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

**Washington, D. C.  20549**

#### ** **

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

 

| **(MARK  ONE)** |
|-----------------|
|            |   |   |
| **ý**      |   | **QUARTERLY REPORT PURSUANT TO  SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934.** |
|            |   |   |
|            |   | **For the quarterly period ended****April 17,  2004** |
|            |   |   |
| **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 ofregistrant 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 May 31, 2004** |
|-------------------------------|--------|---------------------------------|
|                          |   |                            |
| Common Stock,  $.01 par value |   | 16,033,229  shares              |

 

 

----

 

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

 

**INDEX**

 
|         |                                                                                        | **Page**                                                                                                    |
|--------------|---------------------------------------------------------------------------------------------|-------------------------------------------------------------------------------------------------------------|
|         |                                                                                        |                                                                                                        |
| **Part I.**  | **Financial Information**                                                                   |                                                                                                        |
|         |                                                                                        |                                                                                                        |
| Item 1.      | Financial Statements (Unaudited)                                                            |                                                                                                        |
|         |                                                                                        |                                                                                                        |   |
|         |                                                                                        | Condensed  Consolidated Balance Sheets -  April 17, 2004 and November 1, 2003                               | 3 |
|         |                                                                                        |                                                                                                        |   |
|         |                                                                                        | Condensed  Consolidated Statements of Operations -  12 and 24 weeks ended April 17, 2004 and April 19, 2003 | 4 |
|         |                                                                                        |                                                                                                        |   |
|         |                                                                                        | Condensed  Consolidated Statements of Cash Flows -  24 weeks ended April 17, 2004 and April 19, 2003        | 5 |
|         |                                                                                        |                                                                                                        |   |
|         |                                                                                        | Notes  to Condensed Consolidated Financial Statements                                                       | 6 |
|         |                                                                                        |                                                                                                        |   |
| Item  2.     | Management’s  Discussion and Analysis of Financial Condition and Results of Operations | 13                                                                                                          |
|         |                                                                                        |                                                                                                        |
| Item  3.     | Quantitative  and Qualitative Disclosures About Market Risk                                 | 19                                                                                                          |
|         |                                                                                        |                                                                                                        |
| Item 4.      | Controls and  Procedures                                                                    | 20                                                                                                          |
|         |                                                                                        |                                                                                                        |
| **Part II.** | **Other Information**                                                                       |                                                                                                        |
|         |                                                                                        |                                                                                                        |
| Item 1.      | Legal Proceedings                                                                           | 21                                                                                                          |
|         |                                                                                        |                                                                                                        |
| Item 2.      | Changes in Securities, Use of Proceeds and  Issuer Purchases of Equity Securities           | 21                                                                                                          |
|         |                                                                                        |                                                                                                        |
| Item 3.      | Defaults Upon  Senior Securities                                                            | 21                                                                                                          |
|         |                                                                                        |                                                                                                        |
| Item  4.     | Submission  of Matters to a Vote of Security Holders                                        | 21                                                                                                          |
|         |                                                                                        |                                                                                                        |
| Item 5.      | Other Information                                                                           | 22                                                                                                          |
|         |                                                                                        |                                                                                                        |
| Item 6.      | Exhibits and  Reports on Form 8-K                                                           | 22                                                                                                          |
|         |                                                                                        |
| Signatures   | 23                                                                                          |

 

2

----

 

**PartI.****  FinancialInformation**

** **

**Item 1****. Financial Statements**

 

**Westaff, Inc.**

** **

**Condensed Consolidated Balance Sheets****(Unaudited)(In thousands except per share amounts)**

** **
|                                                                                                                                                                                                                               |   | **April 17,  2004** |    | **November  1,  2003** |   |
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|---------------------|---------|------------------------|--------|
| **ASSETS**                                                                                                                                                                                                                         |   |                |    |                   |   |
| Current assets:                                                                                                                                                                                                                    |   |                |    |                   |   |
| Cash and cash  equivalents                                                                                                                                                                                                         |   | $                   | 1,809   |                   | $      | 4,759 |   |
| Trade accounts  receivable, less allowance for doubtful accounts of $827 and $1,067                                                                                                                                                |   | 71,415              |    | 74,564                 |   |
| Income taxes  receivable                                                                                                                                                                                                           |   | 536                 |    | 536                    |   |
| Prepaid expenses                                                                                                                                                                                                                   |   | 2,774               |    | 2,833                  |   |
| Other current  assets                                                                                                                                                                                                              |   | 1,211               |    | 1,741                  |   |
| Total current  assets                                                                                                                                                                                                              |   | 77,745              |    | 84,433                 |   |
|                                                                                                                                                                                                                               |   |                |    |                   |   |
| Property and  equipment, net                                                                                                                                                                                                       |   | 9,966               |    | 12,569                 |   |
| Goodwill, net                                                                                                                                                                                                                      |   | 11,754              |    | 11,687                 |   |
| Other long-term  assets                                                                                                                                                                                                            |   | 10,830              |    | 4,458                  |   |
| Total Assets                                                                                                                                                                                                                       |   | $                   | 110,295 |                   | $      | 113,147 |   |
|                                                                                                                                                                                                                               |   |                |    |                   |   |
| **LIABILITIES  AND STOCKHOLDERS’ EQUITY**                                                                                                                                                                                     |   |                |    |                   |   |
| Current  liabilities:                                                                                                                                                                                                              |   |                |    |                   |   |
| Borrowing under  revolving credit facilities                                                                                                                                                                                       |   | $                   | 19,311  |                   | $      | 25,410 |   |
| Current portion  of capital lease obligations                                                                                                                                                                                      |   | 447                 |    | 432                    |   |
| Note payable to  related party                                                                                                                                                                                                     |   | 1,000               |    |                   |   |
| Accounts payable                                                                                                                                                                                                                   |   | 2,169               |    | 2,013                  |   |
| Accrued expenses                                                                                                                                                                                                                   |   | 37,064              |    | 34,086                 |   |
| Income taxes  payable                                                                                                                                                                                                              |   | 387                 |    | 626                    |   |
| Net liabilities  of discontinued operations                                                                                                                                                                                        |   | 437                 |    | 629                    |   |
| Total current  liabilities                                                                                                                                                                                                         |   | 60,815              |    | 63,196                 |   |
|                                                                                                                                                                                                                               |   |                |    |                   |   |
| Note payable to  related party                                                                                                                                                                                                     |   | 2,000               |    | 2,000                  |   |
| Long-term  capital lease obligations                                                                                                                                                                                               |   | 377                 |    | 590                    |   |
| Other long-term  liabilities                                                                                                                                                                                                       |   | 11,712              |    | 11,905                 |   |
| Total  liabilities                                                                                                                                                                                                                 |   | 74,904              |    | 77,691                 |   |
|                                                                                                                                                                                                                               |   |                |    |                   |   |
| Commitments and  contingencies                                                                                                                                                                                                     |   |                |    |                   |   |
|                                                                                                                                                                                                                               |   |                |    |                   |   |
| Stockholders’  equity:                                                                                                                                                                                                        |   |                |    |                   |   |
| Preferred stock,  $.01 par value; authorized and unissued: 1,000 shares

Common stock,  $.01 par value; authorized: 25,000 shares; issued and outstanding: 16,033  shares at April 17, 2004 and 16, 015 shares at November 1, 2003 |   | 160                 |    | 160                    |   |
| Additional  paid-in capital                                                                                                                                                                                                        |   | 36,737              |    | 36,706                 |   |
| Accumulated  retained deficit                                                                                                                                                                                                      |   | (1,185              | )       | (448                   | )      |
| Accumulated  other comprehensive loss                                                                                                                                                                                              |   | (321                | )       | (962                   | )      |
| Total  stockholders’ equity                                                                                                                                                                                                   |   | 35,391              |    | 35,456                 |   |
| Total  Liabilities and Stockholders’ Equity                                                                                                                                                                                   |   | $                   | 110,295 |                   | $      | 113,147 |   |

 

See accompanying notes to condensed consolidatedfinancial statements.

 

3

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**Westaff, Inc.**

 

**Condensed Consolidated Statements ofOperations****(Unaudited)(In thousands except per share amounts)**

** **
|                                                                                                                   |   | **12 Weeks  Ended** |    | **24 Weeks Ended**  |   |
|------------------------------------------------------------------------------------------------------------------------|--------|---------------------|---------|---------------------|--------|
|                                                                                                                   |   | **April 17,  2004** |    | **April 19,  2003** |   | **April 17,  2004** |   | **April 19,  2003** |   |
|                                                                                                                   |   |                |    |                |   |   |   |   |   |
| Revenue                                                                                                                |   | $                   | 131,172 |                | $      | 116,442 |   | $ | 253,656 |   | $ | 234,275 |   |
|                                                                                                                   |   |                |    |                |   |   |   |   |   |
| Costs of  services                                                                                                     |   | 109,187             |    | 96,632              |   | 211,024 |   | 194,095 |   |
|                                                                                                                   |   |                |    |                |   |   |   |   |   |
| Gross profit                                                                                                           |   | 21,985              |    | 19,810              |   | 42,632 |   | 40,180 |   |
|                                                                                                                   |   |                |    |                |   |   |   |   |   |
| Franchise  agents’ share of gross profit                                                                          |   | 3,985               |    | 3,562               |   | 7,787 |   | 6,973 |   |
| Selling and  administrative expenses                                                                                   |   | 16,228              |    | 17,226              |   | 32,320 |   | 33,114 |   |
| Depreciation and  amortization                                                                                         |   | 1,071               |    | 1,310               |   | 2,174 |   | 2,591 |   |
|                                                                                                                   |   |                |    |                |   |   |   |   |   |
| Operating income  (loss) from continuing operations                                                                    |   | 701                 |    | (2,288              | )      | 351 |   | (2,498 | ) |
|                                                                                                                   |   |                |    |                |   |   |   |   |   |
| Interest expense                                                                                                       |   | 442                 |    | 356                 |   | 914 |   | 822 |   |
| Interest income                                                                                                        |   | (14                 | )       | (49                 | )      | (34 | ) | (101 | ) |
|                                                                                                                   |   |                |    |                |   |   |   |   |   |
| Income (loss)  from continuing operations before income taxes and cumulative effect of  change in accounting principle |   | 273                 |    | (2,595              | )      | (529 | ) | (3,219 | ) |
| Provision for  income taxes                                                                                            |   | 105                 |    | 68                  |   | 208 |   | 109 |   |
|                                                                                                                   |   |                |    |                |   |   |   |   |   |
| Income (loss)  from continuing operations before cumulative effect of change in accounting  principle                  |   | 168                 |    | (2,663              | )      | (737 | ) | (3,328 | ) |
|                                                                                                                   |   |                |    |                |   |   |   |   |   |
| Income from  discontinued operations                                                                                   |   |                |    |                |   |   |   | 316 |   |
| Cumulative  effect of change in accounting principle                                                                   |   |                |    |                |   |   |   | (670 | ) |
|                                                                                                                   |   |                |    |                |   |   |   |   |   |
| Net income  (loss)                                                                                                     |   | $                   | 168     |                | $      | (2,663 | ) | $ | (737 | ) | $ | (3,682 | ) |
|                                                                                                                   |   |                |    |                |   |   |   |   |   |
| Earnings (loss)  per share - basic and diluted:                                                                        |   |                |    |                |   |   |   |   |   |
|                                                                                                                   |   |                |    |                |   |   |   |   |   |
| Continuing  operations before cumulative effect of change in accounting principle                                      |   | $                   | 0.01    |                | $      | (0.17 | ) | $ | (0.05 | ) | $ | (0.21 | ) |
|                                                                                                                   |   |                |    |                |   |   |   |   |   |
| Discontinued  operations                                                                                               |   | $                   | —  |                | $      | — |   | $ | — |   | $ | 0.02 |   |
|                                                                                                                   |   |                |    |                |   |   |   |   |   |
| Cumulative  effect of change in accounting principle                                                                   |   | $                   | —  |                | $      | — |   | $ | — |   | $ | (0.04 | ) |
|                                                                                                                   |   |                |    |                |   |   |   |   |   |
| Net income  (loss)                                                                                                     |   | $                   | 0.01    |                | $      | (0.17 | ) | $ | (0.05 | ) | $ | (0.23 | ) |
|                                                                                                                   |   |                |    |                |   |   |   |   |   |
| Weighted average  shares outstanding - basic                                                                           |   | 16,032              |    | 15,994              |   | 16,024 |   | 15,983 |   |
| Weighted average  shares outstanding - diluted                                                                         |   | 16,036              |    | 15,994              |   | 16,024 |   | 15,983 |   |

 

See accompanying notes to condensed consolidatedfinancial statements.

 

4

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**Westaff,Inc.**

** **

**Condensed Consolidated Statements ofCash Flows****(Unaudited)(In thousands)**

 
|                                                                             |   | **24 Weeks  Ended** |   |
|----------------------------------------------------------------------------------|--------|---------------------|--------|
|                                                                             |   | **April 17,  2004** |   | **April 19,  2003** |   |
| **Cash  flows from operating activities**                                        |   |                |   |   |   |
| Net loss                                                                         |   | $                   | (737   | ) | $ | (3,682 | ) |
| Adjustments to  reconcile net loss to net cash provided by operating activities: |   |                |   |   |   |
| Income from  discontinued operations                                             |   |                |   | (316 | ) |
| Loss from  cumulative effect of change in accounting principle                   |   |                |   | 670 |   |
| Depreciation and  amortization                                                   |   | 2,174               |   | 2,591 |   |
| Provision for  losses on doubtful accounts                                       |   | 480                 |   | 291 |   |
| Gain on sale or  disposal of assets                                              |   | (667                | )      | (9 | ) |
| Other                                                                            |   | (115                | )      | (62 | ) |
| Changes in  assets and liabilities:                                              |   |                |   |   |   |
| Trade accounts  receivable                                                       |   | 3,603               |   | 12,486 |   |
| Other assets                                                                     |   | (4,019              | )      | 1,225 |   |
| Accounts payable  and accrued expenses                                           |   | 719                 |   | (5,286 | ) |
| Income taxes  payable                                                            |   | (258                | )      | (300 | ) |
| Other  liabilities                                                               |   | 221                 |   | 17 |   |
|                                                                             |   |                |   |   |   |
| Net cash  provided by continuing operations                                      |   | 1,401               |   | 7,625 |   |
| Net cash (used)  provided by discontinued operations                             |   | (192                | )      | 391 |   |
|                                                                             |   |                |   |   |   |
| Net cash  provided by operating activities                                       |   | 1,209               |   | 8,016 |   |
|                                                                             |   |                |   |   |   |
| **Cash  flows from investing activities**                                        |   |                |   |   |   |
| Capital  expenditures                                                            |   | (792                | )      | (1,439 | ) |
| Proceeds from  sales of affiliate operations                                     |   | 16                  |   | 272 |   |
| Proceeds from  sales of assets                                                   |   | 1,937               |   | 7,386 |   |
| Other, net                                                                       |   | (10                 | )      |   |   |
|                                                                             |   |                |   |   |   |
| Net cash  provided by investing activities                                       |   | 1,151               |   | 6,219 |   |
|                                                                             |   |                |   |   |   |
| **Cash  flows from financing activities**                                        |   |                |   |   |   |
| Net repayments  under line of credit agreements                                  |   | (6,302              | )      | (9,718 | ) |
| Principal  payments on long-term debt and capital lease obligations              |   | (196                | )      | (4,629 | ) |
| Proceeds from  notes payable to related parties                                  |   | 1,000               |   |   |   |
| Payment of note  payable to related party                                        |   |                |   | (1,000 | ) |
| Payment of debt  issuance costs                                                  |   | (67                 | )      | (202 | ) |
| Issuance of  common stock                                                        |   | 32                  |   | 43 |   |
|                                                                             |   |                |   |   |   |
| Net cash used by  financing activities                                           |   | (5,533              | )      | (15,506 | ) |
|                                                                             |   |                |   |   |   |
| Effect of  exchange rate changes on cash                                         |   | 223                 |   | 17 |   |
|                                                                             |   |                |   |   |   |
| Net change in  cash and cash equivalents                                         |   | (2,950              | )      | (1,254 | ) |
| Cash and cash  equivalents at beginning of period                                |   | 4,759               |   | 5,484 |   |
| Cash and cash  equivalents at end of period                                      |   | $                   | 1,809  |   | $ | 4,230 |   |

 

See accompanying notes to condensed consolidatedfinancial statements.

 

5

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**Westaff, Inc.**

** **

**Notes to Condensed ConsolidatedFinancial Statements****(Unaudited)(In thousands 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 April 17, 2004 and forthe 12 and 24 week periods ended April 17, 2004 and April 19, 2003 areunaudited.

 

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 as of November 1, 2003 presented herein,has been derived from the audited balance sheet included in the Company’s AnnualReport on Form 10-K for the fiscal year ended November 1, 2003.

 

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 Annual Reporton Form 10-K for the fiscal year ended November 1, 2003.

 

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 and 24 week periods endedApril 17, 2004 are not necessarily indicative of the results to be expected forthe full 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 4).  As a result, theCompany has classified its medical operations as discontinued operations inthese condensed consolidated financial statements and notes thereto.

 

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

 

The Company measurescompensation cost for employee stock options and similar equity instrumentsusing the intrinsic value-based method of accounting prescribed by AccountingPrinciples Board Opinion No. 25, “Accounting for Stock Issued to Employees”(APB25), and follows the disclosure-only provisions of SFAS No. 123, “Accountingfor Stock-Based Compensation”, as amended by SFAS No. 148, “Accounting forStock-Based Compensation – Transition and Disclosure”.  As all options have been granted at fairvalue, no compensation cost has been recognized in the financialstatements.  The following table representspro forma net income (loss) and pro forma income (loss) per share had compensationcost been determined using the fair value method:

 

6

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|                                                             |   | **12 Weeks  Ended** |   | **24 Weeks  Ended** |   |
|------------------------------------------------------------------|--------|---------------------|--------|---------------------|--------|
|                                                             |   | **April 17,  2004** |   | **April 19,  2003** |   | **April 17,  2004** |   | **April 19,  2003** |   |
|                                                             |   |                |   |                |   |   |   |   |   |
| Net income  (loss) as reported                                   |   | $                   | 168    |                | $      | (2,663 | ) | $ | (737 | ) | $ | (3,682 | ) |
| Stock based  compensation determined under the fair value method |   | (101                | )      | (126                | )      | (207 | ) | (254 | ) |
|                                                             |   |                |   |                |   |   |   |   |   |
| Pro forma net  income (loss)                                     |   | $                   | 67     |                | $      | (2,789 | ) | $ | (944 | ) | $ | (3,936 | ) |
|                                                             |   |                |   |                |   |   |   |   |   |
| Income (loss)  per common share:                                 |   |                |   |                |   |   |   |   |   |
| Basic and  diluted - as reported                                 |   | $                   | 0.01   |                | $      | (0.17 | ) | $ | (0.05 | ) | $ | (0.23 | ) |
| Basic and  diluted - pro forma                                   |   | $                   | 0.00   |                | $      | (0.17 | ) | $ | (0.06 | ) | $ | (0.25 | ) |

 

Because stock optionsgenerally become exercisable over several years and additional grants arelikely to be made in future periods, the pro forma amounts for compensationcost may not be indicative of the effects on net income and earnings per sharefor future periods.

 

**3.****              Goodwill**

 

Effective 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 assetswith indefinite lives are no longer amortized, but rather are evaluated forimpairment by applying a fair-value based test. The impairment test iscomprised of two parts.  The first stepcompares the fair value of a reporting unit with its carrying value, includinggoodwill.  If the carrying value of areporting unit exceeds its fair value, the second step of the goodwillimpairment test must be performed.  Thesecond step compares the implied fair value of the reporting units’ goodwillwith the respective carrying value in order to determine the amount of impairmentloss, if any.

 

During fiscal 2003, theCompany performed tests for impairment in accordance with the newstandard.   In the initial test underthe transitional provisions of SFAS No. 142, the Company determined that animpairment of $670 existed in its Australia reporting unit. In accordance withSFAS No. 142, the impairment was classified as a cumulative effect of a

 

7

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change in accountingprinciple.

 

The Company performs itsannual impairment evaluation in the fourth quarter of each fiscal year. Noadditional impairment was identified in the Company’s annual impairmentevaluation for fiscal 2003.

 

Thechange in the carrying amount of goodwill for the 24 weeks ended April 17, 2004is due to the effect of changes in foreign currency translation rates.

 

Inaccordance with SFAS No. 142, noamortization of goodwill was recorded in the 12 and 24 week periods ended April17, 2004 and April 19, 2003.

 

**4.****              DiscontinuedOperations**

 

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 fiscal 2003, theCompany appealed Western Medical’s 1996 Medicare cost report settlement.  During the first quarter of fiscal 2003, theappeal was settled and Western Medical received additional costreimbursements.  As a result of thefavorable appeal settlement, the Company recognized $316 of income fromdiscontinued operations in the fiscal quarter ended January 25, 2003.

 

As of April 17, 2004, theremaining current liabilities of the discontinued medical operations are forestimated pending legal claims of $250, malpractice/liability claims of  $189 and other costs of $2.

 
|                                        |   | **April 17,  2004** |   | **November  1,  2003** |   |
|---------------------------------------------|--------|---------------------|--------|------------------------|--------|
|                                        |   |                |   |                   |   |
| Current assets  (primarily receivables)     |   | $                   | 4      |                   | 15     |   |
| Current  liabilities                        |   | (441                | )      | (644                   | )      |
| Net liabilities  of discontinued operations |   | $                   | (437   | )                      | $      | (629 | ) |
|                                             |        |                     |        |                        |        |  |  |

 

8

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

 

The Company is responsible for and pays workers’ compensation costs forits temporary and regular employees and is self-insured for the deductibleamount related to workers’ compensation claims ($500 per claim for fiscal year2003 and increasing to $750 per claim for fiscal 2004.)  Each policy year the terms of the agreementwith the insurance carrier are renegotiated. The Company is contractually required to collateralize its recordedobligations through the use of irrevocable letters of credit, surety bonds orcash. The Company is cash collateralizing its fiscal 2004 policy year throughpayments totaling $13,800.  As of April17, 2004, $8,500 had been paid and is included in long term assets on theCompany’s Consolidated Balance Sheet at April 17, 2004.

 

**6.****              Earnings (Loss) PerShare**

 

The followingtable sets forth the computation of basic and diluted earnings (loss) pershare:

 
|                                                                                                                                |   | **12 Weeks  Ended** |   | **24 Weeks  Ended** |   |
|-------------------------------------------------------------------------------------------------------------------------------------|--------|---------------------|--------|---------------------|--------|
|                                                                                                                                |   | **April 17,  2004** |   | **April 19,  2003** |   | **April 17,  2004** |   | **April 19,  2003** |   |
|                                                                                                                                |   |                |   |                |   |   |   |   |   |
| Income (loss)  from continuing operations before cumulative effect of change in accounting  principle                               |   | $                   | 168    |                | $      | (2,663 | ) | $ | (737 | ) | $ | (3,328 | ) |
|                                                                                                                                |   |                |   |                |   |   |   |   |   |
| Denominator for  basic earnings per share - weighted average shares                                                                 |   | 16,032              |   | 15,994              |   | 16,024 |   | 15,983 |   |
|                                                                                                                                |   |                |   |                |   |   |   |   |   |
| Effect of  dilutive securities - stock options                                                                                      |   | 4                   |   | —              |   | — |   | — |   |
| Denominator for  diluted earnings per share - adjusted weighted average shares and assumed  conversions                             |   | 16,036              |   | 15,994              |   | 16,024 |   | 15,983 |   |
|                                                                                                                                |   |                |   |                |   |   |   |   |   |
| Basic and diluted  earnings (loss) per share from continuing operations before cumulative effect  of change in accounting principle |   | $                   | 0.01   |                | $      | (0.17 | ) | $ | (0.05 | ) | $ | (0.21 | ) |
|                                                                                                                                |   |                |   |                |   |   |   |   |   |
| Anti-dilutive  weighted shares excluded from diluted loss per share                                                                 |   | 1,003               |   | 1,102               |   | 1,009 |   | 1,101 |   |

 

**7.****              Comprehensive Loss**

 

Comprehensive lossconsists of the following:

 

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|                              |   | **12 Weeks  Ended** |   | **24 Weeks  Ended** |   |
|-----------------------------------|--------|---------------------|--------|---------------------|--------|
|                              |   | **April 17,  2004** |   | **April 19,  2003** |   | **April 17,  2004** |   | **April 19,  2003** |   |
|                              |   |                |   |                |   |   |   |   |   |
| Net income  (loss)                |   | $                   | 168    |                | $      | (2,663 | ) | $ | (737 | ) | $ | (3,682 | ) |
| Currency  translation adjustments |   | (234                | )      | 24                  |   | 640 |   | 533 |   |
|                              |   |                |   |                |   |   |   |   |   |
| Comprehensive  loss               |   | $                   | (66    | )                   | $      | (2,639 | ) | $ | (97 | ) | $ | (3,149 | ) |

 

**8.****              CreditAgreement**

 

At fiscal year endNovember 1, 2003 and through the first fiscal quarter of 2004, the Company wasout of compliance with certain financial covenants under its MulticurrencyCredit Agreement, including a minimum earnings before interest, taxes,depreciation and amortization (EBITDA) covenant.  On February 20, 2004, the Company and its lending agents executeda fourth amendment to that agreement. The amendment allowed certain one-time add-backs to EBITDA for thefiscal period ended November 1, 2003, which corrected the covenant defaults andreset the EBITDA and certain other covenants going forward.  The amendment also required a separateEBITDA covenant calculation for the Company’s domestic operations on astand-alone basis.  In addition, theamendment reset the reserves which effect the Company’s borrowing capacity,redefined eligible trade accounts receivable for purposes of calculating the USand UK borrowing base, increased the applicable margins on outstandingirrevocable letters of credit by 1.0% and reduced maximum capital expendituresallowed for fiscal 2004 by $1,000.

 

At April 17, 2004the Company was in compliance with all covenants under the credit agreement.

 

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

 

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

 

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The Company alsohas an unsecured subordinated promissory note payable to its principalstockholder and Chairman of the Board of Directors dated May 17, 2002 in theamount of $2,000.  The note has amaturity date of August 18, 2007 and an interest rate equal to an indexed rateas calculated under the Company’s credit facilities plus seven percent,compounded monthly and payable 60 calendar days after the end of each of theCompany’s fiscal quarters.  The interestrate in effect on April 17, 2004 was 11.0%. Payment of interest is contingent on the Company meeting minimum availabilityrequirements under its credit facilities. Additionally, payments of principalor interest are prohibited in the event of any default under the creditfacilities.

 

**10.****       OperatingSegments**

 

The followingtable summarizes reporting segment data:

 
|                                                                                                            |   | **Domestic  Business Svcs.** |    | **United  Kingdom  Operations** |   | **Other  International** |   | **Total  Continuing  Operations** |   |
|-----------------------------------------------------------------------------------------------------------------|--------|------------------------------|---------|---------------------------------|--------|--------------------------|--------|-----------------------------------|--------|
|                                                                                                            |   |                         |    |                            |   |                     |   |                              |   |
| **12  Weeks Ended April 17, 2004**                                                                              |   |                         |    |                            |   |                     |   |                              |   |
|                                                                                                            |   |                         |    |                            |   |                     |   |                              |   |
| Revenue                                                                                                         |   | $                            | 102,115 |                            | $      | 9,727                    |   | $                                 | 19,330 |   | $ | 131,172 |   |
| Operating income  from continuing operations before cumulative effect of change in accounting  principle        |   | $                            | 339     |                            | $      | 312                      |   | $                                 | 50     |   | $ | 701 |   |
|                                                                                                            |   |                         |    |                            |   |                     |   |                              |   |
| **12  Weeks Ended April 19, 2003**                                                                              |   |                         |    |                            |   |                     |   |                              |   |
|                                                                                                            |   |                         |    |                            |   |                     |   |                              |   |
| Revenue                                                                                                         |   | $                            | 94,371  |                            | $      | 7,167                    |   | $                                 | 14,904 |   | $ | 116,442 |   |
| Operating income  (loss) from continuing operations before cumulative effect of change in  accounting principle |   | $                            | (2,190  | )                               | $      | 192                      |   | $                                 | (290   | ) | $ | (2,288 | ) |
|                                                                                                            |   |                         |    |                            |   |                     |   |                              |   |
| **24  Weeks Ended April 17, 2004**                                                                              |   |                         |    |                            |   |                     |   |                              |   |
|                                                                                                            |   |                         |    |                            |   |                     |   |                              |   |
| Revenue                                                                                                         |   | $                            | 196,553 |                            | $      | 18,287                   |   | $                                 | 38,816 |   | $ | 253,656 |   |
| Operating income  (loss) from continuing operations before cumulative effect of change in  accounting principle |   | $                            | (339    | )                               | $      | 595                      |   | $                                 | 95     |   | $ | 351 |   |
|                                                                                                            |   |                         |    |                            |   |                     |   |                              |   |
| **24  Weeks Ended April 19, 2003**                                                                              |   |                         |    |                            |   |                     |   |                              |   |
|                                                                                                            |   |                         |    |                            |   |                     |   |                              |   |
| Revenue                                                                                                         |   | $                            | 190,866 |                            | $      | 13,646                   |   | $                                 | 29,763 |   | $ | 234,275 |   |
| Operating income  (loss) from continuing operations before cumulative effect of change in  accounting principle |   | $                            | (2,266  | )                               | $      | 295                      |   | $                                 | (527   | ) | $ | (2,498 | ) |

 

11

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

 

In the ordinarycourse of its business, the Company is periodically threatened with or named asa defendant 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.

 

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

 

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

 

In January 2003,the Financial Accounting Standards Board (FASB) issued FASB Interpretation No.46, “Consolidation of Variable Interest Entities, an Interpretation ofAccounting Research Bulletin No. 51” (FIN 46). FIN 46 provides guidance on identifying variable interest entities andassessing whether or not they should be consolidated.  The Company was required to adopt the Interpretation effectivewith its fiscal quarter ended April 17, 2004. The adoption did not have a material impact on the Company’sconsolidated results of operations or financial position.

 

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

 

### **Cautionary Statement**

### ** **

This notice is intended to takeadvantage of the “safe harbor” provided by the Private Securities LitigationReform Act of 1995 with respect to forward-looking statements. Except for thehistorical information contained herein, the matters discussed should beconsidered forward-looking statements and readers are cautioned not to placeundue reliance on those statements. The forward-looking statements in thisdiscussion are made based on information available as of the date hereof andare subject to a number of risks and uncertainties that could cause theCompany’s actual results and financial position to differ materially from thoseexpressed or implied in the forward-looking statements. These risks anduncertainties include, but are not limited to, those discussed in Item 1.“Factors Affecting Future Operating Results” and elsewhere in the Company’sAnnual Report on Form 10-K for the fiscal year ended November 1, 2003.  The Company undertakes no obligation topublicly release the results of any revisions to these forward-lookingstatements to reflect events or circumstances after the date hereof or to reflectthe occurrence of unanticipated events, except as required by applicable lawsand regulations.

 

The following discussion isintended to assist in the understanding and assessment of significant changesand trends related to the results of operations and financial condition ofWestaff, Inc., together with its consolidated subsidiaries. Thisdiscussion and analysis should be read in conjunction with the Company’sConsolidated Financial Statements and Notes thereto included elsewhere in thisForm 10-Q and in the Company’s Annual Report on Form 10-K for the fiscal yearended November 1, 2003.

 

### **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, income taxes and contingencies and litigation.  Management’s estimates and assumptions are based on historicalexperiences and other factors believed to be reasonable under the circumstances.  However, actual results under circumstancesand conditions different than those assumed could result in differences fromthe estimated amounts in the financial statements.

 

The Company’s critical accounting policies aredescribed in Item 7 “Management’s Discussion and Analysis of Financial Conditionand Results of Operations” and in the notes to the consolidated financialstatements in the Company’s previously filed Annual Report on Form 10-K for thefiscal year ended November 1, 2003. There were no changes to these policies during the 24 week period endedApril 17, 2004.

 

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### **Executive Overview**

### ** **

Revenue for the second quarterof fiscal 2004 grew 12.7% when compared to the second quarter of fiscal2003.  On a constant currency basis(i.e. excluding the effect of varying exchange rates when translating ourinternational local currency results into US dollars), second quarter revenuegrew 8.4% over the prior year quarter. Domestic revenue is showing signs of sustained growth, and management iscautiously optimistic that a recovery in the U.S. staffing industry has begunas suggested by recent economic data.

 

Improving gross marginshowever, remains a challenge at this time - for us and for many other companiesin our industry.  Competitive pricingpressures have not eased and the increased costs of doing business,particularly workers’ compensation and state unemployment costs, continue toerode margins and make sustained bottom-line profitability difficult to achievewithout continued revenue growth or stringent efforts to control operatingcosts.

 

We are continuing to faceconsiderable challenges with our liquidity. Without sustained revenue growth, higher gross and operating margins, oradditional debt or equity financing, we expect to face periods of low cashavailability.  The borrowing capacityunder our current credit facilities has eased some as a result of the secondquarter improvements in operating performance and a recent $2.0 millionreduction in our outstanding letters of credit.  However, based on current forecasts and expectations regardingthe remainder of fiscal 2004, we believe that we will be required to carefullymanage our cash position throughout the year. Furthermore, if we are unable to achieve our operating forecasts for theyear, or if there are unexpected reductions in cash inflows or increases incash outlays, we may be faced with a cash shortfall which could have a materialadverse effect on our business and financial condition.

 

These and other trends anddevelopments are discussed in further detail in the following Results ofOperations, Liquidity and Capital Resources.

 

**Results of Operations**

 

**Fiscal Quarter Ended April 17, 2004 comparedto Fiscal Quarter Ended April 19, 2003**

 

Total revenue increased $14.7million or 12.7% for the fiscal quarter of 2004 as compared to the fiscal 2003quarter.  Domestic revenue increased8.2%, while international revenue increased 31.7%, largely due to the effect offavorable exchange rates.

 

The domestic revenue increaseis the result of an increase in billed hours of 6.6% coupled with a modestincrease in average bill rates of 1.4%. The growth in domestic billed hours reflects new business as well asincreases in volume with various existing customers.  Competitive pricing pressures continue to hinder increases inaverage bill rates.

 

Excluding the effect ofexchange rate fluctuations, international revenue increased 9.1%, with anincrease of 4.8% in billed hours and, on a constant currency basis, an increasein average bill rates of 2.2%.

 

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Costs of services includehourly wages of temporary employees, employer payroll taxes, state unemploymentand workers’ compensation insurance and other employee-related costs.  Costs of services increased $12.6 million,or 13.0%, in the 2004 fiscal quarter as compared to 2003.  Gross margin declined from 17.0% for thesecond quarter of fiscal 2003 to 16.8% for the same period in 2004.  The margin decline reflects an industry-widestrain on domestic margins due to competitive pressures and escalating workers’compensation and state unemployment costs.

 

Domestic workers’ compensationcosts were 5.8% of direct labor for the second quarter of fiscal 2004 ascompared to 5.4% for the fiscal 2003 quarter.  Unexpected adverse development of open claims and increases in theCompany’s incurred but not reported claims can significantly effect the levelof accruals needed to cover workers’ compensation costs.  Due to these factors, additional workers’compensation charges of $0.5 million and $0.6 million were recorded in thesecond quarters of fiscal 2004 and fiscal 2003, respectively, to adjust theaccruals to actuarially determined levels. Based on current projections, the Company estimates that accrual rates forworkers’ compensation costs for the remainder of fiscal 2004 will be in therange of 5.2% to 5.6% of direct labor for its domestic operations.  However, unanticipated adverse lossdevelopment trends could require even higher accrual rates than those currentlyestimated or could result in a need for additional charges to be recordedbefore the end of the fiscal year.

 

Franchise agents’ share ofgross profit represents the net distribution paid to franchise agents basedeither on a percentage of the sales or gross profit generated by the franchiseagents’ operations. As a percentage of consolidated revenue, franchise agents’share of gross profit was 3.0% for the fiscal 2004 quarter and 3.1% for thefiscal 2003 quarter.

 

Selling and administrativeexpenses decreased $1.0 million, or 5.8% for the 2004 quarter as compared tothe 2003 quarter.  Personnel reductions,office closures and other cost containment measures contributed to thisdecrease, and were partially offset by higher exchange rates used to translatelocal currencies of the Company’s international operations’ expenses into USdollars.  In the fiscal 2004 quarterselling and administrative expenses were reduced by a $0.7 million gain on thesale of the former executive headquarters building in Walnut Creek,California.  As a percent of revenue,consolidated selling and administrative expenses decreased from 14.8% in thefiscal 2003 quarter to 12.4% in the current fiscal quarter.

 

Depreciation and amortizationdecreased $0.2 million or 18.2%, primarily due to reduced capital expendituresand assets reaching fully depreciated useful lives.

 

**24 WeeksEnded April 17, 2004 compared to 24 Weeks Ended April 19, 2003**

 

Ona constant currency basis, fiscal year-to-date revenue growth for 2004 was 4.3%over the same 24-week period in 2003. Although revenue growth picked up for the second quarter of fiscal 2004as discussed above, the year-to-date growth is impacted by a reduction in salesfor some high-volume government business as noted in several of the Company’sprevious filings.

 

Gross margin for the 24 weeksended April 17, 2004 was 16.8% as compared to 17.2% for the 2003 period.  The margin decrease reflects the samecompetitive pricing pressures and increased

 

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state unemployment and workers’compensation costs noted in the fiscal quarter discussion above.  The Company is continuing its focus onincreasing margins through adjusting bill rates where feasible, and by marketingits domestic direct hire program.

 

During fiscal 1999, the Company discontinued itsmedical operations (Western Medical), principally through a sale to IntrepidU.S.A. (Intrepid). 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 Western Medical’s 1996 Medicare cost reportsettlement.  During the first quarter offiscal 2003, the appeal was settled and Western Medical received additionalcost reimbursements.  As a result of thefavorable appeal settlement, the Company recognized $0.3 million of income fromdiscontinued operations in the first quarter of fiscal 2003.  Currently, the Company believes it hasadequate reserves for remaining estimated liabilities related to the medicalbusiness of $0.4 million, which primarily relate to pending legal ormalpractice liability claims.  However,if actual resolution costs differ materially from those estimated by management,the Company would record additional losses (or gains) in future periods.

 

EffectiveNovember 3, 2002, the Company adopted Statement of Financial AccountingStandards (SFAS) No. 142 “Goodwill and Other Intangible Assets”.  SFAS No. 142 provides that goodwill andother intangible assets with indefinite lives are no longer amortized, butrather are evaluated for impairment by applying a fair-value based test.  During fiscal 2003, the Company performedtests for impairment in accordance with the new standard.   In the initial test under the transitionalprovisions of SFAS No. 142, the Company determined that an impairment of$670,000 existed in its Australia reporting unit.  In accordance with SFAS No. 142, the impairment was classified asa cumulative effect of a change in accounting principle.

 

**Liquidity and Capital Resources**

 

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

 

The Company finances itsoperations primarily through cash generated by its operating activities andborrowings under its revolving credit facilities. Net cash provided byoperating activities was $1.2 million for the 24 weeks ended April 17, 2004, and$8.0 million for the 24 weeks ended April 19, 2003.  In the 2004 period, cash provided by operating activities wasreduced by approximately $6.6 million for payments made to cash collateralize aportion of the Company’s workers’ compensation obligations.  The higher level of net cash provided byoperating activities in the prior year quarter was primarily due to increasesin trade accounts receivable collections exceeding new receivables generatedthrough sales of services.  As of May15, 2004, total borrowing availability was $7.4 million, with $2.5 million,$2.1 million and $2.8 million available in the US, UK and Australia,respectively.

 

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The Company has also generatedcash in the past through sales and sale/leasebacks of property and equipment,loans from related parties, sales of Company-owned offices to franchise ownersor sales of franchise agent and license offices back to the franchise agent orlicense owner.  The Company currentlybelieves that it may be unable to raise any significant additional cash throughthese types of activities.

 

The US operations have beenexperiencing periods of low cash availability and have been carefully managingthe timing of cash inflows and outlays where possible to help mitigatepotential cash shortfalls.  EffectiveMay 24, 2004, the Company negotiated a $2.0 million reduction in theoutstanding irrevocable letters of credit which secure its workers’compensation obligations.  Thisreduction will improve borrowing capacity in the immediate future.  However, based on current forecasts andexpectations for the remainder of fiscal 2004, management believes that theCompany may continue to face periods of low cash availability and that it maybe reasonably possible that the Company may be unable to meet its workingcapital requirements without increases in its borrowing capacity under thecurrent credit facilities or additional sources of debt or equityfinancing.  The Company furtherestimates that if such additional borrowing capacity or capital is required,the Company would seek a minimum of $3.0 million to $5.0 million to meetworking capital requirements through at least the end of fiscal 2004.  Additional capital may be required in fiscal2005.  While as a result of itsevaluation of the current financial markets the Company believes that suchadditional financing will be readily available, there can be no assurance thatthe Company will be able to increase its available capital or obtain adequatealternative financing, and if alternative financing were obtained, that thecost of such financing would not have a material adverse effect on its resultsof operations and financial condition.

 

At November 1, 2003 andthrough the first quarter of fiscal 2004, the Company was out of compliancewith certain financial covenants under its Multicurrency Credit Agreement,including a minimum earnings before interest, taxes, depreciation andamortization (EBITDA) covenant.  OnFebruary 20, 2004, the Company and its lending agents executed a fourthamendment to the agreement.  Theamendment allowed certain one-time addbacks to EBITDA for the fiscal periodended November 1, 2003 and reset the EBITDA and certain other covenants goingforward.  The amendment also required aseparate EBITDA covenant calculation for the Company’s domestic operations on astand-alone basis.  In addition, theamendment reset the reserves which affect the Company’s borrowing capacity,redefined eligible trade accounts receivable for purposes of calculating the USand UK borrowing base, increased the applicable margins on outstandingirrevocable letters of credit by 1.0% and reduced maximum capital expendituresallowed for fiscal 2004 by $1.0 million. The amendment also increased borrowingavailability in the UK by approximately $2.3 million.

 

Under the terms of theamended credit agreement, reserves against the US borrowing availability werereset from a reserve of $2.0 million prior to the amendment to a graduatingreserve of $0 as of the amendment date to $2.5 million at October 15, 2004 andthereafter.  The amount the Company isentitled to borrow under its amended US revolving credit facility is calculatedeach day and is dependent on the trade accounts receivable generated fromoperations which are affected by financial, business, economic and otherfactors, as well as by the daily timing of cash collections and cash outflows.

 

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The Company is incompliance with all of its covenants under the credit agreement as of April 17,2004.  In the event the Company is outof compliance with one or more covenants in the future, there can be noassurance that its lenders would grant a waiver or amendment with respect tothose covenants, which could have a significant adverse effect on the Company’sfinancial condition and operations.

 

The Company works tobalance its worldwide cash needs through dividends from and loans to itsinternational subsidiaries.  These loansand dividends are limited by the immediate future cash availability and needsof each respective subsidiary, restrictions imposed by the Company’s seniorsecured debt facilities and, in some cases, statutory regulations of thesubsidiary.  The US operations cannot directlydraw on the excess borrowing availability of the UK or Australian operations;however, the Company may request dividends from the UK.  During the first 24 weeks of fiscal 2004,the UK utilized cash from operations and excess borrowing capacity to paydividends to the US totaling $2.7 million. The US can also request payments on its intercompany loan to Australia,although currently any significant remittances from Australia are restrictedunder the terms of the Australia credit facility.

 

Cash used for capitalexpenditures, which are primarily for management information systemsinitiatives, other software, computers and peripherals, and office furnitureand equipment, totaled $0.8 million for the 24 weeks ended April 17, 2004 ascompared to $1.4 million for the same period in fiscal 2003.  The Company continues to invest inenhancements and upgrades to its computer-based technologies; however, capitalexpenditures are limited under the terms of its amended senior secured debtfacilities and cannot exceed $2.5 million for fiscal 2004.

 

In December 2002, the Companyentered into a sale-leaseback transaction whereby the Company sold and leasedback the land and buildings housing its administrative offices.  The result of the sale was a net pre-taxgain of approximately $5.0 million that the Company deferred and isamortizing as an offset to rent expense over the seven-year lease term.  A portion of the net proceeds from the saleof $6.9 million was used to repay the outstanding principal and interest undera term loan of $4.5 million. Additionally, the Company paid the outstanding principal and accruedinterest of $1.0 million on a promissory note payable to the Company’sPresident and Chief Executive Officer.

 

On February 12, 2004 the Company completed the sale ofits remaining unoccupied corporate headquarters’ building for cash proceeds of$1.9 million.  The proceeds were used topay down outstanding borrowings under the Company’s revolving creditfacilities.

 

The Company has an unsecuredsubordinated promissory note payable to its principal stockholder and Chairmanof the Board of Directors in the amount of $2.0 million with a maturitydate of August 18, 2007, and an interest rate equal to an indexed rate ascalculated under the Company’s credit facilities plus seven percent, compoundedmonthly and payable 60 calendar days after the end of each of the Company’sfiscal quarters.  The interest rate ineffect on April 17, 2004 was 11.0%. Payment of interest is contingent on the Company meeting minimumavailability requirements under its credit facilities.  Additionally, payments of principal orinterest are prohibited in the event of any default under the creditfacilities.

 

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On September 25, 2003 theCompany executed a one-year unsecured subordinated draw down note with itsprincipal stockholder and Chairman of the Board of Directors.  The note provides for the Chairman to makeadvances to the Company upon request, at his sole discretion and with noobligation to do so, in an aggregate principal amount not to exceed $1.0million outstanding at any one time. Principal and interest on advances are due and payable on the earlier oftwenty-two business days from the date of the advance or the final maturity dateof the draw down note (September 25, 2004), subject to certain restrictionsregarding borrowing capacity and compliance with certain covenants in theCompany’s senior secured credit facilities. The interest rate on outstanding advances is equal to an indexed rate ascalculated under the Company’s credit facilities plus seven percent, compoundedmonthly.  On December 23, 2003 theChairman made a $1.0 million advance to the Company under the terms of thenote.

 

The Company is responsible forand pays workers’ compensation costs for its temporary and regular employeesand is self-insured for the deductible amount related to workers’ compensationclaims ($500,000 per claim for fiscal year 2003 and increasing to $750,000 perclaim for fiscal 2004.)  Each policyyear the terms of the agreement with the insurance carrier arerenegotiated.  The Company iscontractually required to collateralize its recorded obligations through theuse of irrevocable letters of credit, surety bonds or cash.  At April 17, 2004 the Company had $14.3million of outstanding letters of credit and $5.8 million in surety bonds tosecure workers compensation obligations for policy years 1992 through2003.  Effective May 24, 2004, theCompany’s insurance carriers reduced the required outstanding letters of creditby $2.0 million and agreed to a $2.0 million reduction in the surety bonds tobe effective in July 2004.  The Companyis cash collateralizing its fiscal 2004 policy year through payments totaling$13.8 million, with additional payments of $4.1 million for insurance premiumsand expenses.  As of May 31, 2004 theCompany has made payments of $11.7 million. Five additional monthly payments of $1.2 million are due through the endof fiscal 2004.   The Company will alsomake ongoing cash payments for claims for all open policy years except 2003,which is fully funded, although subject to annual retroactive premiumadjustments based on actual claims activity

 

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

 

The Company is exposed to certain market risks from transactionsthat are entered into during the normal course of business.  The Company’s primary market risk exposurerelates to interest rate risk.  At April17, 2004, the Company’s outstanding debt under variable-rate interestborrowings was approximately $22.3 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 balancesheet.  The Company currently has noplans to hold an investment portfolio that includes derivative financialinstruments.

 

For the 24 weeks ended April17, 2004, the Company’s international operations comprised 22.5% of its revenueand, as of the end of that period, 21.5% 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

 

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Kingdom subsidiaries to borrowin local currencies, partially mitigates the exchange rate risk resulting fromfluctuations in foreign currency denominated net investments in thesesubsidiaries in relation to the U.S. dollar. The Company does not currently hold any market risk sensitiveinstruments entered into for hedging transaction risks related to foreigncurrencies.  In addition, the Companyhas not entered into any transactions with derivative financial instruments fortrading purposes.

 

**Item4.  Controls and Procedures**

 

The Company carried out anevaluation, under the supervision and with the participation of the Company’smanagement, including the Chief Executive Officer and Chief Financial Officer,of the effectiveness of the Company’s “disclosure controls and procedures”(which are defined under SEC rules as controls and other procedures of acompany that are designed to ensure that information required to be disclosedby a company in the reports it files under the Securities Exchange Act of 1934is recorded, processed, summarized and reported within required timeperiods).  Based on this evaluation, theChief Executive Officer and Chief Financial Officer concluded that, as of April17, 2004 (the end of the period covered by this report) the Company’sdisclosure controls and procedures are effective.  There was no change in the Company’s internal control overfinancial reporting that occurred during the fiscal period ended April 17,2004, that has materially affected, or is reasonably likely to materiallyaffect, the Company’s internal controls over financial reporting.

 

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**Part II. Other Information**

 

**Item 1. Legal Proceedings**

 

As previously reported inthe Company’s Annual Report on Form 10-K for the fiscal year ended November 1,2003, and the Company’s Quarterly Report on Form 10-Q for the quarter endedJanuary 24, 2004, Synergy Staffing, Inc. (“claimant”) filed a complaint againstthe Company on March 9, 2000, alleging, among other things, that they werefraudulently induced to sell the assets of The Personnel Connection, Inc.  During the Company’s fiscal year 2002, anarbitration panel awarded the claimant $1.4 million for compensatory damages,attorneys’ fees and other related costs. During the fourth quarter of fiscal 2001, the Company recorded anaccrued liability and related pretax charge of $3.6 million for the estimatedcost of the arbitration award, attorney’s fees and related expenses.  OnFebruary 11, 2002, the arbitration panel issued an Order Modifying InterimAward, crediting the Company for $800,000 previously paid under a priceprotection clause in the asset purchase agreement and thereby reducing theprincipal amount of the award to $1.4 million. As a result of the interim award, the Company determined that $693,000of the initial estimated liabilities were no longer required, and recorded thereduction in its fourth fiscal quarter of 2002.

 

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

 

Except asdisclosed above, the Company is not currently a party to any materiallitigation. However, from time to time the Company has been threatened with, ornamed as a defendant in, lawsuits, including countersuits brought by formerfranchise agents or licensees, and administrative claims and lawsuits broughtby employees or former employees.

 

**Item 2.**** Changes inSecurities, Use of Proceeds and Issuer Purchases of Equity Securities**

 

None.

 

**Item3.  Defaults Upon Senior Securities**

 

Notapplicable.

 

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

 

Notapplicable.

 

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**Item 5. Other Information**

 

Notapplicable.

 

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

 

(a)            Exhibits

 

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

 

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

 

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

 

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

 

(b)            Reports on Form 8-K

 

Current Reporton Form 8-K (Items 5 and 7) dated February 2, 2004 filed with the Securitiesand Exchange Commission on February 2, 4004.

 

Current Reporton Form 8-K (Items 5 and 7) dated February 20, 2004 filed with the Securitiesand Exchange Commission on February 23, 4004.

 

Current Reporton Form 8-K (Items 5 and 7) dated February 24, 2004 filed with the Securitiesand Exchange Commission on February 25, 4004.

 

Current Reporton Form 8-K (Items 5 and 7) dated March 1, 2004 filed with the Securities andExchange Commission on March 2, 4004.

 

Current Reporton Form 8-K (Items 5 and 7) dated March 5, 2004 filed with the Securities andExchange Commission on March 8, 4004.

 

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**SIGNATURES**

 

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

 

 
|         | WESTAFF, INC.                                     |
|--------------|---------------------------------------------------|
|         |                                              |
|         |                                              |
|         |                                              |
| June 1, 2004 |                                              |   | /s/ Dirk A. Sodestrom |   |
| Date         |                                              |   | Dirk A. Sodestrom |
|         | Senior Vice President and Chief Financial Officer |
|              |                                                   |  |  |  |  |  |

 

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