $ | 106,993 |   |
|                                                     |   |                   |    |   |   |
| Costs  of services                                       |   | 97,463                 |    | 86,990 |   |
|                                                     |   |                   |    |   |   |
| Gross  profit                                            |   | 20,371                 |    | 20,003 |   |
|                                                     |   |                   |    |   |   |
| Franchise  agents’ share of gross profit            |   | 3,412                  |    | 3,130 |   |
| Selling  and administrative expenses                     |   | 15,888                 |    | 17,761 |   |
| Depreciation  and amortization                           |   | 1,281                  |    | 1,516 |   |
| Restructuring  charges                                   |   |                   |    | 1,896 |   |
|                                                     |   |                   |    |   |   |
| Operating  loss from continuing operations               |   | (210                   | )       | (4,300 | ) |
|                                                     |   |                   |    |   |   |
| Interest  expense                                        |   | 465                    |    | 467 |   |
| Interest  income                                         |   | (52                    | )       | (112 | ) |
|                                                     |   |                   |    |   |   |
| Loss  from continuing operations before income taxes     |   | (623                   | )       | (4,655 | ) |
| Provision  (benefit) for income taxes                    |   | 41                     |    | (2 | ) |
|                                                     |   |                   |    |   |   |
| Loss  from continuing operations                         |   | (664                   | )       | (4,653 | ) |
|                                                     |   |                   |    |   |   |
| Income  from discontinued operations                     |   | 316                    |    |   |   |
|                                                     |   |                   |    |   |   |
| Net  loss                                                |   | $                      | (348    | ) | $ | (4,653 | ) |
|                                                     |   |                   |    |   |   |
| Basic  and diluted earnings (loss) per share:            |   |                   |    |   |   |
|                                                     |   |                   |    |   |   |
| Continuing  operations:                                  |   | $                      | (0.04   | ) | $ | (0.29 | ) |
|                                                     |   |                   |    |   |   |
| Discontinued  operations:                                |   | $                      | 0.02    |   | $ | — |   |
|                                                     |   |                   |    |   |   |
| Net  loss                                                |   | $                      | (0.02   | ) | $ | (0.29 | ) |
|                                                     |   |                   |    |   |   |
| Weighted  average shares outstanding - basic and diluted |   | 15,972                 |    | 15,913 |   |

 

See accompanyingnotes to condensed consolidated financial statements.

 

 

4

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** **

**Westaff,Inc.**

** **

**CondensedConsolidated Statements of Cash Flows (Unaudited)**

**(Inthousands)**

 
|                                                                      |   | **12 Weeks Ended**    |   |
|---------------------------------------------------------------------------|--------|-----------------------|--------|
|                                                                      |   | **January 25,  2003** |   | **January 26,  2002** |   |
| **Cash flows from operating activities**                                  |   |                  |   |   |   |
| Net  loss                                                                 |   | $                     | (348   | ) | $ | (4,653 | ) |
| Adjustments  to reconcile net loss to net cash from operating activities: |   |                  |   |   |   |
| Income  from discontinued operations                                      |   | (316                  | )      |   |   |
| Restructuring  charges, net of payments                                   |   |                  |   | 1,589 |   |
| Depreciation  and amortization                                            |   | 1,281                 |   | 1,516 |   |
| Provision  for losses on doubtful accounts                                |   | (75                   | )      | 241 |   |
| (Gain)  loss on sale or disposal of assets                                |   | (4                    | )      | 45 |   |
| Other                                                                     |   | (97                   | )      |   |   |
| Changes  in assets and liabilities:                                       |   |                  |   |   |   |
| Trade  accounts receivable                                                |   | 10,335                |   | 13,344 |   |
| Other  assets                                                             |   | (79                   | )      | 981 |   |
| Accounts  payable and accrued expenses                                    |   | (8,283                | )      | (8,662 | ) |
| Income  taxes payable                                                     |   | (261                  | )      | (291 | ) |
| Other  liabilities                                                        |   | 7                     |   | 6 |   |
|                                                                      |   |                  |   |   |   |
| Net  cash provided by continuing operations                               |   | 2,160                 |   | 4,116 |   |
| Net  cash provided by discontinued operations                             |   | 475                   |   | 76 |   |
|                                                                      |   |                  |   |   |   |
| Net  cash provided by operating activities                                |   | 2,635                 |   | 4,192 |   |
|                                                                      |   |                  |   |   |   |
| **Cash flows from investing activities**                                  |   |                  |   |   |   |
| Capital  expenditures                                                     |   | (625                  | )      | (1,211 | ) |
| Proceeds  from sales of affiliate operations                              |   | 170                   |   | 160 |   |
| Proceeds  from sales of assets                                            |   | 7,386                 |   |   |   |
| Payments  for intangibles                                                 |   |                  |   | (223 | ) |
| Other,  net                                                               |   | (14                   | )      | 39 |   |
|                                                                      |   |                  |   |   |   |
| Net  cash provided by (used in) investing activities                      |   | 6,917                 |   | (1,235 | ) |
|                                                                      |   |                  |   |   |   |
| **Cash flows from financing activities**                                  |   |                  |   |   |   |
| Net  repayments under line of credit agreements                           |   | (5,211                | )      |   |   |
| Principal  payments on long-term debt                                     |   | (4,500                | )      |   |   |
| Payment  of note payable to related party                                 |   | (1,000                | )      |   |   |
| Repurchase  of common stock                                               |   |                  |   | (7 | ) |
|                                                                      |   |                  |   |   |   |
| Net  cash used in financing activities                                    |   | (10,711               | )      | (7 | ) |
|                                                                      |   |                  |   |   |   |
| Effect  of exchange rate changes on cash                                  |   | 76                    |   | (136 | ) |
|                                                                      |   |                  |   |   |   |
| Net  change in cash and cash equivalents                                  |   | (1,083                | )      | 2,814 |   |
| Cash  and cash equivalents at beginning of period                         |   | 5,484                 |   | 6,443 |   |
| Cash  and cash equivalents at end of period                               |   | $                     | 4,401  |   | $ | 9,257 |   |

 

See accompanyingnotes to condensed consolidated financial statements.

 

5

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**Westaff,Inc.**

** **

**Notesto Condensed Consolidated FinancialStatements (Unaudited)**

**(Inthousands except per share amounts)**

 

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

 

The accompanyingcondensed consolidated financial statements of Westaff, Inc. and its domesticand foreign subsidiaries (together, the Company), as of and for the 12 weekperiods ended January 25, 2003 and January 26, 2002 are unaudited. Intercompanyaccounts and transactions have been eliminated.

 

The condensedconsolidated financial statements, in the opinion of management, reflect alladjustments, which are of a normal recurring nature, necessary for a fairpresentation of the financial position, results of operations and cash flowsfor the periods presented.  Thecondensed consolidated balance sheet at November 2, 2002, presented herein, hasbeen derived from the audited balance sheet included in the Company’s AnnualReport on Form 10-K for the fiscal year ended November 2, 2002.

 

Certain financialinformation which is normally included in annual financial statements preparedin accordance with accounting principles generally accepted in the UnitedStates, but which is not required for interim reporting purposes, has beencondensed or omitted.  The accompanyingcondensed consolidated financial statements should be read in conjunction withthe financial statements and notes thereto included in the Company’s AnnualReport on Form 10-K for the fiscal year ended November 2, 2002.

 

The Company’sfiscal year is a 52 or 53 week period ending the Saturday nearest the end ofOctober.  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 week period ended January25, 2003 are not necessarily indicative of the results to be expected for thefull fiscal year or for any future period.

 

During fiscal year1999, the Company sold its medical business, primarily operated through WesternMedical Services, Inc. (Western Medical), a wholly-owned subsidiary of theCompany (see Note 3).  As a result, theCompany has classified its medical operations as discontinued in thesecondensed consolidated financial statements and notes thereto.

 

The Company hasreclassified certain amounts in the January 26, 2002 financial statements inorder to conform to the presentation adopted for the period ended January 25,2003.

 

**2.****                    Goodwill**

 

Effective November3, 2002, the Company adopted Statement of Financial Accounting Standards (SFAS)No. 142 “Goodwill and Other Intangible Assets”.  SFAS No. 142 provides that goodwill and other intangible assetswith indefinite lives are no longer amortized, but rather are evaluated forimpairment by applying a fair-value based test.  Under the transitional provisions of SFAS No. 142, the first stepis to identify if a potential impairment exists.  This step must be measured as of the beginning of the fiscal yearin which the statement is adopted; however, the Company has six months fromthat date to

 

6

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complete thisfirst step.  The second step of thegoodwill impairment test measures the amount of the impairment loss, ifany.  This step must be completed assoon as possible, but no later than the end of the Company’s fiscal year2003.  Any impairment loss identified inthe year of adoption is to be recognized in the first interim period of theyear as a cumulative effect of a change in accounting principle.  Any impairment loss incurred subsequent tothe initial adoption of SFAS No. 142 is recorded as a charge to current periodearnings.

 

The Company is currentlyevaluating, but has not yet determined, if potential impairment exists atNovember 3, 2002. It is possible that impairment could be recorded based on theCompany’s adoption of the fair-value approach under the new standard.

 

The following tablepresents pro-forma reconciliations of loss per share as if the provisions ofSFAS No. 142 had been applied to all periods presented:

 
|                                                         |   | **12 Weeks Ended**    |       |
|--------------------------------------------------------------|--------|-----------------------|------------|
|                                                         |   | **January 25,  2003** |       | **January 26,  2002** |   |
|                                                         |   |                  | ** ** |   | ** ** |
| Reported  net loss                                           |   | $                     | (348       | ) | $ | (4,653 | ) |
| Goodwill  amortization                                       |   |                  |       | 173 |   |
| Adjusted  net loss                                           |   | $                     | (348       | ) | $ | (4,480 | ) |
|                                                         |   |                  |       |   |   |
| Basic  and diluted loss per share from continuing operations |   | $                     | (0.04      | ) | $ | (0.29 | ) |
| Goodwill  amortization                                       |   |                  |       | 0.01 |   |
| Adjusted  loss per share from continuing operations          |   | $                     | (0.04      | ) | $ | (0.28 | ) |

 

**3.****                   ****Discontinued Operations**

 

During fiscal 1999, theCompany sold certain of its franchise agent and Company-owned medical officesand entered into a termination agreement with one of its medical licensees.During the fourth quarter of fiscal 1999, the Company completed the sale of theremaining medical business to Intrepid U.S.A. Inc. (Intrepid) under an assetpurchase agreement. Under the terms of the sale, the Company retained themajority of accounts receivable, including trade and Medicare accountsreceivable balances.

 

Prior to fiscal2003,  the Company appealed WesternMedical’s 1996 Medicare cost reports settlements.  During the first quarter of fiscal 2003, the appeal was settledand Western Medical received additional cost reimbursements.  As a result of the favorable appealsettlement, the Company has recognized $316 of income from discontinuedoperations in the fiscal quarter ended January 25, 2003.

 

7

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As of January 25, 2003,the remaining current liabilities of the discontinued medical operations arefor pending legal claims of $350, malpractice/liability claims of  $373, consultant’s fees of $86 and othercosts of $2.

 
|                                        |   | **January 25,  2003** |       | **November 2,  2002** |       |
|---------------------------------------------|--------|-----------------------|------------|-----------------------|------------|
|                                        |   |                  | ** ** |                  | ** ** |
| Current  assets (primarily receivables)     |   | $                     | 48         |                  | $          | 130 |   |
| Current  liabilities                        |   | (811                  | )          | (735                  | )          |
| Net  liabilities of discontinued operations |   | $                     | (763       | )                     | $          | (605 | ) |

 

**4.****                    RestructuringCharges**

 

During fiscal 2002, theCompany implemented a restructuring plan designed to improve the Company’sprofitability.  The restructuring planresulted in a fiscal 2002 pre-tax charge to operations of $1,896. Of this amount,$993 was the result of abandoning front and back office management informationsystems that were under development with two software vendors.  One of these vendors chose to cease furtherdevelopment of its portion of the project and that caused the continued developmentof these systems to no longer be cost-effective for the Company.  In conjunction with this abandonment, theCompany recognized the historical fees paid to vendors, fees paid toconsultants and certain in-house development costs as expenses, all of whichhad been previously capitalized. An additional $629 resulted from severance andother employment termination costs due to planned personnel reductions.  Finally, as of the date the restructuringplan was finalized, the Company decided to close 18 offices within the UnitedStates and the resulting termination costs, including lease terminations, wereestimated to be $274.  At January 25,2003, only lease obligations of $26 remain unpaid.

 

 

8

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**5.****                   ****Loss Per Share**

 

Thefollowing table sets forth the computation of basic and diluted loss per share:
|                                                                                                    |   | **12 Weeks Ended**    |   |
|---------------------------------------------------------------------------------------------------------|--------|-----------------------|--------|
|                                                                                                    |   | **January 25,  2003** |   | **January 26,  2002** |   |
|                                                                                                    |   |                  |   |   |   |
| Loss  from continuing operations                                                                        |   | $                     | (664   | ) | $ | (4,653 | ) |
|                                                                                                    |   |                  |   |   |   |
| Denominator  for basic earnings per share - weighted average shares                                     |   | 15,972                |   | 15,913 |   |
|                                                                                                    |   |                  |   |   |   |
| Effect  of dilutive securities:                                                                         |   |                  |   |   |   |
| Stock  options                                                                                          |   | —                |   | — |   |
| Denominator  for diluted earnings per share - adjusted weighted average shares and assumed  conversions |   | 15,972                |   | 15,913 |   |
|                                                                                                    |   |                  |   |   |   |
| Basic  and diluted loss per share from continuing operations                                            |   | $                     | (0.04  | ) | $ | (0.29 | ) |
|                                                                                                    |   |                  |   |   |   |
| Anti-dilutive  weighted shares excluded from diluted loss per share                                     |   | 1,100                 |   | 253 |   |

 

**6.****                    ComprehensiveIncome**

 

Comprehensiveincome (loss) consists of the following:

 
|                              |   | **12 Weeks Ended**    |       |
|-----------------------------------|--------|-----------------------|------------|
|                              |   | **January 25,  2003** |       | **January 26,  2002** |   |
|                              |   |                  | ** ** |   | ** ** |
| Net  loss                         |   | $                     | (348       | ) | $ | (4,653 | ) |
| Currency  translation adjustments |   | 509                   |       | (182 | ) |
| Comprehensive  income (loss)      |   | $                     | 161        |   | $ | (4,835 | ) |

 

**7.****                    LeaseTransactions**

 

On December 12, 2002, theCompany entered into a sale-leaseback transaction whereby the Company sold andleased back its administrative offices’ land and buildings.  The result of the sale was a net pre-taxgain of approximately $5,500 which the Company deferred and is amortizing as anoffset to rent expense over the seven year lease term.  A portion of the net proceeds from the saleof $6,866 were used to repay the outstanding principal and interest under aterm loan of $4,515.  Additionally, theCompany paid the outstanding principal and interest of $1,020 under theprovisions of a promissory note payable to the Company’s President and CEO (seeNote 8).  The remainder of the netproceeds were used to repay outstanding borrowings under the Company’s revolvingcredit facilities.

 

The lease, which is beingaccounted for as an operating lease, has a term of seven years with an optionto renew the lease for an additional five years.  In connection with the lease agreement, the Company issued a $700irrevocable standby letter of credit as a security deposit.  The minimum lease payments required by thelease over the next seven years are as

 

9

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follows:  fiscal 2003 - $691; fiscal 2004 - $799;fiscal 2005 - $825; fiscal 2006 - $852; fiscal 2007 - $879; fiscal 2008 - $908;fiscal 2009 - $938 and fiscal 2010 - $103.

 

In December 2002, theCompany entered into a lease transaction for certain information technologyequipment.  This lease, which has a termof 37 months, is being accounted for as a capital lease. As a part of thislease transaction, the Company sold equipment which was then leased back.  Net proceeds of $413 on the sale were usedto pay down additional outstanding borrowings under the Company’s domesticrevolving credit facility. The capital asset and related lease obligationincluded in property and equipment and capital lease obligations are asfollows:

 
|                                              |   | **January 25,  2003** |   |
|---------------------------------------------------|--------|-----------------------|--------|
|                                              |   |                  |   |
| Capital  lease equipment                          |   | $                     | 1,243  |   |
| Less  accumulated amortization                    |   | (27                   | )      |
| Net  capital lease equipment                      |   | $                     | 1,216  |   |
| Minimum  lease payments:                          |   |                  |   |
| Fiscal  2003                                      |   | $                     | 455    |   |
| Fiscal  2004                                      |   | 455                   |   |
| Fiscal  2005                                      |   | 496                   |   |
| Fiscal  2006                                      |   | 124                   |   |
| Total  minimum lease payments                     |   | 1,530                 |   |
| Less  executory costs                             |   | (133                  | )      |
| Net  minimum capital lease payments               |   | 1,397                 |   |
| Less  amount representing interest                |   | (154                  | )      |
| Present  value of net minimum lease payments      |   | 1,243                 |   |
| Less  current portion of capital lease obligation |   | (402                  | )      |
| Long-term  capital lease obligation               |   | $                     | 841    |   |

 

Capital leaseamortization expense of $27 is included in depreciation and amortization in theJanuary 25, 2003 Statement of Operations.

 

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

 

The Company has anunsecured subordinated promissory note payable to its principal stockholder andChairman of the Board of Directors in the amount of $2,000 with a maturity dateof August 18, 2007 and an interest rate equal to an indexed rate as calculatedunder the Company’s credit facilities plus seven percent, compounded monthlyand payable 60 calendar days after the end of each of the Company’s fiscalquarters.  The interest rate in effecton January 25, 2003 was 11.75%.  Paymentof interest is contingent on the Company meeting minimum availabilityrequirements under its credit facilities. Additionally, payments

 

10

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of principal or interestare prohibited in the event of any default under the credit facilities.  Interest paid on this note was $73 duringthe first quarter of fiscal 2003.

 

In May 2002, the Companyexecuted an unsecured subordinated promissory note payable to its President andChief Executive Officer in the amount of $1,000 with a maturity date of August18, 2007 and provisions for accelerated maturity under certaincircumstances.  The accelerated maturityprovisions were met in conjunction with the Company’s December 12, 2002sale-leaseback transaction (see Note 7) and on December 13, 2002 theoutstanding principal and interest balance on the note of $1,020 was paid inits entirety.

 

**9.****                    OperatingSegments**

 

The following tablesummarizes reporting segment data :

 
|                                                |   | **Domestic  Business Svcs** |   | **United  Kingdom  Operations** |   | **Other  International** |   | **Continuing  Operations** |   |
|-----------------------------------------------------|--------|-----------------------------|--------|---------------------------------|--------|--------------------------|--------|----------------------------|--------|
|                                                |   |                        |   |                            |   |                     |   |                       |   |
| **12 Weeks Ended January 25, 2003**                 |   |                        |   |                            |   |                     |   |                       |   |
|                                                |   |                        |   |                            |   |                     |   |                       |   |
| Revenues                                            |   | $                           | 96,495 |                            | $      | 6,480                    |   | $                          | 14,859 |   | $ | 117,834 |   |
| Operating  income (loss) from continuing operations |   | $                           | (98    | )                               | $      | 104                      |   | $                          | (216   | ) | $ | (210 | ) |
|                                                |   |                        |   |                            |   |                     |   |                       |   |
| **12 Weeks Ended January 26, 2002**                 |   |                        |   |                            |   |                     |   |                       |   |
|                                                |   |                        |   |                            |   |                     |   |                       |   |
| Revenues                                            |   | $                           | 88,011 |                            | $      | 5,660                    |   | $                          | 13,322 |   | $ | 106,993 |   |
| Operating  loss from continuing operations          |   | $                           | (3,882 | )                               | $      | (131                     | )      | $                          | (287   | ) | $ | (4,300 | ) |

 

**10.****             Commitments and Contingencies**

 

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

 

On March 9, 2000, SynergyStaffing, Inc. (Synergy) filed a complaint against the Company alleging, amongother things, that they were fraudulently induced to sell the assets of ThePersonnel Connection, Inc.  During theCompany’s fiscal year 2002, an arbitration panel awarded Synergy $1,424 forcompensatory damages, attorneys’ fees and other related costs.  During the fourth quarter of fiscal 2001,the Company recorded an accrued liability and related pretax charge of $3,600for the estimated cost of the arbitration award, attorney’s fees and relatedexpenses.  The estimate was based onmanagement’s assumptions as to the ultimate outcome of future eventssurrounding the arbitration.  Inconnection with the final outcome of the arbitration award in fiscal 2002, someof these events were resolved in the Company’s favor and $693 of the estimatedliabilities were no longer required. This reduction was included in the second quarter of fiscal 2002Statement of Operations.

 

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From time to time theCompany has been threatened with, or named as a defendant in, lawsuits,including countersuits brought by former franchise agents or licensees, andadministrative claims and lawsuits brought by employees or formeremployees.  The Company does not believethe outcome of any proceedings on these actions would have a material adverseeffect on its financial position, results of operations or cash flows.  The Company is not currently a party to anymaterial litigation, except as disclosed above.

 

**11.****             RecentAccounting Pronouncements**

 

Effective November 3,2002, the Company adopted SFAS No. 144, “Accounting for the Impairment orDisposal of Long-Lived Assets”.  The newstandard supercedes SFAS No. 121, “Accounting for the Impairment of Long-LivedAssets and for Long-Lived Assets to be Disposed of”.  The new standard also supercedes the provisions of AccountingPrinciples Board No. 30, “Reporting the Results of Operations – Reporting theEffects of Disposal of a Segment of a Business, and Extraordinary, Unusual andInfrequently Occurring Events and Transactions” and will require expectedfuture operating losses from discontinued operations to be displayed indiscontinued operations in the period(s) in which the losses are incurred,rather than as of the measurement date as presently required.  Adoption of the new standard did not have amaterial impact on the Company’s financial statements.

 

Effective January 1,2003, the Company adopted SFAS No. 146, “Accounting for Costs Associated withExit or Disposal Activities.”  SFAS No.146 addresses financial accounting and reporting for costs associated with exitor disposal activities and nullifies EITF Issue No. 94-3, “LiabilityRecognition for Certain Employee Termination Benefits and Other Costs to Exitan Activity (including Certain Costs Incurred in a Restructuring).”  SFAS No. 146 requires recognition of aliability for a cost associated with an exit or disposal activity when theliability is incurred, as opposed to when the entity commits to an exit planwhich was a requirement under EITF Issue No. 94-3.  Adoption of the new standard did not have a material impact onthe Company’s financial statements.

 

In December 2002, theFASB issued SFAS No. 148 “Accounting for Stock-Based Compensation – Transitionand Disclosure - an amendment to FASB Statement No. 123”.  SFAS No. 148 provides alternative methods oftransition for a voluntary change to the fair value based method of accountingfor stock-based employee compensation. In addition, SFAS No. 148 amends the disclosure requirements of SFAS No.123 to require prominent disclosures in both annual and interim financialstatements about the method of accounting for stock-based employee compensationand the effect of the method used on reported results.  SFAS No. 148 is effective for fiscal yearsending after December 15, 2002 for transition guidance and annual disclosureprovisions and for financial reports containing financial statements forinterim periods beginning after December 15, 2002 for interim disclosureprovisions.  As permitted by SFAS No. 148and SFAS No. 123, the Company continues to account for stock-based employeecompensation under the intrinsic value based method and

 

12

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will adopt the disclosurerequirements of SFAS No. 148 in its interim report for the second fiscalquarter of 2003.

 

**12.****             SubsequentEvent**

 

In February 2003 theCompany received approximately $4,715 in federal income tax refunds arisingfrom a net operating loss carryback in a prior year.  These refunds will reduce the income taxes receivable of  $5,227 shown on the Company’s January 25,2003 balance sheet and were used to pay down outstanding borrowings under theCompany’s revolving credit facility.

 

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**Item2****.  Management’sDiscussion and Analysis of Financial Condition and Results of Operations**

 

Thefollowing discussion is intended to assist in the understanding and assessmentof significant changes and trends related to the results of operations andfinancial condition of Westaff, Inc., together with its consolidatedsubsidiaries. This discussion and analysis should be read in conjunction withthe Company’s unaudited Condensed Consolidated Financial Statements and Notesthereto included herein, and with the Consolidated Financial Statements andNotes thereto included in the Company’s Annual Report on Form 10-K for thefiscal year ended November 2, 2002.

 

Inaddition to historical information, this discussion and analysis includescertain forward–looking statements regarding events and financial trendsthat may affect the Company’s future operating results and financial position.This notice is intended to take advantage of the “safe harbor” provided by thePrivate Securities Litigation Reform Act of 1995 with respect to suchforward-looking statements. These forward-looking statements include, but arenot limited to, statements regarding credit facilities, liquidity andfinancing, sales, long-lived asset impairment, gross margin, workers’compensation costs, selling and administrative expenses, interest expense, incometaxes, capital expenditures, capital resources, medical operations andacquisitions. Readers are cautioned not to place undue reliance on theseforward–looking statements, which are made based on information availableas of the date hereof; actual results may differ materially. The Companyundertakes no obligation to publicly release the results of any revisions tothese forward–looking statements to reflect events or circumstances afterthe date hereof or to reflect the occurrence of unanticipated events, except asrequired by applicable laws and regulations.

 

Theforward-looking statements included herein are also subject to a number ofother risks and uncertainties that could cause the Company’s actual results andfinancial position to differ materially from those anticipated in the forward–lookingstatements. Such risks and uncertainties include, but are not limited to:compliance with debt covenants, liquidity, possible adverse effects offluctuations in the general economy, reliance on executive management,uncertain ability to continue and manage growth, control by a significantshareholder, reliance on management information systems, risk related tointernational operations, variability of employee-related costs includingworkers’ compensation liabilities, risks related to customers, variability ofoperating results and the seasonality of the business cycle, ability to attractand retain the services of qualified temporary personnel, a highly competitivemarket, reliance on field management, employer liability risks and risksrelated to franchise agent and licensed operations.  Due to the foregoing factors, it is possible that in some futureperiod the Company’s results of operations may be below the expectations ofpublic market analysts and investors. In addition, the Company’s results of operations have historically beensubject to quarterly and seasonal fluctuations.  These and other risks and uncertainties related to the Company’sbusiness are described in detail in  Item1, “Factors Affecting Future Operating Results.” in the Company’s AnnualReport on Form 10-K for the fiscal year ended November 2, 2002.

 

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### **Recent Developments**

 

In December 2002 theCompany completed a sale and leaseback of the buildings which house itsadministrative offices, which provided $6.9 million of cash.  All of these proceeds were used to repayoutstanding borrowings.

 

On November 1, 2002, theCompany executed an agreement with its workers’ compensation/general liabilityinsurance carrier for the fiscal 2003 policy year.  Under the terms of the new agreement, over the fiscal 2003 yearthe Company will pay $16.0 million to the carrier for the current estimatedultimate cost of the policy year’s claims and related expenses.

 

 See “Liquidity and Capital Resources” forfurther information on these recent developments.

 

**Goodwill**

 

Effective November 3,2002 the Company adopted Statement of Financial Accounting Standards (SFAS) No.142 “Goodwill and Other Intangible Assets”. SFAS No. 142 provides that goodwill and other intangible assets withindefinites lives are no longer amortized, but rather are evaluated forimpairment by applying a fair-value based test. Under the transitionalprovisions of SFAS No. 142, the first step is to identify if a potentialimpairment exists.  This step must bemeasured as of the beginning of the fiscal year in which the statement isadopted; however, the Company has six months from that date to complete thisfirst step.  The second step of the goodwillimpairment test measures the amount of the impairment loss, if any.  This step must be completed as soon aspossible, but no later than the end of the Company’s fiscal year 2003.  Any impairment loss identified in the yearof adoption is to be recognized in the first interim period of the year as acumulative effect of a change in accounting principle.  Any impairment loss incurred  subsequent to the initial adoption of SFASNo. 142 is recorded as a charge to current period earnings.

 

The Company is currentlyevaluating, but has not yet determined, if potential impairment exists atNovember 3, 2002. It is possible that impairment could be recorded based on theCompany’s adoption of the fair-value approach under the new standard.

 

### **Critical Accounting Policies**

 

The preparation of the Company’s financial statementsin conformity with generally accepted accounting principles in the UnitedStates of America requires management to make estimates and assumptionsaffecting the amounts and disclosures reported within those financialstatements.  These estimates areevaluated on an ongoing basis by management and generally affect revenuerecognition, collectibility of accounts receivable, workers’ compensationcosts, recoverability of intangible assets, 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.

 

The Company’s critical accounting policies aredescribed in Item 7 “Management’s Discussion and Analysis of FinancialCondition and Results of Operations” and in the notes to the

 

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consolidated financial statements in the Company’spreviously filed Annual Report on Form 10-K for the fiscal year ended November2, 2002.  Excluding the adoption of SFASNo. 142 noted above, the Company did not make any changes to these policiesduring the fiscal quarter ended January 25, 2003.

 

**Discontinued Operations**

 

During fiscal 1999, theCompany sold certain of its franchise agent and Company-owned medical officesand entered into a termination agreement with one of its medical licensees.During the fourth quarter of fiscal 1999 the Company completed the sale of theremaining medical business to Intrepid U.S.A. Inc. under an asset purchaseagreement. Under the terms of the sale, the Company retained the majority ofaccounts receivable, including trade and Medicare accounts receivable balances.

 

Prior to fiscal2003,  the Company appealed WesternMedical’s 1996 Medicare cost reports settlements.  During the first quarter of fiscal 2003, the appeal was settledand Western Medical received additional cost reimbursements.  As a result of the favorable appealsettlement, the Company has recorded $0.3 million in income from discontinuedoperations in the fiscal quarter ended January 25, 2003.

 

Currently,the Company believes it has adequate reserves for estimated liabilities relatedto the medical business, which primarily relate to pending legal or malpracticeliability claims. However, if actual resolution costs differ materially fromthose estimated by management, the Company would record additional losses (orgains) in future periods.

 

**Results of Continuing Operations**

 

**Fiscal Quarter Ended January 25, 2003 compared to FiscalQuarter Ended January 26, 2002**

 

*Revenues.* Total revenues increased $10.8 million, or 10.1%for the fiscal 2003 quarter as compared to the fiscal 2002 quarter.  Billed hours increased 5.4% reflecting animprovement in the domestic economy. However, average bill rates increased only slightly by 1.6% over thefiscal 2002 quarter due primarily to considerable pricing competition in thelight industrial and clerical/administrative sectors of the staffing industry.

 

Overall,domestic revenues increased 9.6%. Domestic same branch revenues showed marked improvements with a 16.3%increase over the prior year fiscal quarter, reflecting the successful resultsof certain sales initiatives implemented during fiscal 2002 and continuing infiscal 2003 and an improvement in the domestic economy.  International revenues  increased 12.4% almost entirely due tochanges in exchange rates.  Absent theexchange rate effect, international revenues decreased 1.0%, as the result ofthe closure of the Company’s Mexico operations in the second quarter of fiscal2002.  International same branchrevenues increased 0.6% in the first quarter of fiscal 2003 as compared to thecomparable period in fiscal 2002.

 

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*Costs of Services*. Costs of services include hourly wages of temporary employees, employerpayroll taxes, state unemployment and workers’ compensation insurance and otheremployee–related costs. Costs of services increased $10.5 million,or 12.0%, in the 2003 fiscal quarter as compared to 2002. Gross margin declinedfrom 18.7% in the first quarter of fiscal 2002 to 17.3% in the first quarter offiscal 2003. The decrease in gross margin for the fiscal 2003 quarter isprimarily due to considerable domestic pricing competition.  Additionally, the Company has experiencedincreases in domestic state unemployment rates and overall workers’compensation costs, both of which negatively affect margins.  The Company strives to improve gross marginwhere feasible; however, with continued competitive pressures on domesticprices and increasing costs, the opportunities available to increase grossmargin may be limited, and there can be no assurance that gross margin will notdecrease in future periods.

 

Domesticworkers’ compensation costs were 4.5% of direct labor for the first quarter offiscal 2003 compared to 4.1% for the fiscal 2002 quarter. Recent upward trendsin the Company’s actuarially estimated ultimate costs for all open policy yearshave resulted in an increase in the Company’s workers’ compensation accrualsfor these estimated costs. These costs tend to vary depending upon the mix ofbusiness between clerical/administrative staffing and light industrialstaffing. The Company reviews interim actuarial estimates and monitors accrualrates to ensure that they remain appropriate in light of loss trends; however,there can be no assurance that the Company’s programs to control workers’compensation costs will be effective or that loss development trends will notrequire additional increases in workers’ compensationaccruals in future periods.

 

*Franchise Agents’ Share of GrossProfit.*  Franchise agents’ share of gross profitrepresents the net distribution paid to franchise agents based either on apercentage of sales or of gross profit generated by the franchise agents’operation. Franchise agents’ share of gross profit increased $0.3 million,or 9.0%, for the first quarter of fiscal 2003 as compared to the firstquarter of fiscal 2002, primarily due to the increase in revenues. As a percentage of revenues, franchise agents’share of gross profit was 2.9% for both fiscal year quarters.

 

*Selling and Administrative Expenses.*Selling and administrative expenses decreased$1.9 million, or 10.5% for the fiscal 2003 quarter as compared tothe fiscal 2002 quarter. As a percent of revenues, selling and administrativeexpenses decreased from 16.6% in the fiscal 2002 quarter to 13.5% in fiscal2003.  These decreases are primarily dueto cost savings realized from personnel reductions and office closures enactedthroughout fiscal 2002.  Additionally,the Company has instituted company-wide policies limiting domestic full-timeemployee hiring and wage increases in response to its declining margins.  The Company continues to closely monitor itsvariable costs and evaluate the performance of field offices.  If warranted, additional under-performingoffices may be closed or consolidated in future periods and additional costsaving measures may be implemented. However, there can be no assurance that the cost savings implemented fromsuch actions, if enacted, would be sufficient to offset any potential futuredeclines in gross margin.

 

*Restructuring Charges*. During the first quarter of fiscal 2002, theCompany implemented a restructuring plan designed to improve the Company’sprofitability.  This restructuring planresulted in a fiscal 2002 first quarter pre-tax charge of $1.9 million.  The plan included costs associated with

 

17

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theabandonment of certain management information systems which were underdevelopment of $1.0 million, severance and other termination costs of  $0.6 million and lease termination costs of$0.3 million, related to the Company’s announced layoffs and office closures.

 

*Depreciation and amortization.*Depreciation and amortization decreased $0.2 millionor 15.5%, primarily due to the cessation of goodwill amortization as noted in“Goodwill” above.

 

*Interest.*Interest expense was $0.5 million for both fiscal 2003 and fiscal 2002quarters. Despite lower debt levels, the weighted average interest rate washigher for the first quarter of 2003.

 

*Provision (Benefit) for Income Taxes.*For the first quarter of fiscal 2003, the Company recorded an income tax provision of$40,000 on a pre-tax loss of $0.6 million.  The tax provision primarily reflects certain state andinternational income taxes.  The Companyrecognized a 100% valuation allowance against its first quarter 2003 income taxbenefit resulting from its net loss. This is consistent with the Company’s fiscal quarter ended January 26,2002 when substantially all of the Company’s deferred tax assets werereserved.  At January 25, 2003, theCompany maintained $17.5 million of gross deferred tax assets.

 

**Liquidity and Capital Resources**

 

Historically,the Company has financed its operations through cash generated by operatingactivities and through various forms of debt and equity financing. TheCompany’s principal use of cash is for financing of accounts receivable,particularly during periods of economic upswings and growth and during periodswhere sales are seasonally high throughout the year. Temporary personnel aregenerally paid on a weekly basis while payments from customers are generallyreceived 30 to 60 days after billing. As a result of seasonalfluctuations, accounts receivable balances are historically higher in thefourth fiscal quarter and are generally at their lowest during the first fiscalquarter. Accordingly, short-term borrowings used to finance accounts receivablegenerally follow a similar seasonal pattern.

 

Netcash provided by operating activities was $2.6 million for the 12 weeks endedJanuary 25, 2003, a decrease of  $1.6million from net cash provided by operating activities for the same period infiscal 2002.  The decrease is primarilya result of decreased cash generated by collection of receivables in thefiscal  2003 quarter versus the fiscal2002 quarter, partially offset by a lower net loss.

 

Cashused for capital expenditures, which are primarily for management informationsystems initiatives, other software, computers and peripherals, and officefurniture and equipment, totaled $0.6 million for the 12 weeks ended January25, 2003 as compared to $1.2 million for the same period in fiscal 2002.  Currently, the Company anticipates thattotal fiscal 2003 cash outflows for management information systems and othercapital expenditures will be above fiscal 2002 levels of $2.1 million, with thebulk of the expenditures related to enhancements to its existingmanagement  information systems.

 

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On December 12, 2002, theCompany entered into a sale-leaseback transaction whereby the Company sold andleased back its administrative offices’ land and buildings.  The result of the sale was a net pre-taxgain of approximately $5.5 million which the Company deferred and is amortizingas an offset to rent expense over the seven year lease term.  A portion of the net proceeds from the saleof $6.9 million were used to repay the outstanding principal and interest undera term loan of $4.5 million.  Additionally,the Company paid the outstanding principal of $1.0 million, plus accruedinterest, under the provisions of a promissory note payable to the Company’sPresident and Chief Executive Officer. The remainder of the net proceeds were used to repay outstandingborrowings under the Company’s domestic revolving credit facilities.

 

The minimum leasepayments required by the lease over the next seven years are:  fiscal 2003 - $0.7 million; fiscal 2004 -$0.8 million; fiscal 2005 - $0.8 million; fiscal 2006 - $0.9 million;fiscal 2007 - $0.9 million; fiscal 2008 - $0.9 million; fiscal 2009 - $0.9million and fiscal 2010 - $0.1 million. In connection with the lease agreement,the Company issued a $0.7 million irrevocable standby letter of credit as asecurity deposit.

 

In December 2002, theCompany entered into a lease transaction for certain information technologyequipment.  This lease, which has a termof 37 months, is being accounted for as a capital lease.  As a part of this lease transaction, theCompany sold equipment which was then leased back.  Net proceeds of $0.4 million on the sale were used to pay downadditional outstanding borrowings under the Company’s domestic revolving creditfacility.  Future minimum lease paymentobligations for this capital lease are: $0.4 million in fiscal 2003; $0.5 million in fiscal 2004; $0.5 millionin fiscal 2005 and $0.1 million in fiscal 2006.

 

On November 1, 2002, theCompany executed an agreement with its workers’ compensation/general liabilityinsurance carrier for the fiscal 2003 policy year.  Under the terms of the new agreement, over the fiscal 2003 yearthe Company will pay $16.0 million to the carrier for the current estimatedultimate cost of the policy year’s claims and related expenses.  As of January 25, 2003, the Company has madetotal payments of $5.4 million.

 

During the first fiscalquarter of 2003, the Company reduced borrowings by $10.7 million, which includepayments in full on the Company’s outstanding term loan and a note payable tothe Company’s Chief Executive Officer as noted above.  At January 25, 2003, the Company’s remaining debt consists of a$2.0 million note payable to the Company’s principal stockholder and Chairmanof the Board of Directors and $14.6 million outstanding under the Company’srevolving credit facilities.  At January25, 2003 the Company had approximately $7.4 million borrowing availabilityunder the credit facilities.  Inaddition, the Company has $18.0 million of outstanding irrevocable standbyletters of credit, primarily in support of its workers’ compensation program.

 

The Company also has anoutstanding financial guarantee bond in the amount of $11.8 million thatsecures a portion of its workers’ compensation premium and deductibleobligations and expires on November 1, 2003. Due to the change in the Company’s fiscal 2003 policy year

 

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premium and claims costfunding noted above, the Company does not currently anticipate that this bondwill require renewal at its expiration.

 

In February 2003 theCompany received approximately $4.7 million in federal income tax refundsarising from a net operating loss carryback in a prior year.  The cash refunds were used to pay downoutstanding borrowings under the Company’s revolving credit facility.

 

The Company believes thatcash reserves, cash generated from operations and the Company’s currentborrowing capacity will be sufficient to meet anticipated needs for workingcapital and capital expenditures at least through the next twelve months.

 

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

 

The Company is exposed tocertain market risks from transactions that are entered into during the normalcourse of business.  The Company has notentered into derivative financial instruments for trading purposes.  The Company’s primary market risk exposurerelates to interest rate risk.  AtJanuary 25, 2003, the Company’s outstanding debt under variable-rate interestborrowings was approximately $16.6 million. A change of 2% in the interest rates would cause a change in interestexpense of approximately $0.3 million on an annual basis.  The Company’s exposure to market risk forchanges in interest rates is not significant with respect to interest income,as its investment portfolio is not material to its consolidated balance sheet.

 

During the 12 weeks endedJanuary 25, 2003 the Company’s international operations comprised 18.1% of itsrevenues and, as of the end of that period, 18.9% of its total assets.  The Company is exposed to foreign currencyrisk primarily due to its investments in foreign subsidiaries.  The Company’s multicurrency credit facility,which allows the Company’s Australia and United Kingdom subsidiaries to borrowin local currencies, partially mitigates the exchange rate risk resulting fromforeign currency denominated net investments in these subsidiaries fluctuatingin relation to the U.S. dollar. The Company does not currently hold any marketrisk sensitive instruments entered into for hedging transaction risks relatedto foreign currencies.

 

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

 

Within the 90 days priorto the filing of this Quarterly Report on Form 10-Q, the Company carried out anevaluation, under the supervision and with the participation of the Company’smanagement, including the Company’s Chief Executive Officer and Chief FinancialOfficer, of the effectiveness of the design and operation of the Company’sdisclosure controls and procedures. Based on this evaluation, the Chief Executive Officer and Chief FinancialOfficer concluded that the Company’s disclosure controls and procedures areeffective in timely alerting them to material information required to beincluded in this report­.  It should benoted that the design of any system of controls is based in part upon certainassumptions about the likelihood of future events, and there can be noassurance that any design will succeed in achieving its stated goals under allpotential future conditions, regardless of how remote. There have been nosignificant changes in the Company’s internal controls or in other factors thatcould significantly affect internal controls subsequent to the date of the mostrecent evaluation.

 

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**PART II.  OTHERINFORMATION**

 
| Item 1. |   | LEGAL PROCEEDINGS                                                                                                                                                                                                                                                                                                                                                                  |
|---------|--------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|    |   | With regard to the  Synergy litigation, which was previously reported in the Company’s Annual  Report on Form 10-K for the fiscal year ended November 2, 2002, there have  been no material developments.                                                                                                                                                                     |
|    |   |                                                                                                                                                                                                                                                                                                                                                                               |
|    |   | Except  as disclosed above in Part I, Item 2, the Company is not currently a party to  any material litigation. However, from time to time the Company has been  threatened with, or named as a defendant in, lawsuits, including countersuits  brought by former franchise agents or licensees, and administrative claims  and lawsuits brought by employees or former employees. |
|    |   |                                                                                                                                                                                                                                                                                                                                                                               |
| Item 2. |   | CHANGES IN SECURITIES                                                                                                                                                                                                                                                                                                                                                              |
|    |   |                                                                                                                                                                                                                                                                                                                                                                               |
|    |   | Not  applicable.                                                                                                                                                                                                                                                                                                                                                                   |
|    |   |                                                                                                                                                                                                                                                                                                                                                                               |
| Item 3. |   | DEFAULTS UPON SENIOR SECURITIES                                                                                                                                                                                                                                                                                                                                                    |
|    |   |                                                                                                                                                                                                                                                                                                                                                                               |
|    |   | Not  applicable.                                                                                                                                                                                                                                                                                                                                                                   |
|    |   |                                                                                                                                                                                                                                                                                                                                                                               |
| Item 4. |   | SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS                                                                                                                                                                                                                                                                                                                                |
|    |   |                                                                                                                                                                                                                                                                                                                                                                               |
|    |   | Not  applicable.                                                                                                                                                                                                                                                                                                                                                                   |
|    |   |                                                                                                                                                                                                                                                                                                                                                                               |
| Item 5. |   | OTHER INFORMATION                                                                                                                                                                                                                                                                                                                                                                  |
|    |   |                                                                                                                                                                                                                                                                                                                                                                               |
|    |   | Not  applicable.                                                                                                                                                                                                                                                                                                                                                                   |
|    |   |                                                                                                                                                                                                                                                                                                                                                                               |
| Item 6. |   | EXHIBITS AND REPORTS ON  FORM 8-K                                                                                                                                                                                                                                                                                                                                                  |
|    |   |                                                                                                                                                                                                                                                                                                                                                                               |
|    |   | (a)                                                                                                                                                                                                                                                                                                                                                                                | Exhibits |
|    |   |                                                                                                                                                                                                                                                                                                                                                                               |   |
|    |   |                                                                                                                                                                                                                                                                                                                                                                               | None. |
|    |   |                                                                                                                                                                                                                                                                                                                                                                               |   |
|    |   | (b)                                                                                                                                                                                                                                                                                                                                                                                | Reports  on Form 8-K |
|    |   |                                                                                                                                                                                                                                                                                                                                                                               |   |
|    |   |                                                                                                                                                                                                                                                                                                                                                                               | No  reports were filed in or for the twelve-week period ended January 25, 2003. |

 

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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.                                      |
|----------------|--------|----------------------------------------------------|
|           |   |                                               |
|           |   |                                               |
| March 11, 2003 |   |                                               | /s/  Dirk A. Sodestrom |   |
| Date           |   | Dirk A. Sodestrom                                  |
|           |   | Senior Vice  President and Chief Financial Officer |

 

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##### **CERTIFICATIONS**

 

I, Dwight S. Pedersen,certify that:

 
| 1.     |   | I have reviewed this  quarterly report on Form 10-Q of Westaff, Inc.;                                                                                                                                                                                                                                                              |
|--------|--------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                                                                                                                                                                               |
| 2.     |   | Based on my knowledge,  this quarterly report does not contain any untrue statement of a material  fact or omit to state a material fact necessary to make the statements made,  in light of the circumstances under which such statements were made, not  misleading with respect to the period covered by this quarterly report; |
|   |   |                                                                                                                                                                                                                                                                                                                               |
| 3.     |   | Based on my knowledge,  the financial statements, and other financial information included in this  quarterly report, fairly present in all material respects the financial  condition, results of operations and cash flows of the registrant as of, and  for, the periods presented in this quarterly report;                    |
|   |   |                                                                                                                                                                                                                                                                                                                               |
| 4.     |   | The registrant’s other  certifying officer and I are responsible for establishing and maintaining  disclosure controls and procedures (as defined in Exchange Act Rules 13a-14  and 15d-14) for the registrant and we have:                                                                                                   |
|   |   |                                                                                                                                                                                                                                                                                                                               |
|   | A)     |                                                                                                                                                                                                                                                                                                                               | designed such  disclosure controls and procedures to ensure that material information  relating to the registrant, including its consolidated subsidiaries, is made  known to us by others within those entities, particularly during the period  in which this quarterly report is being prepared; |
|   |   |                                                                                                                                                                                                                                                                                                                               |   |
|   | B)     |                                                                                                                                                                                                                                                                                                                               | evaluated the  effectiveness of the registrant’s disclosure controls and procedures as of a  date within 90 days prior to the filing date of this quarterly report (the  “Evaluation Date”); and |
|   |   |                                                                                                                                                                                                                                                                                                                               |   |
|   | C)     |                                                                                                                                                                                                                                                                                                                               | presented in this  quarterly report our conclusions about the effectiveness of the disclosure  controls and procedures based on our evaluation as of the Evaluation Date; |
|   |   |                                                                                                                                                                                                                                                                                                                               |   |
| 5.     |   | The registrant’s other  certifying officer and I have disclosed, based on our most recent evaluation,  to the registrant’s auditors and the audit committee of registrant’s board of  directors (or persons performing the equivalent functions):                                                                   |
|   |   |                                                                                                                                                                                                                                                                                                                               |
|   | A)     |                                                                                                                                                                                                                                                                                                                               | all significant  deficiencies in the design or operation of internal controls which could  adversely affect the registrant’s ability to record, process, summarize and  report financial data and have identified for the registrant’s auditors any  material weaknesses in internal controls; and |
|   |   |                                                                                                                                                                                                                                                                                                                               |   |
|   | B)     |                                                                                                                                                                                                                                                                                                                               | any fraud, whether or  not material, that involves management or other employees who have a  significant role in the registrant’s internal controls; and |

 

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| 6. |   | The registrant’s other  certifying officer and I have indicated in this quarterly report whether or  not there were significant changes in internal controls or in other factors  that could significantly affect internal controls subsequent to the date of  our most recent evaluation, including any corrective actions with regard to  significant deficiencies and material weaknesses. |
|----|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

 

Date: March 11, 2003

 
| /s/ Dwight S. Pedersen                 |   |
|----------------------------------------|--------|
|                                   |
| Dwight S. Pedersen                     |
| President and Chief  Executive Officer |
| Westaff, Inc.                          |
| (Principal Executive  Officer)         |

 

24

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I, Dirk A. Sodestrom,certify that:

 
| 1.     |   | I have reviewed this  quarterly report on Form 10-Q of Westaff, Inc.;                                                                                                                                                                                                                                                              |
|--------|--------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                                                                                                                                                                               |
| 2.     |   | Based on my knowledge,  this quarterly report does not contain any untrue statement of a material  fact or omit to state a material fact necessary to make the statements made,  in light of the circumstances under which such statements were made, not  misleading with respect to the period covered by this quarterly report; |
|   |   |                                                                                                                                                                                                                                                                                                                               |
| 3.     |   | Based on my knowledge,  the financial statements, and other financial information included in this  quarterly report, fairly present in all material respects the financial  condition, results of operations and cash flows of the registrant as of, and  for, the periods presented in this quarterly report;                    |
|   |   |                                                                                                                                                                                                                                                                                                                               |
| 4.     |   | The registrant’s other  certifying officer and I are responsible for establishing and maintaining  disclosure controls and procedures (as defined in Exchange Act Rules 13a-14  and 15d-14) for the registrant and we have:                                                                                                   |
|   |   |                                                                                                                                                                                                                                                                                                                               |
|   | A)     |                                                                                                                                                                                                                                                                                                                               | designed such  disclosure controls and procedures to ensure that material information relating  to the registrant, including its consolidated subsidiaries, is made known to  us by others within those entities, particularly during the period in which  this quarterly report is being prepared; |
|   |   |                                                                                                                                                                                                                                                                                                                               |   |
|   | B)     |                                                                                                                                                                                                                                                                                                                               | evaluated the  effectiveness of the registrant’s disclosure controls and procedures as of a  date within 90 days prior to the filing date of this quarterly report (the  “Evaluation Date”); and |
|   |   |                                                                                                                                                                                                                                                                                                                               |   |
|   | C)     |                                                                                                                                                                                                                                                                                                                               | presented in this  quarterly report our conclusions about the effectiveness of the disclosure  controls and procedures based on our evaluation as of the Evaluation Date; |
|   |   |                                                                                                                                                                                                                                                                                                                               |   |
| 5.     |   | The registrant’s other  certifying officer and I have disclosed, based on our most recent evaluation,  to the registrant’s auditors and the audit committee of registrant’s board of  directors (or persons performing the equivalent functions):                                                                   |
|   |   |                                                                                                                                                                                                                                                                                                                               |
|   | A)     |                                                                                                                                                                                                                                                                                                                               | all significant  deficiencies in the design or operation of internal controls which could  adversely affect the registrant’s ability to record, process, summarize and  report financial data and have identified for the registrant’s auditors any  material weaknesses in internal controls; and |
|   |   |                                                                                                                                                                                                                                                                                                                               |   |
|   | B)     |                                                                                                                                                                                                                                                                                                                               | any fraud, whether or  not material, that involves management or other employees who have a  significant role in the registrant’s internal controls; and |

 

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| 6. |   | The registrant’s other  certifying officer and I have indicated in this quarterly report whether or  not there were significant changes in internal controls or in other factors  that could significantly affect internal controls subsequent to the date of  our most recent evaluation, including any corrective actions with regard to  significant deficiencies and material weaknesses. |
|----|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

 

Date: March 11, 2003

 
| /s/ Dirk A. Sodestrom                              |   |
|----------------------------------------------------|--------|
|                                               |
| Dirk A. Sodestrom                                  |
| Senior Vice President  and Chief Financial Officer |
| Westaff, Inc.                                      |
| (Principal Financial  Officer)                     |

 

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